-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QH0v4w6SCeXgF1HJABa6ZsQj1XZUSHRpXixc6u0IW5MfL5rOFyNzm9fLdh75TCYD 3UXNa8OngNS12TUC8kjBiA== 0000950148-99-000649.txt : 19990402 0000950148-99-000649.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950148-99-000649 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DECKERS OUTDOOR CORP CENTRAL INDEX KEY: 0000910521 STANDARD INDUSTRIAL CLASSIFICATION: RUBBER & PLASTICS FOOTWEAR [3021] IRS NUMBER: 953015862 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22446 FILM NUMBER: 99581263 BUSINESS ADDRESS: STREET 1: 495-A S FAIRVIEW AVE CITY: GOLETA STATE: CA ZIP: 93117 BUSINESS PHONE: 8059677611 MAIL ADDRESS: STREET 1: 495-A S FAIRVIEW AVE CITY: GOLETA STATE: CA ZIP: 93117 FORMER COMPANY: FORMER CONFORMED NAME: DECKERS FOOTWEAR CORP DATE OF NAME CHANGE: 19930811 10-K 1 FORM 10-K 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------ FORM 10-K ------------------------------ (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, 1998 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, CALIFORNIA 93117 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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 REGISTERED NONE 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 26, 1999 based on the closing price of the Common Stock on the NASDAQ National Market System on such date was $12,366,053. The number of shares of the registrant's Common Stock outstanding at February 26, 1999 was 8,522,679. Portions of registrant's definitive proxy statement relating to registrant's 1999 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, 1998, are incorporated by reference in Part III of this Form 10-K. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 DECKERS OUTDOOR CORPORATION FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 INDEX TO ANNUAL REPORT ON FORM 10-K
CAPTION PAGE ------- ---- 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..................................... 19 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 20 Item 7A. Quantitative and Qualitative Disclosures about Market Risk........................................................ 27 Item 8. Financial Statements and Supplementary Data................. 27 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................... 27 PART III Item 10. Directors and Executive Officers of the Registrant.......... 49 Item 11. Executive Compensation...................................... 49 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................................. 49 Item 13. Security Relationships and Related Transactions............. 49 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................................................... 49
i 3 PART I ITEM 1. BUSINESS GENERAL The Company designs 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 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. Teva is a registered trademark of Mark Thatcher, the inventor and licensor of Teva Sport Sandals. Simple, Ugg and Picante are registered trademarks of the Company and its subsidiaries. All of the Company's footwear and apparel possess the common features of high quality with a primary focus on functionality and comfort. In 1998, the Company sold approximately 3,941,000 pairs of footwear. Revenues from sales (domestic and international) of Teva products have been $67,916,000, $61,863,000 and $43,898,000 during 1998, 1997 and 1996, representing 66.5%, 58.0% and 43.1% of net sales, respectively. For financial information regarding the Company's industry segments, see note 12 to the accompanying consolidated financial statements. 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 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 the Company to more accurately predict its manufacturing and sourcing needs. By placing futures 1 4 orders, retailers are also able to reduce the risk that the Company will be unable to meet the retailer's delivery requirements. Retailers are generally encouraged to purchase goods on a futures basis by receiving discounts or special payment terms not otherwise available. RISK FACTORS This Annual Report on Form 10-K contains a variety of forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including forward-looking statements in this "Risk Factors" section, the "Outlook" section, the last paragraph under "Liquidity and Capital Resources", the discussion under "Seasonality" and other statements in this Annual Report. These forward-looking statements relate to sales and operating expense expectations, the potential imposition of certain customs duties, the potential impact of the Teva license expiration, the potential impact of certain litigation, the potential impact of the Year 2000 issue on the Company and the impact of seasonality on the Company's operations. These forward-looking statements 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. 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 LICENSE AGREEMENTS The Company manufactures and sells its Teva sport sandals and clothing line pursuant to two exclusive licensing agreements with Mark Thatcher, the inventor of the Teva sport sandal and owner of the Teva 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 (which levels 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 footwear and apparel accounted for approximately 66.5%, 58.0% and 43.1% of the Company's net sales for fiscal years 1998, 1997 and 1996, respectively. The termination of the licenses would have a material adverse effect on the Company's results of operations. As announced in November 1998, Mr. Thatcher has engaged a financial advisor to explore various strategic options for the Teva brand. The Company is in continuing negotiations with Mr. Thatcher, pursuing various options including a renewal of the existing license. The Company is hopeful that it will be able to successfully negotiate a favorable arrangement with Mr. Thatcher. However, there can be no assurances that such arrangements can be secured. In the event that the Company does not come to a favorable arrangement with Mr. Thatcher, the Company will not be able to sell Teva products beyond August 31, 2001, which would result in a material adverse impact on the Company's results of operations, financial condition and cash flows. BRANDS STRENGTH; CHANGES IN FASHION TRENDS The Company's success is largely dependent on the continued strength of the Teva, Simple and Ugg 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 2 5 models and styles of footwear and apparel. Achieving market acceptance for new products will also likely 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. INVENTORY RISK The footwear industry has relatively long lead times for design and production of product and, thus, the Company must 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. QUALITY AND PERFORMANCE 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. 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, Costa Rica, Australia and New Zealand, with the vast majority of production occurring in China. 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. 3 6 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. The Company may also experience general risks associated with managing operations effectively and efficiently from a far distance and understanding and complying with local laws, regulations and customs. There can be no assurance that such factors will not materially adversely affect the Company's business, financial conditions and result of operations. Products 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 certain popular Teva styles 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 Dutch Customs to resolve the situation. In the event that Dutch 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 of approximately $500,000. In addition, if Dutch 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. As a precautionary measure, the Company has obtained alternative sourcing for the majority of the potentially impacted products from sources outside of China in an effort to reduce the potential risk in the future. See "Risks of Foreign Operations/Restrictions on Imports." 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 products, Mark Thatcher, Mr. Thatcher initially may bring proceedings to halt infringement of the Teva 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 Chairman of the Board, Chief Executive Officer and President, and a core group of key executive officers and employees. 4 7 Mr. Otto has an employment agreement with the Company through 2001. 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 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. 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 Company's Simple or Ugg trademark rights or the ability to use the licensed Teva trademarks 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. 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 was 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, 1998, Douglas B. Otto and all executive officers and directors of the Company, as a group, owned approximately 43.7% and 49.5%, 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, would likely be able to control the affairs and policies of the Company and would likely 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"), in the Company's Certificate of Incorporation and Bylaws, and in the Company's shareholder rights plan would likely 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. 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. 5 8 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, Simple and Ugg lines which are offered in the Company's 1999 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 name, the Company has expanded this brand into the casual footwear market, with increased offerings of leather and other casual footwear in recent years. The 1999 Teva line includes many new upper constructions and outsole designs. Additions to the Teva line for 1999 include a Bluewater Series of technical deck sandals designed specifically for boating enthusiasts, several styles of closed amphibious footwear for use in and out of the water and a range of styles of closed leather casual footwear for women, among many others. In addition, in 1997, the Company further leveraged the Teva brand, introducing a line of casual apparel under the Teva brand name. As part of the Company's strategy for the Simple brand, the 1999 product line has an increased focus on leather casuals and sandals, in addition to a variety of sneakers and clogs. In 1999, the Company expects its Ugg product line to be expanded beyond its heritage boots and slippers by adding a variety of new, more streetwise products including clogs, driving moccasins and apres ski boots, as well as more weather-resistant boots with water resistant leathers. Exercise Selective Distribution. The Company has exercised a policy of selective distribution of its product offerings. The Company has implemented this strategy by generally limiting its distribution 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 distribution network includes outdoor retailers, athletic footwear stores, specialty retailers and upscale department stores. The Company may review or modify its distribution for Teva in the event it is not able to obtain a favorable arrangement with respect to Teva beyond the expiration of the existing Teva licenses. 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 international markets. For the years ended December 31, 1998, 1997 and 1996 international net sales totaled $24,194,000, $26,704,000 and $24,061,000, representing 23.7%, 25.0% and 23.6% 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 sports sandals in certain countries in Europe, including France, Germany and the United Kingdom, as well as in Asia and the Caribbean. As a precautionary measure in response to the European Commission's 1997 enactment of anti-dumping duty provisions on certain types of footwear produced in China, the Company has obtained alternative sourcing for the majority of the potentially impacted products from suppliers outside of China in an effort to reduce the risk of anti-dumping duties in the future. See "Risks of Foreign Operations/Restrictions on Imports". PRODUCTS The Company currently offers four principal product lines: (1) Teva sports sandals and apparel; (2) Simple casual footwear; (3) Ugg sheepskin footwear; and (4) Picante 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 footwear and 6 9 apparel lines and the Simple footwear line are generally previewed twice per year, once in the summer for deliveries that commence in the fall and once in the winter for the following back to school and fall season. The Ugg line of sheepskin footwear is generally previewed in the winter with most deliveries occurring in the following fall and winter. The Picante 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 Sports Sandals and Apparel. The Teva sport sandal is one of the first sport sandals to be developed and is popular among outdoor enthusiasts and the general public. The Company licenses the Teva patents and trademark from Mark Thatcher, a professional river guide who invented the Teva sport sandal. The terms of such licenses run through August 31, 2001. Certain styles of the Teva sport 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 leather, is fully adjustable, and holds the foot firmly to the sandal's durable, cellular rubber, molded EVA, polyurethane or leather footbed. Teva sports sandals are extremely durable and many of the styles are water resistant. The Spring 1999 line includes 58 different models designed for a variety of uses. The Wilderness Series, a category of sandals built for high performance and rugged outdoor use, includes 14 models of men's and women's sandals. The Utility Series includes 21 styles, combining elements of sport performance with casual everyday comfort. This series includes a variety of sandals, slides and thongs, as well as the newly introduced XPDition collection of sandals with new patterned uppers of performance air-mesh, water-resistant suede, nylon webbing and Dri-Tec linings. The Circuit, a woman's walking sandal, was designed to deliver performance, stability and comfort for moderate and brisk fitness walking. The Circuit, which was introduced in the fall of 1998, is offered in both a nylon and a leather version. Continuing on the success of recent years, the Spring 1999 line includes 17 styles of men's and women's leather casuals, including an updated version of the City Sport collection of women's casual sandals. The Spring 1999 Children's category has been expanded to include six different styles of nylon and leather sandals. The domestic manufacturer's suggested retail prices for adult sizes of Teva footwear products range from $19.95 to $79.95. Teva Apparel and Accessories is a natural extension of the Company's sport sandal business. The Spring 1999 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 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 sports sandals, Teva 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 $12.00 to $96.00. Simple Casual Footwear. The Simple line consists of casual shoes that combine the comfort and function of athletic footwear construction with the simple, understated styling of "back-to-basics," casual lifestyle footwear. The Simple line is designed to appeal to men and women between the ages of 20-35 and others who are looking for comfortable, fashionable, basic shoes. The Fall 1999 line includes an emphasis on men's and women's leather casuals, as well as a variety of sneakers, clogs and sandals. For Fall 1999, Simple is offering 39 models. The variety of styles offered in the Fall 1999 line reflects the Company's strategy to focus the Simple brand toward men's and women's leather casuals, while reducing the number of styles offered in the highly competitive sneaker market. In addition, the Simple Fall 1999 line no longer offers styles specifically for the children's market due to the high competition and low margins previously experienced in this area. The domestic manufacturer's suggested retail prices for adult sizes for the Fall 1999 line range from $40.00 to $90.00. Ugg Sheepskin Footwear. Ugg is a line of authentic sheepskin footwear, popularized in Australia in the 1960's and 1970's. These sheepskin boots, slippers and other footwear styles have high-grade fleece linings which act as a natural insulator, keeping feet warm and comfortable. The 1999 Ugg line offers a range of 28 models of casual, fashionable and streetwise styles of sheepskin footwear in various colors, including several new styles of shoes and boots for men and women. The 1999 line includes several styles with new innovative fashionable uppers and several styles with water resistant leather treatments to address more inclement 7 10 weather conditions. The 1999 line also includes a new "Street Collection" with products designed for more fashionable and functional everyday use in both warm and cold climates. This collection includes a variety of boots, clogs and driving moccasins. The domestic manufacturer's suggested retail prices for adult sizes for the Ugg line range from $65.00 to $250.00. Picante Casual Apparel. Picante 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 and Simple lines. Picante 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 $120.00. MARKETING AND DISTRIBUTION The Company's products are distributed throughout North America by a network of approximately 51 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 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 include 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 17.5% of the Company's net sales for the year ended December 31, 1998, compared to 16.3% for the year ended December 31, 1997. No single customer accounted for more than 10% of the Company's net sales for the years ended December 31, 1998 or 1997. In order to encourage accounts to place orders early in the season, the Company has implemented a preseason discount program under which 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, as in 1997, the Company offered a spring 1999 early delivery program that provided retailers an incentive to order Teva product for delivery in the fourth quarter of 1998. This early delivery program allows the Company to reduce the impact of peak inventory warehouse utilization during the Spring and provides retailers the opportunity to have earlier sell through, lengthening the retail selling season and increasing the potential for inventory turns at retail. 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 Canada and the Netherlands. ADVERTISING AND PROMOTION The Company attempts to maximize the impact of its advertising, public relations 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 in addition to highly visible editorial coverage in both consumer and trade publications. Retail presence and "point of purchase" materials along with production packaging provide additional visible brand support. The 8 11 Company's in-house marketing department works closely with certain accounts in many 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 offerings, including the leather casual models, the Company has increased its Teva advertising focus in more mainstream print publications, including Men's Health, Details, Shape, Elle, Self, and Walking Magazine, among others. The national print advertising campaign which has been the focus of the Company's Simple marketing approach in recent years has been replaced with a less costly grass roots marketing approach. This new approach includes public relations and product placement campaigns in addition to regional advertising efforts. In-house marketing personnel work closely with a public relations firm and a product placement agency to gain brand visibility in popular magazines, television shows and feature films. Recent public relations efforts include coverage in Footwear News, People Magazine, YM Magazine and Footwear Plus. Simple product has also appeared on popular television programs including Friends, Will and Grace, Dharma and Greg, and Dawson's Creek. These public relations efforts have also resulted in Simple products appearing in feature films including: The League, starring Al Pacino, Cameron Diaz and James Woods; The Story of Us, starring Bruce Willis, Michelle Pfeiffer and Paul Reiser; Sundowning, starring Kirk Douglas and Dan Aykroyd; and Kimberly, starring Robert Mailhouse and Gabrielle Anwar. In 1999, the Company plans to continue to build on the success of its Ugg 1998 national print advertising campaign. Targeting luxury consumers living or vacationing in cold weather climates, the Company expects to advertise Ugg products in upscale publications such as In Style, Elle, Self, Martha Stewart Living, Fashions of the NY Times and Vanity Fair. In addition, the Company also continues to support Ugg's core surf audience with ads in Surfing and Longboard magazines. Regional advertising in local newspapers rounds out the Company's Ugg print advertising program. In addition to this national print advertising campaign, the Ugg brand is being supported by public relations and product placement efforts. In-house marketing personnel work closely with a public relations firm and a product placement agency to gain brand visibility in popular magazines, television shows and feature films. Recent public relations efforts include editorial coverage in magazines such as In Style, Footwear News, Footwear Plus, Paper, Martha Stewart Living, Jane, YM Magazine, and Us. Television coverage of Ugg product includes shows such as Dharma and Greg, Suddenly Susan, X Files, Mad About You, Dawson's Creek, 3rd Rock from the Sun, Friends, Will and Grace, Ally McBeal, 7th Heaven and Party of Five. These public relations efforts have also resulted in Ugg product appearances in the following feature films: Seven Girlfriends, starring Jamie Gertz and Mimi Rogers; Two Goldsteins, starring Elliot Gould and Alicia Witt; Hanging Up, starring Meg Ryan, Lisa Kudrow and Diane Keaton; Panic, starring William H. Macy and Neve Campbell; Snow Day, starring Chevy Chase; and More Dogs Than Bones, starring Whoopi Goldberg and Mercedes Ruehl. 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 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 was the official supplier to the United States Canoe and Kayak Team. Additionally, Ugg 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 Ben and Jerry's Folk Festival in Rhode Island, the Gauley River Festival in West Virginia, the National Cherry Festival in Michigan, the Mammoth Mountain Bike Race in California and musical festivals such as the Teva Spirit of Unity Tour, Reggae on the River and the Telluride Bluegrass Festival in Colorado, among many others. These representatives promote the Teva products through exhibits, demonstrations, sponsorships and product give-aways. In 1998, 1997 and 1996, the Company incurred $5,847,000, $4,096,000 and $4,738,000 respectively, for advertising, marketing and promotional expenses. The Company is required under its Teva license agreements 9 12 to spend a minimum amount for advertising and promoting the Teva 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 was in effect prior to September 1995. However, the Company has historically spent more on advertising than is contractually required. The Company may review or modify its approach to advertising spending and may reduce future spending to approximate the contractually required amounts in the event it is not able to obtain a favorable arrangement with respect to Teva beyond the expiration of the existing Teva licenses. The Company works closely with Mr. Thatcher, the Teva licensor, in managing its advertising program for the Teva 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 $2,393,000, $1,780,000 and $1,546,000 in 1998, 1997 and 1996, respectively. With respect to Teva, 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. For example, certain styles within the "Guide series" of high-performance Teva sandals employ quick release buckles rather than "hook and loop" fasteners in response to such feedback. In addition, for improved traction and durability, the Company recently incorporated Spider Rubber(TM) into the high performance Wilderness Series. While Teva 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 recently introduced several new styles of leather casual footwear for men and women and has expanded its offering under its collection of children's sandals. The Company has also expanded the leather casuals offering under the Simple line for 1999. 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 product was in need of updates and became subject to low cost imitations. Since then, the Company has taken steps to update the Ugg 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 with new lug outsoles to improve traction. In addition, the 1999 Ugg line includes a new "Street Collection" with products designed for more fashionable and functional everyday use in both warm and cold climates. New styles include clogs, driving moccasins and apres ski type boots with water-resistant leathers. More fashionable and unique upper styles help to differentiate Ugg from the low cost imitation brands. 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. In recent years, the Company has directed significant efforts and resources toward its design and product development functions. The Company has been able to increase and strengthen its design and development staff in the process. This staff works closely 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 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. 10 13 PRODUCT SOURCING The Company currently sources the majority of its Teva footwear from the Far East, and to a lesser extent from Costa Rica. In addition, the Company imports nearly all of its finished Simple footwear from independent contract manufacturers in the Far East and imports the majority of its finished Ugg footwear from independent contract manufacturers in Australia, New Zealand and the Far East. The majority of Picante casual apparel is manufactured in Guatemala at a wholly owned subsidiary of Heirlooms, Inc., a 50% owned subsidiary of the Company. Historically, the Company had manufactured a significant portion of its Teva products in its company-owned manufacturing facilities in California and Mexico. However, in efforts to improve its manufacturing cost structure, the Company closed its California factory in Spring 1997 and closed its Mexican factory in Fall 1998. The related production has since been reallocated to independent subcontractors in the Far East and Costa Rica. As a result of the closure of these facilities, the Company is no longer involved in the direct manufacture of footwear, but rather sources completed footwear entirely from independent subcontractors. As the Company continues to grow, it expects to continue to rely heavily on its independent subcontractors for its sourcing needs. With the closure of the last remaining company-owned manufacturing facility in 1998, the Company now sources completed footwear from a variety of independent contract manufacturers. The manufacturing of footwear is performed in accordance with detailed specifications provided by the Company and is subject to quality control standards. In efforts to ensure the production of high quality products, many of the materials and components used in production are purchased from independent suppliers designated by the Company. The Company believes that its completed footwear as well as the various raw materials and components used in the manufacture of the footwear, including rubber, leather, nylon webbing and sheepskin, are generally available from multiple sources at competitive prices. 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 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 $2,282,000 was outstanding at December 31, 1998 ($782,000 net of allowance). Under the terms of the arrangement, 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. 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 are repaid, and to 24% when the Company's investment in Holbrook and the original loan are repaid in full. As a result of the closure of the last remaining company-owned manufacturing facility, the Company no longer has a need to purchase the footwear components previously supplied by Prosperous Dragon. Accordingly, the Company ceased purchasing products from Prosperous Dragon during the third quarter of 1998. The owner of Prosperous Dragon is pursuing a possible sale of Prosperous Dragon or its underlying assets in order to generate the cash to repay the remaining outstanding net receivable balance owed to the Company. There are no assurances that this will occur. The Company generally does not have any remaining long-term agreements with the manufacturers or suppliers of its products, but does business based on individual purchase orders. QUALITY CONTROL The Company has instituted inspections and other procedures to satisfy the high quality demanded by users of the Company's products. The Company's quality assurance program includes inspection procedures at 11 14 the factory level as well as a final inspection upon arrival at the Company's distribution center. The Company uses on-site inspectors at its independent suppliers who oversee the production process and perform quality assurance inspections. In addition, the products undergo further inspection procedures prior to being accepted by the Company's distribution center. LICENSES Teva License. The Company manufactures its Teva footwear line pursuant to two exclusive license agreements with Mark Thatcher, the inventor of the Teva sport sandal and the owner of the Teva patents and trademark. Mr. Thatcher owns two United States patents on strap designs used in Teva sport sandals and has a United States trademark registration for the Teva mark. The first of these agreements authorizes the Company to make, use and sell products using the Teva 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 may 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 name. In 1996, the Company exercised its right of first refusal with respect to the licensing of apparel under the Teva name and began selling Teva apparel as the exclusive licensee in 1997. In 1992, the Company and Mr. Thatcher entered into the second exclusive license agreement allowing the Company to manufacture and sell Teva products in eight countries in Europe in which Mr. Thatcher had registered the Teva trademark, including France, Germany and the United Kingdom. As Mr. Thatcher obtains registrations of the Teva 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 sport 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 specifically related only to Teva sport sandals acquired during the term of the agreement. As a result of the Company's selling a specified minimum of Teva 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 trademark in those countries. Mr. Thatcher has subsequently obtained the Teva 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. The Company has the exclusive rights to manufacture and distribute the Teva 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 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 was in effect prior to September 1995. The Teva 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 12 15 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 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 (which levels 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 sport 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 only to Teva sport sandals acquired during the term of the agreement. Such agreement also provides that the Company may not manufacture or sell sandals during the term of the license that are "competitive" with Teva sport 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 sport 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 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 those for the other Teva 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 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 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." On May 23, 1996, the Company exercised its right of first refusal with respect to the licensing of apparel under the Teva name and began selling Teva apparel in 1997. Under the license agreement, the Company has the exclusive rights to manufacture and sell Teva apparel in the United States, Canada, Mexico, Japan and other countries in the world where Licensor has registered Teva as a trademark and the Company has received Licensor's written approval. The term of the Teva apparel license is through December 31, 1997, with one year options to renew through December 31, 1999 provided that the Company meets minimum annual sales requirements. The Company is required to pay royalties ranging from 4% to 5% of sales of Teva apparel, depending on specified sales levels, and is required to spend 5% of net sales on advertising. The agreement provides for minimum annual sales requirements of $2,500,000 and $4,000,000 in 1997 and 1998, respectively, which the Company has not met. Although the licensor has not taken any action as a result of the Company's non-compliance with the minimum sales requirements, the Company cannot provide any assurance that it will continue to sell Teva apparel products in the future. As announced in November 1998, Mr. Thatcher has engaged a financial advisor to explore various strategic options for the Teva brand. The Company is in continuing negotiations with Mr. Thatcher, pursuing various options including a renewal of the existing license or the purchase of the underlying Teva rights. The Company is hopeful that it will be able to successfully negotiate a favorable arrangement with Mr. Thatcher. However, there can be no assurances that such arrangements can be secured. In the event that the Company does not come to a favorable arrangement with Mr. Thatcher, the Company will not be able to sell Teva 13 16 products beyond August 31, 2001, which would result in a material adverse impact on the Company's results of operations, financial condition and cash flows. SIMPLE SHOES AGREEMENT The Company was a party to an agreement with Eric Meyer, the founder of Simple Shoes, Inc. under which Mr. Meyer provided 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 also received 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. Upon the expiration of the agreement on December 31, 1998, the Company agreed with Mr. Meyer to license a Simple trademark which incorporates Mr. Meyer's name from Mr. Meyer for $25,000 through December 31, 1999. HEIRLOOMS, INC. AGREEMENT The Company and Bob Eason, the designer and founder of Picante 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 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, as amended, Mr. Eason has granted the Company the option to acquire all or part of his interest in Heirlooms, exercisable through June 30, 1999. The purchase price for such shares is $2,000,000. Mr. Eason may elect to retain a 20% interest in Heirlooms, in which case the purchase price would be reduced proportionately. Mr. Eason is 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 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 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 20 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 License." The Company also owns the Simple and Ugg 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 mark in the United States and Benelux (Belgium, Netherlands and Luxembourg) and the mark for Rancho Picante 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 14 17 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 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 line are Nike, Adidas, Timberland, Clarks and Salomon. The principal competitors for the Simple line include Rockport, Clarks, Hush Puppy, Birkenstock, Ecco, Dr. Martens, Naot, Vans and Airwalk. The Ugg line's most significant competitors include Acorn, Aussie Dogs and Minnetonka, 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 line of footwear competes primarily on the basis of its authenticity and consumer brand recognition as one of the first sandals of its kind, as well as its high performance nature and its diversity of styles offered. In addition, several of the most popular styles employ a distinctive patented strapping system, which contributes to performance and the brand's consumer recognition. The Company competes through its Simple line by offering a diversity of styles designed for a variety of recreational and leisure activities. Ugg 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), the cost of transportation, restrictions on the transfer of funds, labor unrest and strikes, and in certain parts of the world, political instability. 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 6.8% of the entered value of footwear components of various materials. "Entered value" means the value taken into account for purposes of determining the amount of any customs duties or any other duties which may be imposed on the importation of any property. In general, the entered value is normally based on the price paid or payable by the Company to the seller of the imported merchandise. 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. 15 18 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 (the "NTE Report") identifying significant restrictions or barriers on United States access to foreign markets. In January 1999, 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 noted on April 30, 1998, "that China now has a functioning system to protect intellectual property rights." 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. In June 1998, President Clinton extended non-discriminating "normal trade relations" ("NTR," formerly "most favored nation") trading status with China through June 1999 and Congress supported this decision. While NTR status has been extended for another year, this topic has traditionally been the subject of vigorous debate and the Company is unable to predict if the United States will revoke China's NTR status at some point in the future. If a revocation of NTR status were to occur, it would result in significantly higher duties on imports from China. On April 30, 1998, the USTR announced that 31 countries had been placed on the "special 301" watch list and 15 countries on the priority watch list because of intellectual property protection concerns. Watch list countries include: Australia, Canada, Denmark, Costa Rica, Hong Kong 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. 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 certain popular Teva styles 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 Dutch Customs to resolve the situation. In the event that Dutch 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 of up to approximately $500,000. In addition, if Dutch 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, 1998, the Company employed approximately 161 full-time employees in its U.S. facilities, 13 at its European subsidiary and 30 at its Hong Kong subsidiaries, none of whom is represented by a union. The Company believes its relationship with its employees is good. 16 19 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. In addition, through a second-tier subsidiary, the Company leased an approximately 18,000 square foot manufacturing facility in Mexico. However, in connection with the closure of the Mexican production facility in 1998, the Company terminated the underlying lease. The Company also leases approximately 10,000 square feet of office and warehouse space in the Netherlands for its European sales and distribution efforts and approximately 2,000 square feet of office space in Macau for its Far East staff. The Company paid approximately $1,122,000 in rent for all of its facilities in 1998. The terms of the leases for the Company's corporate offices and its Ventura County warehouse expire in 2001. The lease for the Company's European facilities expires in July 1999 and the lease for the Company's Macau office space expires in August 2000. 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 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 Yetti by Molly, Ltd. (collectively, "Molly") which alleged, among other things, that the Company violated a non-disclosure agreement and obtained purported trade secrets regarding a line of winter footwear which Deckers stopped producing in 1994. The matter resulted in a jury verdict which was announced in open court March 17, 1999. The various parts of the verdict aggregated $1,785,000 for the two separate plaintiffs. Molly claimed specified damages of $18 million, as well as other unspecified damages. The Company is appealing the verdict and continues to believe such claims are without merit. The Company intends to continue contesting this claim vigorously. In October 1998, the Company was served in an action brought by a Plaintiff claiming, among other things, breach of contract and misrepresentation related to the Company's sale of its interest in Trukke Winter Sports Products, Inc. ("Trukke") to the founder of Trukke, rather than to the Plaintiff. The Plaintiff contended, among other things, that a letter of intent between the Company and the Plaintiff was a binding agreement. The Plaintiff was indebted to the Company for approximately $270,000 for goods previously purchased by the Plaintiff from the Company in the ordinary course of business. This action was to be heard in the federal district court in Pocatello, Idaho. Effective February 1999, all parties settled the matter and the action is expected to be dismissed with prejudice. As full settlement, the terms provided that the Company extend the due dates of the $270,000 of previous indebtedness, requiring periodic payments through 2002. The Company is also 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 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. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 17 20 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, 1999, the number of holders of record of the Common Stock was 146, and the number of beneficial owners was approximately 2,300.
1998 1997 -------------- -------------- HIGH LOW HIGH LOW ----- ----- ----- ----- First Quarter............................................. $8.50 $7.13 $7.88 $6.25 Second Quarter............................................ 7.94 6.63 8.50 6.00 Third Quarter............................................. 7.50 4.56 8.44 6.88 Fourth Quarter............................................ 5.25 1.25 10.00 7.00
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." 18 21 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, 1998.
YEARS ENDED DECEMBER 31 --------------------------------------------------- INCOME STATEMENT DATA 1998 1997 1996 1995 1994 --------------------- -------- -------- -------- -------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net sales................................ $102,172 $106,713 $101,838 $102,334 $85,818 Cost of sales............................ 65,592 62,453 61,009 65,856 43,979 -------- -------- -------- -------- ------- Gross profit........................... 36,580 44,260 40,829 36,478 41,839 Selling, general and administrative expenses............................... 39,378 35,648 32,989 32,373 24,287 Loss on factory closure.................. -- 500 -- -- -- -------- -------- -------- -------- ------- Earnings (loss) from operations........ (2,798) 8,112 7,840 4,105 17,552 Other (income) expense................... 1,320 143 1,241 1,382 (563) -------- -------- -------- -------- ------- Earnings (loss) before income taxes.... (4,118) 7,969 6,599 2,723 18,115 Income taxes (benefit)................... (1,211) 3,445 2,943 1,287 7,609 -------- -------- -------- -------- ------- Net earnings (loss).................... $ (2,907) $ 4,524 $ 3,656 $ 1,436 $10,506 ======== ======== ======== ======== ======= Net earnings (loss) per common share: Basic.................................. $ (.34) $ .50 $ .40 $ .13 $ 1.09 Diluted................................ (.34) .50 .39 .13 1.09 -------- -------- -------- -------- ------- Weighted average common shares outstanding: Basic.................................. 8,632 8,961 9,248 9,324 9,630 Diluted................................ 8,632 9,012 9,292 9,352 9,673 ======== ======== ======== ======== =======
AT DECEMBER 31 --------------------------------------------------- BALANCE SHEET DATA 1998 1997 1996 1995 1994 ------------------ -------- -------- -------- -------- ------- (IN THOUSANDS) Current assets........................... $ 59,309 $ 48,801 $ 49,348 $ 50,031 $53,987 Current liabilities...................... 17,174 9,579 9,618 6,262 5,731 Total assets............................. 84,373 74,693 74,897 74,917 62,651 Long-term debt, less current installments........................... 15,199 7,983 10,290 15,170 -- Total stockholders' equity............... 52,000 57,131 54,989 53,485 56,920 ======== ======== ======== ======== =======
19 22 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 operations and sets forth, for the periods indicated, certain operating data as a percentage of net sales.
YEARS ENDED DECEMBER 31 ----------------------- 1998 1997 1996 ----- ----- ----- Net sales................................................... 100.0% 100.0% 100.0% Cost of sales............................................... 64.2 58.5 59.9 ----- ----- ----- Gross profit.............................................. 35.8 41.5 40.1 Selling, general and administrative expenses................ 38.5 33.4 32.4 Loss on factory closure..................................... 0.0 0.5 0.0 ----- ----- ----- Earnings (loss) from operations........................... (2.7) 7.6 7.7 Other expense............................................... 1.3 0.2 1.2 ----- ----- ----- Earnings (loss) before income taxes....................... (4.0) 7.4 6.5 Income taxes (benefit)...................................... (1.2) 3.2 2.9 ----- ----- ----- Net earnings (loss)......................................... (2.8)% 4.2% 3.6% ===== ===== =====
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 Net sales decreased by $4,541,000, or 4.3%, between the years ended December 31, 1998 and 1997. Sales of the Teva line increased to $67,916,000 for the year ended December 31, 1998 from $61,863,000 for the year ended December 31, 1997, a 9.8% increase. The increase in Teva sales was partially due to an increase in sales under the Company's early delivery program in 1998, compared to that in 1997. Under this program, retailers are encouraged to take early delivery of spring product in the fourth quarter in an effort to expand the length of the selling season. In addition, the Company introduced several successful new styles and experienced a general increase in demand for the Teva products. Sales of Teva products represented 66.5% and 58.0% of net sales for the years ended December 31, 1998 and 1997, respectively. Net sales of footwear under the Simple product line decreased 31.0% to $19,939,000 from $28,901,000 between the years ended December 31, 1998 and 1997. Simple sales represented 19.5% of sales in 1998 and 27.1% of sales in 1997. The decrease in Simple sales occurred due to a decline in demand for Simple products caused by a variety of factors, including competition, an abundance of similar products at retail, and a general decrease in the popularity of the products. Sales of Ugg footwear increased 16.8% to $10,710,000 in 1998 from $9,169,000 in 1997, representing 10.5% of sales for the year ended December 31, 1998 and 8.6% for the year ended December 31, 1997. The increase in Ugg sales was due to a general increase in demand for the products, caused in part by an improved print advertising and public relations campaign in 1998. In addition, the Company's overall sales declined as the Company exited two businesses since 1997. The Company sold it's interest in the Trukke line of winter sport boots effective December 31, 1997 and ceased its business of supplying footwear components for independent factories in the Far East during the third quarter of 1998. In the aggregate, the reduced sales contribution from these two businesses was $2,928,000. Overall, international sales for all of the Company's products decreased 9.4% to $24,194,000 from $26,704,000, representing 23.7% of net sales in 1998 and 25.0% in 1997. This decrease in international sales was caused in part by the reduction in sales of footwear components in the Far East, when the Company exited that business in 1998. The volume of footwear sold worldwide increased 2.0% to 3,941,000 pairs during the year ended December 31, 1998 from 3,865,000 pairs during the year ended December 31, 1997, for the reasons discussed above. The weighted average wholesale price per pair sold during the year ended December 31, 1998 decreased by 4.4% to $24.84 from $25.97 for the year ended December 31, 1997. The decrease occurred as a result of an increase in the proportion of footwear sold at closeout prices in 1998 compared to 1997, primarily related to the Simple line. 20 23 Cost of sales increased by $3,139,000, or 5.0%, to $65,592,000 for the year ended December 31, 1998, compared with $62,453,000 for the year ended December 31, 1997. Gross profit decreased by $7,680,000, or 17.4%, to $36,580,000 for the year ended December 31, 1998 from $44,260,000 for the year ended December 31, 1997 and decreased as a percentage of net sales to 35.8% from 41.5%. The decrease in gross margin during the period was due to several factors. As a result of the Simple sales decline, the Company experienced inventory write-downs on excess Simple inventory, as well as an increase in the volume of Simple closeouts. In addition, the Company experienced write-downs of Teva raw materials inventory, partially as a result of the Company's closure of its Mexican manufacturing facility, the last remaining Company owned manufacturing facility. The Company also experienced increased airfreight costs in 1998 compared to 1997. Lastly, the Company announced a product recall on the Teva nylon infant sandals during 1998. The Company recorded a loss of approximately $460,000 related to this recall, of which approximately $360,000 was included as a reduction of gross profit and approximately $100,000 was included in selling, general and administrative expenses. Selling, general and administrative expenses increased by $3,730,000, or 10.5%, for the year ended December 31, 1998, compared with the year ended December 31, 1997, and increased as a percentage of net sales to 38.5% in 1998 from 33.4% in 1997. In its continuing efforts to improve sales growth, the Company increased its advertising and marketing and increased its research and development to improve design as well as to improve the transition from design to production. Accordingly, the Company incurred approximately $1,880,000 more in advertising, marketing and promotion costs, including $130,000 of in-house costs, and approximately $613,000 more in research and development costs in 1998 than in 1997. The Company also experienced an increase in warehouse costs of approximately $730,000, an increase in Teva apparel operating costs of approximately $340,000, an increase in costs associated with its management information systems of approximately $460,000, an increase in sales sample expenses of approximately $220,000, increased European office expenses of approximately $140,000, product recall costs of approximately $100,000, and severance costs of approximately $200,000 in conjunction with the closure of the Mexican manufacturing facility in 1998. Net interest expense was $1,171,000 for the year ended December 31, 1998 compared with net interest expense of $344,000 for the year ended December 31, 1997, primarily due to increased borrowings on the Company's credit facility in 1998 compared to 1997. For the year ended December 31, 1998, the Company experienced an income tax benefit of $1,211,000, as a result of the Company's loss for the period, reflecting the Company's ability to recover income taxes previously paid. This represents an effective income tax rate of 29.4%. For the year ended December 31, 1997, the Company had income tax expense of $3,445,000, representing an effective income tax rate of 43.2%. The change in the effective income tax rate is due to certain non-deductible expenses, primarily goodwill amortization, which were a greater proportion of earnings (loss) before income taxes in 1998 than in 1997. In addition, for California state income tax purposes, net operating losses cannot be carried back to offset income taxes previously paid in prior years and, therefore, the income tax benefit is reduced accordingly. The Company had a net loss of $2,907,000 for the year ended December 31, 1998 as compared with net earnings of $4,524,000 for the year ended December 31, 1997 due to the reasons discussed above. 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 line increased to $61,863,000 for the year ended December 31, 1997 from $43,898,000 for the year ended December 31, 1996, a 40.9% increase. Sales of Teva products represented 58.0% and 43.1% of net sales for the years ended December 31, 1997 and 1996, respectively. The increase in Teva sales was primarily due to increased demand for this line. In addition, in early 1996, sales of the Teva 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 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 product was shipped in the fourth quarter of 1997, which the Company believes ordinarily would have 21 24 shipped in the first quarter of 1998. Net sales of footwear under the Simple product line decreased 19.8% to $28,901,000 for the year ended December 31, 1997 from $36,029,000 for the year ended December 31, 1996. This decrease was primarily due to the continued repositioning of the Simple brand and its distribution, and the non-recurrence of last year's demand for certain styles of Simple clogs. Net sales of footwear under the Ugg product line decreased 38.2% to $9,169,000 for the year ended December 31, 1997 from $14,831,000 for the year ended December 31, 1996. 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% to $26,704,000 from $24,061,000, representing 25.0% of net sales in 1997 and 23.6% in 1996. Because the increase in the volume of sales of Teva footwear products more than offset the decrease in the volume of sales of Simple and Ugg footwear products, the volume of footwear sold increased 7.8% to 3,865,000 pairs for the year ended December 31, 1997 from 3,587,000 pairs for the year ended December 31, 1996. The weighted average wholesale price per pair sold during the years ended December 31, 1997 and 1996 decreased 6.7% to $25.97 from $27.85. The decrease was primarily due to a change in the sales mix resulting from the reduction in sales of Ugg 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 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 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 and Ugg 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 close-outs during this period. Selling, general and administrative expenses increased by $2,659,000, or 8.1% for the year ended December 31, 1997, compared with the year ended December 31, 1996, and increased as a percentage of net sales to 33.4% in 1997 from 32.4% in 1996. The increase was largely a result of increased royalties payable to the licensor of the Teva patents and trademarks due to a change in the sales mix toward Teva 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 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 license fees for the five year period beginning September 1996, as well as increased goodwill amortization associated with the 1997 Ugg 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 to $143,000 in 1997 from $1,241,000 in 1996. 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, the Company had a net gain on disposal of assets of $51,000 in 1997, compared with a loss on disposal of assets aggregating $548,000 in 1996. 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, 22 25 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. OUTLOOK This "Outlook" section, the "Risk Factors" section, the last paragraph under "Liquidity and Capital Resources," the discussion under "Seasonality" and other statements in this Annual Report contain a number of forward-looking statements including forward-looking statements relating to sales and operating expense expectations, the potential imposition of certain customs duties, the potential impact of the Teva license expiration, the potential impact of certain litigation, the potential impact of the Year 2000 on the Company and the impact of seasonality on the Company's operations. All of the forward-looking statements are based on current expectations. Actual results may differ materially for a variety of reasons, including the reasons discussed below and under "Risk Factors." Sales and Operating Expense Expectations. The Company's sales under the Teva and Ugg product lines increased in 1998 compared to 1997. The Company expects sales for both of these lines to increase in 1999. The Company experienced a 31.0% decrease in Simple sales in 1998 compared to 1997. The Company expects sales under the Simple line to be lower in 1999 than in 1998. The Company's selling, general and administrative expenses increased to 38.5% of sales in 1998, for a variety of reasons. The Company expects that these costs will decrease as a percentage of sales in 1999. The foregoing forward-looking statements represent the Company's current analysis of trends and information. Actual results could vary as a result of numerous 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 and the necessity of selling products at significantly reduced selling prices, all 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. The Company's sales can be adversely impacted by the ability of the Company's suppliers to manufacture and deliver products in time for the Company 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 sales occurring in the first and second quarter of each year, the highest percentage of Simple sales occurring in the third quarter and the highest percentage of Ugg sales occurring in the fourth quarter. Consequently, the results for these product lines are highly dependent on results during these specified periods. In addition, the Company's results of operations, financial condition and cash flows are subject to risks and uncertainties with respect to the following: overall economic and market conditions; competition; demographic changes; the loss of significant customers or suppliers; the performance and reliability of the Company's products; customer service; the Company's ability to secure and maintain intellectual property rights; the Company's ability to secure and maintain adequate financing; the Company's ability to forecast and subsequently achieve those forecasts; its ability to attract and retain key employees; and the general risks associated with doing international business including foreign exchange risks, duties, quotas and political instability. Sales of the Company's products, particularly those under the Teva and Ugg lines, are very sensitive to weather conditions. Extended periods of unusually cold weather during the spring and summer could adversely impact demand for the Company's Teva line. Likewise, unseasonably warm weather during the fall and winter months could adversely impact demand for the Company's Ugg product line. 23 26 Year 2000 Issue. The Year 2000 issue results from computer hardware or software programs written using two digits to identify the year. These computer programs and hardware were designed and developed without consideration of the impact of the upcoming change in the century. As a result, such systems may not be able to properly distinguish between years that begin with a "20" and years that begin with a "19". If not corrected, such hardware and software programs could create erroneous information by or at the year 2000, causing the Company, or its customers or suppliers, to become unable to process normal business transactions accurately or at all. State of Readiness. The Company's Year 2000 compliance strategy includes several overlapping phases, which the Company has defined as follows: Identification -- This phase involves the identification of the hardware and software systems used by the Company which could be adversely impacted by the Year 2000 issue. It includes identification of information technology ("IT") systems and non-IT systems (including telecommunications systems and systems associated with facilities -- such as utilities and security, among others), as well as identification of the impact that Year 2000 issues may have on the Company's key third party relationships (including customers, suppliers and financing sources, among others). Analysis -- This phase involves the determination of the likelihood, impact and magnitude of potential Year 2000 non-compliance for each of the items in the areas previously identified in the Identification phase. Conversion -- This phase involves the development and execution of a plan to bring the previously identified items into Year 2000 compliance. Testing -- This phase involves the testing of the various systems to ascertain that the conversion procedures were successful at bringing the systems into compliance. Implementation -- This phase involves putting the various Year 2000 compliant systems into use in the Company's operations. The Company is continuing to assess the readiness of its various systems for handling the Year 2000 issue. The Company determined that the version of the software that operated the Company's enterprise business systems prior to 1999 was not Year 2000 compliant. These enterprise business systems include the Company's systems for order entry and processing, allocations, inventory, accounts receivable, accounts payable and financial reporting. In late 1998, the Company received the current version of the underlying software, which the software vendor has stated is Year 2000 compliant. The Company has completed the Conversion phase of its Year 2000 strategy with respect to its enterprise business systems, and is currently in the Testing phase. The Company currently anticipates that it will complete the Testing and Implementation phases for its enterprise business systems by June 30, 1999. With respect to the Company's remaining IT systems, including desktops, networks and several departmental hardware and software systems, and its non-IT systems, the Company has recently completed the Analysis phase and has begun the Conversion phase. The Company currently expects completion of the Conversion phase for the majority of the remaining IT and non-IT systems by June 30, 1999 and currently anticipates completion of the Testing and Implementation phases by September 30, 1999. The Company's plan for addressing the readiness of its key external business partners includes requesting information from these partners regarding their own readiness to address their Year 2000 issues, and an assessment of the potential impact that any non-compliance might have on the Company's operations. The Company has requested compliance information from key business partners and has begun to receive responses. The Company may add additional business partners to its Year 2000 program as the Company's Year 2000 readiness plan progresses. The various phases for this segment are expected to continue throughout 1999. Estimated Costs. The Company currently estimates that total costs related to all phases of the Year 2000 strategy with respect to its enterprise business systems will aggregate $350,000. This estimate is for outside goods and service providers only. The estimate does not include the time and costs associated with its in-house employees, the amount of which is not currently determinable In addition, the estimated costs to 24 27 bring the remaining IT and non-IT systems into compliance and to address and remedy any non-compliance issues at its key business partners are not yet determinable, but will likely exceed $200,000. These costs are expected to be funded through operating cash flows and the Company's bank facility. The Company does not currently anticipate using any independent verification or validation processes. The Company anticipates that the Year 2000 compliance efforts will ultimately result in the deferral of other IT projects. However, the deferral of such projects is not expected to have a material adverse impact on the Company's results of operations, financial condition or cash flows. The estimated Year 2000 compliance costs are based on the Company's current assessment of its Year 2000 situation and could change significantly as the Year 2000 compliance strategy progresses. As of December 31, 1998, the Company had incurred Year 2000 compliance costs of approximately $100,000. Risks and Contingency Plan. Although the Company is not aware of any material operational issues 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 a material adverse effect on future results of operations, financial condition and cash flows. The potential inability of the Company's business partners to address their own Year 2000 issues sufficiently and timely remains a risk which is difficult to assess. Among other things, the Company is currently highly dependent on the combination of approximately 12 key suppliers, primarily located in the Far East, for the production of its footwear products. The failure of one or more of these suppliers to adequately address their own Year 2000 issues could cause them to be unable to manufacture or deliver product to the Company on a timely basis, materially adversely impacting the Company's results of operations, financial condition and cash flows. In addition, the inability of one or more of the Company's significant customers to become compliant could adversely impact the customers' operations, thus impacting the Company's sales and subsequent collections with respect to those customers. The Company's Year 2000 compliance efforts are subject to many additional risks including the following, among others: the Company's failure to adequately identify and analyze issues, convert to compliant systems, fully test converted systems, and implement compliant systems; unanticipated issues or delays in any of the phases of the Company's strategy; the inability of customers, suppliers and other business partners to become compliant; and the breakdown of local and global infrastructures resulting from the non-compliance of utilities, banking systems, transportation, government and communications systems. As the Company has not yet completed various phases of its internal readiness and has not yet determined the readiness of its key business partners, the Company cannot yet fully and accurately identify and quantify the most reasonably likely worst case Year 2000 scenario at this time. However, the Company is currently assessing scenarios and will take steps to mitigate the impact of these scenarios if they were to occur. This contingency planning has been completed for certain areas while the contingency plans for most areas are still in process. the Company expects to more fully address such contingencies by the end of the second quarter of 1999. The Company's above assessment of the risks associated with Year 2000 issues is forward-looking. Actual results may vary for a variety of reasons including those described above. LIQUIDITY AND CAPITAL RESOURCES The Company's liquidity consists primarily of cash, trade accounts receivable, inventories and a revolving credit facility. At December 31, 1998, working capital was $42,135,000 including $263,000 of cash. Cash used in operating activities aggregated $10,156,000 for the year ended December 31, 1998. Trade accounts receivable increased 18.0% since December 31, 1997 as a result of the increase in sales in the fourth quarter of 1998 compared to 1997, an increase in the amount of receivables with extended payment terms at year-end, and the impact of a general decline in the average collection periods. Inventories increased 24.7% since December 31, 1998 primarily as the Company requested its suppliers to deliver its Spring 1999 Teva inventory earlier than it had done in the prior year. This acceleration of inventory deliveries was intended to increase 25 28 available inventory to improve the Company's ability to fulfill its customers' orders on a timely basis and to improve the Company's ability to address its Spring Teva fill-in business. At December 31, 1998, the Company had outstanding borrowings of $20,380,000 under its existing credit facility and had outstanding letters of credit aggregating $4,419,000. On January 21, 1999, the Company replaced the existing credit facility with a new revolving credit facility (the "Facility") with a new lender. The new Facility provides a maximum availability of $50,000,000, subject to a borrowing base of up to 85% of eligible accounts receivables, as defined, and 65% of eligible inventory, as defined. Up to $15,000,000 of borrowings may be in the form of letters of credit. The Facility bears interest at the lender's prime rate (7.75% at December 31, 1998), or at the Company's election at an adjusted Eurodollar rate plus 2%. The Facility is secured by substantially all assets of the Company. The agreement underlying the Facility includes a tangible net worth covenant, requiring the Company to maintain tangible net worth, as defined, of $30,000,000. At December 31, 1998, the actual tangible net worth, as defined, was approximately $31,300,000. The Facility expires July 1, 2001. However, in the event that the Teva license agreements are extended beyond August 31, 2001 on terms acceptable to the lender, the Facility will be extended through the earlier of 60 days preceding the expiration of any new license arrangement or January 21, 2002. Under the terms of the Facility, if the Company terminates the arrangement prior to the expiration date of the Facility, the Company may be required to pay the lender an early termination fee ranging between 1% and 3% of the Facility's commitment amount, depending upon when such termination occurs. The Company has an agreement with a supplier, Prosperous Dragon, to provide financing for the supplier's operations, of which $2,282,000 was outstanding at December 31, 1998 ($782,000 net of allowance). The note is secured by all assets of the supplier and bears interest at the prime rate (7.75% at December 31, 1998) plus 1%. See "Business -- Manufacturing." Capital expenditures totaled $1,916,000 for the year ended December 31, 1998. The Company's capital expenditures related primarily to a new warehouse management system at the Company's Ventura County, California distribution center, molds purchased for production, upgrades to corporate computer systems and a new booth for European tradeshows. The Company currently has no material future commitments for capital expenditures. In December 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 1,200,000 shares to 2,200,000 shares. Such repurchases are authorized to be made from time to time in open market or in privately negotiated transactions, subject to price and market conditions as well as the Company's cash availability. Under this program, the Company repurchased 300,000 shares in 1996 for cash consideration of $2,390,000, 330,000 shares in 1997 for cash consideration of $2,581,000 and 343,000 shares in 1998 for cash consideration of $2,528,000. At December 31, 1998, 1,227,000 shares remained available for repurchase under the program. The Company is endeavoring to come to an agreement with the Teva licensor which would provide the Company with the ability to continue to sell the Teva products beyond the expiration of the current license terms. Among the possible arrangements, the Company may pursue the purchase of the underlying Teva rights, a renewal of the existing licenses or a variety of other possibilities. Certain of these possible arrangements may require a significant amount of additional financing. There are no assurances that the additional financing will be available or that a favorable arrangement with the licensor can be achieved. The Company believes that internally generated funds, the available borrowings under its existing credit facility, and the cash on hand will provide sufficient liquidity to enable it to meet its current and foreseeable working capital requirements. However, risks and uncertainties which could impact the Company's ability to maintain its cash position include the Company's growth rate, its ability to collect its receivables in a timely manner, the Company's ability to effectively manage its inventory, and the volume of letters of credit used to purchase product, among others. See also the discussion regarding forward-looking statements in the preceding "Outlook" section. 26 29 SEASONALITY Financial results for the outdoor and footwear industries are generally seasonal. Sales of each of the Company's different product lines have historically been higher in different seasons, with the highest percentage of Teva sales occurring in the first and second quarter of each year, the highest percentage of Simple sales occurring in the third quarter and the highest percentage of Ugg sales occurring in the fourth quarter. Based on the Company's historical experience, the Company would expect greater sales in the first and second quarters than in the third and fourth quarters. The actual results could differ materially depending upon consumer preferences, availability of product, competition, and the Company's customers continuing to carry and promote it's various product lines, among other risks and uncertainties. See also the discussion regarding forward-looking statements under "Outlook". 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 In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (FAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." FAS No. 133 modifies the accounting for derivative and hedging activities and is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Since the Company does not presently invest in derivatives or engage in hedging activities, the Company expects that the adoption of SFAS No. 133 will not impact the Company's financial position or results of operations. In March 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." The Company will adopt SOP 98-1 effective in 1999. The adoption of SOP 98-1 will require the Company to modify its method of accounting for software. Based on information currently available, the Company does not expect the adoption of SOP 98-1 to have a significant impact on its financial position or results of operations. In April 1998, the AICPA Accounting Standards Executive Committee issued Statement of Position 98-5 (SOP 98-5), "Reporting on the Costs of Start-Up Activities." SOP 98-5 requires that costs of start-up activities, including organization costs and retail store openings, be expensed as incurred. SOP 98-5 is effective for financial statements for fiscal years beginning after December 15, 1998. Earlier application is encouraged. Restatement of previously issued financial statements is not permitted. In the fiscal year in which the SOP is first adopted, the application should be reported as a cumulative effect of a change in accounting principle. The Company has not yet determined whether the application of SOP 98-5 will have a material impact upon the Company's financial position or results of operations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Item 14(a) and page 28 for an index to the consolidated financial statements and supplementary information included herein. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 27 30 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
PAGE -------- Independent Auditors' Report................................ 29 Consolidated Balance Sheets as of December 31, 1998 and 1997...................................................... 30 Consolidated Statements of Operations for each of the years in the three-year period ended December 31, 1998.......... 31 Consolidated Statements of Stockholders' Equity for each of the years in the three-year period ended December 31, 1998...................................................... 32 Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 1998.......... 33 Notes to Consolidated Financial Statements.................. 34 Consolidated Financial Statement Schedule: Valuation and Qualifying Accounts......................... 48
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. 28 31 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, 1998 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, 1998 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 LLP Los Angeles, California February 24, 1999, except for the fourth paragraph of note 11, which is as of March 17, 1999. 29 32 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1997 ASSETS
1998 1997 ----------- ----------- Current assets: Cash and cash equivalents................................. $ 263,000 $ 3,238,000 Trade accounts receivable, less allowance for doubtful accounts of $1,204,000 and $1,092,000 as of December 31, 1998 and 1997, respectively........................ 27,180,000 23,037,000 Inventories (note 4)...................................... 23,665,000 18,979,000 Prepaid expenses and other current assets................. 2,178,000 2,190,000 Refundable income taxes (note 8).......................... 4,267,000 -- Deferred tax assets (note 8).............................. 1,756,000 1,357,000 ----------- ----------- Total current assets.............................. 59,309,000 48,801,000 Property and equipment, at cost, net (note 5)............... 2,994,000 2,509,000 Intangible assets, less applicable amortization............. 20,702,000 21,866,000 Note receivable from supplier, net (note 7)................. 782,000 966,000 Other assets, net........................................... 586,000 551,000 ----------- ----------- $84,373,000 $74,693,000 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable (note 2).................................... $ -- $ 2,000,000 Current installments of long-term debt (note 6)........... 6,236,000 107,000 Trade accounts payable.................................... 7,947,000 3,629,000 Accrued bonuses........................................... 66,000 1,095,000 Other accrued expenses.................................... 2,925,000 2,726,000 Income taxes payable (note 8)............................. -- 22,000 ----------- ----------- Total current liabilities......................... 17,174,000 9,579,000 ----------- ----------- Long-term debt, less current installments (note 6).......... 15,199,000 7,983,000 Commitments and contingencies (notes 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 9,495,631 and outstanding 8,522,679 at December 31, 1998; issued 9,419,431 and outstanding 8,789,431 at December 31, 1997......................... 85,000 88,000 Additional paid-in capital.................................. 22,813,000 25,034,000 Retained earnings........................................... 29,726,000 32,633,000 ----------- ----------- 52,624,000 57,755,000 Less note receivable from stockholder/officer............... 624,000 624,000 ----------- ----------- Total stockholders' equity........................ 52,000,000 57,131,000 ----------- ----------- $84,373,000 $74,693,000 =========== ===========
See accompanying notes to consolidated financial statements. 30 33 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS THREE-YEAR PERIOD ENDED DECEMBER 31, 1998
1998 1997 1996 ------------ ------------ ------------ Net sales (notes 10 and 12)...................... $102,172,000 $106,713,000 $101,838,000 Cost of sales.................................... 65,592,000 62,453,000 61,009,000 ------------ ------------ ------------ Gross profit.............................. 36,580,000 44,260,000 40,829,000 Selling, general and administrative expenses..... 39,378,000 35,648,000 32,989,000 Loss on factory closure (note 3)................. -- 500,000 -- ------------ ------------ ------------ Earnings (loss) from operations........... (2,798,000) 8,112,000 7,840,000 Other expense (income): Interest expense, net.......................... 1,171,000 344,000 910,000 (Gain) loss on disposal of assets.............. 13,000 (51,000) 548,000 Minority interest in net loss of unconsolidated subsidiary.................................. -- (45,000) (55,000) Miscellaneous expense (income)................. 136,000 (105,000) (162,000) ------------ ------------ ------------ Earnings (loss) before income taxes....... (4,118,000) 7,969,000 6,599,000 Income taxes (benefit) (note 8).................. (1,211,000) 3,445,000 2,943,000 ------------ ------------ ------------ Net earnings (loss)....................... $ (2,907,000) $ 4,524,000 $ 3,656,000 ============ ============ ============ Net earnings (loss) per share: Basic.......................................... $ (0.34) $ 0.50 $ 0.40 Diluted........................................ (0.34) 0.50 0.39 ============ ============ ============ Weighted average shares: Basic.......................................... 8,632,000 8,961,000 9,248,000 Diluted........................................ 8,632,000 9,012,000 9,292,000 ============ ============ ============
See accompanying notes to consolidated financial statements. 31 34 DECKER OUTDOOR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY THREE-YEAR PERIOD ENDED DECEMBER 31, 1998
COMMON STOCK ADDITIONAL STOCKHOLDER/ TOTAL ------------------- PAID-IN RETAINED OFFICER NOTE STOCKHOLDERS' SHARES AMOUNT CAPITAL EARNINGS RECEIVABLE EQUITY --------- ------- ----------- ----------- ------------ ------------- 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 Common stock repurchased............. (342,952) (3,000) (2,525,000) -- -- (2,528,000) Common stock issuance under stock incentive plan.................... 57,572 -- 213,000 -- -- 213,000 Common stock issued under the employee stock purchase plan........... 18,628 -- 91,000 -- -- 91,000 Net loss.................. -- -- -- (2,907,000) -- (2,907,000) --------- ------- ----------- ----------- --------- ----------- Balance at December 31, 1998.................... 8,522,679 $85,000 $22,813,000 $29,726,000 $(624,000) $52,000,000 ========= ======= =========== =========== ========= ===========
See accompanying notes to consolidated financial statements. 32 35 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS THREE-YEAR PERIOD ENDED DECEMBER 31, 1998
1998 1997 1996 ------------ ----------- ----------- Cash flows from operating activities: Net earnings (loss)................................... $ (2,907,000) $ 4,524,000 $ 3,656,000 ------------ ----------- ----------- Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities: Depreciation of property and equipment.............. 1,276,000 1,235,000 1,338,000 Amortization of intangible assets................... 1,362,000 1,271,000 965,000 Provision for doubtful accounts..................... 589,000 966,000 2,587,000 (Gain) loss on disposal of assets................... 13,000 (51,000) 548,000 Loss on factory closure............................. -- 500,000 -- Stock compensation.................................. 166,000 84,000 86,000 Minority interest in net loss of unconsolidated subsidiary....................................... -- (45,000) (55,000) Changes in assets and liabilities (net of effects of acquisitions and dispositions): (Increase) decrease in: Trade accounts receivable........................ (4,732,000) (5,575,000) 263,000 Inventories...................................... (4,686,000) 5,951,000 (5,374,000) Prepaid expenses and other current assets........ 12,000 1,448,000 (1,101,000) Deferred tax assets.............................. (399,000) 265,000 403,000 Refundable income taxes.......................... (4,267,000) -- 2,969,000 Note receivable from supplier.................... 184,000 372,000 1,000 Other assets..................................... (233,000) (159,000) (877,000) Increase (decrease) in: Trade accounts payable........................... 4,318,000 (1,870,000) 2,474,000 Accrued expenses................................. (830,000) 948,000 55,000 Income taxes payable............................. (22,000) (963,000) 983,000 ------------ ----------- ----------- Total adjustments.............................. (7,249,000) 4,377,000 5,265,000 ------------ ----------- ----------- Net cash provided by (used in) operating activities................................... (10,156,000) 8,901,000 8,921,000 ------------ ----------- ----------- Cash flows from investing activities: Proceeds from sale of property and equipment.......... 142,000 -- -- Purchase of property and equipment.................... (1,916,000) (1,731,000) (1,407,000) Cash paid for acquisitions, net of cash received...... (2,000,000) (954,000) (495,000) ------------ ----------- ----------- Net cash used in investing activities.......... (3,774,000) (2,685,000) (1,902,000) ------------ ----------- ----------- Cash flows from financing activities: Proceeds from (repayments of) notes payable and long-term debt...................................... 13,345,000 (1,799,000) (4,891,000) Cash received from issuances of common stock.......... 138,000 739,000 152,000 Cash paid for repurchases of common stock............. (2,528,000) (2,581,000) (2,390,000) 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................................... 10,955,000 (4,265,000) (8,954,000) ------------ ----------- ----------- Net increase (decrease) in cash and cash equivalents.................................. (2,975,000) 1,951,000 (1,935,000) Cash and cash equivalents at beginning of year.......... 3,238,000 1,287,000 3,222,000 ------------ ----------- ----------- Cash and cash equivalents at end of year................ $ 263,000 $ 3,238,000 $ 1,287,000 ============ =========== =========== Supplemental disclosure of cash flow information: Cash paid during the year for: Interest............................................ $ 1,092,000 $ 524,000 $ 874,000 Income taxes........................................ $ 3,800,000 $ 3,437,000 $ 480,000 ============ =========== ===========
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. 33 36 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998 AND 1997 (1) THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) 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. (b) Inventories Inventories are stated at the lower of cost (first-in, first-out) or market (net realizable value). (c) Revenue Recognition Revenue is recognized upon shipment of the merchandise. Allowances for estimated returns and discounts are provided when related revenue is recorded. (d) 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 non-discounted 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, 1998 and 1997. (e) 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, 1998 and 1997 was $4,042,000 and $2,676,000, respectively. (f) Fair Value of Financial Instruments The fair values of the Company's cash, trade accounts receivable, prepaid expenses, refundable income taxes 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. 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. 34 37 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 (g) Stock Compensation The Company accounts for stock-based compensation under the provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). Under the provisions of SFAS 123, the Company has elected to continue to measure compensation cost under APBO No. 25 and comply with the pro forma disclosure requirements. (h) 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. (i) Research and Development Costs Research and development costs are charged to expense as incurred. Such costs amounted to $2,393,000, $1,780,000, $1,546,000 in 1998, 1997 and 1996, respectively. (j) Advertising, Marketing and Promotion Costs The Company expenses the cost of advertising, marketing and promotion as incurred. These expenses charged to operations for the years ended 1998, 1997 and 1996 were $5,847,000, $4,096,000 and $4,738,000, respectively. (k) 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. (l) Earnings per Share The Company accounts for earnings per share under the provisions of SFAS No. 128, "Earnings per Share." SFAS 128 specifies the computation, presentation and disclosure requirements for earnings (loss) per share (EPS). The reconciliations of basic to diluted weighted average shares are as follows:
1998 1997 1996 ----------- ---------- ---------- Net earnings (loss) used for basic and diluted earnings (loss) per share................... $(2,907,000) $4,524,000 $3,656,000 =========== ========== ========== Weighted average shares used in basic computation................................. 8,632,000 8,961,000 9,248,000 Dilutive stock options........................ -- 51,000 44,000 ----------- ---------- ---------- Weighted average shares used for diluted computation............... 8,632,000 9,012,000 9,292,000 =========== ========== ==========
35 38 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 Options to purchase 698,000 shares of common stock at prices ranging from $5.50 to $13.75 were outstanding during 1998, but were not included in the computation of diluted loss per share because the options' exercise price was greater than the average market price of the common shares. Options to purchase 811,000 shares of common stock at a price of $1.56 per share were outstanding during 1998, but were not included in the computation of diluted loss per share because the options were anti-dilutive, as the Company incurred a net loss for the period. Options to purchase 572,000 and 430,000 shares of common stock at prices ranging from $7.50 to $15.00 and $7.00 to $15.00 were outstanding during 1997 and 1996, respectively, but were not included in the computation of diluted EPS because the options' exercise price was greater than the average market price of the common shares. (m) 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. (n) Comprehensive Income The Company adopted SFAS No. 130, "Reporting Comprehensive Income" on January 1, 1998. SFAS No. 130 establishes standards to measure all changes in equity that result from transactions and other economic events other than transactions with owners. Comprehensive income is the total of net earnings (loss) and all other non-owner changes in equity. Except for net earnings (loss) and foreign currency translation adjustments, the Company does not have any transactions and other economic events that qualify as comprehensive income as defined under SFAS No. 130. As foreign currency translation adjustments were immaterial to the Company's consolidated financial statements, net earnings (loss) approximated comprehensive income for each of the years in the three year period ended December 31, 1998. (o) Business Segment Reporting The Company adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," effective in 1998. SFAS No. 131 establishes new standards for reporting information about business segments and related disclosures about products and services, geographic areas and major customers, if applicable. Management of the Company has determined its reportable segments are strategic business units that offer geographic brand images. Significant reportable business segments are the domestic Teva, Simple and Ugg brands. Information related to these segments is summarized in Note 12. (2) ACQUISITION 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 $351,000 in 1997. During 1997, the former stockholders 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 36 39 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 Company and the former Ugg stockholders reached an agreement. In addition, the remaining Ugg stockholders 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 stockholders, thus eliminating any future due payments. As of December 31, 1997, the Company had unpaid notes payable to the former stockholders 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. (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:
1998 1997 ----------- ----------- Finished goods...................................... $22,396,000 $14,081,000 Work in process..................................... 35,000 1,189,000 Raw materials....................................... 1,234,000 3,709,000 ----------- ----------- Total inventories......................... $23,665,000 $18,979,000 =========== ===========
(5) PROPERTY AND EQUIPMENT Property and equipment is summarized as follows:
1998 1997 ---------- ---------- Machinery and equipment............................... $5,185,000 $4,328,000 Furniture and fixtures................................ 616,000 529,000 Leasehold improvements................................ 535,000 560,000 ---------- ---------- 6,336,000 5,417,000 Less accumulated depreciation and amortization........ 3,342,000 2,908,000 ---------- ---------- Net property and equipment.................. $2,994,000 $2,509,000 ========== ==========
37 40 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 (6) LONG-TERM DEBT Long-term debt consists of the following:
1998 1997 ----------- ---------- Revolving credit line, secured by all the assets of the Company........................................ $20,751,000 $7,300,000 Unsecured note payable in quarterly installments of $41,700, including interest at a rate of 7.93%, due December 2003...................................... 684,000 790,000 ----------- ---------- 21,435,000 8,090,000 Less current installments............................ 6,236,000 107,000 ----------- ---------- $15,199,000 $7,983,000 =========== ==========
The aggregate maturities of long-term debt as of December 31, 1998 are as follows: 1999............................ $ 6,236,000 2000............................ 126,000 2001............................ 14,767,000 2002............................ 147,000 2003............................ 159,000 ----------- $21,435,000 ===========
The Company's revolving credit agreement with a bank at December 31, 1998, as amended, permitted borrowings up to $40,000,000 through May 31, 1999, reducing to $25,000,000 on June 1, 1999, and expiring July 31, 1999. This revolving credit facility was for working capital and general corporate purposes. The borrowing availability was subject to a borrowing base of eligible assets, as defined. Borrowings bear interest at the bank's prime rate (7.75% at December 31, 1998) plus up to 1%, depending on whether the Company satisfied certain financial ratios. Alternatively, the Company may have elected borrowings bear interest at LIBOR plus 1.5% to 1.75%, depending on whether the Company satisfied such financial ratios. On January 21, 1999, the Company replaced its existing revolving credit agreement with a new financial institution. Under the new agreement, the Company is permitted borrowings up to $50,000,000, subject to a borrowing base up to 85% of eligible accounts receivable and 65% of eligible inventory, as defined. Up to $15,000,000 of borrowings may be in the form of letters of credit. The agreement bears interest at the lenders' prime rate (7.75% at December 31, 1998) or, at the Company's election, an adjusted Eurodollar rate plus 2%, is secured by substantially all assets of the Company and expires July 1, 2001. However, in the event that the Teva license agreements are extended beyond August 31, 2001 on terms acceptable to the lender, the agreement will be extended through the earlier of 60 days preceding the expiration of any new license arrangement or January 21, 2002. Additionally, under the terms of the agreement, should the Company terminate the arrangement prior to the expiration date, the Company may be required to pay the lender an early termination fee ranging between 1% and 3% of the commitment amount, depending upon when such termination occurs. The new agreement underlying the credit facility includes a tangible net worth covenant. At December 31, 1998, the Company was in compliance with the terms of the new 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). 38 41 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 The note is secured by all the assets of the Supplier and bears interest at prime (8.25% at December 31, 1998) 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, 1998 and 1997 was $2,282,000 and $2,466,000, respectively. Additionally, the Company has a valuation allowance related to the note of $1,500,000 at December 31, 1998 and 1997. (8) INCOME TAXES Components of income taxes (benefit) are as follows:
FEDERAL STATE TOTAL ---------- --------- ----------- 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 ========== ========= =========== 1998: Current................................. $ (866,000) $ 54,000 $ (812,000) Deferred................................ (105,000) (294,000) (399,000) ---------- --------- ----------- $ (971,000) $(240,000) $(1,211,000) ========== ========= ===========
Actual income taxes differ from that obtained by applying the statutory Federal income tax rate to earnings (loss) before income taxes (benefit) as follows:
1998 1997 1996 ----------- ---------- ---------- Computed "expected" tax expense (benefit)............................... $(1,400,000) $2,710,000 $2,244,000 State income taxes, net of Federal income tax benefit............................. (288,000) 492,000 405,000 Losses of subsidiary not deductible....... 241,000 -- -- Other..................................... 236,000 243,000 294,000 ----------- ---------- ---------- $(1,211,000) $3,445,000 $2,943,000 =========== ========== ==========
39 42 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 Deferred income tax (benefit) expense resulted from the following for the years ended December 31, 1998, 1997 and 1996:
1998 1997 1996 --------- --------- --------- Inventory obsolescence...................... $ (30,000) $ 8,000 $ 401,000 State income taxes.......................... 314,000 (134,000) (100,000) Accrued expenses............................ (215,000) (211,000) (213,000) Goodwill.................................... 18,000 18,000 18,000 Bad debt reserve............................ (343,000) (282,000) 214,000 Net operating losses........................ (193,000) -- -- Other....................................... 50,000 38,000 (9,000) --------- --------- --------- $(399,000) $(563,000) $ 311,000 ========= ========= =========
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 1998 and 1997 are presented below:
1998 1997 ---------- ---------- Deferred tax assets: Uniform capitalization adjustment to inventory...... $ 171,000 $ 144,000 Inventory obsolescence reserve...................... 9,000 -- Bad debt and other reserves......................... 1,445,000 1,547,000 Amortization........................................ 518,000 (248,000) Net operating loss carryforwards.................... 620,000 268,000 ---------- ---------- Total gross deferred tax assets............. 2,763,000 1,711,000 Less valuation allowance............................ (509,000) (268,000) ---------- ---------- Net deferred tax assets..................... 2,254,000 1,443,000 ---------- ---------- Deferred tax liabilities: Depreciation........................................ 319,000 27,000 State taxes......................................... 179,000 (275,000) Accounts receivable................................. -- 334,000 ---------- ---------- Total deferred tax liabilities.............. 498,000 86,000 ---------- ---------- Net deferred tax assets..................... $1,756,000 $1,357,000 ========== ==========
Although the Company incurred an operating loss in 1998, management believes it is more likely than not that the results of future operations will generate sufficient taxable income to realize the net deferred tax assets. Certain federal and state tax laws reduce the availability of net operating losses generated outside the group which is consolidated for tax purposes. Accordingly, management has provided a full valuation allowance against such losses. Any subsequently recognized tax benefits related to the portion of the valuation allowance of $268,000, which relates to preacquisition net operating loss carryforwards will be applied to reduce the related goodwill. Refundable income taxes as of December 31, 1998 arise primarily from the overpayment of estimated taxes. 40 43 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 (9) STOCKHOLDERS' EQUITY In February 1998, the Company amended the 1993 Stock Incentive Plan (1993 Plan). 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, 57,572, 126,000 and 24,173 shares of common stock were issued in 1998, 1997 and 1996, respectively, including 100,000 shares in 1997 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. Common stock option activity under the 1993 Plan for the years ended December 31, 1998, 1997, and 1996 is as follows:
WEIGHTED- AVERAGE SHARES EXERCISE PRICE --------- -------------- 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 Granted............................................... 925,000 2.23 Exercised............................................. (34,250) 1.40 Canceled.............................................. (99,000) 9.17 --------- Outstanding at December 31, 1998...................... 1,509,000 4.73 ========= ====== Options exercisable at December 31, 1998.............. 574,650 $ 7.11 ========= ======
The per share weighted average fair value of stock options granted during 1996, 1997 and 1998 was $3.92, $4.44 and $1.25, respectively, on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: 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. 1998 -- expected dividend yield of 0%, stock volatility of 48.5%, risk-free interest rate of 4.7%, and an expected life of seven years. 41 44 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 The Company applies APB Opinion No. 25 in accounting for its plans. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS 123, the Company's net earnings (loss) would have been changed to the pro forma amounts below:
1998 1997 1996 ----------- ---------- ---------- Pro forma net earnings (loss)............. $(3,400,000) 4,318,000 3,281,000 =========== ========== ========== Pro forma net earnings (loss) per share: Basic................................... $ (.39) $ .48 $ .35 Diluted................................. (.39) .48 .35 =========== ========== ==========
Pro forma net earnings reflect only options granted in 1998, 1997 and 1996. Therefore, the full impact of calculating compensation cost for stock options under SFAS 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 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, 18,628, 9,875 and 17,008 shares were issued in 1998, 1997 and 1996, respectively. In December 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 1,200,000 shares to 2,200,000 shares. Under this program, the Company repurchased 300,000 shares in 1996 for cash consideration of $2,390,000, 330,000 shares in 1997 for cash consideration of $2,581,000 and 343,000 shares in 1998 for cash consideration of $2,528,000. At December 31, 1998, 1,227,000 shares remained available for repurchase under the program. On October 9, 1998, the Company adopted a stockholder rights plan. The Company adopted the plan to protect stockholders against unsolicited attempts to acquire control of the Company that do not offer what the Company believes to be an adequate price to all stockholders. As part of the plan, the Board of Directors of the Company declared a dividend of one preferred share purchase right (a "Right") for each outstanding share of common stock, par value $0.01 per share (the "Common Shares"), of the Company. The dividend is payable to stockholders of record on December 1, 1998 (the "Record Date"). In addition, one Right shall be issued with each Common Share that becomes outstanding (i) between the Record Date and the earliest of the Distribution Date, the Redemption Date and the Final Expiration Date (as such terms are defined in the Rights Agreement) or (ii) following the Distribution Date and prior to the Redemption Date or Final Expiration Date, pursuant to the exercise of stock options or under any employee plan or arrangement or upon the exercise, conversion or exchange of other securities of the Company, which options or securities were outstanding prior to the Distribution Date, in each case upon the issuance of the Company's common stock in connection with any of the foregoing. Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series B Junior Participating Preferred Stock, par value $0.01 per share (the "Preferred Shares"), of the Company, at a price of $50.00, subject to adjustment. The rights have no voting power and expire on November 11, 2008. The rights may be redeemed by the Company for $.01 per right until the right becomes exercisable. 42 45 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 (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 Teva Sports Sandals, Inc. ("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. Royalty expense related to Teva sales is included in selling, general and administrative expenses in the accompanying consolidated financial statements and was $3,657,000, $3,503,000 and $2,281,000 during the years ended December 31, 1998, 1997 and 1996, respectively. Advertising expense, which is included in selling, general and administrative expenses in the accompanying consolidated financial statements, related to Teva sales was $3,261,000, $1,960,000 and $2,177,000 during the years ended December 31, 1998, 1997 and 1996, respectively. The owner of Teva Sports Sandals, Inc., has engaged a financial advisor to explore various strategic option for the Teva brand. The Company is in continuing negotiations with the owner, pursuing various options including a renewal of the existing license or the purchase of the underlying Teva rights. The Company is hopeful that it will be able to successfully negotiate a favorable arrangement with the owner. In the event that the Company does not come to a favorable arrangement with the owner, the Company will not be able to sell Teva products beyond August 31, 2001, which would result in a material adverse impact on the Company's results of operations, financial condition, and cash flows. (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: 1999............................ $959,000 2000............................ 904,000 2001............................ 830,000 ========
Total rent expense for the years ended December 31, 1998, 1997 and 1996 was approximately $1,122,000, $1,153,000 and $1,207,000, respectively. 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 Yetti by Molly, Ltd. (collectively, "Molly") which alleged, among other things, that the Company violated a certain non-disclosure agreement and obtained purported trade secrets regarding a line of winter footwear which Deckers stopped producing in 1994. Molly claimed specified damages of $18 million, as well as other unspecified damages. The matter resulted in a jury verdict which was announced in open court March 17, 1999. The various parts of the verdict aggregated $1,785,000 for the two separate plaintiffs. The Company is appealing the verdict and continues to believe such claims are without merit. The Company intends to continue contesting this claim vigorously. The Company, based on advice from legal counsel, does not anticipate that the ultimate outcome will have a material adverse effect upon its financial condition, results of operations or cash flows. 43 46 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 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 certain popular Teva styles 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 from 1997 of up to approximately $500,000. 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 may have to cease shipping such styles from China into Europe in the future or may have to begin to source these styles from countries not covered by the legislation. As a precautionary measure, the Company has obtained alternative sourcing for the potentially impacted products from sources outside of China in an effort to reduce the potential risk in the future. The Company is unable to predict the outcome of this matter and the effect, if any, on the Company's consolidated financial statements. The Company is currently involved in various other 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. (12) BUSINESS SEGMENTS, CONCENTRATION OF BUSINESS AND CREDIT RISK AND SIGNIFICANT CUSTOMERS The Company's accounting policies of the segments below are the same as those described in the summary of significant accounting policies, except that the Company does not allocate income taxes or unusual items to segments. The Company evaluates performance based on net revenues and profit or loss from operations. The Company's reportable segments are strategic business units that offer geographic brand images. They are managed separately because each business requires different marketing, sourcing and sales strategies. Business segment information is summarized as follows:
1998 1997 1996 ------------ ------------ ------------ Sales to external customers: Teva, domestic................... $ 54,775,000 $ 50,573,000 $ 34,830,000 Simple, domestic................. 13,699,000 21,554,000 30,110,000 Ugg, domestic.................... 10,710,000 9,169,000 14,831,000 Other............................ 22,988,000 25,417,000 22,067,000 ------------ ------------ ------------ $102,172,000 $106,713,000 $101,838,000 ============ ============ ============ Intersegment sales: Teva, domestic................... $ 1,171,000 $ 1,539,000 $ 2,036,000 Simple, domestic................. 150,000 315,000 -- Ugg, domestic.................... -- -- -- Other............................ 8,702,000 8,732,000 7,246,000 ------------ ------------ ------------ $ 10,023,000 $ 10,586,000 $ 9,282,000 ============ ============ ============ Earning (loss) from operations: Teva, domestic................... $ (1,473,000) $ 2,363,000 $ (1,476,000) Simple, domestic................. (1,973,000) 1,823,000 6,509,000 Ugg, domestic.................... (1,091,000) (321,000) (721,000) Other............................ 1,551,000 4,388,000 3,674,000 ------------ ------------ ------------ $ (2,986,000) $ 8,253,000 $ 7,986,000 ============ ============ ============
44 47 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997
1998 1997 1996 ------------ ------------ ------------ Depreciation and amortization: Teva, domestic................... $ 1,326,000 $ 1,057,000 $ 701,000 Simple, domestic................. 267,000 244,000 244,000 Ugg, domestic.................... 635,000 575,000 624,000 Other............................ 410,000 630,000 734,000 ------------ ------------ ------------ $ 2,638,000 $ 2,506,000 $ 2,303,000 ============ ============ ============ Net interest expense (income): Teva, domestic................... $ 229,000 $ (597,000) $ (684,000) Simple, domestic................. 51,000 154,000 511,000 Ugg, domestic.................... 938,000 803,000 1,105,000 Other............................ (47,000) (16,000) (22,000) ------------ ------------ ------------ $ 1,171,000 $ 344,000 $ 910,000 ============ ============ ============ Capital expenditures: Teva, domestic................... $ 1,382,000 $ 1,241,000 Other............................ 534,000 490,000 ------------ ------------ $ 1,916,000 $ 1,731,000 ============ ============ Total assets: Teva, domestic................... $ 67,467,000 $ 53,833,000 Simple, domestic................. 8,358,000 11,693,000 Ugg, domestic.................... 24,680,000 23,530,000 Other............................ 7,255,000 14,996,000 ------------ ------------ $107,760,000 $104,052,000 ============ ============
45 48 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 The Teva-domestic operating segment includes shared costs of the consolidated group, including domestic payroll costs, facilities costs, warehouse costs and other administrative costs. The Company has allocated costs to the Simple-domestic, Ugg-domestic and other segments based on a percentage of revenues for each of these segments. Because each segment's sales volume and the resulting allocation of shared costs continually change, the allocations to individual segments may or may not be reflective of the actual costs directly attributable to each segment. In addition, virtually all shared assets, capital expenditures and the related depreciation of these assets are generally included in the Teva-domestic segment. As a result, this segment has a disproportionately high amount of these items, while the other segments have a disproportionately low amount. Reconciliations of net sales, earnings (loss) from operations and total assets from segment information to the consolidated financial statements are as follows:
1998 1997 1996 ------------ ------------ ------------ Total sales for reportable segments...... $112,195,000 $117,299,000 $111,120,000 Elimination of intersegment revenues..... 10,023,000 10,586,000 9,282,000 ------------ ------------ ------------ Consolidated net sales................... $102,172,000 $106,713,000 $101,838,000 ============ ============ ============ Total earnings (loss) from operations for reportable segments.................... $ (2,986,000) $ 8,253,000 $ 7,986,000 Intersegment profit change in beginning and ending inventories................. 188,000 359,000 (146,000) Unallocated loss on factory closure...... -- (500,000) -- ------------ ------------ ------------ Consolidated earnings (loss) from operations............................. $ (2,798,000) $ 8,112,000 $ 7,840,000 ============ ============ ============ Total assets for reportable segments..... $107,760,000 104,052,000 Elimination of profit in ending inventories............................ (118,000) (306,000) Elimination of intersegment investments............................ (15,268,000) (16,601,000) Elimination of intersegment receivables............................ (14,024,000) (13,809,000) Unallocated refundable income taxes and deferred tax assets.................... 6,023,000 1,357,000 ------------ ------------ Consolidated total assets................ $ 84,373,000 $ 74,693,000 ============ ============
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, among other regions. Export sales to unaffiliated customers were 23.7%, 25.0% and 23.6% of net sales for the years ended December 31, 1998, 1997 and 1996, 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. For the years ended December 31, 1998, 1997 and 1996, the Company had no single customer exceeding 10% of net sales. As of December 31, 1998 and 1997, the Company had no single customer exceeding 10% of 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 non-tariff barriers, restrictions on the transfer of funds, labor unrest and strikes and, in certain parts of the world, political instability. 46 49 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998 AND 1997 (13) QUARTERLY SUMMARY OF INFORMATION (UNAUDITED) Summarized unaudited financial data are as follows:
1998 ------------------------------------------------------ MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ----------- ----------- ------------ ----------- Net sales........................... $32,177,000 $31,142,000 $13,558,000 $25,295,000 Gross profit........................ 13,537,000 12,922,000 1,307,000 8,814,000 Net earnings (loss)................. 1,753,000 1,406,000 (5,133,000) (933,000) =========== =========== =========== =========== Net earnings (loss) per share: Basic............................. $ .20 $ .16 $ (.60) $ (.11) Diluted........................... .20 .16 (.60) (.11) =========== =========== =========== ===========
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 =========== =========== =========== ===========
47 50 DECKERS OUTDOOR CORPORATION AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS THREE-YEAR PERIOD ENDED DECEMBER 31, 1998
BALANCE AT BEGINNING OF BALANCE AT DESCRIPTION PERIOD ADDITIONS DEDUCTIONS END OF PERIOD ----------- ------------ ---------- ---------- ------------- 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 ========== ========== ========== ========== Year ended December 31, 1998: Allowance for doubtful accounts......... $1,092,000 $ 589,000 $ 477,000 $1,204,000 Reserve for sales discounts............. 256,000 1,053,000 655,000 654,000 Reserve for inventory obsolescence...... 1,568,000 2,543,000 1,221,000 2,890,000 Allowance for doubtful note receivable........................... 1,500,000 -- -- 1,500,000 ========== ========== ========== ==========
48 51 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 1999 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, 1998, 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 1999 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, 1998, 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 1999 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, 1998, 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 1999 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, 1998, 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 28 hereof. (b) Reports on Form 8-K. The Company filed the following Current Reports on Form 8-K: (1) Form 8-K filed on November 6, 1998 (Item 5 -- On November 2, 1998, the Company issued a press release announcing that Mark Thatcher, owner of Teva Sport Sandals, Inc., has engaged an investment firm for purposes of exploring various strategic options for the Teva brand). (c) Consolidated Financial Statements and Schedules required to be filed hereunder are indexed on page 28 hereof. (d) Exhibits
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)
49 52
EXHIBIT - ------- 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) 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)
50 53
EXHIBIT - ------- 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 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) 10.30 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) 10.31 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) 10.32 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) 10.33 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) 10.34 Third Amendment to Credit Agreement between Deckers Outdoor Corporation and Wells Fargo Bank, dated March 24, 1998. (Exhibit 10.35 to the Registrant's Form 10-K for the period ended December 31, 1998 and incorporated by reference herein). 10.35 Fourth Amendment to Credit Agreement between Deckers Outdoor Corporation and Wells Fargo Bank, dated March 25, 1998. (Exhibit 10.36 to the Registrant's Form 10-K for the period ended December 31, 1998 and incorporated by reference herein). 10.36 Fifth Amendment to Credit Agreement between Deckers Outdoor Corporation and Wells Fargo Bank, dated May 29, 1998. (Exhibit 10.37 to the Registrant's Form 10-Q for the period ended June 30, 1998 and incorporated by reference herein)
51 54
EXHIBIT - ------- 10.37 Sixth Amendment to Credit Agreement between Deckers Outdoor Corporation and Wells Fargo Bank, dated July 22, 1998. (Exhibit 10.38 to the Registrant's Form 10-Q for the period ended June 30, 1998 and incorporated by reference herein) 10.38 Shareholder Rights Agreement, dated as of November 12, 1998. (Exhibit 10.39 to the Registrant's Form 10-Q for the period ended September 30, 1998 and incorporated by reference herein) 10.39 Letter agreement between Deckers Outdoor Corporation and Wells Fargo Bank, dated November 20, 1998. (Exhibit 10.40 to the Registrant's 10-Q for the period ended September 30, 1998 and incorporated by reference herein). 10.40 Loan and Security Agreement by and among Congress Financial Corporation (Western) and Deckers Outdoor Corporation, Deckers Outdoor Corporation International, Simple Shoes, Inc., Ugg Holdings, Inc. and Heirlooms, Inc., dated January 21, 1999. 21.1 Subsidiaries of Registrant. 23.1 Independent Auditors' Consent.
52 55 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 Chief Executive Officer Date: 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 (Principal Douglas B. Otto Executive Officer) /s/ M. SCOTT ASH Chief Financial Officer - --------------------------------------------- (Principal Financial and Accounting Officer) M. Scott Ash /s/ RONALD D. PAGE Director - --------------------------------------------- Ronald D. Page /s/ KARL F. LOPKER Director - --------------------------------------------- Karl F. Lopker /s/ GENE E. BURLESON Director - --------------------------------------------- Gene E. Burleson /s/ REX A. LICKLIDER Director - --------------------------------------------- Rex A. Licklider Director - --------------------------------------------- Diana M. Wilson
53 EX-10.40 2 EXHIBIT 10.40 1 Exhibit 10.40 LOAN AND SECURITY AGREEMENT by and among CONGRESS FINANCIAL CORPORATION (WESTERN) as Lender and DECKERS OUTDOOR CORPORATION, DECKERS OUTDOOR CORPORATION INTERNATIONAL, SIMPLE SHOES, INC., UGG HOLDINGS, INC. and HEIRLOOMS, INC. collectively, as Borrowers Dated: January 21, 1999 i 2 TABLE OF CONTENTS
Page SECTION 1. DEFINITIONS....................................................................1 SECTION 2. CREDIT FACILITIES.............................................................11 2.1 Revolving Loans.............................................................11 2.2 Letter of Credit Accommodations.............................................15 SECTION 3. INTEREST AND FEES.............................................................17 3.1 Interest....................................................................17 3.2 Closing Fee.................................................................18 3.3 Loan Servicing Fee..........................................................18 3.4 Unused Line Fee.............................................................19 3.5 Compensation Adjustment.....................................................19 SECTION 4. CONDITIONS PRECEDENT AND SUBSEQUENT...........................................21 4.1 Conditions Precedent to Initial Loans and the Letter of Credit Accommodations..............................................................21 4.2 Conditions Precedent to All Loans and Letter of Credit Accommodations.......23 4.3 Condition Subsequent to All Loans and Letter of Credit Accommodations.......24 SECTION 5. GRANT OF SECURITY INTEREST....................................................24 SECTION 6. COLLECTION AND ADMINISTRATION.................................................25 6.1 Borrowers' Loan Accounts....................................................25 6.2 Statements..................................................................25 6.3 Collection of Accounts......................................................25 6.4 Payments....................................................................26 6.5 Authorization to Make Loans.................................................27 6.6 Use of Proceeds.............................................................27 SECTION 7. COLLATERAL REPORTING AND COVENANTS............................................27 7.1 Collateral Reporting........................................................27 7.2 Accounts Covenants..........................................................28 7.3 Inventory Covenants.........................................................29 7.4 Equipment Covenants.........................................................31 7.5 Power of Attorney...........................................................31 7.6 Right to Cure...............................................................32 7.7 Access to Premises..........................................................32
ii 3 TABLE OF CONTENTS (continued)
Page SECTION 8. REPRESENTATIONS AND WARRANTIES................................................32 8.1 Corporate Existence, Power and Authority; Subsidiaries......................33 8.2 Financial Statements; No Material Adverse Change............................33 8.3 Chief Executive Office; Collateral Locations................................33 8.4 Priority of Liens; Title to Properties......................................33 8.5 Tax Returns.................................................................34 8.6 Litigation..................................................................34 8.7 Compliance with Other Agreements and Applicable Laws........................34 8.8 Bank Accounts...............................................................34 8.9 Environmental Compliance....................................................34 8.10 Employee Benefits...........................................................35 8.11 Accuracy and Completeness of Information....................................36 8.12 Survival of Warranties; Cumulative..........................................36 SECTION 9. AFFIRMATIVE AND NEGATIVE COVENANTS............................................36 9.1 Maintenance of Existence....................................................36 9.2 New Collateral Locations....................................................36 9.3 Compliance with Laws, Regulations, Etc......................................37 9.4 Payment of Taxes and Claims.................................................37 9.5 Insurance...................................................................38 9.6 Financial Statements and Other Information..................................38 9.7 Sale of Assets, Consolidation, Merger, Dissolution, Etc.....................39 9.8 Encumbrances................................................................40 9.9 Indebtedness................................................................40 9.10 Loans, Investments, Guarantees, Etc.........................................41 9.11 Dividends and Redemptions...................................................42 9.12 Transactions with Affiliates................................................42 9.13 Additional Bank Accounts....................................................42 9.14 Compliance with ERISA.......................................................43 9.15 Year 2000 Compliance........................................................43 9.16 Adjusted Net Worth..........................................................43 9.17 Costs and Expenses..........................................................44
iii 4 TABLE OF CONTENTS (continued)
Page 9.18 Further Assurances..........................................................44 SECTION 10. EVENTS OF DEFAULT AND REMEDIES................................................45 10.1 Events of Default...........................................................45 10.2 Remedies....................................................................47 SECTION 11. JURY TRIAL WAIVER; OTHER WAIVERS AND CONSENTS; GOVERNING LAW..........................................................48 11.1 Governing Law; Choice of Forum; Service of Process; Jury Trial Waiver.......48 11.2 Waiver of Notices...........................................................49 11.3 Amendments and Waivers......................................................49 11.4 Indemnification.............................................................50 SECTION 12. TERM OF AGREEMENT; MISCELLANEOUS..............................................50 12.1 Term........................................................................50 12.2 Notices.....................................................................51 12.3 Partial Invalidity..........................................................52 12.4 Successors..................................................................52 12.5 Entire Agreement............................................................52 12.6 Publicity...................................................................52 SECTION 13. JOINT AND SEVERAL LIABILITY AND SURETYSHIP WAIVERS............................52 13.1 Independent Obligations; Subrogation........................................52 13.2 Authority to Modify Obligations and Security................................53 13.3 Waiver of Defenses..........................................................53 13.4 Exercise of Lender's Rights.................................................54 13.5 Additional Waivers..........................................................54 13.6 Additional Indebtedness.....................................................54 13.7 Notices, Demands, Etc.......................................................54 13.8 Subordination...............................................................55 13.9 Revival.....................................................................55 13.10 Understanding of Waivers....................................................55 13.11 Limited Liability...........................................................56
iv 5 Exhibit A Information Certificate Schedule 8.4 Other Liens Schedule 8.8 Bank Accounts Schedule 8.9 Environmental Disclosure
6 LOAN AND SECURITY AGREEMENT This Loan and Security Agreement dated January 21, 1999 is entered into by and among CONGRESS FINANCIAL CORPORATION (WESTERN), a California corporation ("Lender") and DECKERS OUTDOOR CORPORATION, a Delaware corporation ("DOC"), DECKERS OUTDOOR CORPORATION INTERNATIONAL, a Delaware corporation ("DOCI"), SIMPLE SHOES, INC., a California corporation ("SSI"), UGG HOLDINGS, INC., a California corporation ("UHI"), and HEIRLOOMS, INC., a California corporation ("Heirlooms") (DOC, DOCI, SSI, UHI and Heirlooms, collectively referred to herein as "Borrowers" and individually, a "Borrower"). W I T N E S S E T H: WHEREAS, Borrowers have requested that Lender enter into certain financing arrangements with each Borrower pursuant to which Lender may make loans and provide other financial accommodations to each Borrower and each Borrower shall be jointly and severally liable for the obligations of the other Borrowers hereunder; and WHEREAS, DOCI, SSI, UHI and Heirlooms are subsidiaries of DOC and DOC with DOCI, SSI, UHI and Heirlooms are interrelated entities which, collectively constitute an integrated footwear and apparel production and distribution operation, with DOC operating such subsidiaries in coordination with its own operations; and WHEREAS, the directors of DOC, DOCI, SSI, UHI and Heirlooms view the entities as sufficiently dependent upon each other and so interrelated that any advances made by Lender hereunder to any of the constituent entities would benefit all of the constituent entities as a result of their consolidated operations and identity of interests; and WHEREAS, DOC, DOCI, SSI, UHI and Heirlooms have each requested that Lender treat them as co-Borrowers hereunder, jointly and severally responsible for the obligations hereunder of each other Borrower except as provided in Section 13.11 hereof; and WHEREAS, Lender is willing to make such loans and provide such financial accommodations on the terms and conditions set forth herein; NOW, THEREFORE, in consideration of the mutual conditions and agreements set forth herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Lender and each Borrower (with each Borrower acting and being obligated jointly and severally with each other) agree as follows: SECTION 1. DEFINITIONS. All terms used herein which are defined in Article 1 or Article 9 of the California Uniform Commercial Code shall have the respective meanings given therein unless otherwise defined in this Agreement. All references to the plural herein shall also mean the singular and to the singular shall also mean the plural. All references to a Borrower and Lender pursuant to the 7 definitions set forth in the recitals hereto, or to any other person herein, shall include their respective successors and assigns. The words "hereof", "herein", "hereunder", "this Agreement" and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not any particular provision of this Agreement and as this Agreement now exists or may hereafter be amended, modified, supplemented, extended, renewed, restated or replaced. An Event of Default shall exist or continue or be continuing until such Event of Default is waived in accordance with Section 11.3. Any accounting term used herein unless otherwise defined in this Agreement shall have the meaning customarily given to such term in accordance with GAAP. For purposes of this Agreement, the following terms shall have the respective meanings given to them below: 1.1 "Accounts" shall mean all present and future rights of a Borrower to payment for goods sold or leased or for services rendered, which are not evidenced by instruments or chattel paper, and whether or not earned by performance. 1.2 "Adjusted Eurodollar Rate" shall mean, with respect to each Interest Period for any Eurodollar Rate Loan, the rate per annum (rounded upwards, if necessary, to the next one-sixteenth (1/16) of one (1%) percent) determined by dividing (a) the Eurodollar Rate for such Interest Period by (b) a percentage equal to: (i) one (1) minus (ii) the Reserve Percentage. For purposes hereof, "Reserve Percentage" shall mean the reserve percentage, expressed as a decimal, prescribed by any United States or foreign banking authority for determining the reserve requirement which is or would be applicable to deposits of United States dollars in a non-United States or an international banking office of Reference Bank used to fund a Eurodollar Rate Loan or any Eurodollar Rate Loan made with the proceeds of such deposit, whether or not the Reference Bank actually holds or has made any such deposits or loans. The Adjusted Eurodollar Rate shall be adjusted on and as of the effective day of any change in the Reserve Percentage. 1.3 "Adjusted Net Worth" shall mean as to any Borrower, at any time, in accordance with GAAP (except as otherwise specifically set forth below), on a consolidated basis for such Borrower and its subsidiaries (if any), the amount equal to: (a) the difference between: (i) the aggregate net book value of all assets of such Borrower and its subsidiaries, calculating the book value of inventory for this purpose on a first-in-first-out basis, after deducting from such book values all appropriate reserves in accordance with GAAP (including all reserves for doubtful receivables, obsolescence, depreciation and amortization) and (ii) the aggregate amount of the indebtedness and other liabilities of such Borrower and its subsidiaries (including tax and other proper accruals) plus (b) indebtedness of such Borrower and its subsidiaries which is subordinated in right of payment to the full and final payment of all of the Obligations on terms and conditions acceptable to Lender less (c) intangibles of such Borrower and its subsidiaries. 1.4 "Availability Reserves" shall mean, as of any date of determination, such amounts as Lender may from time to time establish and revise in good faith reducing the amount of Revolving Loans and Letter of Credit Accommodations which would otherwise be available to a Borrower, under the lending formula(s) provided for herein: (a) to reflect events, conditions, contingencies or risks which, as determined by Lender in good faith, do or may affect either (i) the Collateral or any other property which is security for the Obligations or its value, including, without limitation, the mix in size, age or style of such Borrower's Inventory, (ii) the assets, 2 8 business or prospects of such Borrower or (iii) the security interests and other rights of Lender in the Collateral (including the enforceability, perfection and priority thereof) or (b) to reflect Lender's good faith belief that any collateral report or financial information furnished by or on behalf of such Borrower to Lender is or may have been incomplete, inaccurate or misleading in any material respect or (c) to reflect any state of facts which Lender determines in good faith constitutes an Event of Default or may, with notice or passage of time or both, constitute an Event of Default. Without limiting the generality of the foregoing, Lender shall establish an Availability Reserve in the aggregate amount of Eight Hundred Thousand Dollars ($800,000) until such time that Lender has received a lien search reflecting Lender's first priority security interest in any and all Inventory located in Canada. Such Availability Reserve shall be allocated among the Borrowers owning such Inventory. 1.5 "Blocked Account" shall have the meaning set forth in Section 6.3 hereof. 1.6 "Business Day" shall mean any day other than a Saturday, Sunday, or other day on which commercial banks are authorized or required to close under the laws of the State of New York or the State of North Carolina, and a day on which the Reference Bank and Lender are open for the transaction of business, except that if a determination of a "Business Day" shall relate to any Eurodollar Rate Loan, the term "Business Day" shall also exclude any day on which banks are closed for dealings in dollar deposits in the London interbank market or other applicable Eurodollar market. 1.7 "Closing Date" shall mean the date of the first to occur of the making of the initial Loans or the issuance of the initial Letter of Credit Accommodation to or on behalf of any Borrower. 1.8 "Code" shall mean the Internal Revenue Code of 1986, as the same now exists or may from time to time hereafter be amended, modified, recodified or supplemented, together with all rules, regulations and interpretations thereunder or related thereto. 1.9 "Collateral" shall have the meaning set forth in Section 5 hereof. 1.10 "Deckers Europe" shall mean Deckers Europe, B.V., a private company with limited liability organized under the laws of the Netherlands. 1.11 "Deckers Japan" shall mean Deckers Japan, Inc., a corporation organized under the laws of the State of California. 1.12 "Eligible Accounts" shall mean as to any Borrower, Accounts created by such Borrower which are and continue to be acceptable to Lender based on the criteria set forth below. Accounts of a Borrower shall be Eligible Accounts of such Borrower if: (a) such Accounts arise from the actual and bona fide sale and delivery (based upon terms of shipment) of goods by such Borrower or rendition of services by such Borrower in the ordinary course of its business which transactions are completed in accordance with the terms and provisions contained in any documents related thereto; 3 9 (b) such Accounts are not unpaid more than sixty (60) days past the original due date thereof or are not unpaid more than one hundred twenty (120) days after the date of the original invoice for them (other than Accounts described in Section 1.12(c) hereof); (c) such Accounts are originally subject to extended payment terms; provided, that (i) such Accounts are not unpaid more than thirty (30) days past the original due date thereof or are not unpaid more than one hundred fifty (150) days from the original invoice date and (ii) such Accounts are not owed by an account debtor who has Accounts unpaid more than thirty (30) days past the original due date thereof or unpaid more than one hundred fifty (150) days from the original invoice for them which constitute more than fifty percent (50%) of the total Accounts of such account debtor; provided, however, no more than Eight Million Five Hundred Thousand Dollars ($8,500,000) of aggregate Revolving Loans advanced against all such Eligible Accounts with extended payment terms shall be outstanding at any time and Lender may reasonably establish a minimum amount of each Account with extended payment terms in order for it to be an Eligible Account; (d) such Accounts comply with the terms and conditions contained in Section 7.2(c) of this Agreement; (e) such Accounts do not arise from sales on consignment, guaranteed sale, sale and return, sale on approval, or other terms under which payment by the account debtor may be conditional or contingent; (f) the chief executive office of the account debtor with respect to such Accounts is located in the United States of America or Canada, or if either: (i) the account debtor has delivered to such Borrower an irrevocable letter of credit issued or confirmed by a bank satisfactory to Lender and payable only in the United States of America and in U.S. dollars, sufficient to cover such Account, in form and substance satisfactory to Lender and, if required by Lender, the original of such letter of credit has been delivered to Lender or Lender's agent and the issuer thereof notified of the assignment of the proceeds of such letter of credit to Lender, or (ii) such Account is subject to credit insurance payable to Lender issued by an insurer and on terms and in an amount acceptable to Lender, or (iii) with respect to an Account of an account debtor whose chief executive office is located in Europe, such Account is subject to credit insurance payable to Lender and on terms and in an amount acceptable to Lender and is guaranteed as to payment or is factored and in either case by a factor acceptable to Lender pursuant to a factoring agreement, in form and substance reasonably satisfactory to Lender and such factor has entered into an intercreditor agreement with Lender, in form and substance reasonably satisfactory to Lender, or (iv) such Account is otherwise acceptable in all respects to Lender (subject to the terms and conditions set forth in Section 2.1(g) hereof and such lending formulas and sublimit amounts with respect thereto as Lender may determine); (g) such Accounts do not consist of progress billings, bill and hold invoices or retainage invoices, except as to bill and hold invoices, if Lender shall have received an agreement in writing from the account debtor, in form and substance satisfactory to Lender, confirming the unconditional obligation of the account debtor to take the goods related thereto and pay such invoice; 4 10 (h) the account debtor with respect to such Accounts has not asserted a counterclaim, defense or dispute and does not have, and does not engage in transactions which may give rise to, any right of setoff against such Accounts (but the portion of the Accounts of such account debtor in excess of the amount at any time and from time to time owed by all Borrowers collectively to such account debtor or claimed owed by such account debtor will be deemed Eligible Accounts of such Borrower); (i) there are no facts, events or occurrences which would impair the validity, enforceability or collectability of such Accounts or reduce the amount payable or delay payment thereunder; (j) such Accounts are subject to the first priority, valid and perfected security interest of Lender and any goods giving rise thereto are not, and were not at the time of the sale thereof, subject to any liens except those permitted in this Agreement; (k) neither the account debtor nor any officer or employee of the account debtor with respect to such Accounts is an executive officer of such Borrower directly or indirectly by virtue of family membership, ownership, control, management or otherwise; (l) the account debtors with respect to such Accounts are not any foreign government, the United States of America, any State, political subdivision, department, agency or instrumentality thereof, unless, if the account debtor is the United States of America, any State, political subdivision, department, agency or instrumentality thereof, upon Lender's request, the Federal Assignment of Claims Act of 1940, as amended or any similar State or local law, if applicable, has been complied with in a manner satisfactory to Lender; (m) there are no proceedings or actions which are threatened or pending against the account debtors with respect to such Accounts which might result in any material adverse change in any such account debtor's financial condition; (n) such Accounts of a single account debtor or its affiliates do not constitute more than ten percent (10%) of all otherwise Eligible Accounts of all Borrowers in the aggregate (but the portion of the Accounts of the Borrowers not in excess of such percentage will be deemed Eligible Accounts of the Borrowers); (o) such Accounts are not owed by an account debtor who has Accounts unpaid more than sixty (60) days past the original due date thereof or unpaid more than one hundred twenty (120) days after the date of the original invoice for them (other than Accounts described in Section 1.12(c) hereof) which constitute more than fifty percent (50%) of the total Accounts of such account debtor; and (p) such Accounts are owed by account debtors deemed creditworthy at all times by Lender, as reasonably determined by Lender. Any Accounts which are not Eligible Accounts shall nevertheless be part of the Collateral. 1.13 "Eligible Assignee" shall mean a financial institution acceptable to Lender organized under (a) the laws of the United States of America, or any State thereof or (b) the laws 5 11 of any other country which is a member of the Organization for Economic Corporation and Development, or a political subdivision of any such country, provided that such bank is acting through a branch, subsidiary or agency located in the United States of America. 1.14 "Eligible In-Transit Inventory" shall mean as to any Borrower, Inventory owned by such Borrower consisting of footwear and apparel finished goods in transit on the water from an overseas port of shipping to Borrower which (a) are subject to bailee agreements, bills of lading, documents of title, warehouse receipts or other documentation, which documentation is in possession and control of Lender or its agent; (b) are insured in a manner acceptable to Lender; and (c) meet all other eligibility criteria set forth in the definition of "Eligible Inventory"; provided, however, the aggregate amount of Revolving Loans outstanding advanced against all Eligible In-Transit Inventory of all Borrowers shall not exceed Eight Million Dollars ($8,000,000) during the period commencing November 15 and ending April 15 of each calendar year and Five Million Dollars ($5,000,000) during the remaining portion of each calendar year. General criteria for Eligible In-Transit Inventory may be established and revised from time to time by Lender in its reasonable credit judgment. Any Inventory in transit which is not Eligible In-Transit Inventory shall nevertheless be part of the Collateral. 1.15 "Eligible Inventory" shall mean as to any Borrower, Inventory consisting of footwear and apparel finished goods held for resale in the ordinary course of the business of such Borrower which are acceptable to Lender based on the criteria set forth below. In general, Eligible Inventory shall not include (a) raw materials; (b) work-in-process; (c) components which are not part of finished goods; (d) spare parts for equipment; (e) packaging and shipping materials; (f) supplies used or consumed in such Borrower's business; (g) Inventory at premises other than those owned and controlled by such Borrower, except if Lender shall have received an agreement in writing from the person in possession of such Inventory and/or the owner or operator of such premises in form and substance satisfactory to Lender acknowledging Lender's first priority security interest in the Inventory, waiving security interests and claims by such person against the Inventory and permitting Lender access to, and the right to remain on, the premises so as to exercise Lender's rights and remedies and otherwise deal with the Collateral; (h) Inventory in transit (other than Eligible In-Transit Inventory); (i) Inventory subject to a security interest or lien in favor of any person other than Lender except those permitted in this Agreement; (j) bill and hold goods; (k) unserviceable, obsolete or slow moving Inventory; (l) Inventory which has been produced as finished goods and remains unsold more than the lesser of six (6) months or one (1) selling season, the period for which shall be determined by Lender in its reasonable discretion; (m) Inventory which is not subject to the first priority, valid and perfected security interest of Lender; (n) returned, damaged and/or defective Inventory; (o) Inventory at premises located outside the United States of America or Canada (provided, that, Inventory located in Canada must be located at a warehouse, the owner or operator of which has entered into a bailee agreement in favor of Lender, in form and substance satisfactory to Lender, in order for such Inventory to be deemed Eligible Inventory); and (p) Inventory purchased or sold on consignment. General criteria for Eligible Inventory may be established and revised from time to time by Lender in its reasonable credit judgment. Any Inventory which is not Eligible Inventory shall nevertheless be part of the Collateral. 1.16 "Environmental Laws" shall mean all federal, state, district, local and foreign laws, rules, regulations, ordinances, and consent decrees relating to health, safety, hazardous 6 12 substances, pollution and environmental matters, as now or at any time hereafter in effect, applicable to any Borrower's business and facilities (whether or not owned by it), including laws relating to emissions, discharges, releases or threatened releases of pollutants, contamination, chemicals, or hazardous, toxic or dangerous substances, materials or wastes into the environment (including, without limitation, ambient air, surface water, ground water, land surface or subsurface strata) or otherwise relating to the generation, manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, chemicals, or hazardous, toxic or dangerous substances, materials or wastes. 1.17 "Equipment" shall mean all of a Borrower's now owned and hereafter acquired equipment, machinery, computers and computer hardware and software (whether owned or licensed), vehicles, tools, furniture, fixtures, all attachments, accessions and property now or hereafter affixed thereto or used in connection therewith, and substitutions and replacements thereof, wherever located. 1.18 "ERISA" shall mean the United States Employee Retirement Income Security Act of 1974, as the same now exists or may hereafter from time to time be amended, modified, recodified or supplemented, together with all rules, regulations and interpretations thereunder or related thereto. 1.19 "ERISA Affiliate" shall mean any person required to be aggregated with any Borrower or any of its affiliates under Sections 414(b), 414(c), 414(m) or 414(o) of the Code. 1.20 "Eurodollar Rate" shall mean with respect to the Interest Period for a Eurodollar Rate Loan, the interest rate per annum equal to the arithmetic average of the rates of interest per annum (rounded upwards, if necessary, to the next one-sixteenth (1/16) of one (1%) percent) at which Reference Bank is offered deposits of United States dollars in the London interbank market (or other Eurodollar Rate market selected collectively by Borrowers and approved by Lender) on or about 9:00 a.m. (New York time) two (2) Business Days prior to the commencement of such Interest Period in amounts substantially equal to the aggregate principal amount of the Eurodollar Rate Loans requested by and available to Borrowers in accordance with this Agreement, with a maturity of comparable duration to the Interest Period selected by Borrowers. 1.21 "Eurodollar Rate Loans" shall mean any Loans or portion thereof on which interest is payable based on the Adjusted Eurodollar Rate in accordance with the terms hereof. 1.22 "Event of Default" shall mean the occurrence or existence of any event or condition described in Section 10.1 hereof. 1.23 "Excess Availability" shall mean the amount, as determined by Lender, calculated at any time, equal to: (a) the lesser of (i) the aggregate amount of the Revolving Loans available to Borrowers as of such time (based on the applicable advance rates set forth in Sections 2.1(a)(i) or 2.1(a)(ii) hereof), subject to the sublimits and Availability Reserves from time to time established by Lender hereunder and (ii) the Maximum Credit, minus 7 13 (b) the sum of: (i) the aggregate amount of all then outstanding and unpaid Obligations, (ii) the aggregate amount of all trade payables of Borrowers which are more than thirty (30) days past due as of such time, (iii) the aggregate amount of Borrowers' book overdrafts, and (iv) the aggregate amount of Borrowers' past due lease and notes payable. 1.24 "Financing Agreements" shall mean, collectively, this Agreement and all notes, guarantees, security agreements and other agreements, documents and instruments now or at any time hereafter executed and/or delivered by any Borrower or Obligor in connection with this Agreement, as the same now exist or may hereafter be amended, modified, supplemented, extended, renewed, restated or replaced. 1.25 "GAAP" shall mean generally accepted accounting principles in the United States of America as in effect from time to time as set forth in the opinions and pronouncements of the Accounting Principles Board and the American Institute of Certified Public Accountants and the statements and pronouncements of the Financial Accounting Standards Boards which are applicable to the circumstances as of the date of determination consistently applied, except that, for purposes of Section 9.16 hereof, GAAP shall be determined on the basis of such principles in effect on the date hereof and consistent with those used in the preparation of the audited financial statements delivered to Lender prior to the date hereof. 1.26 "Hazardous Materials" shall mean any hazardous, toxic or dangerous substances, materials and wastes, including, without limitation, hydrocarbons (including naturally occurring or man-made petroleum and hydrocarbons), flammable explosives, asbestos, urea formaldehyde insulation, radioactive materials, biological substances, polychlorinated biphenyls, pesticides, herbicides and any other kind and/or type of pollutants or contaminants (including, without limitation, materials which include hazardous constituents), sewage, sludge, industrial slag, solvents and/or any other similar substances, materials, or wastes and including any other substances, materials or wastes that are or become regulated under any Environmental Law (including, without limitation any that are or become classified as hazardous or toxic under any Environmental Law). 1.27 "Holbrook" shall mean Holbrook, Ltd., a limited company organized under the laws of Hong Kong. 1.28 "Information Certificate" shall mean as to any Borrower, the Information Certificate of such Borrower collectively constituting Exhibit A hereto containing material information with respect to such Borrower, its business and assets provided by or on behalf of such Borrower to Lender in connection with the preparation of this Agreement and the other Financing Agreements and the financing arrangements provided for herein. 1.29 "Interest Period" shall mean for any Eurodollar Rate Loan, a period of approximately one (1), two (2), or three (3) months duration as Borrowers may collectively elect, the exact duration to be determined in accordance with the customary practice in the applicable Eurodollar Rate market; provided, that, Borrowers may not elect an Interest Period which will end after the last day of the then-current term of this Agreement. 8 14 1.30 "Interest Rate" shall mean, as to Prime Rate Loans, a rate per annum equal to the Prime Rate and, as to Eurodollar Rate Loans, a rate of two percent (2%) per annum in excess of the Adjusted Eurodollar Rate (based on the Eurodollar Rate applicable for the Interest Period collectively selected by Borrowers as in effect three (3) Business Days after the date of receipt by Lender of the request of Borrowers for such Eurodollar Rate Loans in accordance with the terms hereof, whether such rate is higher or lower than any rate previously quoted to Borrowers); provided, that, the Interest Rate shall mean the rate of two percent (2%) per annum in excess of the Prime Rate as to Prime Rate Loans and the rate of four percent (4%) per annum in excess of the Adjusted Eurodollar Rate as to Eurodollar Rate Loans, at Lender's option, without notice, (a) for the period (i) from and after the date of termination or non-renewal hereof until Lender has received full and final payment of all obligations (notwithstanding entry of a judgment against any Borrower) and (ii) from and after the date of the occurrence of an Event of Default for so long as such Event of Default is continuing as determined by Lender, and (b) on the Revolving Loans at any time outstanding in excess of the amounts available to a Borrower under Section 2 (whether or not such excess(es), arise or are made with or without Lender's knowledge or consent and whether made before or after an Event of Default). 1.31 "Inventory" shall mean all of a Borrower's now owned and hereafter existing or acquired raw materials, work in process, finished goods and all other inventory of whatsoever kind or nature, wherever located. 1.32 "Inventory Advance Rate" shall mean as to any Borrower, the advance rate applicable to the Eligible Inventory of such Borrower as determined in accordance with Section 2.1 hereof. 1.33 "Inventory Maximum Credit" shall mean the amount of Twenty Five Million Dollars ($25,000,000). 1.34 "Letter of Credit Accommodations" shall mean the letters of credit, merchandise purchase or other guaranties which are from time to time either (a) issued, opened or provided by Lender for the account of any Borrower or Obligor or (b) with respect to which Lender has agreed to indemnify the issuer or guaranteed to the issuer the performance by any Borrower of its obligations to such issuer. 1.35 "Loans" shall mean the Revolving Loans. 1.36 "Maximum Credit" shall mean, with reference to the Revolving Loans and the Letter of Credit Accommodations, the amount of Fifty Million Dollars ($50,000,000). 1.37 "Net Amount of Eligible Accounts" shall mean as to any Borrower, the gross amount of Eligible Accounts of such Borrower less (a) sales, excise or similar taxes included in the amount thereof and (b) returns, discounts, claims, credits and allowances of any nature at any time issued, owing, granted, outstanding, available or claimed with respect thereto. 1.38 "Obligations" shall mean any and all Revolving Loans, the Letter of Credit Accommodations and all other obligations, liabilities and indebtedness of every kind, nature and description owing by any Borrower (or Borrowers) to Lender and/or its affiliates, including principal, interest, charges, fees, costs and expenses, however evidenced, whether as principal, 9 15 surety, endorser, guarantor or otherwise, whether arising under this Agreement or otherwise, whether now existing or hereafter arising, whether arising before, during or after the initial or any renewal term of this Agreement or after the commencement of any case with respect to any Borrower (or Borrowers) under the United States Bankruptcy Code or any similar statute (including, without limitation, the payment of interest and other amounts which would accrue and become due but for the commencement of such case), whether direct or indirect, absolute or contingent, joint or several, due or not due, primary or secondary, liquidated or unliquidated, secured or unsecured, and however acquired by Lender. 1.39 "Obligor" shall mean Holbrook, Deckers Japan, Deckers Europe, Phillipsburg, Picante and any other guarantor, endorser, acceptor, surety or other person liable on or with respect to the Obligations or who is the owner of any property which is security for the Obligations, other than a Borrower. 1.40 "OLV" shall mean, with respect to Inventory, the orderly liquidation value (net of liquidation expenses) as determined by Lender and in part based upon the written reports or appraisals as to Inventory heretofore delivered to Lender and hereafter delivered to Lender pursuant to Section 7.3 (d) hereof. 1.41 "Participant" shall mean any Eligible Assignee which at any time participates with Lender in respect of the Loans, the Letter of Credit Accommodations or other Obligations or any portion thereof. 1.42 "Payment Account" shall have the meaning set forth in Section 6.3 hereof. 1.43 "Person" or "person" shall mean any individual, sole proprietorship, partnership, corporation (including, without limitation, any corporation which elects subchapter S status under the Internal Revenue Code of 1986, as amended), limited liability company, limited liability partnership, business trust, unincorporated association, joint stock corporation, trust, joint venture or other entity or any government or any agency or instrumentality or political subdivision thereof. 1.44 "Phillipsburg" shall mean Phillipsburg, Limited, a limited company organized under the laws of Hong Kong. 1.45 "Picante" shall mean Picante, S.A., a sociedad anonima organized under the laws of Guatemala. 1.46 "Prime Rate" shall mean the rate from time to time publicly announced by the Reference Bank from time to time as its prime rate, whether or not such announced rate is the best rate available at such bank. 1.47 "Prime Rate Loans" shall mean any Loans or portion thereof on which interest is payable based on the Prime Rate in accordance with the terms thereof. 1.48 "Records" shall mean all of a Borrower's present and future books of account of every kind or nature, purchase and sale agreements, invoices, ledger cards, bills of lading and other shipping evidence, statements, correspondence, memoranda, credit files and other data 10 16 relating to the Collateral or any account debtor, together with the tapes, disks, diskettes and other data and software storage media and devices, file cabinets or containers in or on which the foregoing are stored (including any rights of any Borrower with respect to the foregoing maintained with or by any other person). 1.49 "Reference Bank" shall mean First Union National Bank, or its successors, or such other bank as Lender may from time to time designate. 1.50 "Renewal Date" shall have the meaning set forth in Section 12.1(a) hereof. 1.51 "Revolving Loans" shall mean the loans now or hereafter made by Lender to or for the benefit of any Borrower on a revolving basis (involving advances, repayments and readvances) as set forth in Section 2.1 hereof. 1.52 "Teva License Agreement" shall mean collectively (a) that certain License Agreement dated as of March 13, 1991 between Mark Thatcher, an individual doing business as TEVA Sport Sandals, and DOC and (b) that certain License Agreement for Europe dated as of November 15, 1991 between Mark Thatcher, an individual doing business as TEVA Sport Sandals, and DOC, as all of the foregoing now exists or may hereafter be amended, modified, supplemented, extended, renewed, restated or replaced. 1.53 "Value" shall mean, as determined by Lender in good faith, with respect to Inventory, the lower of (a) cost under the first-in-first-out method, net of vendor discounts or (b) market value. SECTION 2. CREDIT FACILITIES. 2.1 Revolving Loans. (a) Subject to, and upon the terms and conditions contained herein, Lender agrees to make Revolving Loans to DOC from time to time in amounts requested by DOC up to the amount equal to the sum of: (i) eighty-five percent (85%) of the Net Amount of Eligible Accounts of DOC, plus (ii) the lesser of: (A) sixty-five percent (65%) of the Value of Eligible Inventory (including Eligible In-Transit Inventory) of DOC; or (B) eighty-five percent (85%) of the OLV of Eligible Inventory (including Eligible In-Transit Inventory) of DOC; minus (iii) the then undrawn amounts of outstanding Letter of Credit Accommodations for the account of DOC, multiplied by the applicable percentages as provided for in Section 2.2(c)(i) or Section 2.2(c)(ii) hereof; minus (iv) any Availability Reserves with respect to DOC. 11 17 (b) Subject to, and upon the terms and conditions contained herein, Lender agrees to make Revolving Loans to DOCI from time to time in amounts requested by DOCI up to the amount equal to the sum of: (i) eighty-five percent (85%) of the Net Amount of Eligible Accounts of DOCI, plus (ii) the lesser of: (A) sixty-five percent (65%) of the Value of Eligible Inventory (including Eligible In-Transit Inventory) of DOCI; or (B) eighty-five percent (85%) of the OLV of Eligible Inventory (including Eligible In-Transit Inventory) of DOCI; minus (iii) the then undrawn amounts of outstanding Letter of Credit Accommodations for the account of DOCI, multiplied by the applicable percentages as provided for in Section 2.2(c)(i) or Section 2.2(c)(ii) hereof; minus (iv) any Availability Reserves with respect to DOCI. (c) Subject to, and upon the terms and conditions contained herein, Lender agrees to make Revolving Loans to SSI from time to time in amounts requested by SSI up to the amount equal to the sum of: (i) eighty-five percent (85%) of the Net Amount of Eligible Accounts of SSI, plus (ii) the lesser of: (A) sixty-five percent (65%) of the Value of Eligible Inventory (including Eligible In-Transit Inventory) of SSI; or (B) eighty-five percent (85%) of the OLV of Eligible Inventory (including Eligible In-Transit Inventory) of SSI; minus (iii) the then undrawn amounts of outstanding Letter of Credit Accommodations for the account of SSI, multiplied by the applicable percentages as provided for in Section 2.2(c)(i) or Section 2.2(c)(ii) hereof; minus (iv) any Availability Reserves with respect to SSI. (d) Subject to, and upon the terms and conditions contained herein, Lender agrees to make Revolving Loans to UHI from time to time in amounts requested by UHI up to the amount equal to the sum of: (i) eighty-five percent (85%) of the Net Amount of Eligible Accounts of UHI, plus (ii) the lesser of: (A) sixty-five percent (65%) of the Value of Eligible Inventory (including Eligible In-Transit Inventory) of UHI; or (B) eighty-five percent (85%) of the OLV of Eligible Inventory (including Eligible In-Transit Inventory) of UHI; minus (iii) the then undrawn amounts of outstanding Letter of Credit Accommodations for the account of UHI, multiplied by the applicable percentages as provided for in Section 2.2(c)(i) or Section 2.2(c)(ii) hereof; minus 12 18 (iv) any Availability Reserves with respect to UHI. (e) Subject to, and upon the terms and conditions contained herein, Lender agrees to make Revolving Loans to Heirlooms from time to time in amounts requested by Heirlooms up to the amount equal to the sum of: (i) eighty-five percent (85%) of the Net Amount of Eligible Accounts of Heirlooms, plus (ii) the lesser of: (A) sixty-five percent (65%) of the Value of Eligible Inventory (including Eligible In-Transit Inventory) of Heirlooms; or (B) eighty-five percent (85%) of the OLV of Eligible Inventory (including Eligible In-Transit Inventory) of Heirlooms; minus (iii) the then undrawn amounts of outstanding Letter of Credit Accommodations for the account of Heirlooms, multiplied by the applicable percentages as provided for in Section 2.2(c)(i) or Section 2.2(c)(ii) hereof; minus (iv) any Availability Reserves with respect to Heirlooms. (f) Lender may, in its discretion, from time to time, upon not less than ten (10) Business Days prior notice to Borrowers: (i) reduce the lending formula(s) with respect to Eligible Accounts of any Borrower to the extent that Lender determines in good faith that: (A) the dilution with respect to the Accounts of such Borrower or the aggregate Accounts of all Borrowers (based on the ratio of (1) the aggregate amount of reductions in such Accounts other than as a result of payments in cash to (2) the aggregate amount of total sales) has increased above five percent (5%) in the aggregate during any three (3) month period ended on the last day of the immediately preceding month as of the date of determination (in which case the lending formula(s) with respect to Eligible Accounts of each Borrower shall be reduced by one percent (1%) for each percent that dilution exceeds five percent (5%)) or for which dilution may be reasonably anticipated to increase in any material respect above historical levels; or (B) the general creditworthiness of account debtors has declined; or (ii) reduce the lending formula(s) with respect to Eligible Inventory of any Borrower to the extent that Lender determines that: (A) the number of days of the turnover, age or the mix, of the Inventory of such Borrower or the aggregate Inventory of all Borrowers for any period has changed in any materially adverse respect; or (B) the liquidation value of the Eligible Inventory of such Borrower or the aggregate Inventory of all Borrowers, or any category thereof, has decreased in any material respect; or (C) the nature and quality of the Inventory of such Borrower or the aggregate Inventory of all Borrowers has deteriorated in any material respect. In determining whether to reduce the lending formula(s), Lender may consider events, conditions, contingencies or risks which are also considered in determining Eligible Accounts, Eligible Inventory or in establishing Availability Reserves and may allocate any such consideration to such Borrower or Borrowers that it deems appropriate. 13 19 (g) Except in Lender's discretion, (i) the aggregate amount of the Loans, the Letter of Credit Accommodations and other Obligations of all Borrowers outstanding at any time shall not exceed the Maximum Credit, (ii) the aggregate amount of Revolving Loans outstanding at any time advanced against all Eligible Inventory of all Borrowers shall not exceed the Inventory Maximum Credit and (iii) the aggregate amount of Revolving Loans outstanding at any time advanced against all Eligible Inventory consisting of Inventory of all Borrowers within the "Simple" product line shall not exceed Eight Million Dollars ($8,000,000). In the event that the outstanding amount of any component of the Loans and Letter of Credit Accommodations, or the aggregate amount of the outstanding Loans and Letter of Credit Accommodations and other Obligations, exceeds the amounts available under the lending formulas set forth in Section 2.1(a) hereof, the sublimits for Letter of Credit Accommodations set forth in Section 2.2(d), any other sublimits with respect to specific types of Eligible Accounts or Eligible Inventory, the Inventory Maximum Credit or the Maximum Credit, as applicable, such event shall not limit, waive or otherwise affect any rights of Lender in that circumstance or on any future occasions and Borrowers shall, upon demand by Lender, which may be made at any time or from time to time, immediately repay to Lender the entire amount of any such excess(es) for which payment is demanded. (h) Lender may from time to time provide Revolving Loans advanced against a Borrower's Inventory located in the Netherlands and a Borrower's foreign Accounts, the account debtor of which is located outside the United States of America or Canada, provided, that each Borrower and Lender shall have entered into an Amendment to this Agreement, in form and substance satisfactory to Lender, which shall set forth the terms and conditions to which Lender shall provide such Revolving Loans, Lender and its counsel shall be satisfied that Lender has valid, perfected and first priority security interests in and liens upon such Inventory located in the Netherlands and such foreign Accounts, subject only to the security interests and liens permitted herein or in the other Financing Agreements, and such Inventory and Accounts meet the other eligibility requirements for Eligible Inventory (other than the requirement that the Inventory be located at a premises within the United States or Canada) and Eligible Accounts, respectively, set forth herein. 2.2 Letter of Credit Accommodations. (a) Subject to, and upon the terms and conditions contained herein, at the request of any Borrower, Lender agrees to provide or arrange for Letter of Credit Accommodations for the account of such Borrower containing terms and conditions acceptable to Lender and the issuer thereof. Any payments made by Lender to any issuer thereof and/or related parties in connection with the Letter of Credit Accommodations shall constitute additional Revolving Loans to such Borrower requesting such Letter of Credit Accommodation pursuant to this Section 2. (b) In addition to any charges, fees or expenses charged by any bank or issuer in connection with the Letter of Credit Accommodations, each Borrower shall pay to Lender a letter of credit fee at a rate equal to one and one-quarter percent (1.25%) per annum on the daily aggregate outstanding balance of all Letter of Credit Accommodations for such Borrower for the immediately preceding month (or part thereof), payable in arrears as of the first day of each succeeding month; provided, however, that such letter of credit fee shall be increased, at 14 20 Lender's option without notice, to three and one-quarter percent (3.25%) per annum for the period on or after the date of termination or non-renewal of this Agreement, or the date of the occurrence of an Event of Default. Such letter of credit fee shall be calculated on the basis of a three hundred sixty (360) day year and actual days elapsed and the obligation of each Borrower to pay such fee shall survive the termination or non-renewal of this Agreement. (c) No Letter of Credit Accommodations shall be available to a Borrower requesting such Letter of Credit Accommodation unless on the date of the proposed issuance of such Letter of Credit Accommodations, the Revolving Loans available to such Borrower (subject to the Inventory Maximum Credit, the Maximum Credit and any Availability Reserves) are equal to or greater than: (i) if the proposed Letter of Credit Accommodation is for the purpose of purchasing Eligible Inventory, the sum of: (A) the product of the Value of such Eligible Inventory multiplied by one minus the Inventory Advance Rate of such Borrower under Section 2.1 as applicable, plus (B) freight, taxes, duty and other amounts which Lender estimates must be paid in connection with such Inventory upon arrival and for delivery to one of such Borrower's locations for Eligible Inventory within the United States of America or Canada; and (ii) if the proposed Letter of Credit Accommodation is for standby letters of credit guaranteeing the purchase of Eligible Inventory or for any other purpose, an amount equal to one hundred percent (100%) of the face amount thereof and all other commitments and obligations made or incurred by Lender with respect thereto. Effective on the issuance of each Letter of Credit Accommodation, the amount of Revolving Loans which might otherwise be available to a Borrower requesting such Letter of Credit Accommodation shall be reduced by the applicable amount set forth in Section 2.2(c)(i) or Section 2.2(c)(ii); provided, however, with respect to Letter of Credit Accommodations provided to indemnify Wells Fargo Bank, N.A. for open documentary letters of credit issued prior to date hereof, the amount of Revolving Loans available to a Borrower requesting such Letter of Credit Accommodation shall be reduced by an amount equal to the face amount of such Letter of Credit Accommodation allocated to such Borrower by Lender (based upon the aggregate amount of Letters of Credit issued on behalf of such Borrower as an account party) multiplied by one minus the applicable Inventory Advance Rate of such Borrower under Section 2.1. (d) Except in Lender's discretion, the aggregate amount of all outstanding Letter of Credit Accommodations and all other commitments and obligations made or incurred by Lender in connection therewith for all Borrowers shall not at any time exceed Fifteen Million Dollars ($15,000,000). At any time an Event of Default exists or has occurred and is continuing, upon Lender's request, each Borrower will either furnish cash collateral to secure the reimbursement obligations to the issuer in connection with any Letter of Credit Accommodations or furnish cash collateral to Lender for the Letter of Credit Accommodations, and in either case, the Revolving Loans otherwise available to such Borrower shall not be reduced as provided in Section 2.2(c) to the extent of such cash collateral. (e) Each Borrower shall indemnify and hold Lender harmless from and against any and all losses, claims, damages, liabilities, costs and expenses which Lender may 15 21 suffer or incur in connection with any Letter of Credit Accommodations and any documents, drafts or acceptances relating thereto, including, but not limited to, any losses, claims, damages, liabilities, costs and expenses due to any action taken by any issuer or correspondent with respect to any Letter of Credit Accommodation, unless such losses, claims, damages, liabilities, costs and expenses arise from Lender's gross negligence or willful misconduct. Each Borrower assumes all risks with respect to the acts or omissions of the drawer under or beneficiary of any Letter of Credit Accommodation and for such purposes the drawer or beneficiary shall be deemed such Borrower's agent. Each Borrower assumes all risks for, and agrees to pay, all foreign, Federal, State and local taxes, duties and levies relating to any goods subject to any Letter of Credit Accommodations or any documents, drafts or acceptances thereunder. Each Borrower hereby releases and holds Lender harmless from and against any acts, waivers, errors, delays or omissions, whether caused by any Borrower, by any issuer or correspondent or otherwise, unless caused by the gross negligence or willful misconduct of Lender, with respect to or relating to any Letter of Credit Accommodation. The provisions of this Section 2.2(e) shall survive the payment of Obligations and the termination or non-renewal of this Agreement. (f) Nothing contained herein shall be deemed or construed to grant any Borrower any right or authority to pledge the credit of Lender in any manner. Lender shall have no liability of any kind with respect to any Letter of Credit Accommodation provided by an issuer other than Lender unless Lender has duly executed and delivered to such issuer the application or a guarantee or indemnification in writing with respect to such Letter of Credit Accommodation. Each Borrower shall be bound by any interpretation made in good faith by Lender, or any other issuer or correspondent under or in connection with any Letter of Credit Accommodation or any documents, drafts or acceptances thereunder, notwithstanding that such interpretation may be inconsistent with any instructions of such Borrower. Lender shall have the sole and exclusive right and authority to, and no Borrower shall: (i) at any time an Event of Default exists or has occurred and is continuing, (A) approve or resolve any questions of non-compliance of documents, (B) give any instructions as to acceptance or rejection of any documents or goods or (C) execute any and all applications for steamship or airway guaranties, indemnities or delivery orders, and (ii) at all times, (A) grant any extensions of the maturity of, time of payment for, or time of presentation of, any drafts, acceptances, or documents, and (B) agree to any amendments, renewals, extensions, modifications, changes or cancellations of any of the terms or conditions of any of the applications, Letter of Credit Accommodations, or documents, drafts or acceptances thereunder or any letters of credit included in the Collateral. Lender may take such actions either in its own name or in any Borrower's name. (g) Any rights, remedies, duties or obligations granted or undertaken by any Borrower to any issuer or correspondent in any application for any Letter of Credit Accommodation, or any other agreement in favor of any issuer or correspondent relating to any Letter of Credit Accommodation, shall be deemed to have been granted or undertaken by such Borrower to Lender. Any duties or obligations undertaken by Lender to any issuer or correspondent in any application for any Letter of Credit Accommodation, or any other agreement by Lender in favor of any issuer or correspondent relating to any Letter of Credit Accommodation, shall be deemed to have been undertaken by each Borrower to Lender and to apply in all respects to each Borrower. 16 22 SECTION 3. INTEREST AND FEES. 3.1 Interest. (a) Borrowers shall pay to Lender interest on the outstanding principal amount of the non-contingent Obligations at the Interest Rate. All interest accruing hereunder on and after the date of any Event of Default or termination or non-renewal hereof shall be payable on demand. (b) Borrowers may from time to time request that Prime Rate Loans be converted to Eurodollar Rate Loans or that any existing Eurodollar Rate Loans continue for an additional Interest Period. Such request from Borrowers shall specify the amount of the Prime Rate Loans which will constitute Eurodollar Rate Loans (subject to the limits set forth below) and the Interest Period to be applicable to such Eurodollar Rate Loans. Subject to the terms and conditions contained herein, three (3) Business Days after receipt by Lender of such a request from Borrowers, such Prime Rate Loans shall be converted to Eurodollar Rate Loans or such Eurodollar Rate Loans shall continue, as the case may be, provided, that, (i) no Event of Default, or event which with notice or passage of time or both would constitute an Event of Default exists or has occurred and is continuing, (ii) no party hereto shall have sent any notice of termination or non-renewal of this Agreement, (iii) Borrowers shall have complied with such customary procedures as are established by Lender and specified by Lender to Borrowers from time to time for requests by Borrower for Eurodollar Rate Loans, (iv) no more than four (4) Interest Periods may be in effect at any one time, (v) the aggregate amount of the Eurodollar Rate Loans must be in an amount not less than Five Million Dollars ($5,000,000) or an integral multiple of One Million Dollars ($1,000,000) in excess thereof, (vi) the maximum amount of the Eurodollar Rate Loans at any time requested by Borrowers shall not exceed the amount equal to eighty percent (80%) of the lowest principal amount of the Revolving Loans which it is anticipated will be outstanding in the aggregate during the applicable Interest Period, in each case as determined by Lender (but with no obligation of Lender to make such Revolving Loans) and (vii) Lender shall have determined that the Interest Period or Adjusted Eurodollar Rate is available to Lender through the Reference Bank and can be readily determined as of the date of the request for such Eurodollar Rate Loan by Borrowers. Any request by Borrowers to convert Prime Rate Loans to Eurodollar Rate Loans or to continue any existing Eurodollar Rate Loans shall be irrevocable. Notwithstanding anything to the contrary contained herein, Lender and Reference Bank shall not be required to purchase United States Dollar deposits in the London interbank market or other applicable Eurodollar Rate market to fund any Eurodollar Rate Loans, but the provisions hereof shall be deemed to apply as if Lender and Reference Bank had purchased such deposits to fund the Eurodollar Rate Loans. (c) Any Eurodollar Rate Loans shall automatically convert to Prime Rate Loans upon the last day of the applicable Interest Period, unless Lender has received and approved a request to continue such Eurodollar Rate Loan at least three (3) Business Days prior to such last day in accordance with the terms hereof. Any Eurodollar Rate Loans shall, at Lender's option, upon notice by Lender to Borrowers, convert to Prime Rate Loans in the event that (i) an Event of Default or event which, with the notice or passage of time, or both, would constitute an Event of Default, shall exist, (ii) this Agreement shall terminate or not be renewed, or (iii) the aggregate principal amount of the Prime Rate Loans which have previously been 17 23 converted to Eurodollar Rate Loans or existing Eurodollar Rate Loans continued, as the case may be, at the beginning of an Interest Period shall at any time during such Interest Period exceed either (A) the aggregate principal amount of the Loans then outstanding, or (B) the Revolving Loans then available to any Borrower under Section 2 hereof. Borrowers shall pay to Lender, upon demand by Lender (or Lender may, at its option, charge any loan account of Borrower) any amounts required to compensate Lender, the Reference Bank or any Participant with Lender for any loss (including loss of anticipated profits), cost or expense incurred by such person, as a result of the conversion of Eurodollar Rate Loans to Prime Rate Loans pursuant to any of the foregoing. (d) Interest shall be payable by Borrowers to Lender monthly in arrears not later than the first day of each calendar month and shall be calculated on the basis of a three hundred sixty (360) day year and actual days elapsed. The interest rate on non-contingent Obligations (other than Eurodollar Rate Loans) shall increase or decrease by an amount equal to each increase or decrease in the Prime Rate effective on the first day of the month after any change in such Prime Rate is announced based on the Prime Rate in effect on the last day of the month in which any such change occurs. In no event shall charges constituting interest payable by any Borrower to Lender exceed the maximum amount or the rate permitted under any applicable law or regulation, and if any such part or provision of this Agreement is in contravention of any such law or regulation, such part or provision shall be deemed amended to conform thereto. 3.2 Closing Fee. Borrowers shall pay to Lender as a closing fee Two Hundred Fifty Thousand Dollars ($250,000) which fee shall be fully earned as of and payable on the Closing Date. Such closing fee shall be allocated among Borrowers as determined by Lender and payable by Borrowers in accordance with such allocation. 3.3 Loan Servicing Fee. Borrowers collectively shall pay to Lender a monthly loan servicing fee in an aggregate amount equal to Two Thousand Dollars ($2,000) each month, plus reasonable out-of-pocket costs and expenses, in respect of Lender's services for each month (or part thereof) while this Agreement remains in effect and for so long thereafter as any of the Obligations are outstanding, which fee shall be fully earned as of the date hereof and on the first day of each month hereafter, and payable in advance, with the first of such monthly payments payable on the date hereof and on the first day of each month hereafter; provided, however, in the event that any Loans are advanced by Lender to any Borrower against any factored Eligible Account or Eligible Inventory located in Europe, such service fee shall increase to Four Thousand Dollars ($4,000) per month. Such loan servicing fee shall be allocated among Borrowers as determined by Lender and payable by Borrowers in accordance with such allocation. 3.4 Unused Line Fee. Borrowers shall pay to Lender monthly an unused line fee equal to a rate of one-quarter of one percent (0.25 %) per annum calculated upon the amount by which the Maximum Credit exceeds the average daily principal balance of the aggregate outstanding Revolving Loans and Letter of Credit Accommodations for all Borrowers during the immediately preceding month while this Agreement is in effect and for so long thereafter as any of the Obligations are outstanding, which fee shall be payable on the first day of each month in 18 24 arrears. Such unused line fee shall be allocated among Borrowers as determined by Lender and payable by Borrowers in accordance with such allocation. 3.5 Compensation Adjustment. (a) If after the date of this Agreement the introduction of, or any change in, any law or any governmental rule, regulation, policy, guideline or directive (whether or not having the force of law), or any interpretation thereof, or compliance by Lender or any Participant therewith: (i) subjects Lender to any tax, duty, charge or withholding on or from payments due from any Borrower (excluding franchise taxes imposed upon, and taxation of the overall net income of, Lender or any Participant), or changes the basis of taxation of payments, in either case in respect of amounts due it hereunder, or (ii) imposes or increases or deems applicable any reserve requirement or other reserve, assessment, insurance charge, special deposit or similar requirement against assets of, deposits with or for the account of, or credit extended by Lender or any Participant, or (iii) imposes any other condition the result of which is to increase the cost to Lender or any Participant of making, funding or maintaining the Loans or Letter of Credit Accommodations or reduces any amount receivable by Lender or any Participant in connection with the Loans or Letter of Credit Accommodations, or requires Lender or any Participant to make payment calculated by references to the amount of loans held or interest received by it, by an amount deemed material by Lender or any Participant, or (iv) imposes or increases any capital requirement or affects the amount of capital required or expected to be maintained by Lender or any Participant or any corporation controlling Lender or any Participant, and Lender or any Participant reasonably determines that such imposition or increase in capital requirements or increase in the amount of capital expected to be maintained is based upon the existence of this Agreement or the Loans or Letter of Credit Accommodations hereunder, all of which may be determined by Lender's reasonable allocation of the aggregate of its impositions or increases in capital required or expected to be maintained, and the result of any of the foregoing is to increase the cost to Lender or any Participant of making, renewing or maintaining the Loans or Letter of Credit Accommodations, or to reduce the rate of return to Lender or any Participant on the Loans or Letter of Credit Accommodations, then upon demand by Lender, Borrowers shall pay to Lender, and continue to make periodic payments to Lender or any Participant, such additional amounts as may be necessary to compensate Lender or any Participant for any such additional cost incurred or reduced rate of return realized. (b) A certificate of Lender claiming entitlement to compensation as set forth above will be conclusive in the absence of manifest error. Such certificate will set forth the nature of the occurrence giving rise to such compensation, the additional amount or amounts to be paid and the compensation and the method by which such amounts were determined. In determining any additional amounts due from Borrowers under this Section 3.5, Lender shall act reasonably and in good faith and will, to the extent that the increased costs, reductions, or 19 25 amounts received or receivable relate to the Lender's or a Participant's loans or commitments generally and are not specifically attributable to the Loans and commitments hereunder, use averaging and attribution methods which are reasonable and equitable and which cover all loans and commitments under this Agreement by the Lender or such Participant, as the case may be, whether or not the loan documentation for such other loans and commitments permits the Lender or such Participant to receive compensation costs of the type described in this Section 3.5. 3.6 Changes in Laws and Increased Costs of Loans. (a) Notwithstanding anything to the contrary contained herein, all Eurodollar Rate Loans shall, upon notice by Lender to Borrowers, convert to Prime Rate Loans in the event that (i) any change in applicable law or regulation (or the interpretation or administration thereof) shall either (A) make it unlawful for Lender, Reference Bank or any Participant to make or maintain Eurodollar Rate Loans or to comply with the terms hereof in connection with the Eurodollar Rate Loans, or (B) shall result in the increase in the costs to Lender, Reference Bank or any Participant of making or maintaining any Eurodollar Rate Loans by an amount deemed by Lender to be material, or (C) reduce the amounts received or receivable by Lender in respect thereof, by an amount deemed by Lender to be material or (ii) the cost to Lender, Reference Bank or any Participant of making or maintaining any Eurodollar Rate Loans shall otherwise increase by an amount deemed by Lender to be material. Borrowers shall pay to Lender, upon demand by Lender (or Lender may, at its option, charge any loan account of any Borrower) any amounts required to compensate Lender, the Reference Bank or any Participant with Lender for any reasonable loss (including loss of anticipated profits), cost or expense incurred by such person as a result of the foregoing, including, without limitation, any such reasonable loss, cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such person to make or maintain the Eurodollar Rate Loans or any portion thereof. A certificate of Lender setting forth the basis for the determination of such amount necessary to compensate Lender as aforesaid shall be delivered to Borrowers and shall be conclusive, absent manifest error. (b) If any payments or prepayments in respect of the Eurodollar Rate Loans are received by Lender other than on the last day of the applicable Interest Period (whether pursuant to acceleration, upon maturity or otherwise), including any payments pursuant to the application of collections under Section 6.3 or any other payments made with the proceeds of Collateral, Borrowers shall pay to Lender upon demand by Lender (or Lender may, at its option, charge any loan account of any Borrower) any amounts required to compensate Lender, the Reference Bank or any Participant with Lender for any additional reasonable loss (including loss of anticipated profits), cost or expense incurred by such person as a result of such prepayment or payment, including, without limitation, any reasonable loss, cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such person to make or maintain such Eurodollar Rate Loans or any portion thereof. 20 26 SECTION 4. CONDITIONS PRECEDENT AND SUBSEQUENT. 4.1 Conditions Precedent to Initial Loans and the Letter of Credit Accommodations. Each of the following is a condition precedent to Lender making the initial Loans and providing the initial Letter of Credit Accommodations hereunder: (a) Lender shall have received, in form and substance satisfactory to Lender, all releases, terminations and such other documents as Lender may request to evidence and effectuate the termination of any interest in and to any assets and properties of each Borrower, duly authorized, executed and delivered by it or each of them, including, but not limited to, UCC termination statements for all UCC financing statements and Lender shall have satisfied itself that it has valid, perfected and first priority security interests in and liens upon the Collateral and any other property which is intended as security for the Obligations or the liability of any Obligor in respect thereto, subject only to the security interests and liens permitted herein or in the other Financing Agreements; (b) all requisite corporate action and proceedings in connection with this Agreement and the other Financing Agreements shall be satisfactory in form and substance to Lender, and Lender shall have received all information and copies of all documents, including, without limitation, records of requisite corporate action and proceedings which Lender may have requested in connection therewith, such documents where requested by Lender or its counsel to be certified by appropriate corporate officers or governmental authorities; (c) no material adverse change shall have occurred in the assets, business or prospects of any Borrower since the date of Lender's latest field examination and no change or event shall have occurred which would impair the ability of any Borrower or Obligor to perform its obligations hereunder or under any of the other Financing Agreements to which it is a party or of Lender to enforce the Obligations or realize upon the Collateral; (d) Lender shall have completed an updated field review of the Records and of such other financial information, projections, budgets, business plans, cash flows as Lender shall reasonably request from time to time, including, but not limited to, current agings of receivables, current perpetual inventory records and/or rollforwards of Accounts and Inventory through the date of closing (including test counts of the Inventory by a third party acceptable to Lender), together with supporting documentation, including documentation with respect to Inventory in-transit, goods in bonded warehouses or at other third-party locations, that will enable Lender to accurately identify and verify the Eligible Inventory at or before the Closing Date in a manner satisfactory to Lender, the results of which shall be satisfactory to Lender; (e) Lender shall have received, in form and substance satisfactory to Lender, all consents, waivers, acknowledgments and other agreements from third persons which Lender may deem necessary or desirable in order to permit, protect and perfect its security interests in and liens upon the Collateral or to effectuate the provisions or purposes of this Agreement and the other Financing Agreements, including, without limitation, acknowledgments by lessors, mortgagees and warehousemen of Lender's security interests in the Collateral, waivers by such persons of any security interests, liens or other claims by such persons to the Collateral and 21 27 agreements permitting Lender access to, and the right to remain on, the premises to exercise its rights and remedies and otherwise deal with the Collateral; (f) each of Holbrook, Deckers Japan, Deckers Europe, Phillipsburg, and Picante shall have duly executed and delivered to Lender, in form and substance satisfactory to Lender, a guarantee of the Obligations; (g) Lender shall have received, in form and substance satisfactory to Lender, a Stock Pledge Agreement executed by Robert W. Eason, an individual, pledging all of his capital stock of Heirlooms as security for the Obligations; (h) any holders of a security interest in any Borrower's assets, including, without limitation, vendors of inventory of such Borrower, shall have executed and delivered terminations, intercreditor and/or subordination agreements in form and substance satisfactory to Lender; (i) Lender shall have received audited financial statements of each Borrower, on a consolidated basis, and the accompanying notes thereto, for the fiscal year ended December 31, 1997, together with the unqualified opinion a certified public accountant acceptable to Lender that such financial statements have been prepared in accordance with GAAP, and present fairly the results of operations and financial condition of such Borrower for the fiscal year then ended; (j) Lender shall have received unaudited financial statements of each Borrower having any subsidiaries, on a consolidating basis, for the fiscal year ended December 31, 1997, in detail reasonably satisfactory to Lender, fairly presenting the financial position and the results of operations of such Borrower and its subsidiaries for the fiscal year then ended; (k) Lender shall have received, in form and substance satisfactory to Lender, consolidated pro-forma balance sheets of each Borrower reflecting the initial transactions contemplated hereunder, including, but not limited to, the Loans and Letter of Credit Accommodations provided by Lender to such Borrower on the Closing Date and the use of the proceeds of the initial Loans as provided herein, accompanied by a certificate, dated of even date herewith, of the chief financial officer of such Borrower, stating that such pro-forma balance sheet represents the reasonable, good faith opinion of such officer as to the subject matter thereof as of the date of such certificate; (l) Lender shall have received the latest available certified public accountant management letter; (m) Lender shall have received and reviewed to its satisfaction any and all licensing agreements to which any Borrower is a party, including without limitation the Teva License Agreements, together with a schedule setting forth the expiration dates of each of such licensing agreements and such consents by any party thereto as Lender deems necessary to perfect Lender's first priority security interests in such licensing agreements and to exercise its remedies provided hereunder; (n) Lender shall have received evidence of insurance and loss payee endorsements required hereunder and under the other Financing Agreements, in form and 22 28 substance satisfactory to Lender, and certificates of insurance policies and/or endorsements naming Lender as loss payee; (o) Lender shall have received, in form and substance satisfactory to Lender, such opinion letters of counsel to Borrowers and Deckers Japan with respect to the Financing Agreements and such other matters as Lender may request; (p) the Excess Availability as determined by Lender as of the Closing Date, shall be not less than an amount acceptable to Lender after giving effect to the initial Loans made or to be made hereunder and the payment of all fees and expenses payable upon the consummation of the initial transactions contemplated by this Agreement; (q) Lender shall have received, in form and substance satisfactory to Lender and its counsel, the assignment of all of each Borrower's rights in registered patents, trademarks, service marks and copyrights, as Collateral hereunder, on Lender's standard forms of Collateral Assignments; and (r) the other Financing Agreements and all instruments and documents hereunder and thereunder shall have been duly executed and delivered to Lender, in form and substance satisfactory to Lender. 4.2 Conditions Precedent to All Loans and Letter of Credit Accommodations. Each of the following is an additional condition precedent to Lender making Loans and/or providing Letter of Credit Accommodations to any Borrower, including the initial Loans and Letter of Credit Accommodations and any future Loans and Letter of Credit Accommodations: (a) all representations and warranties contained herein and in the other Financing Agreements shall be true and correct in all material respects with the same effect as though such representations and warranties had been made on and as of the date of the making of each such Loan or providing each such Letter of Credit Accommodation and after giving effect thereto; and (b) no Event of Default and no event or condition which, with notice or passage of time or both, would constitute an Event of Default, shall exist or have occurred and be continuing on and as of the date of the making of such Loan or providing each such Letter of Credit Accommodation and after giving effect thereto. 4.3 Condition Subsequent to All Loans and Letter of Credit Accommodations. Performance of the following conditions shall be completed within the time frame set forth below, and the failure to satisfy any condition with the time frame will constitute an Event of Default hereunder: (a) as soon as practicable, but in no event later than thirty (30) days after the Closing Date, Borrowers shall deliver to Lender the bylaws of UHI duly certified as the true, correct and complete bylaws of UHI by the Secretary of UHI. 23 29 (b) on or before January 30, 1999, Lender shall have received, in form and substance satisfactory to Lender, executed copies of Blocked Account Agreements with respect to each Borrower, pursuant to Section 6.3(a) hereof, among Lender, such Borrower and Wells Fargo Bank, N.A.; and (c) as soon as practicable, but in no event later than thirty (30) days after the Closing Date, Borrowers shall deliver or cause to be delivered to Lender all original stock certificates evidencing the shares issued to Robert W. Eason, an individual, and pledged to Lender, together with undated Stock Powers, executed in blank by Robert W. Eason with respect to such shares. SECTION 5. GRANT OF SECURITY INTEREST. To secure payment and performance of all Obligations, each Borrower hereby grants to Lender a continuing security interest in, a lien upon, and a right of set off against, and hereby assigns to Lender as security, the following property and interests in property of such Borrower, whether now owned or hereafter acquired or existing, and wherever located (collectively, the "Collateral"): 5.1 Accounts and other indebtedness owed to such Borrower; 5.2 all present and future contract rights, general intangibles (including, but not limited to, tax and duty refunds, registered and unregistered patents, trademarks, service marks, copyrights, trade names, applications for the foregoing, trade secrets, goodwill, processes, drawings, blueprints, customer lists, licenses, whether as licensor or licensee, choses in action and other claims and existing and future leasehold interests in equipment, real estate and fixtures), chattel paper, documents, instruments, investment property, federal and state tax refunds and credits, letters of credit, proceeds of letters of credit, bankers' acceptances and guaranties; 5.3 all present and future monies, securities, credit balances, deposits, deposit accounts and other property of such Borrower now or hereafter held or received by or in transit to Lender or its affiliates or at any other depository or other institution from or for the account of such Borrower, whether for safekeeping, pledge, custody, transmission, collection or otherwise, and all present and future liens, security interests, rights, remedies, title and interest in, to and in respect of Accounts and other Collateral, including, without limitation, (a) rights and remedies under or relating to guaranties, contracts of suretyship, letters of credit and credit and other insurance related to the Collateral, (b) rights of stoppage in transit, replevin, repossession, reclamation and other rights and remedies of an unpaid vendor, lienor or secured party, (c) goods described in invoices, documents, contracts or instruments with respect to, or otherwise representing or evidencing, Accounts or other Collateral, including, without limitation, returned, repossessed and reclaimed goods, and (d) deposits by and property of account debtors or other persons securing the obligations of account debtors; 5.4 Inventory; 5.5 Equipment; 24 30 5.6 Records; and 5.7 all products and proceeds of the foregoing, in any form, including, without limitation, insurance proceeds and all claims against third parties for loss or damage to or destruction of any or all of the foregoing. SECTION 6. COLLECTION AND ADMINISTRATION. 6.1 Borrowers' Loan Accounts. Lender shall maintain one or more loan account(s) for each Borrower on its books in which shall be recorded (a) all Loans, all Letter of Credit Accommodations and all other Obligations and the Collateral with respect to such Borrower, (b) all payments made by or on behalf of such Borrower and (c) all other appropriate debits and credits as provided in this Agreement, including, without limitation, reasonable fees, charges, costs, expenses and interest. All entries in the loan account(s) shall be made in accordance with Lender's customary practices as in effect from time to time. 6.2 Statements. Lender shall render to Borrowers each month a statement setting forth the balance in each Borrower's loan account(s) maintained by Lender for such Borrower pursuant to the provisions of this Agreement, including principal, interest, fees, costs and expenses. Each such statement shall be subject to subsequent adjustment by Lender but shall, absent manifest errors or omissions, be considered correct and deemed accepted by each Borrower and conclusively binding upon each Borrower as an account stated except to the extent that Lender receives a written notice from Borrowers of any specific exceptions of any Borrower thereto within thirty (30) days after the date such statement has been mailed by Lender. Until such time as Lender shall have rendered to Borrowers a written statement as provided above, the balance in each Borrower's loan account(s) shall be presumptive evidence of the amounts due and owing to Lender by Borrowers. 6.3 Collection of Accounts. (a) Each Borrower shall establish and maintain, at its expense, a blocked account or lockboxes and related blocked accounts (in either case, each a "Blocked Account" and collectively the "Blocked Accounts"), as Lender may specify, with such bank or banks as are acceptable to Lender into which such Borrower shall promptly deposit and direct its account debtors to directly remit all payments on Accounts and all payments constituting proceeds of Inventory or other Collateral (including, without limitation, any federal or state tax refunds or credits) in the identical form in which such payments are made, whether by cash, check or other manner. Each bank at which a Blocked Account is established shall enter into an agreement, in form and substance satisfactory to Lender, providing (unless otherwise agreed to by Lender) that all items received or deposited in such Blocked Account are the Collateral of Lender, that the depository bank has no lien upon, or right to setoff against, the Blocked Accounts, the items received for deposit therein, or the funds from time to time on deposit therein and that the depository bank will wire, or otherwise transfer, in immediately available funds, on a daily basis, all funds received or deposited into such Blocked Account to such bank account of Lender as Lender may from time to time designate for such purpose (the "Payment Account"). Each Borrower agrees that all amounts deposited in the Blocked Account(s) or other funds received 25 31 and collected by Lender, whether as proceeds of Inventory, the collection of Accounts or other Collateral or otherwise shall be the Collateral of Lender. (b) For purposes of calculating interest on the Obligations, such payments or other funds received will be applied (conditional upon final collection) to the Obligations one (1) Business Day following the date of receipt of immediately available funds by Lender in the Payment Account, or one (1) Business Day following the date of receipt of funds that are not immediately available to Lender in the Payment Account, as applicable. For purposes of calculating the amount of the Revolving Loans available to each Borrower such payments will be applied (conditional upon final collection) to the Obligations on the Business Day of receipt by Lender in the Payment Account, if such payments are received within sufficient time (in accordance with Lender's usual and customary practices as in effect from time to time) to credit such Borrower's loan account on such day, and if not, then on the next Business Day. (c) Each Borrower and all of its affiliates, subsidiaries, shareholders, directors, employees or agents shall, acting as trustee for Lender, receive, as the property of Lender, any monies, cash, checks, notes, drafts or any other payment relating to and/or proceeds of Accounts or from sales of Inventory or other Collateral which come into their possession or under their control and immediately upon receipt thereof, shall deposit or cause the same to be deposited in the Blocked Accounts, or remit the same or cause the same to be remitted, in kind, to Lender. In no event shall any such monies, checks, notes, drafts or other payments be commingled with any Borrower's own funds. Each Borrower agrees to reimburse Lender on demand for any amounts owed or paid to any bank at which a Blocked Account is established or any other bank or person involved in the transfer of funds to or from the Blocked Accounts arising out of Lender's payments to or indemnification of such bank or person, unless such payment or indemnification obligation of Lender was a result of Lender's gross negligence or willful misconduct. The obligation of each Borrower to reimburse Lender for such amounts pursuant to this Section 6.3 shall survive the termination or non-renewal of this Agreement. 6.4 Payments. All Obligations shall be payable to the Payment Account as provided in Section 6.3 or such other place as Lender may designate from time to time. Lender may apply payments received or collected from any Borrower or for the account of any Borrower (including, without limitation, the monetary proceeds of collections or of realization upon any Collateral) to such of the Obligations owed by such Borrower, whether or not then due, in such order and manner as Lender determines. At Lender's option, all principal, interest, fees, costs, expenses and other charges provided for in this Agreement or the other Financing Agreements and owed by a Borrower may be charged directly to the loan account(s) of such Borrower. Each Borrower shall make all payments to Lender on the Obligations free and clear of, and without deduction or withholding for or on account of, any setoff, counterclaim, defense, duties, taxes, levies, imposts, fees, deductions, withholding, restrictions or conditions of any kind. If after receipt of any payment of, or proceeds of Collateral applied to the payment of, any of the Obligations, Lender is required to surrender or return such payment or proceeds to any Person for any reason, then the Obligations intended to be satisfied by such payment or proceeds shall be reinstated and continue and this Agreement shall continue in full force and effect as if such payment or proceeds had not been received by Lender. Each Borrower shall be liable to pay to Lender, and does hereby indemnify and hold Lender harmless for the amount of any payments or proceeds surrendered or returned. This Section 6.4 shall remain effective notwithstanding any 26 32 contrary action which may be taken by Lender in reliance upon such payment or proceeds. This Section 6.4 shall survive the payment of the Obligations and the termination or non-renewal of this Agreement. 6.5 Authorization to Make Loans. Lender is authorized to make the Loans and provide the Letter of Credit Accommodations to a Borrower based upon telephonic or other instructions received from anyone purporting to be an officer of such Borrower or other authorized person or, at the discretion of Lender, if such Loans are necessary to satisfy any Obligations. All requests for Loans or Letter of Credit Accommodations hereunder shall specify the date on which the requested advance is to be made or Letter of Credit Accommodations established (which day shall be a Business Day) and the amount of the requested Loan. Requests received after 10:30 a.m. (Los Angeles time) on any day shall be deemed to have been made as of the opening of business on the immediately following Business Day. All Loans and Letter of Credit Accommodations under this Agreement shall be conclusively presumed to have been made to, and at the request of and for the benefit of, a Borrower when deposited to the credit of such Borrower or otherwise disbursed or established in accordance with the instructions of such Borrower or in accordance with the terms and conditions of this Agreement. 6.6 Use of Proceeds. Borrowers shall use the initial proceeds of the Loans provided by Lender to any Borrower hereunder only for: (a) payments to each of the persons listed in the disbursement direction letter furnished by Borrowers to Lender on or about the Closing Date and (b) reasonable costs, expenses and fees in connection with the preparation, negotiation, execution and delivery of this Agreement and the other Financing Agreements. All other Loans made or Letter of Credit Accommodations provided by Lender to Borrower pursuant to the provisions hereof shall be used by such Borrower only for general operating, working capital and other proper corporate purposes of such Borrower not otherwise prohibited by the terms hereof. None of the proceeds will be used, directly or indirectly, for the purpose of purchasing or carrying any margin security or for the purposes of reducing or retiring any indebtedness which was originally incurred to purchase or carry any margin security or for any other purpose which might cause any of the Loans to be considered a "purpose credit" within the meaning of Regulation U of the Board of Governors of the Federal Reserve System, as amended. SECTION 7. COLLATERAL REPORTING AND COVENANTS. 7.1 Collateral Reporting. Each Borrower shall provide Lender with the following documents of such Borrower in a form satisfactory to Lender: (a) on a regular basis as required by Lender, a schedule of Accounts, sales made, credits issued and cash received; (b) on a monthly basis, on or before the tenth (10th) Business Day of such month for the immediately preceding month or more frequently as Lender may reasonably request, (i) perpetual inventory reports, (ii) inventory reports by major category and (iii) agings of accounts payable, lease payables and other payables; (c) within thirty (30) days after the end of each fiscal quarter, a report setting forth any new patents, trademark registrations or copyright registrations and any applications for any of the foregoing; (d) upon Lender's request, (i) copies of customer statements and credit memos, remittance advices and reports, and copies of deposit slips and bank statements, (ii) copies of shipping and delivery documents, and (iii) copies of purchase orders, invoices and delivery documents for Inventory and Equipment acquired by such 27 33 Borrower; (e) agings of accounts receivable on a monthly basis or more frequently as Lender may reasonably request; and (f) such other reports as to the Collateral or other property which is security for the Obligations as Lender shall reasonably request from time to time. If any of a Borrower's records or reports of the Collateral or other property which is security for the Obligations are prepared or maintained by an accounting service, contractor, shipper or other agent, such Borrower hereby irrevocably authorizes such service, contractor, shipper or agent to deliver such records, reports, and related documents to Lender and to follow Lender's instructions with respect to further services at any time that an Event of Default exists or has occurred and is continuing. 7.2 Accounts Covenants. (a) Borrowers shall include in its collateral reporting to Lender pursuant to Section 7.1 hereof: (i) any material delay in any Borrower's performance of any of its obligations to account debtors or the assertion of any claims, offsets, defenses or counterclaims by account debtors, or any disputes with account debtors, or any settlement, adjustment or compromise thereof, (ii) all material adverse information relating to the financial condition of any account debtor and (iii) any event or circumstance which, to any Borrower's knowledge would cause Lender to consider any then existing Accounts as no longer constituting Eligible Accounts. No credit, discount, allowance or extension or agreement for any of the foregoing shall be granted to any account debtor of a Borrower except in the ordinary course of such Borrower's business in accordance with its most recent past practices and policies. So long as no Event of Default exists or has occurred and is continuing, any Borrower may settle, adjust or compromise any claim, offset, counterclaim or dispute with any account debtor of such Borrower in the ordinary course of such Borrower's business in accordance with its most recent past practices and policies. At any time that an Event of Default exists or has occurred and is continuing, Lender shall, at its option, have the exclusive right to settle, adjust or compromise any claim, offset, counterclaim or dispute with account debtors or grant any credits, discounts or allowances. (b) Without limiting the obligation of Borrowers to deliver any other information to Lender, Borrowers shall include in its collateral reporting to Lender pursuant to Section 7.1 hereof, any returns of Inventory by account debtors. At any time that Inventory is returned, reclaimed or repossessed, the Account (or portion thereof) which arose from the sale of such returned, reclaimed or repossessed Inventory shall not be deemed an Eligible Account. In the event any account debtor returns Inventory when an Event of Default exists or has occurred and is continuing, each Borrower shall, upon Lender's request, (i) hold the returned Inventory in trust for Lender, (ii) segregate all returned Inventory from all of its other property, (iii) dispose of the returned Inventory solely according to Lender's instructions, and (iv) not issue any credits, discounts or allowances with respect thereto without Lender's prior written consent. (c) With respect to each Account: (i) the amounts shown on any invoice delivered to Lender or schedule thereof delivered to Lender shall be true and complete, (ii) no payments shall be made thereon except payments delivered to Lender pursuant to the terms of this Agreement, (iii) no credit, discount, allowance or extension or agreement for any of the foregoing shall be granted to any account debtor except as reported to Lender in accordance with this Agreement and except for credits, discounts, allowances or extensions made or given in the ordinary course of Borrower's business in accordance with practices and policies previously 28 34 disclosed to Lender, (iv) there shall be no setoffs, deductions, contras, defenses, counterclaims or disputes existing or asserted with respect thereto except as reported to Lender in accordance with the terms of this Agreement, (v) none of the transactions giving rise thereto will violate any applicable State or Federal Laws or regulations, all documentation relating thereto will be legally sufficient under such laws and regulations and all such documentation will be legally enforceable in accordance with its terms. (d) Lender shall have the right at any time or times, in Lender's name or in the name of a nominee of Lender, to verify the validity, amount or any other matter relating to any Account or other Collateral, by mail, telephone, facsimile transmission or otherwise. (e) Each Borrower shall deliver or cause to be delivered to Lender, with appropriate endorsement and assignment, with full recourse to such Borrower, all chattel paper and instruments which such Borrower now owns or may at any time acquire immediately upon such Borrower's receipt thereof, except as Lender may otherwise agree. (f) Lender may, at any time or times that an Event of Default exists or has occurred, (i) notify any or all account debtors that the Accounts have been assigned to Lender and that Lender has a security interest therein and Lender may direct any or all account debtors to make payments of Accounts directly to Lender, (ii) extend the time of payment of, compromise, settle or adjust for cash, credit, return of merchandise or otherwise, and upon any terms or conditions, any and all Accounts or other obligations included in the Collateral and thereby discharge or release the account debtor or any other party or parties in any way liable for payment thereof without affecting any of the Obligations, (iii) demand, collect or enforce payment of any Accounts or such other obligations, but without any duty to do so, and Lender shall not be liable for its failure to collect or enforce the payment thereof or for the negligence of its agents or attorneys with respect thereto and (iv) take whatever other action Lender may deem necessary or desirable for the protection of its interests. At any time that an Event of Default exists or has occurred and is continuing, at Lender's request, all invoices and statements sent to any account debtor shall state that the Accounts due from such account debtor and such other obligations have been assigned to Lender and are payable directly and only to Lender and Borrowers shall deliver to Lender such originals of documents evidencing the sale and delivery of goods or the performance of services giving rise to any Accounts as Lender may require. 7.3 Inventory Covenants. With respect to the Inventory: (a) each Borrower shall at all times maintain inventory records reasonably satisfactory to Lender, keeping correct and accurate records itemizing and describing the kind, type, quality and quantity of Inventory, such Borrower's cost therefor and daily withdrawals therefrom and additions thereto; (b) Borrowers shall cause a third party firm acceptable to Lender to conduct a physical count of the Inventory, in form and detail reasonably acceptable to Lender and consistent with Borrowers' past practices, at a minimum of once every twelve (12) months but at any time as Lender may request upon the occurrence of an Event of Default, and promptly following such physical count such firm shall supply Lender with a report in the form and with such specificity as may be reasonably satisfactory to Lender concerning such physical count; 29 35 (c) no Borrower shall remove any Inventory from the locations set forth or permitted herein, without the prior written consent of Lender, except for sales of Inventory in the ordinary course of such Borrower's business and except to move Inventory directly from one location set forth or permitted herein to another such location; (d) upon Lender's request, Borrowers shall, at their expense, no more than twice in any twelve (12) month period, but at any time or times as Lender may request upon the occurrence of an Event of Default, deliver or cause to be delivered to Lender written reports or appraisals as to the Inventory in form, scope and methodology acceptable to Lender by an appraiser acceptable to Lender, addressed to Lender or upon which Lender is expressly permitted to rely (with the understanding that Lender may revise the definition of "Eligible Inventory" hereunder or establish Availability Reserves as Lender may deem advisable in its sole discretion based upon the results of such updated appraisals); (e) each Borrower shall produce, use, store and maintain the Inventory, with all reasonable care and caution and in accordance with applicable standards of any insurance and in conformity with applicable laws (including, but not limited to, the requirements of the Federal Fair Labor Standards Act of 1938, as amended and all rules, regulations and orders related thereto); (f) each Borrower assumes all responsibility and liability arising from or relating to the production, use, sale or other disposition of the Inventory; (g) no Borrower shall sell Inventory to any customer on approval, or any other basis which entitles the customer to return or may obligate a Borrower to repurchase such Inventory; (h) each Borrower shall keep the Inventory in good and marketable condition; (i) no Borrower shall, without prior written notice to Lender, acquire or accept any Inventory on consignment or approval; (j) each Borrower shall cause First Union National Bank (as Lender's agent) to be named as consignee on any and all import documentation relating to the Inventory, including, without limitation, all forwarder cargo receipts and bills of lading, all in form and substance satisfactory to Lender and adequate as determined by Lender, to perfect Lender's first priority security interest in such documents of title and the Inventory relating thereto; and (k) upon the occurrence of an Event of Default, no Borrower shall return any Inventory to its vendors without the prior consent of Lender. 7.4 Equipment Covenants. With respect to the Equipment: (a) upon Lender's request, Borrowers shall, at their expense, at any time or times as Lender may request on or after an Event of Default, deliver or cause to be delivered to Lender written reports or appraisals as to the Equipment in form, scope and methodology acceptable to Lender and by an appraiser acceptable to Lender; 30 36 (b) each Borrower shall keep the Equipment in good order, repair, running and marketable condition (ordinary wear and tear excepted); (c) each Borrower shall use the Equipment with all reasonable care and caution and in accordance with applicable standards of any insurance and in conformity with all applicable laws; (d) the Equipment is and shall be used in a Borrower's business and not for personal, family, household or farming use; (e) no Borrower shall remove any Equipment from the locations set forth or permitted herein, except to the extent necessary to have any Equipment repaired or maintained in the ordinary course of the business of such Borrower or to move Equipment directly from one such location set forth or permitted herein to another such location and except for the movement of motor vehicles used by or for the benefit of such Borrower in the ordinary course of business; (f) the Equipment is now and shall remain personal property and no Borrower shall permit any of the Equipment to be or become a part of or affixed to real property; and (g) each Borrower assumes all responsibility and liability arising from the use of the Equipment. 7.5 Power of Attorney. Each Borrower hereby irrevocably designates and appoints Lender (and all persons designated by Lender) as such Borrower's true and lawful attorney-in-fact, and authorizes Lender, in such Borrower's or Lender's name, to: (a) at any time an Event of Default or event with notice or passage of time or both would constitute an Event of Default exists or has occurred and is continuing: (i) demand payment on Accounts or other proceeds of Inventory or other Collateral; (ii) enforce payment of Accounts or other Obligations included in the Collateral by legal proceedings or otherwise; (iii) exercise all of such Borrower's rights and remedies to collect any Account or other proceeds of Inventory or other Collateral; (iv) sell or assign any Account upon such terms, for such amount and at such time or times as the Lender deems advisable; (v) settle, adjust, compromise, extend or renew an Account; (vi) discharge and release any Account or other Obligations included in the Collateral; (vii) prepare, file and sign such Borrower's name on any proof of claim in bankruptcy or other similar document against an account debtor; (viii) notify the post office authorities to change the address for delivery of such Borrower's mail to an address designated by Lender, and open and dispose of all mail addressed to such Borrower; (ix) have access to any postal box into which such Borrower's mail is deposited; and (x) do all acts and things which are necessary, in Lender's determination, to fulfill such Borrower's obligations under this Agreement and the other Financing Agreements; and (b) at any time, subject to the terms of the agreement(s) relating to the Blocked Account(s) to: (i) take control in any manner of any item of payment or proceeds thereof; (ii) have access to any lockbox; (iii) endorse such Borrower's name upon any items of payment or proceeds thereof and deposit the same in the Lender's account for application to the Obligations; (iv) endorse such Borrower's name upon any chattel paper, document, instrument, invoice, or similar document or agreement relating to any Account or any goods pertaining 31 37 thereto or any other Collateral; (v) sign such Borrower's name on any verification of Accounts and notices thereof to account debtors; and (vi) execute in such Borrower's name and file any UCC financing statements or amendments thereto. Each Borrower hereby releases Lender and its officers, employees and designees from any liabilities arising from any act or acts under this power of attorney and in furtherance thereof, whether of omission or commission, except as a result of an indemnified party's own gross negligence or willful misconduct as determined pursuant to a final non-appealable order of a court of competent jurisdiction. 7.6 Right to Cure. Lender may, at its option, (a) cure any default by any Borrower under any agreement with a third party or pay or bond on appeal any judgment entered against such Borrower, (b) discharge taxes, liens, security interests or other encumbrances at any time levied on or existing with respect to the Collateral and (c) pay any amount, incur any expense or perform any act which, in Lender's judgment, is necessary or appropriate to preserve, protect, insure or maintain the Collateral and the rights of Lender with respect thereto. Lender may add any amounts so expended to the Obligations and charge a Borrower's account therefor, such amounts to be repayable by such Borrower on demand. Lender shall be under no obligation to effect such cure, payment or bonding and shall not, by doing so, be deemed to have assumed any obligation or liability of any Borrower. Any payment made or other action taken by Lender under this Section 7.6 shall be without prejudice to any right to assert an Event of Default hereunder and to proceed accordingly. 7.7 Access to Premises. From time to time as requested by Lender, at the cost and expense of Borrowers, (a) Lender or its designee shall have complete access to all of each Borrower's premises during normal business hours and after notice to such Borrower, or at any time and without notice to such Borrower if an Event of Default exists or has occurred and is continuing, for the purposes of inspecting, verifying and auditing the Collateral and all of such Borrower's books and records, including, without limitation, the Records, and (b) such Borrower shall promptly furnish to Lender such copies of such books and records or extracts therefrom as Lender may request to the extent that furnishing Lender with such books and records or extracts therefrom does not impair such Borrower's legal right to keep such books and records or extracts therefrom privileged between such Borrower and the preparer of such books and records, and (c) use during normal business hours such of any Borrower's personnel, equipment, supplies and premises as may be reasonably necessary for the foregoing and if an Event of Default exists or has occurred and is continuing for the collection of Accounts and realization of other Collateral. SECTION 8. REPRESENTATIONS AND WARRANTIES. Each Borrower hereby represents and warrants to Lender the following (which shall survive the execution and delivery of this Agreement), the truth and accuracy of which are a continuing condition of the making of Loans and the providing of Letter of Credit Accommodations by Lender to each Borrower: 8.1 Corporate Existence, Power and Authority; Subsidiaries. Each Borrower is a corporation duly organized and in good standing under the laws of its state of incorporation and 32 38 is duly qualified as a foreign corporation and in good standing in all states or other jurisdictions where the nature and extent of the business transacted by it or the ownership of assets makes such qualification necessary, except for those jurisdictions in which the failure to so qualify would not have a material adverse effect on such Borrower's financial condition, results of operation or business or the rights of Lender in or to any of the Collateral. The execution, delivery and performance of this Agreement, the other Financing Agreements and the transactions contemplated hereunder and thereunder are all within each Borrower's corporate powers, have been duly authorized and are not in contravention of law or the terms of such Borrower's certificate of incorporation, by-laws, or other organizational documentation, or any indenture, agreement or undertaking to which such Borrower is a party or by which such Borrower or its property are bound. This Agreement and the other Financing Agreements constitute legal, valid and binding obligations of each Borrower enforceable in accordance with their respective terms. Each Borrower does not have any subsidiaries except as set forth on the Information Certificate of such Borrower. 8.2 Financial Statements; No Material Adverse Change. All financial statements relating to any Borrower which have been or may hereafter be delivered by any Borrower to Lender have been prepared in accordance with GAAP and fairly present the financial condition and the results of operations of such Borrower as at the dates and for the periods set forth therein. Except as disclosed in any interim financial statements furnished by Borrowers to Lender prior to the date of this Agreement, there has been no material adverse change in the assets, liabilities, properties and condition, financial or otherwise, of any Borrower, since the date of the most recent audited financial statements furnished by such Borrower to Lender prior to the date of this Agreement. 8.3 Chief Executive Office; Collateral Locations. The chief executive office of each Borrower and such Borrower's Records concerning Accounts are located only at the address set forth below such Borrower's signature hereto and its only other places of business and the only other locations of Collateral, if any, are the addresses set forth in such Borrower's Information Certificate, subject to the right of each Borrower to establish new locations in accordance with Section 9.2 below. The Information Certificate of each Borrower correctly identifies any of such locations which are not owned by such Borrower and sets forth the owners and/or operators thereof and, to the best of such Borrower's knowledge, the holders of any mortgages on such locations. 8.4 Priority of Liens; Title to Properties. The security interests and liens granted to Lender under this Agreement and the other Financing Agreements constitute valid and perfected first priority liens and security interests in and upon the Collateral subject only to the liens indicated on Schedule 8.4 hereto and the other liens permitted under Section 9.8 hereof. Each Borrower has good and marketable title to all of its properties and assets subject to no liens, mortgages, pledges, security interests, encumbrances or charges of any kind, except those granted to Lender and such others as are specifically listed on Schedule 8.4 hereto or permitted under Section 9.8 hereof. 8.5 Tax Returns. Each Borrower has filed, or caused to be filed, in a timely manner all tax returns, reports and declarations which are required to be filed by it (without requests for extension except as previously disclosed in writing to Lender). All information in such tax 33 39 returns, reports and declarations is complete and accurate in all material respects. Each Borrower has paid or caused to be paid all taxes due and payable or claimed due and payable in any assessment received by it, except taxes the validity of which are being contested in good faith by appropriate proceedings diligently pursued and available to such Borrower and with respect to which adequate reserves have been set aside on its books. Adequate provision has been made for the payment of all accrued and unpaid Federal, State, county, local, foreign and other taxes whether or not yet due and payable and whether or not disputed. 8.6 Litigation. Except as set forth on the Information Certificate of a Borrower, there is no present investigation by any governmental agency pending, or to the best of any Borrower's knowledge threatened, against or affecting any Borrower, its assets or business and there is no action, suit, proceeding or claim by any Person pending, or to the best of any Borrower's knowledge threatened, against any Borrower or its assets or goodwill, or against or affecting any transactions contemplated by this Agreement, which if adversely determined against such Borrower would result in any material adverse change in the assets, business or prospects of such Borrower or would impair the ability of such Borrower to perform its obligations hereunder or under any of the other Financing Agreements to which it is a party or of Lender to enforce any Obligations or realize upon any Collateral. 8.7 Compliance with Other Agreements and Applicable Laws. No Borrower is in default in any material respect under, or in violation in any material respect of any of the terms of, any agreement, contract, instrument, lease or other commitment to which it is a party or by which it or any of its assets are bound and each Borrower is in compliance in all material respects with all applicable provisions of laws, rules, regulations, licenses, permits, approvals and orders of any foreign, Federal, State or local governmental authority. 8.8 Bank Accounts. All of the deposit accounts, investment accounts or other accounts in the name of or used by any Borrower maintained at any bank or other financial institution are set forth on Schedule 8.8 hereto, subject to the right of each Borrower to establish new accounts in accordance with Section 9.13 below. 8.9 Environmental Compliance. (a) Except as set forth on Schedule 8.9 hereto, no Borrower has generated, used, stored, treated, transported, manufactured, handled, produced or disposed of any Hazardous Materials, on or off its premises (whether or not owned by it) in any manner which at any time violates any applicable Environmental Law or any license, permit, certificate, approval or similar authorization thereunder and the operations of each Borrower complies in all material respects with all Environmental Laws and all licenses, permits, certificates, approvals and similar authorizations thereunder. (b) Except as set forth on Schedule 8.9 hereto, there has been no investigation, proceeding, complaint, order, directive, claim, citation or notice by any governmental authority or any other person nor is any pending or to the best of any Borrower's knowledge threatened, with respect to any non-compliance with or violation of the requirements of any Environmental Law by any Borrower or the release, spill or discharge, threatened or actual, of any Hazardous Material or the generation, use, storage, treatment, transportation, manufacture, handling, 34 40 production or disposal of any Hazardous Materials or any other environmental, health or safety matter, which affects any Borrower or its business, operations or assets or any properties at which any Borrower has transported, stored or disposed of any Hazardous Materials. (c) No Borrower has material liability (contingent or otherwise) in connection with a release, spill or discharge, threatened or actual, of any Hazardous Materials or the generation, use, storage, treatment, transportation, manufacture, handling, production or disposal of any Hazardous Materials. (d) Each Borrower has all licenses, permits, certificates, approvals or similar authorizations required to be obtained or filed in connection with the operations of such Borrower under any Environmental Law and all of such licenses, permits, certificates, approvals or similar authorizations are valid and in full force and effect. 8.10 Employee Benefits. (a) No Borrower has engaged in any transaction in connection with which any Borrower or any of its ERISA Affiliates could be subject to either a civil penalty assessed pursuant to Section 502(i) of ERISA or a tax imposed by Section 4975 of the Code, including any accumulated funding deficiency described in Section 8.10(c) hereof and any deficiency with respect to vested accrued benefits described in Section 8.10(d) hereof. (b) No liability to the Pension Benefit Guaranty Corporation has been or is expected by any Borrower to be incurred with respect to any employee pension benefit plan of any Borrower or any of its ERISA Affiliates. There has been no reportable event (within the meaning of Section 4043(b) of ERISA) or any other event or condition with respect to any employee pension benefit plan of any Borrower or any of its ERISA Affiliates which presents a risk of termination of any such plan by the Pension Benefit Guaranty Corporation. (c) Full payment has been made of all amounts which any Borrower or any of its ERISA Affiliates is required under Section 302 of ERISA and Section 412 of the Code to have paid under the terms of each employee pension benefit plan as contributions to such plan as of the last day of the most recent fiscal year of such plan ended prior to the date hereof, and no accumulated funding deficiency (as defined in Section 302 of ERISA and Section 412 of the Code), whether or not waived, exists with respect to any employee pension benefit plan, including any penalty or tax described in Section 8.10(a) hereof and any deficiency with respect to vested accrued benefits described in Section 8.10(c) hereof. (d) The current value of all vested accrued benefits under all employee pension benefit plans maintained by any Borrower that are subject to Title IV of ERISA does not exceed the current value of the assets of such plans allocable to such vested accrued benefits, including any penalty or tax described in Section 8.10(a) hereof and any accumulated funding deficiency described in Section 8.10(c) hereof. The terms "current value" and "accrued benefit" have the meanings specified in ERISA. (e) No Borrower nor any of its ERISA Affiliates is or has ever been obligated to contribute to any "multiemployer plan" (as such term is defined in Section 4001(a)(3) of ERISA) that is subject to Title IV of ERISA. 35 41 8.11 Accuracy and Completeness of Information. All information furnished by or on behalf of any Borrower in writing to Lender in connection with this Agreement or any of the other Financing Agreements or any transaction contemplated hereby or thereby, including, without limitation, all information on the Information Certificate is true and correct in all material respects on the date as of which such information is dated or certified and does not omit any material fact necessary in order to make such information not misleading. No event or circumstance has occurred which has had or could reasonably be expected to have a material adverse affect on the business, assets or prospects of any Borrower, which has not been fully and accurately disclosed to Lender in writing. 8.12 Survival of Warranties; Cumulative. All representations and warranties contained in this Agreement or any of the other Financing Agreements shall survive the execution and delivery of this Agreement and shall be deemed to have been made again to Lender on the date of each additional borrowing or other credit accommodation hereunder and shall be conclusively presumed to have been relied on by Lender regardless of any investigation made or information possessed by Lender. The representations and warranties set forth herein shall be cumulative and in addition to any other representations or warranties which any Borrower shall now or hereafter give, or cause to be given, to Lender. SECTION 9. AFFIRMATIVE AND NEGATIVE COVENANTS. 9.1 Maintenance of Existence. Each Borrower shall at all times preserve, renew and keep in full, force and effect its corporate existence and rights and franchises with respect thereto and maintain in full force and effect all permits, licenses, trademarks, trade names, approvals, authorizations, leases and contracts necessary to carry on the business as presently or proposed to be conducted. Borrowers shall give Lender thirty (30) days prior written notice of any proposed change in any Borrower's corporate name, which notice shall set forth the new name and Borrowers shall deliver to Lender a copy of the amendment to the Certificate of Incorporation of such Borrower with the new corporate name providing for the name change certified by the Secretary of State of the jurisdiction of incorporation of such Borrower as soon as it is available. 9.2 New Collateral Locations. A Borrower may open any new location within the continental United States provided Borrowers: (a) give Lender thirty (30) days prior written notice of the intended opening of any such new location; and (b) execute and deliver, or cause to be executed and delivered, to Lender such agreements, documents, and instruments as Lender may deem reasonably necessary or desirable to protect its interests in the Collateral at such location, including, without limitation, UCC financing statements and, if such Borrower leases such new location, provides a landlord waiver or subordination reasonably acceptable to Lender. 9.3 Compliance with Laws, Regulations, Etc. (a) Each Borrower shall, at all times, comply in all material respects with all laws, rules, regulations, licenses, permits, approvals and orders applicable to it and duly observe all requirements of any Federal, State or local governmental authority, including, without limitation, the Employee Retirement Security Act of 1974, as amended, the Occupational Safety and Hazard Act of 1970, as amended, the Fair Labor Standards Act of 1938, as amended, and all 36 42 statutes, rules, regulations, orders, permits and stipulations relating to environmental pollution and employee health and safety, including, without limitation, all of the Environmental Laws. (b) Each Borrower shall take prompt and appropriate action to respond to any non-compliance with any of the Environmental Laws and shall report to Lender on such response. (c) Borrowers shall give both oral and written notice to Lender immediately upon any Borrower's receipt of any notice of, or any Borrower's otherwise obtaining knowledge of: (i) the occurrence of any event involving the release, spill or discharge, threatened or actual, of any Hazardous Material; or (ii) any investigation, proceeding, complaint, order, directive, claims, citation or notice with respect to: (A) any non-compliance with or violation of any Environmental Law by any Borrower; (B) the release, spill or discharge, threatened or actual, of any Hazardous Material; (C) the generation, use, storage, treatment, transportation, manufacture, handling, production or disposal of any Hazardous Materials; or (D) any other environmental, health or safety matter, which affects any Borrower or its business, operations or assets or any properties at which any Borrower transported, stored or disposed of any Hazardous Materials. (d) Each Borrower shall indemnify and hold harmless Lender, its directors, officers, employees, agents, invitees, representatives, successors and assigns, from and against any and all losses, claims, damages, liabilities, costs, and expenses (including reasonable attorneys' fees and legal expenses) directly or indirectly arising out of or attributable to the use, generation, manufacture, reproduction, storage, release, threatened release, spill, discharge, disposal or presence of a Hazardous Material, including, without limitation, the costs of any required or necessary repair, cleanup or other remedial work with respect to any property of any Borrower and the preparation and implementation of any closure, remedial or other required plans. All representations, warranties, covenants and indemnifications in this Section 9.3 shall survive the payment of the Obligations and the termination or non-renewal of this Agreement. 9.4 Payment of Taxes and Claims. Each Borrower shall duly pay and discharge all taxes, assessments, contributions and governmental charges upon or against it or its properties or assets, except for taxes the validity of which are being contested in good faith by appropriate proceedings diligently pursued and available to such Borrower and with respect to which adequate reserves have been set aside on its books. Each Borrower shall be liable for any tax or penalties imposed on Lender as a result of the financing arrangements provided for herein and each Borrower agrees to indemnify and hold Lender harmless with respect to the foregoing, and to repay to Lender on demand the amount thereof, and until paid by Borrowers such amount shall be added and deemed part of the Loans, provided, that, nothing contained herein shall be construed to require Borrowers to pay any income or franchise taxes attributable to the income of Lender from any amounts charged or paid hereunder to Lender. The foregoing indemnity shall survive the payment of the Obligations and the termination or non-renewal of this Agreement. 9.5 Insurance. Each Borrower shall, at all times, maintain with financially sound and reputable insurers insurance with respect to the Collateral against loss or damage and all other insurance of the kinds and in the amounts customarily insured against or carried by corporations of established reputation engaged in the same or similar businesses and similarly situated. Said policies of insurance shall be satisfactory to Lender as to form, amount and insurer. Each 37 43 Borrower shall furnish certificates, policies or endorsements to Lender as Lender shall require as proof of such insurance, and, if any Borrower fails to do so, Lender is authorized, but not required, to obtain such insurance at the expense of such Borrower. All policies shall provide for at least thirty (30) days prior written notice to Lender of any cancellation or reduction of coverage and that Lender may act as attorney for each Borrower in obtaining, and at any time an Event of Default exists or has occurred and is continuing, adjusting, settling, amending and canceling such insurance. Each Borrower shall cause Lender to be named as a loss payee and an additional insured (but without any liability for any premiums) under such insurance policies and each Borrower shall obtain non-contributory lender's loss payable endorsements to all insurance policies in form and substance satisfactory to Lender. Such lender's loss payable endorsements shall specify that the proceeds of such insurance shall be payable to Lender as its interests may appear and further specify that Lender shall be paid regardless of any act or omission by any Borrower or any of its affiliates. At its option, Lender may apply any insurance proceeds received by Lender at any time to the cost of repairs or replacement of Collateral and/or to payment of the Obligations, whether or not then due, in any order and in such manner as Lender may determine or hold such proceeds as cash collateral for the Obligations. 9.6 Financial Statements and Other Information. (a) Each Borrower shall keep proper books and records in which true and complete entries shall be made of all dealings or transactions of or in relation to the Collateral and the business of such Borrower and its subsidiaries (if any) in accordance with GAAP and each Borrower shall furnish or cause to be furnished to Lender: (i) within thirty (30) days after the end of each fiscal month, (A) monthly unaudited consolidated financial statements of such Borrower, and, if such Borrower has any subsidiaries, unaudited consolidating financial statements of such Borrower and its subsidiaries (including in each case balance sheets and statements of income and loss), all in detail satisfactory to Lender, fairly presenting the financial position and the results of the operations of such Borrower and its subsidiaries as of the end of and through such fiscal month and (B) a monthly report setting forth the amount of any transfer of money or property to another Borrower during the preceding fiscal month; (ii) within thirty (30) days after the end of each fiscal quarter, a consolidated balance sheet of such Borrower, which shall reflect in each case, without limitation, any outstanding indebtedness owed to or owing by another Borrower, all in detail satisfactory of Lender, fairly presenting the financial position and the results of the operations of such Borrower as of the end of and for such fiscal quarter; and (iii) within ninety (90) days after the end of each fiscal year, (A) audited consolidated financial statements of such Borrower (including in each case balance sheets and statements of income and loss), and the accompanying notes thereto, all in detail satisfactory to Lender, fairly presenting the financial position and the results of the operations of such Borrower as of the end of and for such fiscal year, together with the opinion of independent certified public accountants, which accountants shall be an independent accounting firm selected by Borrowers and reasonably acceptable to Lender, that such financial statements have been prepared in accordance with GAAP, and present fairly the results of operations and financial condition of such Borrower and its subsidiaries as of the end of and for the fiscal year then ended and (B) if such Borrower has any subsidiaries, unaudited consolidating financial statements of such Borrower and its subsidiaries (including in each case balance sheets and statements of income and loss), all in detail satisfactory to Lender, fairly presenting the financial position and the 38 44 results of the operations of such Borrower and its subsidiaries as of the end of and for such fiscal year. (b) Borrowers shall promptly notify Lender in writing of the details of (i) any loss, damage, investigation, action, suit, proceeding or claim relating to the Collateral or any other property which is security for the Obligations or which would result in any material adverse change in any Borrower's business, properties, assets, goodwill or condition, financial or otherwise and (ii) the occurrence of any Event of Default or event which, with the passage of time or giving of notice or both, would constitute an Event of Default. (c) Each Borrower shall promptly after the sending or filing thereof furnish or cause to be furnished to Lender copies of all financial reports which such Borrower sends to its stockholders generally and copies of all reports and registration statements which such Borrower files with the Securities and Exchange Commission, any national securities exchange or the National Association of Securities Dealers, Inc. (d) Each Borrower shall furnish or cause to be furnished to Lender such budgets, forecasts, projections and other information in respect of the Collateral and the business of such Borrower, as Lender may, from time to time, reasonably request. Lender is hereby authorized to deliver a copy of any financial statement or any other information relating to the business of any Borrower to any court or other government agency or to any Eligible Assignee or prospective Eligible Assignee. Each Borrower hereby irrevocably authorizes and directs all accountants or auditors to deliver to Lender upon Lender's request to such Borrower, at such Borrower's expense, copies of the financial statements of such Borrower and any reports or management letters prepared by such accountants or auditors on behalf of such Borrower and to disclose to Lender such information as they may have regarding the business of such Borrower so long as such disclosure does not impair such Borrower's legal right to keep such report or information privileged between such accountants or auditors and such Borrower. Any documents, schedules, invoices or other papers delivered to Lender may be destroyed or otherwise disposed of by Lender one (1) year after the same are delivered to Lender, except as otherwise designated by Borrower to Lender in writing. 9.7 Sale of Assets, Consolidation, Merger, Dissolution, Etc. No Borrower shall, directly or indirectly, (a) merge into or with or consolidate with any other Person or permit any other Person to merge into or with or consolidate with it, or (b) sell, assign, lease, transfer, abandon or otherwise dispose of any stock (except for stock issued pursuant to an employee stock option program of such Borrower) or indebtedness to any other Person or any of its assets to any other Person (except for (i) sales of its Inventory in the ordinary course of business and (ii) the disposition of its worn-out or obsolete Equipment or Equipment no longer used in the business of such Borrower so long as (A) if an Event of Default exists or has occurred and is continuing, any proceeds are paid to Lender and (B) such sales do not involve Equipment having an aggregate fair market value in excess of One Hundred Fifty Thousand Dollars ($150,000) for all such Equipment of all Borrowers disposed of in any fiscal year of Borrowers); provided, however, upon Lender's prior written consent, which shall not be unreasonably withheld, a Borrower may assign on a temporary basis its rights to certain trademarks to a third party for the sole purpose of pursuing litigation involving such trademarks, provided, that such trademarks shall be reassigned to such Borrower immediately upon the conclusion of such litigation, or (c) 39 45 form or acquire any subsidiaries, or (d) wind up, liquidate or dissolve or (e) agree to do any of the foregoing. 9.8 Encumbrances. No Borrower shall create, incur, assume or suffer to exist any security interest, mortgage, pledge, lien, charge or other encumbrance of any nature whatsoever on any of its assets or properties, including, without limitation, the Collateral, except: (a) the liens and security interests of Lender; (b) liens securing the payment of taxes, either not yet overdue or the validity of which are being contested in good faith by appropriate proceedings diligently pursued and available to such Borrower and with respect to which adequate reserves have been set aside on its books; (c) security deposits in the ordinary course of its business; (d) non-consensual statutory liens (other than liens securing the payment of taxes) arising in the ordinary course of such Borrower's business to the extent: (i) such liens secure indebtedness which is not overdue; or (ii) such liens secure indebtedness relating to claims or liabilities which are fully insured and being defended at the sole cost and expense and at the sole risk of the insurer (subject to applicable deductibles) or being contested in good faith by appropriate proceedings diligently pursued and available to such Borrower, in each case prior to the commencement of foreclosure or other similar proceedings and with respect to which adequate reserves have been set aside on its books; (e) zoning restrictions, easements, licenses, covenants and other restrictions affecting the use of real property which do not interfere in any material respect with the use of such real property or ordinary conduct of the business of such Borrower as presently conducted thereon or materially impair the value of the real property which may be subject thereto; (f) purchase money security interests in Equipment (including capital leases) and purchase money mortgages on real estate not so long as such security interests and mortgages do not apply to any property of such Borrower other than the Equipment or real estate so acquired, and the indebtedness secured thereby does not exceed the cost of the Equipment or real estate so acquired, as the case may be; and (g) the security interests and liens set forth on Schedule 8.4 hereto. 9.9 Indebtedness. No Borrower shall incur, create, assume, become or be liable in any manner with respect to, or permit to exist, any obligations or indebtedness, except: (a) the Obligations; (b) trade obligations and normal accruals in the ordinary course of its business not yet due and payable, or with respect to which such Borrower is contesting in good faith the amount or validity thereof by appropriate proceedings diligently pursued and available to such Borrower, and with respect to which adequate reserves have been set aside on its books; 40 46 (c) purchase money indebtedness (including capital leases) to the extent not incurred or secured by liens (including capital leases) in violation of any other provision of this Agreement; (d) obligations or indebtedness owed to another Borrower; provided, however, such obligations or indebtedness shall be (i) disclosed in the financial statements provided to Lender pursuant to Section 9.6 hereof, (ii) limited to amounts which would not render such Borrower insolvent, unable to pay its debts as they mature or to have insufficient capital to carry on its business, and (iii) on a basis subordinate to all other indebtedness of such Borrower, and provided, further, however, after giving effect to such obligations or indebtedness, no Event of Default, or event which with notice or passage of time or both, would constitute an Event of Default, shall exist or have occurred and be continuing; and (e) obligations or indebtedness set forth on the Information Certificate of such Borrower; provided, that, (i) such Borrower may only make regularly scheduled payments of principal and interest in respect of such indebtedness in accordance with the terms of the agreement or instrument evidencing or giving rise to such indebtedness as in effect on the date hereof, (ii) such Borrower shall not, directly or indirectly, (A) amend, modify, alter or change the terms of such indebtedness or any agreement, document or instrument related thereto as in effect on the date hereof, or (B) except as otherwise permitted under this Agreement, redeem, retire, defease, purchase or otherwise acquire such indebtedness, or set aside or otherwise deposit or invest any sums for such purpose, and (iii) such Borrower shall furnish to Lender all notices or demands in connection with such indebtedness either received by such Borrower or on its behalf, promptly after the receipt thereof, or sent by such Borrower or on its behalf, concurrently with the sending thereof, as the case may be. 9.10 Loans, Investments, Guarantees, Etc. No Borrower shall, directly or indirectly, make any loans or advance money or property to any Person, or invest in (by capital contribution, dividend or otherwise) or purchase or repurchase the stock or indebtedness or all or a substantial part of the assets or property of any Person, or guarantee, assume, endorse, or otherwise become responsible for (directly or indirectly) the indebtedness, performance, obligations or dividends of any Person or agree to do any of the foregoing, except: (a) the guarantee of another Borrower's Obligations hereunder to the extent permitted under Section 13.11 hereof; (b) loans or advances of money or property to another Borrower or an Obligor; provided, however, such loans or advances shall be (i) disclosed in the financial statements provided to Lender pursuant to Section 9.6 hereof, (ii) limited to amounts which would not render the Borrower or Obligor receiving such loans or advances insolvent, unable to pay its debts as they mature or to have insufficient capital to carry on its business, (iii) on a basis subordinate to all other indebtedness of the other Borrower or Obligor receiving such loans or advances; (iv) with respect to advances to Holbrook, Deckers Japan, Deckers Europe, Phillipsburg and Picante, limited to an aggregate amount not to exceed Thirty Million Dollars ($30,000,000) at any time; provided, further, however, after giving effect to such loans or advances of money or property, no Event of Default, or event which with notice or passage of 41 47 time or both, would constitute an Event of Default, shall exist or have occurred and be continuing; (c) the endorsement of instruments for collection or deposit in the ordinary course of its business; (d) investments in: (i) short-term direct obligations of the United States Government; (ii) negotiable certificates of deposit issued by any bank satisfactory to Lender, payable to the order of such Borrower or to bearer and delivered to Lender; and (iii) commercial paper rated A1 or P1; provided, that, as to any of the foregoing, unless waived in writing by Lender, each Borrower shall take such actions as are deemed necessary by Lender to perfect the security interest of Lender in such investments; (e) the repurchase of its own stock, provided, that, after giving effect to such repurchase, (i) no Event of Default, or event which with notice or passage of time or both, would constitute an Event of Default, shall exist or have occurred and be continuing and (ii) Excess Availability shall not be less than One Hundred Thousand Dollars ($100,000) in the aggregate; and (f) the guarantees set forth in the Information Certificate of such Borrower. 9.11 Dividends and Redemptions. No Borrower shall, directly or indirectly, declare or pay any dividends on account of any shares of any class of capital stock of such Borrower now or hereafter outstanding other than dividends paid in capital stock, or set aside or otherwise deposit or invest any sums for such purpose, or redeem, retire, defease, purchase or otherwise acquire any shares of any class of capital stock (or set aside or otherwise deposit or invest any sums for such purpose) for any consideration other than common stock and except as set forth in Section 9.10(e) hereof or apply or set apart any sum, or make any other distribution (by reduction of capital or otherwise) in respect of any such shares or agree to do any of the foregoing. 9.12 Transactions with Affiliates. No Borrower shall enter into any transaction for the purchase, sale or exchange of property or the rendering of any service to or by any affiliate, except in the ordinary course of and pursuant to the reasonable requirements of such Borrower's business and upon fair and reasonable terms no less favorable to such Borrower than such Borrower would obtain in a comparable arm's length transaction with an unaffiliated person. 9.13 Additional Bank Accounts. No Borrower shall, directly or indirectly, open, establish or maintain any deposit account, investment account or any other account with any bank or other financial institution, other than the Blocked Accounts and the accounts set forth in Schedule 8.8 hereto, except: (a) as to any new or additional Blocked Accounts and other such new or additional accounts which contain any Collateral or proceeds thereof, with the prior written consent of Lender and subject to such conditions thereto as Lender may establish and (b) as to any accounts used by such Borrower to make payments of payroll, taxes or other obligations to third parties, after prior written notice to Lender. 42 48 9.14 Compliance with ERISA. (a) No Borrower shall with respect to any "employee pension benefit plans" maintained by such Borrower or any of its ERISA Affiliates: (i) terminate any of such employee pension benefit plans so as to incur any liability to the Pension Benefit Guaranty Corporation established pursuant to ERISA; (ii) allow or suffer to exist any prohibited transaction involving any of such employee pension benefit plans or any trust created thereunder which would subject any Borrower or such ERISA Affiliate to a tax or penalty or other liability on prohibited transactions imposed under Section 4975 of the Code or ERISA; (iii) fail to pay to any such employee pension benefit plan any contribution which it is obligated to pay under Section 302 of ERISA, Section 412 of the Code or the terms of such plan; (iv) allow or suffer to exist any accumulated funding deficiency, whether or not waived, with respect to any such employee pension benefit plan; (v) allow or suffer to exist any occurrence of a reportable event or any other event or condition which presents a material risk of termination by the Pension Benefit Guaranty Corporation of any such employee pension benefit plan that is a single employer plan, which termination could result in any liability to the Pension Benefit Guaranty Corporation; or (vi) incur any withdrawal liability with respect to any multiemployer pension plan. (b) As used in this Section 9.14, the term "employee pension benefit plans," "employee benefit plans", "accumulated funding deficiency" and "reportable event" shall have the respective meanings assigned to them in ERISA, and the term "prohibited transaction" shall have the meaning assigned to it in Section 4975 of the Code and ERISA. 9.15 Year 2000 Compliance. Each Borrower agrees to perform all acts reasonably necessary to ensure that: (a) each Borrower and any business in which such Borrower holds a substantial interest; and (b) on a best efforts basis by such Borrower, that all customers, suppliers and vendors that are material to such Borrower's business, become Year 2000 Compliant in a timely manner. Such acts shall include, without limitation, performing a comprehensive review and assessment of all of each Borrower's systems and adopting a detailed plan, with itemized budget, for the remediation, monitoring and testing of such systems. As used herein, "Year 2000 Compliant" shall mean, in regard to any entity, that all software, hardware, firmware, equipment, goods or systems utilized by or material to the business operations or financial condition of such entity, will properly perform date sensitive functions before, during and after the year 2000. Borrowers shall, immediately upon request, provide to Lender such certifications or other evidence of each Borrower's compliance with the terms hereof as Lender may from time to time reasonably require. 9.16 Adjusted Net Worth. Borrowers' Adjusted Net Worth, on a consolidated basis, shall not, as of the end of each calendar quarter, be less than Thirty Million Dollars ($30,000,000). 9.17 Amendments to Teva License Agreements. Without the prior written consent of Lender, which consent shall not be unreasonably withheld, no Borrower shall enter into or consent to any amendment, adjustment and/or modification to the Teva License Agreements which would in Lender's determination (a) adversely affect the economic terms of the Teva 43 49 License Agreements for Borrowers, (b) shorten the duration or term of the Teva License Agreements, (c) adversely affect the material benefits of any Borrower under the Teva License Agreements; or (d) amend, modify or change in any way paragraph 4 of that certain Letter Agreement dated November 4, 1994 between Mark Thatcher and DOC, granting Lender the right to sell any Inventory subject to the Teva License Agreements. 9.18 TEVA Acknowledgement. As soon as practicable, Borrowers shall use their reasonable best efforts to deliver to Lender an acknowledgment, in form and substance satisfactory to Lender, by Mark Thatcher, an individual, of Lender's right to dispose of any Inventory subject to the Teva License Agreements. 9.19 Costs and Expenses. Each Borrower shall pay to Lender on demand all reasonable costs, expenses, filing fees and taxes paid or payable in connection with the preparation, negotiation, execution, delivery, recording, administration, collection, liquidation, enforcement and defense of the Obligations, Lender's rights in the Collateral, this Agreement, the other Financing Agreements and all other documents related hereto or thereto, including any amendments, supplements or consents which may hereafter be contemplated (whether or not executed) or entered into in respect hereof and thereof, including, but not limited to: (a) all costs and expenses of filing or recording (including Uniform Commercial Code financing statement filing taxes and fees, documentary taxes, intangibles taxes and mortgage recording taxes and fees, if applicable); (b) all reasonable costs and expenses and fees for title insurance and other insurance premiums, environmental audits, surveys, assessments, engineering reports and inspections, appraisal fees and search fees; (c) all reasonable costs and expenses of remitting loan proceeds, collecting checks and other items of payment, and establishing and maintaining the Blocked Accounts, together with Lender's customary charges and fees with respect thereto; (d) all charges, fees or expenses charged by any bank or issuer in connection with the Letter of Credit Accommodations; (e) all reasonable costs and expenses of preserving and protecting the Collateral; (f) all reasonable costs and expenses paid or incurred in connection with obtaining payment of the Obligations, enforcing the security interests and liens of Lender, selling or otherwise realizing upon the Collateral, and otherwise enforcing the provisions of this Agreement and the other Financing Agreements or defending any claims made or threatened against Lender arising out of the transactions contemplated hereby and thereby (including, without limitation, preparations for and consultations concerning any such matters); (g) all reasonable out-of-pocket expenses and costs incurred by Lender's examiners in the conduct of their periodic field examinations of the Collateral and any Borrower's operations, plus a per diem charge at the rate of Six Hundred Fifty Dollars ($650) per person per day for Lender's examiners in the field; and 44 50 (h) the reasonable fees and disbursements of counsel (including legal assistants) to Lender in connection with any of the foregoing. 9.20 Further Assurances. At the request of Lender at any time and from time to time, each Borrower shall, at its expense, duly execute and deliver, or cause to be duly executed and delivered, such further agreements, documents and instruments, and do or cause to be done such further acts as may be necessary or proper to evidence, perfect, maintain and enforce the security interests and the priority thereof in the Collateral and to otherwise effectuate the provisions or purposes of this Agreement or any of the other Financing Agreements. Lender may at any time and from time to time request a certificate from an officer of any Borrower representing on behalf of such Borrower that all conditions precedent to the making of Loans and providing Letter of Credit Accommodations contained herein are satisfied. In the event of such request by Lender, Lender may, at its option, cease to make any further Loans or provide any further Letter of Credit Accommodations until Lender has received such certificate and, in addition, Lender has determined that such conditions are satisfied. Where permitted by law, each Borrower hereby authorizes Lender to execute and file one or more UCC financing statements signed only by Lender. SECTION 10. EVENTS OF DEFAULT AND REMEDIES. 10.1 Events of Default. The occurrence or existence of any one or more of the following events are referred to herein individually as an "Event of Default," and collectively as "Events of Default": (a) any Borrower fails to pay when due any of the Obligations; (b) any Borrower fails to perform any of the terms, covenants, conditions or provisions contained in this Agreement or any of the other Financing Agreements and such failure shall continue for five (5) Business Days; provided; that, such five (5) Business Day period shall not apply in the case of: (i) any failure to observe any such term, covenant, condition or provision which is not capable of being cured at all or within such five (5) Business Day period or which has previously been the subject of a prior failure or (ii) an intentional breach by such Borrower of such term, covenant, condition or provision; (c) any representation, warranty or statement of fact made by any Borrower to Lender in this Agreement, the other Financing Agreements or any other agreement, schedule, confirmatory assignment or otherwise shall when made or deemed made be false or misleading in any material respect; (d) any Obligor revokes, terminates or fails to perform any of the terms, covenants, conditions or provisions of any guarantee, endorsement or other agreement of such party in favor of Lender and such failure shall continue for five (5) Business Days; provided, that, such five (5) Business Day period shall not apply in the case of: (i) any failure to observe any such term, covenant, condition or provision which is not capable of being cured at all or within such five (5) Business Day period or which has previously been the subject of a prior failure or (ii) an intentional breach by such Obligor of such term, covenant, condition or provision; 45 51 (e) any judgment for the payment of money is rendered against any Borrower in excess of One Hundred Thousand Dollars ($100,000) in any one case or in excess of Two Hundred Fifty Thousand Dollars ($250,000) in the aggregate with respect to any one Borrower and shall remain undischarged or unvacated for a period in excess of forty-five (45) days or execution shall at any time not be effectively stayed, or any material judgment other than for the payment of money, or injunction, attachment, garnishment or execution is rendered against any Borrower or any of their assets; (f) any Borrower dissolves or suspends or discontinues doing business or without the prior written consent of Lender, which consent shall not be unreasonably withheld, any Obligor if such Obligor is in possession of any assets of any Borrower or is indebted to any Borrower, dissolves or suspends or discontinues doing business; (g) any Borrower becomes insolvent (however defined or evidenced), makes an assignment for the benefit of creditors, makes or sends notice of a bulk transfer, or without the prior written consent of Lender, which consent shall not be unreasonably withheld, any Obligor if such Obligor is in possession of any assets of any Borrower or is indebted to any Borrower becomes insolvent (however defined or evidenced), makes an assignment for the benefit of creditors, makes or sends notice of a bulk transfer; (h) a case or proceeding under the bankruptcy laws of the United States of America now or hereafter in effect or under any insolvency, reorganization, receivership, readjustment of debt, dissolution or liquidation law or statute of any jurisdiction now or hereafter in effect (whether at law or in equity) is filed against any Borrower, or all or any part of its properties and such petition or application is not dismissed within thirty (30) days after the date of its filing or any such Borrower shall file any answer admitting or not contesting such petition or application or indicates its consent to, acquiescence in or approval of, any such action or proceeding or the relief requested is granted sooner; (i) without the prior written consent of Lender, which consent shall not be unreasonably withheld, a case or proceeding under the bankruptcy laws of the United States of America now or hereafter in effect or under any insolvency, reorganization, receivership, readjustment of debt, dissolution or liquidation law or statute of any jurisdiction now or hereafter in effect (whether at law or in equity) is filed against any Obligor if such Obligor is in possession of any assets of any Borrower or is indebted to any Borrower, or all or any part of its properties and such petition or application is not dismissed within thirty (30) days after the date of its filing or any such Obligor shall file any answer admitting or not contesting such petition or application or indicates its consent to, acquiescence in or approval of, any such action or proceeding or the relief requested is granted sooner; (j) a case or proceeding under the bankruptcy laws of the United States of America now or hereafter in effect or under any insolvency, reorganization, receivership, readjustment of debt, dissolution or liquidation law or statute of any jurisdiction now or hereafter in effect (whether at a law or equity) is filed by any Borrower, or for all or any part of its property or without the prior written consent of Lender, which consent shall not be unreasonably withheld, a case or proceeding under the bankruptcy laws of the United States of America now or hereafter in effect or under any insolvency, reorganization, receivership, readjustment of debt, 46 52 dissolution or liquidation law or statute of any jurisdiction now or hereafter in effect (whether at a law or equity) is filed by any Obligor if such Obligor is in possession of any assets of any Borrower or is indebted to any Borrower, or for all or any part of its property; (k) any default by any Borrower under any agreement, document or instrument relating to any indebtedness for borrowed money owing to any person other than Lender, or any capitalized lease obligations, contingent indebtedness in connection with any guarantee, letter of credit, indemnity or similar type of instrument in favor of any person other than Lender, in any case in an amount in excess of One Hundred Thousand Dollars ($100,000), which default continues for more than the applicable cure period, if any, with respect thereto, or any default by any Borrower under any material contract, lease, license or other obligation to any person other than Lender, including without limitation, the Teva License Agreement, which default continues for more than the applicable cure period, if any, with respect thereto; (l) Douglas Otto, an individual, ceases to be the largest shareholder of DOC or without the prior written consent of Lender, DOCI, SSI, or UHI ceases to be wholly owned subsidiaries of DOC; (m) the indictment or threatened indictment of any Borrower under any criminal statute, or the commencement or threatened commencement of criminal or civil proceedings against any Borrower, pursuant to which statute or proceedings the penalties or remedies sought or available include forfeiture of any of the property of such Borrower; (n) there shall be a material adverse change in the business, assets or prospects of any Borrower after the date hereof; or (o) there shall be an event of default under any of the other Financing Agreements. 10.2 Remedies. (a) At any time an Event of Default exists or has occurred and is continuing, Lender shall have all rights and remedies provided in this Agreement, the other Financing Agreements, the California Uniform Commercial Code, as the same now exists or may from time to time hereafter be amended, modified, recodified or supplemented, and other applicable law, all of which rights and remedies may be exercised without notice to or consent by any Borrower or Obligor, except as such notice or consent is expressly provided for hereunder or required by applicable law. All rights, remedies and powers granted to Lender hereunder, under any of the other Financing Agreements, the Uniform Commercial Code or other applicable law, are cumulative, not exclusive and enforceable, in Lender's discretion, alternatively, successively, or concurrently on any one or more occasions, and shall include, without limitation, the right to apply to a court of equity for an injunction to restrain a breach or threatened breach by any Borrower of this Agreement or any of the other Financing Agreements. Lender may, at any time or times, proceed directly against any Borrower or Obligor to collect the Obligations without prior recourse to the Collateral. (b) Without limiting the foregoing, at any time an Event of Default exists or has occurred and is continuing, Lender may, in its discretion and without limitation, (i) 47 53 accelerate the payment of all Obligations and demand immediate payment thereof to Lender (provided, that, upon the occurrence of any Event of Default described in Sections 10.1(h) and 10.1(i), all Obligations shall automatically become immediately due and payable), (ii) with or without judicial process or the aid or assistance of others, enter upon any premises on or in which any of the Collateral may be located and take possession of the Collateral or complete processing, manufacturing and repair of all or any portion of the Collateral, (iii) require any Borrower, at such Borrower's expense, to assemble and make available to Lender any part or all of the Collateral at any place and time designated by Lender, (iv) collect, foreclose, receive, appropriate, setoff and realize upon any and all Collateral, (v) remove any or all of the Collateral from any premises on or in which the same may be located for the purpose of effecting the sale, foreclosure or other disposition thereof or for any other purpose, (vi) sell, lease, transfer, assign, deliver or otherwise dispose of any and all Collateral (including, without limitation, entering into contracts with respect thereto, public or private sales at any exchange, broker's board, at any office of Lender or elsewhere) at such prices or terms as Lender may deem reasonable, for cash, upon credit or for future delivery, with the Lender having the right to purchase the whole or any part of the Collateral at any such public sale, all of the foregoing being free from any right or equity of redemption of any Borrower, which right or equity of redemption is hereby expressly waived and released by each Borrower and/or (vii) terminate this Agreement. If any of the Collateral is sold or leased by Lender upon credit terms or for future delivery, the Obligations shall not be reduced as a result thereof until payment therefor is finally collected by Lender. If notice of disposition of Collateral is required by law, five (5) days prior notice by Lender to only the Borrower whose Collateral is to be sold or disposed, designating the time and place of any public sale or the time after which any private sale or other intended disposition of Collateral is to be made, shall be deemed to be reasonable notice thereof and each Borrower waives any other notice. In the event Lender institutes an action to recover any Collateral or seeks recovery of any Collateral by way of prejudgment remedy, each Borrower waives the posting of any bond which might otherwise be required. Each Borrower waives any right to require Lender to marshall the Collateral or proceed among them in any manner. (c) Lender may apply the cash proceeds of Collateral actually received by Lender from any sale, lease, foreclosure or other disposition of the Collateral to payment of the Obligations, in whole or in part and in such order as Lender may elect, whether or not then due. Each Borrower shall remain liable to Lender for the payment of any deficiency with interest at the highest rate provided for herein and all reasonable costs and expenses of collection or enforcement, including reasonable attorneys' fees and legal expenses. Lender may allocate any payments received or amounts realized among the Borrowers in its sole discretion. (d) Without limiting the foregoing, upon the occurrence of an Event of Default or an event which with notice or passage of time or both would constitute an Event of Default, Lender may, at its option, without notice, (i) cease making Loans or arranging Letter of Credit Accommodations or reduce the lending formulas or amounts of Loans and Letter of Credit Accommodations available to any Borrower and/or (ii) terminate any provision of this Agreement providing for any future Loans or Letter of Credit Accommodations to be made by Lender to any Borrower. 48 54 SECTION 11. JURY TRIAL WAIVER; OTHER WAIVERS AND CONSENTS; GOVERNING LAW. 11.1 Governing Law; Choice of Forum; Service of Process; Jury Trial Waiver. (a) The validity, interpretation and enforcement of this Agreement and the other Financing Agreements and any dispute arising out of the relationship between the parties hereto, whether in contract, tort, equity or otherwise, shall be governed by the internal laws of the State of California (without giving effect to principles of conflicts of law). (b) Each Borrower and Lender irrevocably consent and submit to the non-exclusive jurisdiction of the state courts of the County of Los Angeles, State of California and of the United States District Court for the Central District of California and waive any objection based on venue or forum non conveniens with respect to any action instituted therein arising under this Agreement or any of the other Financing Agreements or in any way connected with or related or incidental to the dealings of the parties hereto in respect of this Agreement or any of the other Financing Agreements or the transactions related hereto or thereto, in each case whether now existing or hereafter arising, and whether in contract, tort, equity or otherwise, and agree that any dispute with respect to any such matters shall be heard only in the courts described above (except that Lender shall have the right to bring any action or proceeding against any Borrower or its property in the courts of any other jurisdiction which Lender deems necessary or appropriate in order to realize on the Collateral or to otherwise enforce its rights against such Borrower or its property). (c) Each Borrower and Lender hereby consents that any and all service of process may be made by certified mail (return receipt requested) directed to its address set forth on the signature pages hereof and service so made shall be deemed effective and to be completed five (5) days after the same shall have been so deposited in the U.S. mails. (d) EACH BORROWER AND LENDER EACH HEREBY WAIVES ANY RIGHT TO TRIAL BY JURY OF ANY CLAIM, DEMAND, ACTION OR CAUSE OF ACTION (i) ARISING UNDER THIS AGREEMENT OR ANY OF THE OTHER FINANCING AGREEMENTS OR (ii) IN ANY WAY CONNECTED WITH OR RELATED OR INCIDENTAL TO THE DEALINGS OF THE PARTIES HERETO IN RESPECT OF THIS AGREEMENT OR ANY OF THE OTHER FINANCING AGREEMENTS OR THE TRANSACTIONS RELATED HERETO OR THERETO IN EACH CASE WHETHER NOW EXISTING OR HEREAFTER ARISING, AND WHETHER IN CONTRACT, TORT, EQUITY OR OTHERWISE. EACH BORROWER AND LENDER EACH HEREBY AGREES AND CONSENTS THAT ANY SUCH CLAIM, DEMAND, ACTION OR CAUSE OF ACTION SHALL BE DECIDED BY COURT TRIAL WITHOUT A JURY AND THAT ANY BORROWER OR LENDER MAY FILE AN ORIGINAL COUNTERPART OF A COPY OF THIS AGREEMENT WITH ANY COURT AS WRITTEN EVIDENCE OF THE CONSENT OF THE PARTIES HERETO TO THE WAIVER OF THEIR RIGHT TO TRIAL BY JURY. (e) Lender shall not have any liability to any Borrower (whether in tort, contract, equity or otherwise) for losses suffered by any Borrower in connection with, arising out of, or in any way related to the transactions or relationships contemplated by this Agreement, or 49 55 any act, omission or event occurring in connection herewith, unless it is determined by a final and non-appealable judgment or court order binding on Lender, that the losses were the result of acts or omissions constituting gross negligence or willful misconduct. In any such litigation, Lender shall be entitled to the benefit of the rebuttable presumption that it acted in good faith and with the exercise of ordinary care in the performance by it of the terms of this Agreement. 11.2 Waiver of Notices. Each Borrower hereby expressly waives demand, presentment, protest and notice of protest and notice of dishonor with respect to any and all instruments and commercial paper, included in or evidencing any of the Obligations or the Collateral, and any and all other demands and notices of any kind or nature whatsoever with respect to the Obligations, the Collateral and this Agreement, except such as are expressly provided for herein. No notice to or demand on any Borrower which Lender may elect to give shall entitle such Borrower to any other or further notice or demand in the same, similar or other circumstances. 11.3 Amendments and Waivers. Neither this Agreement nor any provision hereof shall be amended, modified, waived or discharged orally or by course of conduct, but only by a written agreement signed by an authorized officer of Lender. Lender shall not, by any act, delay, omission or otherwise be deemed to have expressly or impliedly waived any of its rights, powers and/or remedies unless such waiver shall be in writing and signed by an authorized officer of Lender. Any such waiver shall be enforceable only to the extent specifically set forth therein. A waiver by Lender of any right, power and/or remedy on any one occasion shall not be construed as a bar to or waiver of any such right, power and/or remedy which Lender would otherwise have on any future occasion, whether similar in kind or otherwise. 11.4 Indemnification. Each Borrower shall indemnify and hold Lender, and its directors, agents, employees and counsel, harmless from and against any and all losses, claims, damages, liabilities, costs or expenses imposed on, incurred by or asserted against any of them in connection with any litigation, investigation, claim or proceeding commenced or threatened related to the negotiation, preparation, execution, delivery, enforcement, performance or administration of this Agreement, any other Financing Agreements, or any undertaking or proceeding related to any of the transactions contemplated hereby or any act, omission, event or transaction related or attendant thereto, including, without limitation, amounts paid in settlement, court costs, and the reasonable fees and expenses of counsel, unless such losses, claims, damages, liabilities, costs or expenses arose from an indemnified party's gross negligence or willful misconduct. To the extent that the undertaking to indemnify, pay and hold harmless set forth in this Section 11.4 may be unenforceable because it violates any law or public policy, each Borrower shall pay the maximum portion which it is permitted to pay under applicable law to Lender in satisfaction of indemnified matters under this Section 11.4. The foregoing indemnity shall survive the payment of the Obligations and the termination or non-renewal of this Agreement. 50 56 SECTION 12. TERM OF AGREEMENT; MISCELLANEOUS. 12.1 Term. (a) This Agreement and the other Financing Agreements shall become effective as of the date set forth on the first page hereof and shall continue in full force and effect for an initial term ending sixty (60) days prior to the expiration date of either Teva License Agreements, whichever date is earlier, provided, however, if the expiration dates of both the Teva License Agreements are extended beyond August 31, 2001 upon terms and conditions acceptable to Lender, then the initial term of this Agreement shall end on the earlier of sixty (60) days preceding the new expiration date of either Teva License Agreements, whichever date is earlier or the date three (3) years from the date hereof (the end of the initial term of this Agreement shall be referred to herein as, the "Renewal Date"). Borrowers (collectively, but not individually) or Lender may terminate this Agreement and the other Financing Agreements effective on the Renewal Date or on the anniversary of the Renewal Date in any year by giving to the other party at least sixty (60) days prior written notice. Borrowers (collectively, but not individually) may terminate this Agreement prior to the end of the then current term, including any renewal term, for any reason upon sixty (60) days prior written notice to Lender, and in such case Borrowers agree to pay to Lender the applicable early termination fee provided for in Section 12.1(c) hereof; provided, however that no such fee shall be payable if this Agreement is so terminated after the third anniversary date of this Agreement. Regardless of the timing of termination, this Agreement and all other Financing Agreements must be terminated simultaneously. Upon the effective date of termination or non-renewal of the Financing Agreements, Borrowers shall pay to Lender, in full, all outstanding and unpaid Obligations and shall furnish cash collateral to Lender in such amounts as Lender determines are reasonably necessary to secure Lender from loss, cost, damage or expense, including reasonable attorneys' fees and legal expenses, in connection with any contingent Obligations, including issued and outstanding Letter of Credit Accommodations and checks or other payments provisionally credited to the Obligations and/or as to which Lender has not yet received final and indefeasible payment. Such cash collateral shall be remitted by wire transfer in Federal funds to such bank account of Lender, as Lender may, in its discretion, designate in writing to Borrowers for such purpose. Interest shall be due until and including the next Business Day, if the amounts so paid by Borrowers to the bank account designated by Lender are received in such bank account later than 10:30 a.m., Los Angeles time. (b) No termination of this Agreement or the other Financing Agreements shall relieve or discharge any Borrower of its respective duties, obligations and covenants under this Agreement or the other Financing Agreements until all Obligations have been fully and finally discharged and paid, and Lender's continuing security interest in the Collateral and the rights and remedies of Lender hereunder, under the other Financing Agreements and applicable law, shall remain in effect until all such Obligations have been fully and finally discharged and paid. (c) If for any reason this Agreement is terminated prior to the end of the then current term of this Agreement, in view of the impracticality and extreme difficulty of 51 57 ascertaining actual damages and by mutual agreement of the parties as to a reasonable calculation of Lender's lost profits as a result thereof, Borrowers agree to pay to Lender, upon the effective date of such termination, an early termination fee in the amount set forth below if such termination is effective in the period indicated:
Amount Period ------ ------ (i) 3% of the Maximum Credit from the date of this Agreement to and including the first anniversary date of this Agreement; (ii) 2% of the Maximum Credit from the date after the first anniversary of this Agreement to and including the second anniversary date of this Agreement; or (iii) 1% of the Maximum Credit from the date after the second anniversary of this Agreement to and including the third anniversary date of this Agreement.
Notwithstanding the foregoing, such early termination fee shall be waived by Lender in the event that at any time after the first anniversary date of this Agreement, the Obligations are satisfied in full with the proceeds of a refinancing provided by First Union National Bank and no Event of Default or event which with notice or passage of time or both would constitute an Event of Default exists or has occurred and is continuing. Such early termination fee shall be presumed to be the amount of damages sustained by Lender as a result of such early termination and each Borrower agrees that it is reasonable under the circumstances currently existing. The early termination fee provided for in this Section 12.1 shall be deemed included in the Obligations. 12.2 Notices. All notices, requests and demands hereunder shall be in writing and (a) made to Lender at its address set forth below and to Borrowers at their respective chief executive offices set forth below, or to such other address as either party may designate by written notice to the other in accordance with this provision, and (b) deemed to have been given or made: if delivered in person, immediately upon delivery; if by telex, telegram or facsimile transmission, immediately upon sending and upon confirmation of receipt; if by nationally recognized overnight courier service with instructions to deliver the next Business Day, one (1) Business Day after sending; and if by certified mail, return receipt requested, five (5) days after mailing. Notice by Lender to one Borrower shall be effective notice to all Borrowers. Lender shall use its best efforts to provide to DOC copies of any notices sent by Lender hereunder to any other Borrower. 12.3 Partial Invalidity. If any provision of this Agreement is held to be invalid or unenforceable, such invalidity or unenforceability shall not invalidate this Agreement as a whole, but this Agreement shall be construed as though it did not contain the particular provision held to 52 58 be invalid or unenforceable and the rights and obligations of the parties shall be construed and enforced only to such extent as shall be permitted by applicable law. 12.4 Successors. This Agreement, the other Financing Agreements and any other document referred to herein or therein shall be binding upon and inure to the benefit of and be enforceable by Lender, each Borrower and their respective successors and assigns, except that no Borrower may assign its rights under this Agreement, the other Financing Agreements and any other document referred to herein or therein without the prior written consent of Lender. Lender may, after notice to Borrowers, assign its rights and delegate its obligations under this Agreement and the other Financing Agreements and further may assign, or sell participations in, all or any part of the Loans, the Letter of Credit Accommodations or any other interest herein to any Eligible Assignee, in which event, the Eligible Assignee shall have, to the extent of such assignment or participation, the same rights and benefits as it would have if it were the Lender hereunder, except as otherwise provided by the terms of such assignment or participation. 12.5 Entire Agreement. This Agreement, the other Financing Agreements, any supplements hereto or thereto, and any instruments or documents delivered or to be delivered in connection herewith or therewith represents the entire agreement and understanding concerning the subject matter hereof and thereof between the parties hereto, and supersede all other prior agreements, understandings, negotiations and discussions, representations, warranties, commitments, proposals, offers and contracts concerning the subject matter hereof, whether oral or written. 12.6 Publicity. Each Borrower consents to Lender publishing a tombstone or similar advertising material, the content of which shall be mutually acceptable to Borrowers and Lender, relating to the financing transaction contemplated by this Agreement. SECTION 13. JOINT AND SEVERAL LIABILITY AND SURETYSHIP WAIVERS. 13.1 Independent Obligations; Subrogation. The obligations of each Borrower, as guarantor of another Borrower's Obligations hereunder are joint and several. To the maximum extent permitted by law, each Borrower hereby waives any claim, right or remedy which either may now have or hereafter acquire against any other Borrower that arises hereunder including, without limitation, any claim, remedy or right of subrogation, reimbursement, exoneration, contribution, indemnification, or participation in any claim, right or remedy of Lender against any Borrower or any Collateral which Lender now has or hereafter acquires, whether or not such claim, right or remedy arises in equity, under contract, by statute, under common law or otherwise until the Obligations are fully paid and finally discharged. In addition, each Borrower hereby waives any right to proceed against the other Borrower, now or hereafter, for contribution, indemnity, reimbursement, and any other suretyship rights and claims, whether direct or indirect, liquidated or contingent, whether arising under express or implied contract or by operation of law, which any Borrower may now have or hereafter have as against the other Borrower with respect to the Obligations until the Obligations are fully paid and finally discharged. Each Borrower also hereby waives any rights of recourse to or with respect to any asset of the other Borrower until the Obligations are fully paid and finally discharged. 53 59 13.2 Authority to Modify Obligations and Security. Each Borrower authorizes Lender, without notice or demand and without affecting any Borrower's liability hereunder, from time to time, whether before or after any notice of termination hereof or before or after any default in respect of the Obligations, to: (i) renew, extend, accelerate, or otherwise change the time for payment of, or otherwise change any other term or condition of, any document or agreement evidencing or relating to any Obligations as such Obligations relate to the other Borrower, including, without limitation, to increase or decrease the rate of interest thereon; (ii) accept, substitute, waive, defease, increase, release, exchange or otherwise alter any Collateral, in whole or in part, securing the other Borrower's Obligations; (iii) apply any and all such Collateral and direct the order or manner of sale thereof as Lender, in its sole discretion, may determine; (iv) deal with the other Borrower as Lender may elect; (v) in Lender's sole discretion, settle, release on terms satisfactory to Lender, or by operation of law or otherwise, compound, compromise, collect or otherwise liquidate any of the other Borrower's Obligations and/or any of the Collateral in any manner, and bid and purchase any of the collateral at any sale thereof; (vi) apply any and all payments or recoveries from the other Borrower as Lender, in its sole discretion, may determine, whether or not such indebtedness relates to the Obligations; all whether such Obligations are secured or unsecured or guaranteed or not guaranteed by others; and (vii) apply any sums realized from Collateral furnished by the other Borrower upon any of its indebtedness or obligations to Lender as Lender, in its sole discretion, may determine, whether or not such indebtedness relates to the Obligations; all without in any way diminishing, releasing or discharging the liability of any Borrower hereunder. 13.3 Waiver of Defenses. Upon an Event of Default by any Borrower in respect of any Obligations, Lender may, at its option and without notice to the Borrowers, proceed directly against any Borrower to collect and recover the full amount of the liability hereunder, or any portion thereof, and each Borrower waives any right to require Lender to: (i) proceed against the other Borrower or any other person whomsoever; (ii) proceed against or exhaust any Collateral given to or held by Lender in connection with the Obligations; (iii) give notice of the terms, time and place of any public or private sale of any of the Collateral except as otherwise provided herein; or (iv) pursue any other remedy in Lender's power whatsoever. A separate action or actions may be brought and prosecuted against any Borrower whether or not action is brought against the other Borrower and whether the other Borrower be joined in any such action or actions; and each Borrower waives the benefit of any statute of limitations affecting the liability hereunder or the enforcement hereof, and agrees that any payment of any Obligations or other act which shall toll any statute of limitations applicable thereto shall similarly operate to toll such statute of limitations applicable to the liability hereunder. 13.4 Exercise of Lender's Rights. Each Borrower hereby authorizes and empowers Lender in its sole discretion, without any notice or demand to such Borrower whatsoever and without affecting the liability of such Borrower hereunder, to exercise any right or remedy which Lender may have available to it against the other Borrower. 13.5 Additional Waivers. Each Borrower waives any defense arising by reason of any disability or other defense of the other Borrower or by reason of the cessation from any cause whatsoever of the liability of the other Borrower or by reason of any act or omission of Lender or others which directly or indirectly results in or aids the discharge or release of the other Borrower or any Obligations or any Collateral by operation of law or otherwise. The Obligations 54 60 shall be enforceable against each Borrower without regard to the validity, regularity or enforceability of any of the Obligations with respect to any of the other Borrower or any of the documents related thereto or any collateral security documents securing any of the Obligations. No exercise by Lender of, and no omission of Lender to exercise, any power or authority recognized herein and no impairment or suspension of any right or remedy of Lender against any Borrower or any Collateral shall in any way suspend, discharge, release, exonerate or otherwise affect any of the Obligations or any Collateral furnished by the Borrowers or give to the Borrowers any right of recourse against Lender. The Borrowers specifically agree that the failure of Lender: (i) to perfect any lien on or security interest in any property heretofore or hereafter given by Borrowers to secure payment of the Obligations, or to record or file any document relating thereto or (ii) to file or enforce a claim against the estate (either in administration, bankruptcy or other proceeding) of any Borrower shall not in any manner whatsoever terminate, diminish, exonerate or otherwise affect the liability of any Borrower hereunder. 13.6 Additional Indebtedness. Additional Obligations may be created from time to time at the request of any Borrower and without further authorization from or notice to any other Borrower even though the borrowing Borrower's financial condition may deteriorate since the date hereof. Each Borrower waives the right, if any, to require Lender to disclose to such Borrower any information it may now have or hereafter acquire concerning the other Borrower's character, credit, Collateral, financial condition or other matters. Each Borrower has established adequate means to obtain from the other Borrower on a continuing basis financial and other information pertaining to such Borrower's business and affairs, and assumes the responsibility for being and keeping informed of the financial and other conditions of the other Borrower and of all circumstances bearing upon the risk of nonpayment of the Obligations which diligent inquiry would reveal. Lender need not inquire into the powers of any of the Borrowers or the authority of any of their respective officers, directors, partners or agents acting or purporting to act in their behalf, and any obligations created in reliance upon the purported exercise of such power or authority is hereby guaranteed. All obligations of Borrowers to Lender heretofore, now or hereafter created shall be deemed to have been granted at Borrowers' special insistence and request and in consideration of and in reliance upon this Agreement. 13.7 Notices, Demands, Etc. Except as expressly provided by this Agreement, Lender shall be under no obligation whatsoever to make or give to any Borrower, and each Borrower hereby waives diligence, all rights of setoff and counterclaim against Lender, all demands, presentments, protests, notices of protests, notices of protests, notices of nonperformance, notices of dishonor, and all other notices of every kind or nature, including notice of the existence, creation or incurring of any new or additional Obligations. 13.8 Subordination. Except as otherwise provided in this Section 13.8, any indebtedness of any Borrower now or hereafter owing to any other Borrower is hereby subordinated to the Obligations, whether heretofore, now or hereafter created, and whether before or after notice of termination hereof, and, following the occurrence and during the continuation of an Event of Default, no Borrower shall, without the prior consent of Lender, pay in whole or in part any of such indebtedness nor will any such Borrower accept any payment of or on account of any such indebtedness at any time while such Borrower remains liable hereunder. At the request of Lender, after the occurrence and during the continuance of an Event 55 61 of Default, each Borrower shall pay to Lender all or any part of such subordinated indebtedness and any amount so paid to Lender at its request shall be applied to payment of the Obligations. Each payment on the indebtedness of any Borrower to the other Borrower received in violation of any of the provisions hereof shall be deemed to have been received by any other Borrower as trustee for Lender and shall be paid over to Lender immediately on account of the Obligations, but without otherwise affecting in any manner any such Borrower's liability under any of the provisions of this Agreement. Each Borrower agrees to file all claims against the other Borrower in any bankruptcy or other proceeding in which the filing of claims is required by law in respect of any indebtedness of the other Borrower to such Borrower, and Lender shall be entitled to all of any such Borrower's rights thereunder. If for any reason any such Borrower fails to file such claim at least thirty (30) days prior to the last date on which such claim should be filed, Lender, as such Borrower's attorney-in-fact, is hereby authorized to do so in Borrowers' name or, in Lender's discretion, to assign such claim to, and cause a proof of claim to be filed in the name of, Lender's nominee. In all such cases, whether in administration, bankruptcy or otherwise, the person or persons authorized to pay such claim shall pay to Lender the full amount payable on the claim in the proceeding, and to the full extent necessary for that purpose any such Borrower hereby assigns to Lender all such Borrower's rights to any payments or distributions to which such Borrower otherwise would be entitled. If the amount so paid is greater than any such Borrower's liability hereunder, Lender will pay the excess amount to the party entitled thereto. 13.9 Revival. If any payments of money or transfers of property made to Lender by any Borrower should for any reason subsequently be declared to be, or in Lender's counsel's good faith opinion be determined to be, fraudulent (within the meaning of any state or federal law relating to fraudulent conveyances), preferential or otherwise voidable or recoverable in whole or in part for any reason (hereinafter collectively called "voidable transfers") under the Bankruptcy Code or any other federal or state law and Lender is required to repay or restore, or in Lender's counsel's opinion may be so liable to repay or restore, any such voidable transfer, or the amount or any portion thereof, then as to any such voidable transfer or the amount repaid or restored and all reasonable costs and expenses (including reasonable attorneys' fees) of Lender related thereto, such Borrower's liability hereunder shall automatically be revived, reinstated and restored and shall exist as though such voidable transfer had never been made to Lender. 13.10 Understanding of Waivers. Each Borrower warrants and agrees that the waivers set forth in this Section 13 are made with full knowledge of their significance and consequences. If any of such waivers are determined to be contrary to any applicable law or public policy, such waivers shall be effective only to the maximum extent permitted by law. 13.11 Limited Liability. The Obligations of each Borrower shall be owed and payable jointly and severally; provided, however, notwithstanding any other provision of this Agreement, at Lender's option and upon Lender's acceleration of the Obligations following an Event of Default, the aggregate liability of each Borrower for Obligations owed by the other Borrowers (exclusive of the Obligations owed by such Borrower directly to Lender which shall be unlimited and not reduced in any way) shall be limited to the respective dollar amount set forth below opposite such Borrower's name: 56 62
Borrower Liability Amount -------- ---------------- Deckers Outdoor Corporation $50,000,000 Deckers Outdoor Corporation International $ 5,000,000 Simple Shoes, Inc. $ 5,000,000 UGG Holdings, Inc. $10,000,000 Heirlooms, Inc. $ 5,000,000;
it being understood that payments and prepayments of the Obligations by another Borrower, any Obligor or any other Person, or the application of any proceeds from foreclosure or other exercise of remedies against any Collateral, for purposes of this Section 13.11, shall be applied by Lender in its sole determination. Lender shall at any time have the right, without notice to any Borrower, to reduce the limitation amount set forth above for any Borrower and each Borrower hereby consents to any such unilateral reduction by Lender at any time. No Borrower may benefit from such limitations set forth herein by Lender except as agreed to by Lender in writing. Such limitations shall not be used by any Borrower as a defense to or limitation of payment or in satisfaction of any Obligation as asserted by Lender to be owed and do not alter, modify or limit the terms of this Agreement except as to the extent as Lender agrees in writing. 57 63 IN WITNESS WHEREOF, Lender and each Borrower have caused this Agreement to be duly executed as of the day and year first above written. LENDER BORROWER CONGRESS FINANCIAL CORPORATION DECKERS OUTDOOR CORPORATION, (WESTERN) a Delaware corporation By: /s/ June M. Cowgill By: /s/ M. Scott Ash ----------------------------- -------------------------------- Name: June M. Cowgill Name: M. Scott Ash ----------------------------- -------------------------------- Title: Vice President Title: ----------------------------- -------------------------------- Address Chief Executive Office 225 South Lake Avenue, Suite 1000 495-A South Fairview Avenue Pasadena, California 91101 Goleta, California 93117 DECKERS OUTDOOR CORPORATION INTERNATIONAL, a Delaware corporation By: /s/ M. Scott Ash -------------------------------- Name: M. Scott Ash -------------------------------- Title: -------------------------------- Chief Executive Office 495-A South Fairview Avenue Goleta, California 93117 58 64 SIMPLE SHOES, INC., a California corporation By: /s/ M. Scott Ash -------------------------------- Name: M. Scott Ash -------------------------------- Title: -------------------------------- Chief Executive Office 495-A South Fairview Avenue Goleta, California 93117 UGG HOLDINGS, INC., a California corporation By: /s/ M. Scott Ash -------------------------------- Name: M. Scott Ash -------------------------------- Title: -------------------------------- Chief Executive Office 495-A South Fairview Avenue Goleta, California 93117 HEIRLOOMS, INC., a California corporation By: /s/ M. Scott Ash -------------------------------- Name: M. Scott Ash -------------------------------- Title: -------------------------------- Chief Executive Office 495-A South Fairview Avenue Goleta, California 93117 59 EX-21.1 3 EXHIBIT 21.1 1 EXHIBIT 21.1 Subsidiaries of the Registrant Sensi, U.S.A., Inc. (California) Simple Shoes, Inc. (California) Deckers, Mexico, Inc. (California) Deckers Baja, S.A. de C.V. (Mexico) Holbrook Limited (Hong Kong) Heirlooms, Inc. (California) Deckers Outdoor Corporation International (Delaware) Phillipsburg Limited (Hong Kong) Picante, S.A. (Guatemala) Ugg Holdings, Inc. (California) Deckers Japan, Inc. (California) Deckers Europe B.V. (The Netherlands)
EX-23.1 4 EXHIBIT 23.1 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT The Board of Directors Deckers Outdoor Corporation: We consent to incorporation by reference in the registration statement on Form S-8 of Deckers Outdoor Corporation of our report dated February 24, 1999, except for the fourth paragraph of note 11, which is as of March 17, 1999, relating to the consolidated balance sheets of Deckers Outdoor Corporation and subsidiaries as of December 31, 1997, and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1998, and all related schedules, which report appears in the December 31, 1998, annual report on Form 10-K of Deckers Outdoor Corporation. KPMG LLP Los Angeles, California March 29, 1999 EX-27 5 FINANCIAL DATA SCHEDULE
5 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 236,000 0 28,384,000 1,204,000 23,665,000 59,309,000 6,336,000 3,342,000 84,373,000 17,174,000 15,199,000 0 0 85,000 51,915,000 84,373,000 102,172,000 102,172,000 65,592,000 65,592,000 0 589,000 1,171,000 (4,118,000) (1,211,000) (2,907,000) 0 0 0 (2,907,000) (0.34) (0.34)
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