Business Combination

9 Months Ended

Sep. 30, 2011

Business Combination

Business Combination

(10) Business Combination

On May 19, 2011, the Company entered into an asset purchase agreement whereby it would acquire substantially all of the assets and assume the related liabilities of Sanuk, an action sport footwear brand rooted in the surf community, known for its original sandals and shoes.  On July 1, 2011, the Company completed the acquisition of the purchased assets and the assumption of the assumed liabilities.  The total purchase price for the assets related to the Sanuk brand was an initial cash payment of approximately $119,800 subject to certain working capital adjustments, which were preliminarily determined to be approximately $6,800 that were paid at closing.  The Company and the sellers of the assets related to the Sanuk brand are in the process of finalizing the balance sheet and working capital as of the closing, which may result in a further adjustment to the preliminary working capital adjustment which was paid at closing.  The purchase price also includes additional participation payments (contingent consideration) over the next five years as follows:

· 2011 EBITDA of the Sanuk brand multiplied by ten, less the closing payment, up to maximum of $30,000;

· 51.8% of the gross profit of the Sanuk brand in 2012, defined as total sales less the cost of sales for the business of the sellers;

· 36.0% of gross profit of the Sanuk brand in 2013;

· 8.0% of the product of gross profit of the Sanuk brand in 2015 multiplied by five.

There is no maximum to the contingent consideration payments for 2012, 2013, and 2015.

The Company acquired the Sanuk brand based upon the belief that Sanuk is a profitable, well-run business with a similar corporate culture, and provides substantial growth opportunities, particularly within the action sports market where it has a large and loyal customer base of active outdoor enthusiasts.  The Sanuk brand complements the Company’s existing brand portfolio with its unique market position through the combination of original and innovative product designs, as well as authentic and irreverent marketing campaigns.  The brand assists in balancing the Company’s existing seasonality, with its largest revenues being generated in the first half of the year.  The Sanuk brand also brings additional distribution channels to the Company, as it sells to hundreds of independent specialty surf and skate shops throughout the US that were not significantly in the Company’s existing customer portfolio.  The acquisition was accounted for as a business combination, and the Sanuk brand is reported as a new reportable segment.

The Company has included the operating results of the Sanuk brand in its condensed consolidated financial statements since the date of acquisition, including worldwide revenue of $15,578 and operating loss of $307 for all distribution channels.  This operating loss includes overhead costs that are excluded from worldwide wholesale segment operating income of $1,459 (see note 8).  The operating loss also included $2,990 of amortization expense on the acquired Sanuk intangibles and $1,389 of expense related to the change in fair value of the Sanuk contingent consideration due to accretion.  For the nine months ended September 30, 2011, the Company incurred approximately $4,000 of transaction costs for the Sanuk acquisition which was included in SG&A expense.

The fair value of the acquired intangible assets and contingent consideration is provisional pending the Company’s final determination of fair value, including the valuation report for those assets and liabilities from a third party valuation expert assisting the Company.  Also, the fair value of the purchase price is provisional pending agreement on the final working capital adjustment.  The fair value of the contingent consideration is based on Level 3 inputs, and further changes in the fair value of the contingent consideration will be recorded through operating income (see note 5).  The Company allocated the excess of the purchase price over the identifiable intangible and net tangible assets to goodwill.  The goodwill arising from the acquisition of the Sanuk brand relates to the projected earnings power over the future.  The goodwill is included in the Sanuk wholesale reportable segment and all of it is expected to be deductible for tax purposes.

The Company used the income approach to value the contingent consideration and identifiable intangible assets.  The contingent consideration used a discounted cash flow method with a discount rate of 5.0% in 2011 and 7.0% thereafter.  The following table summarizes the methods used under the income approach for the identifiable intangible assets and their corresponding discount rates and royalty rates, where applicable:

Identifiable intangible asset	Method	Discount Rate		Royalty Rate
US tradenames	Relief from royalty	15.0	%	5.0	%
International tradenames	Relief from royalty	17.0	%	5.0	%
Customer relationships	Excess earnings	15.5	%
International distributor relationships	Lost profits	17.5	%
US non-compete agreements	Lost profits	15.5	%
International non-compete agreements	Lost profits	17.5	%
Patents	Relief from royalty	16.5	%	3.0	%
US backlog	Excess earnings	14.0	%
International backlog	Excess earnings	16.0	%

The amortizable intangible assets are being amortized straight-line over their estimated useful lives, with the exception of the customer relationships, which are being amortized on an accelerated basis based on their aggregate projected after tax undiscounted cash flows.  The following table summarizes the consideration paid and the amounts of estimated fair value of the assets acquired and the liabilities assumed at the acquisition date:

				Estimated
	Estimated			Useful
	Fair Value			Life (Years)
Consideration
Cash paid	$	126,615
Estimated working capital adjustment	(4,091		)
Contingent consideration arrangement	84,300
Total consideration transferred	$	206,824
Recognized amounts of identifiable assets acquired and liabilities assumed:
Trade accounts receivable, net of allowances of $1,130	$	12,809
Inventories	7,545
Other current assets	367
Trade accounts payable	(5,590		)
Other liabilities	(507		)
Net tangible assets acquired	$	14,624
Identifiable intangible assets:
Tradenames	$	47,200		20
Customer relationships	21,300			10
International distributor relationships	800			2
Non-compete agreements	5,300			5
Patents	6,600			14
Backlog	1,830			1
Goodwill	109,170			Non-amortizable
Total purchase price	$	206,824

The following table presents the unaudited pro forma results of the Company for the three and nine months ended September 30, 2011 and September 30, 2010 as if the acquisition of the Sanuk brand had occurred on January 1, 2010.  These results are not intended to reflect the actual operations of the Company had the acquisition occurred on January 1, 2010.  Acquisition transaction costs that were incurred in the three months ended September 30, 2011 are included in the pro forma operating income for the nine months ended September 30, 2010 in the table below.  Transaction costs that were incurred prior to July 1, 2011 have been excluded from the pro forma operating income.

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2011		2010		2011		2010
Revenue	$	414,358	$	288,644	$	815,706	$	609,005
Operating income	$	95,021	$	65,994	$	120,066	$	106,882

The Company entered into a deferred purchase factoring agreement with CIT Commercial Services (CIT) whereby CIT collects the Sanuk accounts receivable at the gross amount of such receivables, less any discounts and allowances.  CIT is responsible for the servicing and administration of accounts receivables collected on behalf of the Company and, to the extent that an eligible account is in default, CIT is required to purchase the account from the Company.  CIT collects amounts due and remits collected funds, less factoring and various administrative fees.  Open receivables collected by CIT totaled approximately $6,100 at September 30, 2011 and are included in accounts receivable in the condensed consolidated balance sheets.  Collection fees for the three and nine months ended September 30, 2011 were $69.