SKECHERS USA INC - Annual Report: 2006 (Form 10-K)
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
| þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2006
OR
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 001-14429
SKECHERS U.S.A., INC.
(Exact Name of Registrant as Specified in Its Charter)
| Delaware | 95-4376145 | |
| (State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) |
| 228 Manhattan Beach Blvd., Manhattan Beach, California | 90266 | |
| (Address of Principal Executive Offices) | (Zip Code) |
Registrant’s telephone number, including area code: (310) 318-3100
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class | Name of Each Exchange on Which Registered |
|
| Class A Common Stock, $0.001 par value | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act:
None
(Title of Class)
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act. Yes o No þ
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. Yeso Noþ
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. Yesþ Noo
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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 the Form 10-K
or any amendment to this Form 10-K.þ
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in
Rule 12b-2 of the Exchange Act.
(Check one): Large accelerated filer o Accelerated filer þ Non-accelerated filer o
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yeso Noþ
As of June 30, 2006, the aggregate market value of the voting and non-voting Class A and Class B
Common Stock held by non-affiliates of the Registrant was approximately $615 million based upon the
closing price of $24.11 of the Class A Common Stock on the New York Stock Exchange on such date.
The number of shares of Class A Common Stock outstanding as of March 1, 2007: 31,674,250.
The number of shares of Class B Common Stock outstanding as of March 1, 2007: 13,768,189.
The number of shares of Class B Common Stock outstanding as of March 1, 2007: 13,768,189.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Definitive Proxy Statement issued in connection with the 2007 Annual
Meeting of the Stockholders of the Registrant are incorporated by reference into Part III.
SKECHERS U.S.A., INC.
TABLE OF CONTENTS TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2006
TABLE OF CONTENTS TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2006
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SPECIAL NOTE ON FORWARD LOOKING STATEMENTS
This annual report on Form 10-K contains forward-looking statements that are made pursuant to
the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including
statements with regards to future revenue, projected 2007 results, earnings, spending, margins,
cash flow, orders, expected timing of shipment of products, inventory levels, future growth or
success in specific countries, categories or market sectors, continued or expected distribution to
specific retailers, liquidity, capital resources and market risk, strategies and objectives.
Forward-looking statements include, without limitation, any statement that may predict, forecast,
indicate or simply state future results, performance or achievements of our company, and can be
identified by the use of forward looking language such as “believe,” “anticipate,” “expect,”
“estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will result,” “could,” “may,”
“might,” or any variations of such words with similar meanings. Any such statements are subject to
risks and uncertainties that could cause actual results to differ materially from those which are
management’s current expectations or forecasts. Such information is subject to the risk that such
expectations or forecasts, or the assumptions underlying such expectations or forecasts, become
inaccurate.
Risk factors include but are not limited to the following: international, national and local
general economic, political and market conditions; intense competition among sellers of footwear
for consumers; changes in fashion trends and consumer demands; popularity of particular designs and
categories of products; the level of sales during the spring, back-to-school and holiday selling
seasons; the ability to anticipate, identify, interpret or forecast changes in fashion trends,
consumer demand for our products and the various market factors described above; the ability of our
company to maintain its brand image; the ability to sustain, manage and forecast our company’s
growth and inventories; the ability to secure and protect trademarks, patents and other
intellectual property; the loss of any significant customers, decreased demand by industry
retailers and cancellation of order commitments; potential disruptions in manufacturing related to
overseas sourcing and concentration of production in China, including, without limitation,
difficulties associated with political instability in China, the occurrence of a natural disaster
or outbreak of a pandemic disease in China, or electrical shortages, labor shortages or work
stoppages that may lead to higher production costs and/or production delays; changes in monetary
controls and valuations of the Yuan by the Chinese government; increased costs of freight and
transportation to meet delivery deadlines; violation of labor or other laws by our independent
contract manufacturers, suppliers or licensees; potential imposition of additional duties, tariffs
or other trade restrictions; business disruptions resulting from natural disasters such as an
earthquake due to the location of our company’s domestic warehouse, headquarters and a substantial
number of retail stores in California; changes in business strategy or development plans; the
ability to attract and retain qualified personnel; the disruption, expense and potential liability
associated with existing or unanticipated future litigation; and other factors referenced or
incorporated by reference in this report and other reports that we filed with the United States
Securities and Exchange Commission (the “SEC”).
The risks included here are not exhaustive. Other sections of this report may include
additional factors that could adversely impact our business and financial performance. Moreover, we
operate in a very competitive and rapidly changing environment. New risk factors emerge from time
to time and we cannot predict all such risk factors, nor can we assess the impact of all such risk
factors on our business or the extent to which any factor, or combination of factors, may cause
actual results to differ materially from those contained in any forward-looking statements. Given
these risks and uncertainties, investors should not place undue reliance on forward-looking
statements as a prediction of actual results. Moreover, reported results shall not be considered
an indication of our company’s future performance. Investors should also be aware that while we
do, from time to time, communicate with securities analysts, we do not disclose any material
non-public information or other confidential commercial information to them. Accordingly,
individuals should not assume that we agree with any statement or report issued by any analyst,
regardless of the content of the report. Thus, to the extent that reports issued by securities
analysts contain any projections, forecasts or opinions, such reports are not our responsibility.
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PART I
ITEM 1. BUSINESS
We were incorporated in California in 1992 and reincorporated in Delaware in 1999. Throughout
this annual report, we refer to Skechers U.S.A., Inc., a Delaware corporation, and its consolidated
subsidiaries as “we,” “us,” “our,” “our company” and “Skechers” unless otherwise indicated. Our
Internet website address is www.skechers.com. Our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, Form 3’s, 4’s and 5’s filed on behalf of
directors, officers and 10% stockholders, and any amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of
charge on our website as soon as reasonably practicable after we electronically file such material
with, or furnish it to, the SEC. You can learn more about us by reviewing such filings on our
website or at the SEC’s website at www.sec.gov.
GENERAL
We design and market Skechers-branded contemporary footwear for men, women and children under
several unique lines. Our footwear reflects a combination of style, quality and value that appeals
to a broad range of consumers. In addition to Skechers-branded lines, we also offer nine uniquely
branded designer, fashion and street-focused footwear lines for men, women and children. These
lines are branded and marketed separately from Skechers and appeal to specific audiences. Our
brands are sold through department stores, specialty stores, athletic retailers, and boutiques as
well as our e-commerce website and our own retail stores. We operate 50 concept stores, 61 factory
outlet stores and 33 warehouse outlet stores in the United States, and 10 concept stores and two
factory outlets internationally. Our objective is to profitably grow our operations worldwide
while leveraging our recognizable Skechers brand through our strong product lines, innovative
advertising and diversified distribution channels.
We seek to offer consumers a vast array of fashionable footwear that satisfies their active,
casual, dress casual and dress footwear needs. Our core consumers are style-conscious 12- to
24-year-old men and women attracted to our youthful brand image and fashion forward designs. Many
of our best-selling and core styles are also developed for children with colors and materials that
reflect a playful image appropriate for this demographic.
We believe that brand recognition is an important element for success in the footwear
business. We have aggressively promoted our brands through comprehensive marketing campaigns for
men, women and children. In 2005, we signed American Idol winner and rising star Carrie Underwood
for our domestic and international print advertising which ran through the end of 2006. During
2006, we continued our celebrity driven ads with the launch of platinum recording artist Ashlee
Simpson as our new Skechers celebrity endorsee. In addition, we launched television sponsor spots
for many of our Skechers branded men’s and women’s lines. Our strategy for kids continues to
primarily focus on television ads. For adults, our strategy continues to focus on print
advertisements in targeted publications, which are supported by sponsorship television spots.
Select fashion brands were also supported by television commercials, including 310 and Marc Ecko
Footwear. For 310 Motoring, we also continued print ads featuring accomplished actor Terrence
Howard, and multi-platinum hip hop recording artist The Game for his signature 310 footwear line.
Our Unltd. by Marc Ecko and Rhino Red Footwear lines are also supported through print ads developed
by Marc Ecko, as well as ads for Zoo York and Avirex. During 2006, we signed Evangeline Lilly, star
of the hit TV show Lost, to support our Michelle K line.
Since we introduced our first line, Skechers USA Sport Utility Footwear, in December 1992, we
have expanded our product offering and grown our net sales while substantially increasing the
breadth and penetration of our account base. Our men’s, women’s and children’s Skechers-branded
product lines benefit from the Skechers reputation for contemporary and progressive styling,
quality, comfort and affordability. Our lines that are not branded with the Skechers name benefit
from our marketing support, quality management and expertise. To promote innovation and brand
relevance, we manage our product lines separately by utilizing dedicated sales and design teams.
Our product lines share back office services in order to limit our operating expenses and fully
utilize our management’s vast experience in the footwear industry.
SKECHERS LINES
Skechers USA. Our Skechers USA category for men and women includes five types of footwear: (i)
Casuals, (ii) Dress Casuals, (iii) Comfort (for men only), (iv) Outdoor (for men only) and (v)
Casual Fusion. This category is generally sold through mid-tier retailers, department stores and
some footwear specialty shops.
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| • | For men, the Casuals category includes “black and brown” boots, shoes and sandals that generally have a rugged urban design — some with industrial-inspired fashion features. This category is defined by the heavy-lugged outsole and value-oriented materials employed in the uppers. For women, the Casuals category includes basic “black and brown” oxfords and slip-ons, lug outsole boots, and casual sandals. The women’s line also uses value-oriented materials, but a growing number of styles may also be designed in leather. We design and price both the men’s and women’s categories to appeal primarily to younger consumers with broad acceptance across age groups. | ||
| • | For men, the Dress Casuals category is comprised of basic “black and brown” men’s shoes that feature shiny leathers and dress details, but may utilize traditional or lugged outsoles as well as value-oriented materials. For women, the Dress Casual line is comprised of trend-influenced stylized boots and shoes, which may include leather uppers, shearling or faux fur lining or trim. | ||
| • | Skechers Comfort is a line of trend-right casuals for men who want all-day comfort without compromising style. Characteristics of the line include comfortable outsoles, cushioned insoles and quality leather uppers. A category with unique features, we market and package the Skechers Comfort styles in a shoe box that is distinct from that of other categories in the Skechers USA line of footwear. | ||
| • | Our Outdoor styles for men primarily consist of hiker-influenced constructions including boots and shoes. While this category includes many technical performance features, we market this category of footwear primarily on the basis of style and comfort. Outsoles generally consist of molded and contoured hardened rubber. Many designs include gussetted tongues to prevent penetration of water and debris, cushioned mid-soles, motion control devices such as heel cups, water-resistant or water-proof construction and materials, and more durable hardware such as metal D-rings instead of eyelets. Uppers are generally constructed of heavily oiled nubuck and full-grain leathers. | ||
| • | Our Casual Fusion line is comprised of low-profile, sport-influenced Euro casuals targeted at trend-conscious young men and women. The outsoles are primarily rubber and adopted from our men’s Sport and women’s Active lines. This collection features leather or nubuck uppers, but may also include mesh, and may be in shades of browns and beiges as well as in black, gray, greens and blues. |
Skechers Sport. Our Skechers Sport footwear for men and women includes: (i) Joggers, Trail
Runners, Sport Hikers, Terrainers, (ii) Performance (for men only), (iii) Street Casuals and (iv)
Sport Sandals. Our Skechers Sport category is distinguished by its technical performance-inspired
looks; however, we generally do not promote the technical performance features of these shoes.
Skechers Sport is typically sold through specialty shoe stores, department stores and athletic
footwear retailers.
| • | Our Jogger, Trail Runner, Sport Hiker and cross trainer-inspired Terrainer designs are lightweight constructions that include cushioned heels, polyurethane midsoles, phylon and other synthetic outsoles, as well as leather or synthetic uppers such as durabuck, cordura and nylon mesh. Careful attention is devoted to the design, pattern and construction of the outsoles, which vary greatly depending on the intended use. This category features earth tones and athletic-inspired hues with contrasting pop colors such as lime green, orange and red in addition to traditional athletic white. | ||
| • | The Performance category is comprised of multi-purpose running shoes that are marketed as men’s lifestyle athletic footwear. Some styles include 3M reflective accents, breathable upper construction, quality leathers, abrasion-resistant toe and heel cap, removable moisture wicking molded EVA sock liner, outsole forefoot flex grooves for improved flexibility, non-marking rubber lugs with impact dispersment technology (IDT), aggressive all terrain traction lugs, external torsion stabilizer and tuned dual-density molded ethyl vinyl acetate (EVA) midsole with pronation control. | ||
| • | Street Casual incorporates lower profiles, classic details and skate, street and fusion influences in a collection of essential, basic casual sneakers. The uppers are designed in leather, suede, nubuck, canvas and/or mesh, and many include vulcanized outsoles. Street Casual is targeted to young consumers, but also appeals to a broader demographic. | ||
| • | Our Sport Sandals are primarily designed from existing Skechers Sport outsoles and may include many of the same sport features as our sneakers with the addition of new technologies geared toward making a comfortable sport sandal. Sport sandals are designed as seasonal footwear for the consumer who already wears our Skechers Sport sneakers. |
Skechers Active. A natural companion to Skechers Sport, Skechers Active has grown from a
casual everyday line into a complete line of fusion and sport fusion sneakers for females of all
ages. Marked by low-profile outsoles, the Active line is available in a multitude of colors as well
as solid white or black, in fabrics, leathers and meshes, and with various closures – traditional
laces, zig-
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zag and cross straps, among others. The line also now includes Mary Janes, sandals and open
back styles. Active sneakers are typically retailed through specialty casual shoe stores and
department stores.
Skechers Collection. The Skechers Collection line is comprised of stylish dress shoes, dress
casual shoes and sandals for the young fashion-forward male consumer. The looks include classic
tailored and fashion-forward square, round and pointed lasts in a variety of styles, such as
bicycle toes, monk straps, wingtips, oxfords, cap toes, demi-boots and boots. The outsoles project
a sleeker profile and may be either leather or man-made. The uppers are quality leathers including
glossy, box, distressed and aniline. Skechers Collection is designed and priced for young men
seeking their first dress or evening shoe. Adding to the line is a reasonably priced assortment of
stylized boots and oxfords designed in Italy. This group is designed for the more style-conscious
male consumer which can be worn at work, on weekends or in clubs. Skechers Collection is sold
through specialty casual shoe stores and department stores.
Skechers
Cali. Launched in 2006, Skechers Cali is new line of sneakers, skimmers and sandals
for young women designed to typify the California lifestyle. The sneakers are designed primarily
with canvas uppers in unique prints, some with patch details, on vulcanized outsoles. The skimmers
and flats are designed with many of the same upper materials and outsoles as the sneakers. The
sandals range from dress casual looks to casual to beach thongs. Skechers Cali is sold through
specialty casual shoe stores and department stores.
Skechers
Work. Expanding on our heritage of cutting-edge utility footwear, Skechers Work
offers a complete line of men’s and women’s sport oxfords, field boots, trail hikers and athletic
shoes. The Skechers Work line includes the (i) Lightweight Alloy Series (“LAS”), (ii) Safety Toe,
(iii) Occupational and (iv) Slip-Resistant categories, which may feature electrical hazard,
electrostatic-dissipative and slip-resistant technologies, as well as breathable, seam-sealed
HydroguardTM waterproof membranes. Our LAS, Safety Toe and Occupational products have
been independently tested and certified to meet ASTM, CSA or SATRA standards, and our
slip-resistant soles have been tested pursuant to the Mark II testing method for slip resistance.
The uppers are in high-quality leather, nubuck, trubuck and durabuck. Constructed on high-abrasion,
long wearing soles, the line is designed for men and women with jobs that require certain safety
requirements. Skechers Work is primarily marketed through business-to-business channels, but is
also available direct-to-consumers and through select department and specialty stores.
| • | Our LAS trail hikers and sport oxfords are exclusively designed for industry professionals who need lightweight, all-day footwear protection. Their innovative design includes a durable, ultra-lightweight safety toe, and high-grade materials for superior strength and comfort. | ||
| • | Our safety toe athletic sneakers, boots, hikers, oxfords and sport oxfords are ideal for environments requiring safety footwear. These durable styles feature breathable lining, oil and abrasion resistant outsoles and safety toe design for optimal protection, all-day comfort and prolonged durability. | ||
| • | Our occupational boots, oxfords and hikers offer versatile features for those requiring utility, safety and comfort features, but who also want style. Designed with an array of textured uppers and colorways, the footwear capitalizes on function and comfort – from breathable lining to contoured insoles and abrasion-resistant outsoles for prolonged wear. | ||
| • | Our slip-resistant boots, athletics, sport and slip-on oxfords, and clogs are ideal for the service industry. These shoes offer comfort and safety in dry or wet conditions by utilizing breathable lining and Mark II-tested slip, oil and abrasion resistant outsoles for optimal safety and reliability. |
Skechers Kids. The Skechers Kids line includes: (i) Skechers Kids, which is a range of
infants, toddlers, boys and girls boots, shoes and sneakers; (ii) S-Lights, which is lighted
footwear for toddlers, boys and girls; (iii) Skechers Cali for Girls, which is trend-inspired
boots, shoes, sandals and dress sneakers; and (iv) Airators by Skechers. Skechers Kids and Skechers
Cali for Girls are comprised primarily of shoes that are designed as “takedowns” of their adult
counterparts, allowing the younger set the opportunity to wear the same popular styles as their
older siblings and schoolmates. This “takedown” strategy maintains the product’s integrity by
offering premium leathers, hardware and outsoles without the attendant costs involved in designing
and developing new products. In addition, we adapt current fashions from our men’s and women’s
lines by modifying designs and choosing colors and materials that are more suitable for the playful
image that we have established in the children’s footwear market. Each Skechers Kids line is
marketed and packaged separately with a distinct shoe box. Skechers Kids shoes are available at
department stores and specialty and athletic retailers.
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| • | The Skechers Kids line includes embellishments or adornments such as fresh colors and fabrics from our Skechers adult shoes. Some of these styles are also adapted for toddlers with softer, more pliable outsoles, and for infants with soft, leather-sole crib shoes. | ||
| • | S-Lights is a line of sneakers and sandals with a combined pattern of lights on the outsole and other areas of the shoes. We market and package the S-Lights styles in a shoe box that is distinct from that of other categories in the Skechers Kids line of footwear. | ||
| • | Skechers Cali for Girls is a line of sneakers, skimmers and sandals for young women designed to typify the California lifestyle. The sneakers are designed primarily with canvas uppers in unique prints, some with patch details, on vulcanized outsoles. The skimmers and flats are designed with many of the same upper materials and outsoles as the sneakers. | ||
| • | Airators by Skechers is a new line of boys sneakers with an air cooling system designed to pump air from the heel through to the toes. |
FASHION AND STREET BRANDS
The Fashion and Street Division and its brands are marketed separately from Skechers.
Unltd. by Marc Ecko and Rhino Red. Unltd. by Marc Ecko is a line of men’s street-inspired
traditional sneakers, fusion sneakers and urban-focused casuals. Rhino Red is a line of women’s
classic and fashion-forward fusion sneakers and Mary Janes for young women, casual and dress causal
heels and boots. Targeted to the street-savvy 18- to 34-year-old consumer, the footwear reflects
Ecko Unltd.’s men’s apparel and the Ecko Red women’s apparel, and effectively utilizes the globally
recognized Rhino logo on the majority of sneakers and casuals. Within the Rhino Red line is the
Red by Marc Ecko offering, a line of designer dress and dress casual footwear for the urban chic
woman. The men’s and women’s footwear collections are designed in leather, canvas, mesh, as well as
other materials. Unltd. by Marc Ecko for boys and Rhino Red for girls sneaker lines primarily
consist of takedowns from the adult Marc Ecko footwear lines with additional or different colorways
geared toward children and that reflect the boys’ and girls’ Ecko Unltd. and Ecko Red clothing.
The licensed brands are sold through select department stores and specialty retailers.
310 Motoring. The 310 Motoring footwear collection for men utilizes top-quality leathers, a
fashion-forward approach to design and comfort, and materials that are derived from 310 Motoring’s
customized cars, including wood burl and carbon fiber. A multi-tiered approach, the line consists
of high-end and high-design boots and shoes, sophisticated driving-inspired shoes and boots, and
stylized athletics. 310 Motoring footwear is available in select department stores, specialty
retailers and urban independents.
In the last week of 2005, we launched multi-platinum hip hop recording artist The Game’s
signature 310 sneaker, known as Hurricane by 310, in select specialty athletic stores in one color
and one style that was followed by five additional colors in 2006. We also introduced the second
Hurricane shoe in the fourth quarter of 2006. Hurricane sneakers are also available for boys and
toddlers.
Michelle K. Targeted toward stylish 18- to 34-year-old women, Michelle K is a signature
designer line of fashion forward fusion sneakers, sporty boots and sandals. The Michelle K line is
marked by a unique combination of materials, textures and colors. The line is available in select
upscale department stores and better boutiques. This brand also includes Michelle K Girl, a
fashion-forward line, primarily comprised of fusion casual sneakers as well as boots and sandals
marked by a unique combination of colors, materials, textures and embellishments.
Mark Nason and Siren by Mark Nason. Mark Nason is a sophisticated and fashion forward footwear
collection, marketed to style-conscious men, designed to complement designer denim and dress casual
wear. Primarily crafted and constructed in Italy, the Mark Nason collection is comprised of classic
and modern boots, shoes and sandals with distinctive profiles and luxurious hand-distressed
leathers. The Mark Nason line distinguishes itself with high quality individual styling and may
utilize unique materials such as premium leathers, etched and tattooed leathers, hand-treated,
hand-scraped and hand-cut leathers, hand-treated leather uppers and soles, snakeskin and eel skin.
Within the Mark Nason line is Lounge by Mark Nason, which is a collection of high-end
sport-influenced casuals. Siren by Mark Nason is the ultimate accompaniment to designer denim and
casual couture for discerning women. The line’s boots are fueled with bold profiles, alluring
details and distinct textures. Handcrafted in Italy, the boots utilize premium leathers,
hand-treated details, leather outsoles, and some may include snakeskin and other exotic materials.
The Mark Nason lines are available in upscale department stores and better boutiques.
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SoHo Lab. Targeting 16- to 34-year-old trend-savvy females, SoHo Lab is designed to be a more
fashionable and sophisticated line and is primarily made from higher quality materials and
leathers. The stylish shoes, boots, heels, flats and sandals are manufactured in Europe and Brazil
as well as China. This line is typically sold through department and specialty stores.
Kitson. Launched in the fourth quarter of 2005, Kitson footwear is a line of fashion sneakers
and sandals targeted to hip and trend-savvy women and girls. A licensed brand, Kitson is an
ultra-hip Los Angeles boutique known for sparking the hottest and newest trends, and where young
Hollywood celebrities come to shop. Kitson goods are must-have merchandise, featured in leading
style and lifestyle magazines. Kitson footwear is available at the Kitson retail boutique, upscale
department stores and other boutiques.
Zoo York. Launched in the fourth quarter of 2006, Zoo York footwear is a line of action
sports and lifestyle footwear for men. Zoo York footwear is designed by Marc Ecko Enterprises and
borrows from the color palette and trends from Zoo York apparel that targets core skaters and those
that embrace skate fashion. Zoo York footwear is available in skate and specialty shops as well as
select athletic and department stores.
Avirex. Launching in the first quarter of 2007, Avirex footwear is a line of athletic and
skate-inspired sneakers and slip-ons that appeal to both urban and suburban consumers. Avirex is an
authentic American-inspired aviation apparel brand with 30-plus years in the fashion industry that
targets young men and the music community. Avirex footwear is designed by Mark Ecko Enterprises
and complements Avirex’s apparel, using similar prints and graphics. Avirex footwear is available
in national department and chain stores, and in select specialty retailers.
PRODUCT DESIGN AND DEVELOPMENT
Our principal goal in product design is to generate new and exciting footwear in all of our
product lines with contemporary and progressive styles and comfort-enhancing performance features.
Targeted to the active, youthful and style-savvy, we design most new styles to be fashionable and
marketable to the 12- to 24-year old consumer, while substantially all of our lines appeal to the
broader range of 5- to 40-year-old consumers, with an exclusive selection for infants and toddlers.
While many of our shoes have performance features, we generally do not position our shoes in the
marketplace as technical performance shoes.
We believe that our products’ success is related to our ability to recognize trends in the
footwear markets and to design products that anticipate and accommodate consumers’ ever-evolving
preferences. We are able to quickly translate the latest footwear trends into stylish, quality
footwear at a reasonable price by analyzing and interpreting current and emerging lifestyle trends.
Lifestyle trend information is compiled and analyzed by our designers from various sources,
including the review and analysis of modern music, television, cinema, clothing, alternative sports
and other trend-setting media; traveling to domestic and international fashion markets to identify
and confirm current trends; consulting with our retail and e-commerce customers for information on
current retail selling trends; participating in major footwear trade shows to stay abreast of
popular brands, fashions and styles; and subscribing to various fashion and color information
services. In addition, a key component of our design philosophy is to continually reinterpret and
develop our successful styles in our brand’s image.
The footwear design process typically begins about nine months before the start of a season.
Our products are designed and developed primarily by our in-house design staff. To promote
innovation and brand relevance, we utilize dedicated design teams, who report to our senior design
executives, and focus on each of the men’s, women’s and children’s categories. In addition, we
utilize outside design firms on an item-specific basis to supplement our internal design efforts.
The design process is extremely collaborative, as members of the design staff frequently meet with
the heads of retail, merchandising, sales, production and sourcing to further refine our products
to meet the particular needs of the target market.
After a design team arrives at a consensus regarding the fashion themes for the coming season,
the designers then translate these themes into our products. These interpretations include
variations in product color, material structure and embellishments, which are arrived at after
close consultation with our production department. Prototype blueprints and specifications are
created and forwarded to our manufacturers for a design prototype. The design prototypes are then
sent back to our design teams. Our major retail customers may also review these new design
concepts. Customer input not only allows us to measure consumer reaction to the latest designs, but
also affords us an opportunity to foster deeper and more collaborative relationships with our
customers. We also occasionally order limited production runs that may initially be tested in our
concept stores. By working closely with store personnel, we obtain customer feedback that often
influences product design and development. Our design teams can easily and quickly modify and
refine a design based on customer input. Generally, the production process can take six months to
nine months from design concept to commercialization.
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SOURCING
Factories. Our products are produced by independent contract manufacturers located primarily
in China and, to a lesser extent, in Italy, Vietnam, Brazil and various other countries. We do not
own or operate any manufacturing facilities as we believe that the use of independent manufacturers
substantially increases our production flexibility and capacity while reducing capital expenditures
and avoiding the costs of managing a large production work force.
When possible, we seek to use manufacturers that have previously produced our footwear, which
we believe enhances continuity and quality while controlling production costs. We attempt to
monitor our selection of independent factories to ensure that no one manufacturer is responsible
for a disproportionate amount of our merchandise. We source product for styles that account for a
significant percentage of our net sales from at least four different manufacturers. During the year
ended December 31, 2006, we had four manufacturers that accounted for approximately 59.6% of total
purchases. One manufacturer accounted for 30.8%, and two others each accounted for over 10.0% of
our total purchases. To date, we have not experienced difficulty in obtaining manufacturing
services.
We finance our production activities in part through the use of interest-bearing open purchase
arrangements with certain of our Asian manufacturers. These facilities currently bear interest at a
rate between 0% and 1.5% for 30 to 60 days financing, depending on the factory. We believe that the
use of these arrangements afford us additional liquidity and flexibility. We do not have any
long-term contracts with any of our manufacturers; however, we have long-standing relationships
with many of our manufacturers and believe our relationships to be good.
We closely monitor sales activity after initial introduction of a product in our concept
stores to determine whether there is substantial demand for a style, thereby aiding us in our
sourcing decisions. Styles that have substantial consumer appeal are highlighted in upcoming
collections or offered as part of our periodic style offerings, while less popular styles can be
discontinued after only a limited production run. We believe that sales in our concept stores can
also help forecast sales in national retail stores, and we share this sales information with our
wholesale accounts. Sales, merchandising, production and allocations management analyze historical
and current sales and market data from our wholesale account base and our own retail stores to
develop an internal product quantity forecast that allows us to better manage our future production
and inventory levels. For those styles with high sell-through percentages, we maintain an in-stock
position to minimize the time necessary to fill customer orders by placing orders with our
manufacturers prior to the time we receive customers’ orders for such footwear.
Production
Oversight. To safeguard product quality and consistency, we oversee the key aspects
of production from initial prototype manufacture through initial production runs to final
manufacture. Monitoring of all production is performed in the United States by our in-house
production department and in Asia through an approximately 250-person staff working from our
offices in China and Taiwan. We believe that our Asian presence allows us to negotiate supplier and
manufacturer arrangements more effectively, decrease product turnaround time and ensure timely
delivery of finished footwear. In addition, we require our manufacturers to certify that neither
convicted, forced or indentured labor (as defined under U.S. law) nor child labor (as defined by
the manufacturer’s country) is used in the production process, and that compensation will be paid
according to local law and that the factory is in compliance with local safety regulations.
Quality Control. We believe that quality control is an important and effective means of
maintaining the quality and reputation of our products. Our quality control program is designed to
ensure that not only finished goods meet our established design specifications, but also that all
goods bearing our trademarks meet our standards for quality. Our quality control personnel located
in China and Taiwan perform an array of inspection procedures at various stages of the production
process, including examination and testing of prototypes of key raw materials prior to manufacture,
samples and materials at various stages of production and final products prior to shipment. Our
employees are on-site at each of our major manufacturers to oversee production. For some of our
lower volume manufacturers, our staff is on-site during significant production runs or we will
perform unannounced visits to their manufacturing sites to further monitor compliance with our
manufacturing specifications.
ADVERTISING AND MARKETING
With a marketing philosophy of “Unseen, Untold, Unsold,” we take a targeted approach to
marketing to drive traffic, build brand recognition and properly position our diverse lines within
the marketplace. Senior management is directly involved in shaping our image and the conception,
development and implementation of our advertising and marketing activities. The focus of our
marketing plan is print and television advertising, which is supported by outdoor, trend-influenced
marketing, public relations, promotions and
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in-store support. In addition, we utilize celebrity endorsees in our advertisements. We also
believe our Internet websites and trade shows are effective marketing tools to both consumers and
corporate accounts. We have historically budgeted advertising as a percentage of projected net
sales. During 2006, we broadened our marketing campaign which resulted in advertising and marketing
expenditures equaling 6.9% of our annual net sales, which was higher than the prior year and below
our targeted range of 8% to 10% of annual net sales.
Advertising. The majority of our advertising is conceptualized by our in-house design team. We
believe that our advertising strategies, methods and creative campaigns are directly related to our
success. Through our lifestyle and image-driven advertising, we generally seek to build and
increase brand awareness by linking the Skechers brand and our fashion and street brands to
youthful, contemporary lifestyles and attitudes rather than to market a particular footwear
product. In addition to our compelling Skechers lifestyle ads, we have also created product
specific ads for our men’s lines to appeal to men as well as women who purchase footwear for men.
Our ads are designed with a broad approach to eliminate single categorization and to provide
merchandise flexibility and to facilitate the “brands and product designs” direction of evolving
footwear fashions and consumer preferences.
To further build brand awareness and influence consumer spending, we have selectively signed
endorsement agreements with celebrities whom we believed would reach new markets. In 2005, we
signed American Idol winner and rising star Carrie Underwood for a Skechers marketing agreement
through 2006, and in 2006 we signed pop star Ashlee Simpson to appear in Skechers marketing
campaigns through 2007. In past years, we had similar endorsement agreements for Skechers with
singers Christina Aguilera and Britney Spears, professional basketball player and actor Rick Fox,
and actors Robert Downey, Jr., Matt Dillon and Rob Lowe. From time to time, we may sign other
celebrities to endorse our brand name and image in order to strategically market our products among
specific consumer groups in the future.
In addition to advertising our Skechers branded lines through men’s, women’s and children’s
ads, we also support Michelle K, Mark Nason, 310 Motoring, Marc Ecko, Zoo York and Avirex lines
through individual unique print advertisements – some which may include celebrity endorsees. In
2006, we signed Evangeline Lilly, star of the hit TV show Lost, to appear in Michelle K
advertisements through 2007. In 2005, we signed critically acclaimed actor Terrence Howard to
appear in 310 lifestyle advertisements and we signed an agreement with multi-platinum hip hop
superstar The Game to appear in marketing campaigns in support of his signature 310 shoe Hurricane.
During 2006, we also signed an endorsement deal with Nas to support a 310 signature shoe. For
Mark Nason, we have focused on key-selling styles in product-driven ads that captured the brand’s
essence. For the Marc Ecko footwear brands, Marc Ecko’s design team has created relevant targeted
ads for men and women. These include a multi-media men’s campaign featuring our graffiti painted
shoe as well as the first Unltd. by Marc Ecko for boys spot. In 2007, singer/actress JoJo became
the new face of Rhino Red, and she will appear in print and outdoor advertising and a compelling
television commercial.
With a targeted approach, our print ads appear regularly in popular fashion and lifestyle
consumer publications, such as GQ, Cosmopolitan, Elle, Lucky, In Style, Seventeen, Maxim, Slam,
Road & Track, and Complex, as well as in weekly publications such as People, Us Weekly, Star,
Sports Illustrated and InTouch, among others.
Our television commercials are produced both in-house and through producers we have utilized
in the past and are familiar with our brands. In 2006, we created product-driven sponsor spots like
our first animated spot for Skechers Airators as well as lifestyle campaigns for men, women and
kids. We have found these to be a cost-effective way to advertise during key national and cable
programming in key selling seasons. Our in-house media buyer strategically selects the ideal
programs and geographic areas for our commercials for maximum consumer impact.
Outdoor. In an effort to reach consumers where they shop and in high traffic areas as they
travel to and from work or while running errands, we continued our multi-level outdoor campaign
that included kiosks in key malls across the United States, and billboards, transportation systems
and telephone kiosks in North America and Europe. We believe these are effective and efficient
ways to reach a broad range of consumers and leave a lasting impression of our many brands.
Trend-Influenced Marketing/Public Relations. Our public relations team’s objectives are to
secure product placement in key fashion magazines, place our footwear on the feet of trend-setting
celebrities, and garner positive and accurate press on our company. Through our commitment to
aggressively promote our upcoming styles, our products are often featured in leading fashion and
pop culture magazines, as well as in select films and popular television shows. Our footwear and
our company have been prominently displayed and referenced on news and magazine shows including The
Today Show, Good Day L.A., Entertainment Tonight, and E!; and on television programs, including Law
& Order, Entourage, and The Big Idea with Donny Deutsch, among others. We have also amassed an
array of prominent product placements in magazines including Lucky, Seventeen, OK!, Teen Vogue,
CosmoGirl, InStyle, Stuff, Maxim, Slam, Dime and Footwear News. In addition, our brands have been
associated with cutting edge events and select
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celebrities, and our product has been seen worn by trend-setters like Denis Leary, Chris
Cornell, Debra Messing, Nicole Richie, Ashlee Simpson, The Game, Paris Hilton and Jamie Foxx, among
others.
Promotions. By applying creative sales techniques via a broad spectrum of mediums, our
marketing team seeks to build brand recognition and drive traffic to Skechers’ retail stores,
websites and our retail partners’ locations. Skechers’ promotional strategies have encompassed
in-store specials, charity events, product tie-ins and giveaways, and collaborations with national
retailers and radio stations. Our imaginative promotions are consistent with Skechers’ imaging and
lifestyle.
Visual Merchandising. Our in-house visual merchandising team supports wholesale accounts,
distributors and our retail stores by developing displays that effectively leverage our products at
the point of purchase. Our point-of-purchase display items include signage, graphics, displays,
counter cards, banners and other merchandising items. These materials mirror the look and feel of
our national print advertising in order to reinforce brand image at the point-of-purchase.
Our visual merchandising coordinators (“VMC’s”) work with our sales force and directly with
our customers to ensure better sell-through at the retail level by generating greater consumer
awareness through Skechers brand displays. Our VMC’s communicate with and visit our wholesale
customers on a regular basis to aid in proper display of our merchandise. They also run in-store
promotions to enhance the sale of Skechers footwear and create excitement surrounding the Skechers
brand. We believe that these efforts help stimulate impulse sales and repeat purchases.
Trade Shows. To better showcase our diverse products to footwear buyers in the United States
and Europe, and to distributors around the world, we regularly exhibit at leading trade shows.
Along with specialty trade shows, we exhibit at WSA’s The Shoe Show, FFANY, ASR and MAGIC in the
United States, and GDS, MICAM, Bread & Butter, MIDEC and Who’s Next in Europe. Our dynamic,
state-of-the-art trade show exhibits are developed by our in-house architect to showcase our latest
product offerings in a lifestyle setting reflective of each of our brands. By investing in
innovative displays and individual rooms showcasing each line, our sales force can present a sales
plan for each line and buyers are able to truly understand the breadth and depth of our offerings,
thereby optimizing commitments and sales at the retail level. For select non-Skechers branded lines
such as Michelle K, 310 Motoring and our Marc Ecko footwear lines, we have created individual
exhibits to ensure their brand integrity. Our innovative exhibits have won numerous awards over the
years, including Best Booth Design at the WSA Shoe Show, February 2001 and February 2003, and for
our Unltd. by Marc Ecko and Rhino Red booth in August 2004 and February 2005.
Internet. We also promote our brands through our e-commerce websites www.skechers.com
and www.soholab.com to consumers who access the Internet. These websites currently enable
us to present information on our products, provide a brand experience and store locations to
consumers, and allow consumers the ability to directly order products on the Internet. These sites
also provide us a mechanism for customer feedback as well as allowing us to receive and respond
directly to consumer feedback. Our websites are intended to enhance the Skechers brand and increase
sales through all our retail channels. Similarly, www.soholab.com is an extension of our
SoHo Lab retail stores and allows us the opportunity to offer consumers our fashion and street
brands through an e-commerce site. Our websites also allow us to leverage our brand awareness at a
lower cost than traditional distribution channels.
Along with www.skechers.com and www.soholab.com, we have also established
unique Internet websites for our fashion brands Mark Nason (www.marknason.com) and 310
Motoring (www.310motoring.com). These websites are designed to serve as marketing tools,
properly imaging these brands while also informing customers about the respective product lines.
PRODUCT DISTRIBUTION CHANNELS
We have four reportable segments – domestic wholesale sales, international wholesale sales,
retail sales and e-commerce sales. In the United States, our products are available through a
network of wholesale accounts comprised of department, athletic and specialty stores.
Internationally, our products are available through wholesale accounts in more than 100 countries
and territories through our global network of distributors and our Canadian and European
subsidiaries. Additionally, 15 distributors have opened 52 distributor-owned Skechers retail
stores in 21 countries as of December 31, 2006. Skechers owns and operates retail stores both
domestically and internationally through three integrated retail formats—concept, factory outlet
and warehouse outlet stores. Each of these channels serves an integral function in the global
distribution of our products.
Domestic Wholesale. We distribute our footwear through the following domestic wholesale
distribution channels: department stores, specialty stores, athletic shoe stores and independent
retailers. Department stores and specialty retailers are the largest distribution channels, but we
believe that we appeal to a variety of wholesale accounts, many of whom may operate stores within
the same retail location due to our distinct product lines and variety of styles, from which
retailers can select those lines and styles that
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best satisfy the fashion, function and price criteria of their customers. Management has a
clearly defined growth strategy for each of our channels of distribution. An integral component of
our strategy is to offer our accounts the highest level of customer service so that our products
will be fully represented in existing retail locations and new locations within each account.
In an effort to provide knowledgeable and personalized service to our wholesale accounts, the
sales force is segregated by product line, each of which is headed by a vice president or national
sales manager. Reporting to each sales manager are knowledgeable account executives and territory
managers. Our vice presidents and national sales managers report to a senior vice president of
sales. All of our vice presidents and national sales managers are compensated on a salary basis,
while our account executives and territory managers are compensated on a commission basis. None of
our domestic sales personnel sell competing products.
We believe that we have developed a loyal customer base of wholesale accounts through a
heightened level of customer service. We believe that our close relationships with these accounts
help us to maximize their retail sell-throughs. Our visual merchandise coordinators work with our
wholesale accounts to ensure that our merchandise and point-of-purchase marketing materials are
properly presented. Sales executives and merchandise personnel work closely with accounts to ensure
that appropriate styles are purchased for specific accounts and for specific stores within those
accounts as well as to ensure that appropriate inventory levels are carried at each store. Such
information is then utilized to help develop sales projections and determine the product needs of
our wholesale accounts. The value-added services we provide our wholesale customers help us
maintain strong relationships with our existing wholesale customers and attract potential new
wholesale customers.
International Wholesale. Our products are sold in more than 100 countries and territories
throughout the world. We generate revenues from outside the United States from three principal
sources: (i) direct sales to department stores and specialty retail stores through our subsidiaries
in Canada, France, Germany, Spain, Italy, Portugal, Switzerland, Austria, the Benelux Region and
the United Kingdom (ii) sales of our footwear to foreign distributors who distribute such footwear
to department stores and specialty retail stores in countries and territories across Eastern
Europe, Asia, Latin America, South America, Africa, the Middle East and Australia, among other
regions and (iii) to a lesser extent, royalties from licensees who manufacture and distribute our
non-footwear products outside the United States.
We believe that international distribution of our products represents a significant
opportunity to increase sales and profits. We intend to further increase our share of the
international footwear market by heightening our marketing presence in those countries in which we
currently have a presence through our international advertising campaigns, which are designed to
establish Skechers as a global brand synonymous with trend-right casual shoes.
| • | International Subsidiaries |
Europe
We currently distribute product in most of Western Europe through the following
subsidiaries: Skechers USA Ltd., with its offices and showrooms in London, England;
Skechers S.a.r.l., with its offices and showrooms in Lausanne, Switzerland; Skechers USA
France S.A.S., with its offices and showrooms in Paris, France; Skechers USA Deutschland
GmbH, with its offices and showrooms in Dietzenbach, Germany; Skechers USA Iberia, S.L.,
with its offices and showrooms in Madrid, Spain; Skechers USA Benelux B.V., with its
offices and showrooms in Waalwijk, the Netherlands; and Skechers USA Italia S.r.l., with
its offices and showroom in Verona, Italy.
Skechers-owned retail stores in Europe include nine concept stores and one factory
outlet store located in five countries, including the key locations of Oxford Street in
London, Alstadt District in Düsseldorf and Kalverstraat Street in Amsterdam.
To accommodate our European subsidiaries’ operations, we operate an approximately
240,000 square foot distribution center in Liege, Belgium. This distribution center is
currently used to store and deliver product to our subsidiaries and retail stores
throughout Europe.
Canada
Merchandising and marketing of our product in Canada is managed by our wholly-owned
subsidiary, Skechers USA Canada, Inc. with its offices and showrooms outside Toronto in
Mississauga, Ontario. Product sold in Canada is
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primarily sourced from our U.S. distribution center in Ontario, California. We have
two concept stores, one located in Toronto’s Eaton Centre, and one in the West Edmonton
Mall and one factory outlet store located in Toronto.
| • | Distributors |
Outside of Western Europe and Canada, our footwear is distributed through an extensive
network of more than 30 distributors, who sell our products to department, athletic and
specialty stores in more than 100 countries around the world. Through agreements with 14 of
these distributors, 51 distributor-owned Skechers retail stores are open in 20 countries,
including 15 stores that were opened in 2006 and one that was opened to date in 2007. Two
distributor-owned stores were closed in 2006.
| STORE | NUMBER OF | |||||||
| REGION | FORMAT | STORES | LOCATION(1) | |||||
Asia
|
Concept | 4 | Osaka, Japan; Tokyo, Japan; Shanghai, China; Malaysia | |||||
| Warehouse | 4 | Osaka, Japan (2); Shizuoka, Japan; Tochigi-ken, Japan | ||||||
Australia
|
Concept | 1 | Sydney, Australia | |||||
| Warehouse | 1 | Sydney, Australia | ||||||
Central America/South America |
Concept | 26 | Chile (7); Columbia (6); Ecuador; El Salvador; Guatemala (2); Panama (2); Peru; Venezuela (6) | |||||
Western Europe
|
Concept | 6 | Spain (6) | |||||
Eastern Europe
|
Concept | 4 | Moscow, Russia (2); Kiev, Ukraine; Poland | |||||
Middle East
|
Concept | 4 | Saudi Arabia (3); Dubai, UAE | |||||
South Africa
|
Concept | 1 | Sandton, South Africa | |||||
| (1) | One store per location except as otherwise noted. |
The distributors are responsible for their respective store’s operations, have ownership
of their respective store’s assets and select the broad collection of our products to sell to
consumers in their regions. In order to maintain a globally consistent image, we provide
architectural, graphic and visual guidance and materials for the design of the stores, and we
train the local staff on our products and corporate culture. We intend to expand our
international presence and global recognition of the Skechers brand name by continuing to
sell our footwear to foreign distributors and by opening flagship retail stores with
distributors that have local market expertise.
Retail Stores. We pursue our retail store strategy through our three integrated retail
formats: the concept store, the factory outlet store and the warehouse outlet store. Our
three-store format enables us to promote the full Skechers product offering in an attractive
environment that appeals to a broad group of consumers. In addition to Skechers stores, we also
operate SoHo Lab concept stores, which are designed to specifically promote our SoHo Lab and other
fashion brands as well as more fashionable Skechers styles. This format also allows us to manage
our inventory in an efficient and brand sensitive manner. In addition, most of our retail stores
are profitable and have a positive effect on our operating results. As of February 28, 2007, we
owned and operated 50 concept stores, 61 factory outlet stores and 33 warehouse outlet stores in
the United States, and 10 concept stores and two factory outlet stores internationally. We closed
three stores and opened 23 new stores in 2006. We opened four new stores in the first two months
of 2007, while closing one store in Germany, and we plan to open an additional 20 to 25 stores by
the end of 2007. In addition, we own and operate six SoHo Lab concept stores, including four
that opened in 2006.
| • | Concept Stores. |
Our concept stores are located at either marquee street locations or in major shopping
malls in large metropolitan cities. Our concept stores have a threefold purpose in our
operating strategy. First, concept stores serve as a showcase for a wide range of our product
offering for the current season as we estimate that our average wholesale customer carries no
more than 5% of the complete Skechers line in any one location. Our concept stores showcase
our products in a cutting-edge, open-floor setting, providing the customer with the complete
Skechers story. Second, retail locations are generally chosen to generate maximum marketing
value for the Skechers brand name through signage, store front presentation and interior
design. Domestic locations include concept stores at Times Square and 34th Street in New
York, Hollywood and Highland in Hollywood, Santa Monica’s Third Street Promenade, Dallas’
Northpark Center, Las Vegas’ Fashion Show Mall, Seattle’s
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Bellevue Square Mall, Woodfield Mall outside Chicago and international locations include
Oxford Street in London, Alstadt District in Dusseldorf, Toronto’s Eaton Centre, and
Kalverstraat Street in Amsterdam. The stores are typically designed to create a distinctive
Skechers look and feel, and enhance customer association of the Skechers brand name with
current youthful lifestyle trends and styles. Third, the concept stores serve as marketing
and product testing venues. We believe that product sell-through information and rapid
customer feedback derived from our concept stores enables our design, sales, merchandising
and production staff to respond to market changes and new product introductions. Such
responses serve to augment sales and limit our inventory markdowns and customer returns and
allowances. We opened 13 domestic concept stores, one international concept store and closed
one domestic concept store in 2006.
The typical Skechers concept store is approximately 2,500 square feet, although in
certain markets we have opened concept stores as large as 6,400 square feet or as small as
1,200 square feet. When deciding where to open concept stores, we identify top geographic
markets in the larger metropolitan cities in the United States, Europe and Canada. When
selecting a specific site, we evaluate the proposed sites’ traffic pattern, co-tenancies,
sales volume of neighboring concept stores, lease economics and other factors considered
important within the specific location. If we are considering opening a concept store in a
shopping mall, our strategy is to obtain space as centrally located as possible in the mall
where we expect foot traffic to be most concentrated. We believe that the strength of the
Skechers brand name has enabled us to negotiate more favorable terms with shopping malls that
want us to open up concept stores to attract customer traffic to their venues.
In an effort to market and test our non-Skechers brands, we opened a new concept format
store, SoHo Lab. In 2004, we converted an existing Skechers concept store in New York’s SoHo
district to the new format. In 2005, we converted two additional Skechers concept stores in
urban and/or fashion locations to SoHo Lab stores. In 2006, we opened four more SoHo Lab
locations built from the ground up, including San Diego’s Gas Lamp District. We also
converted one SoHo Lab store back to a Skechers concept store in 2006, bringing our total for
this concept to six. These stores may also include more fashion forward Skechers styles.
| • | Factory Outlet Stores. |
Our factory outlet stores are generally located in manufacturers’ direct outlet centers
throughout the United States. In addition, we have two international outlet stores – one in
Canada and one in England. Our factory outlet stores provide opportunities for us to sell
discontinued and excess merchandise, thereby reducing the need to sell such merchandise to
discounters at excessively low prices, which could otherwise compromise the Skechers brand
image. Skechers’ factory outlet stores range in size from approximately 1,900 to 9,000 square
feet. Inventory in these stores is supplemented by certain first-line styles sold at full
retail price points. We opened eight domestic factory outlet stores in 2006.
| • | Warehouse Outlet Stores. |
Our free-standing warehouse outlet stores, which are located throughout the United
States, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory
in a cost-efficient manner. Skechers’ warehouse outlet stores range in size from
approximately 5,200 to 14,800 square feet. Our warehouse outlet stores enable us to sell
discontinued and excess merchandise that would otherwise typically be sold to discounters at
excessively low prices, which could otherwise compromise the Skechers brand image. We seek to
open our warehouse outlet stores in areas that are in close proximity to our concept stores
in order to facilitate the timely transfer of inventory that we want to liquidate as soon as
practicable. We opened one new warehouse outlet store in 2006.
Electronic Commerce. Our e-commerce sales represented less than 1.0% of total net sales in
each of 2006, 2005 and 2004. Our websites, www.skechers.com and www.soholab.com are
virtual storefronts that promote the Skechers and street and fashion brands. Our websites are
designed to provide a positive shopping and brand experience, showcasing our products in an
easy-to-navigate format, allowing consumers to browse our selections and purchase our footwear.
This virtual store has provided a convenient alternative-shopping environment and brand experience.
These websites have become an efficient and effective additional retail distribution channel, and
have improved our customer service.
LICENSING
We believe that selective licensing of the Skechers brand name and our product line names to
manufacturers may broaden and enhance the individual brands without requiring significant capital
investments or additional incremental operating expenses. Our multiple product lines plus
additional subcategories present many potential licensing opportunities on terms with licensees
that we
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believe will provide more effective manufacturing, distribution or marketing of non-footwear
products. We also believe that the reputation of Skechers and its history in launching brands has
also enabled us to partner with reputable non-footwear brands in order to design and market their
footwear.
The first launch of Skechers licensed product was Skechers Kids apparel for boys and girls
from the licensee, Kids Headquarters, in the United States for the 2003 back-to-school selling
season. Due to the successful in-store launch of Skechers Kids, we expanded our licensing agreement
with Kids Headquarters to include infant and toddler apparel, boys’ and girls’ daywear and
sleepwear, and swimwear for boys and girls.
As of February 28, 2007, we had 10 active domestic and international licensing agreements in
which we are the licensor. We have international licensing agreements for the design and
distribution of men’s and women’s active apparel in Israel; men’s and women’s apparel in select
European countries; bags in select Central and South American countries; watches in the
Philippines, and bags in China.
We have signed agreements to design, develop and market footwear for the street lifestyle
apparel brands, Ecko Unltd., Ecko Red, Red by Marc Ecko, Zoo York and Avirex under the Marc Ecko
Enterprises umbrella, and apparel and footwear for Kitson, the ultra-hip Hollywood boutique.
DISTRIBUTION FACILITIES AND OPERATIONS
We believe that strong distribution support is a critical factor in our operations. Once
manufactured, our products are packaged in shoe boxes bearing bar codes that are shipped either (i)
to our approximately 1.7 million square-foot distribution centers located in
Ontario, California, (ii) to our approximately 240,000 square-foot distribution center located in
Liege, Belgium or (iii) directly from third-party manufacturers to our other international
customers. Upon receipt at either of the distribution centers, merchandise is inspected and
recorded in our management information system and packaged according to customers’ orders for
delivery. Merchandise is shipped to customers by whatever means each customer requests, which is
usually by common carrier. The distribution centers have multi-access docks, enabling us to receive
and ship simultaneously, and to pack separate trailers for shipments to different customers at the
same time. We have an electronic data interchange system, or EDI system, to which some of our
larger customers are linked. This system allows these customers to automatically place orders with
us, thereby eliminating the time involved in transmitting and inputting orders, and it includes
direct billing and shipping information.
BACKLOG
As of December 31, 2006, our backlog was $322.9 million, compared to $250.5 million as of
December 31, 2005. While backlog orders are subject to cancellation by customers, we have not
experienced significant cancellation of orders in the past, and we expect that substantially all
the orders will be shipped in 2007. However, for a variety of reasons, including customer demand
for our products, the timing of shipments, product mix of customer orders, the amount of in-season
orders and a shift towards tighter lead times within backlog levels, backlog may not be a reliable
measure of future sales for any succeeding period.
INTELLECTUAL PROPERTY RIGHTS
We own and utilize a variety of trademarks, including the Skechers trademark. We have a
significant number of both registrations and pending applications for our trademarks in the United
States. In addition, we have trademark registrations and trademark applications in approximately 80
foreign countries. We also have design patents and pending design and utility patent applications
in both the United States and approximately 25 foreign countries. We continuously look to increase
the number of our patents and trademarks both domestically and internationally where necessary to
protect valuable intellectual property. We regard our trademarks and other intellectual property as
valuable assets and believe that they have significant value in the marketing of our products. We
vigorously protect our trademarks against infringement, including through the use of cease and
desist letters, administrative proceedings and lawsuits.
We rely on trademark, patent, copyright and trade secret protection, non-disclosure agreements
and licensing arrangements to establish, protect and enforce intellectual property rights in our
logos, tradenames and in the design of our products. In particular, we believe that our future
success will largely depend on our ability to maintain and protect the Skechers trademark. Despite
our efforts to safeguard and maintain our intellectual property rights, we cannot be certain that
we will be successful in this regard. Furthermore, we cannot be certain that our trademarks,
products and promotional materials or other intellectual property rights do not or will not violate
the intellectual property rights of others, that our intellectual property would be upheld if
challenged, or that we would, in such an
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event, not be prevented from using our trademarks or other intellectual property rights. Such
claims, if proven, could materially and adversely affect our business, financial condition and
results of operations. In addition, although any such claims may ultimately prove to be without
merit, the necessary management attention to and legal costs associated with litigation or other
resolution of future claims concerning trademarks and other intellectual property rights could
materially and adversely affect our business, financial condition and results of operations. We
have sued and have been sued by third parties for infringement of intellectual property. It is our
opinion that none of these claims has materially impaired our ability to utilize our intellectual
property rights.
The laws of certain foreign countries do not protect intellectual property rights to the same
extent or in the same manner as do the laws of the United States. Although we continue to implement
protective measures and intend to defend our intellectual property rights vigorously, these efforts
may not be successful or the costs associated with protecting our rights in certain jurisdictions
may be prohibitive. From time to time we discover products in the marketplace that are counterfeit
reproductions of our products or that otherwise infringe upon intellectual property rights held by
us. Actions taken by us to establish and protect our trademarks and other intellectual property
rights may not be adequate to prevent imitation of our products by others or to prevent others from
seeking to block sales of our products as violating trademarks and intellectual property rights. If
we are unsuccessful in challenging a third party’s products on the basis of infringement of our
intellectual property rights, continued sales of such products by that or any other third party
could adversely impact the Skechers brand, result in the shift of consumer preferences away from
our products and generally have a material adverse effect on our business, financial condition and
results of operations.
COMPETITION
Competition in the footwear industry is intense. Although we believe that we do not compete
directly with any single company with respect to its entire range of products, our products compete
with other branded products within their product category as well as with private label products
sold by retailers, including some of our customers. Our utility footwear and casual shoes compete
with footwear offered by companies such as The Timberland Company, Dr. Martens, Kenneth Cole
Productions Inc., Steven Madden, Ltd., Wolverine World Wide, Inc., V.F. Corporation, and CROCS,
Inc. Our athletic lifestyle shoes compete with footwear offered by companies such as Nike, Inc.,
Reebok International Ltd., Adidas-Salomon AG, Puma AG and New Balance Athletic Shoe, Inc. Our
children’s shoes compete with footwear offered by companies such as The Stride Rite Corporation. In
varying degrees, depending on the product category involved, we compete on the basis of style,
price, quality, comfort and brand name prestige and recognition, among other considerations. These
and other competitors pose challenges to our market share in our major domestic markets and may
make it more difficult to establish our products in Europe, Asia and other international regions.
We also compete with numerous manufacturers, importers and distributors of footwear for the limited
shelf space available for the display of such products to the consumer. Moreover, the general
availability of contract manufacturing capacity allows ease of access by new market entrants. Many
of our competitors are larger, have been in existence for a longer period of time, have achieved
greater recognition for their brand names, have captured greater market share and/or have
substantially greater financial, distribution, marketing and other resources than we do. We cannot
be certain that we will be able to compete successfully against present or future competitors, or
that competitive pressures will not have a material adverse effect on our business, financial
condition and results of operations.
EMPLOYEES
As of February 28, 2007, we employed 3,628 persons, 1,982 of whom were employed on a full-time
basis and 1,646 of whom were employed on a part-time basis. None of our employees are subject to a
collective bargaining agreement. We believe that our relations with our employees are satisfactory.
ITEM 1A. RISK FACTORS
In addition to the other information in this annual report, the following factors should be
considered in evaluating us and our business.
Our Future Success Depends On Our Ability To Respond To Changing Consumer Demands, Identify And
Interpret Fashion Trends And Successfully Market New Products.
The footwear industry is subject to rapidly changing consumer demands and fashion trends.
Accordingly, we must identify and interpret fashion trends and respond in a timely manner. Demand
for and market acceptance of new products are uncertain and achieving market acceptance for new
products generally requires substantial product development and marketing efforts and
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expenditures. If we do not continue to meet changing consumer demands and develop successful
styles in the future, our growth and profitability will be negatively impacted. We frequently make
decisions about product designs and marketing expenditures several months in advance of the time
when consumer acceptance can be determined. If we fail to anticipate, identify or react
appropriately to changes in styles and trends or are not successful in marketing new products, we
could experience excess inventories, higher than normal markdowns or an inability to profitably
sell our products. Because of these risks, a number of companies in the footwear industry
specifically, and others in the fashion and apparel industry in general, have experienced periods
of rapid growth in revenues and earnings and thereafter periods of declining sales and losses,
which in some cases have resulted in companies in these industries ceasing to do business.
Similarly, these risks could have a material adverse effect on our results of operations or
financial condition.
Our Business And The Success Of Our Products Could Be Harmed If We Are Unable To Maintain Our Brand
Image.
Our success to date has been due in large part to the strength of the Skechers brand, and to a
lesser degree, the reputation of our fashion brands. If we are unable to timely and appropriately
respond to changing consumer demand, our brand name and brand image may be impaired. Even if we
react appropriately to changes in consumer preferences, consumers may consider our brand image to
be outdated or associate our brand with styles of footwear that are no longer popular. In the past,
several footwear companies including ours have experienced periods of rapid growth in revenues and
earnings followed by periods of declining sales and losses. Our business may be similarly affected
in the future.
Our Business Could Be Harmed If We Fail To Maintain Proper Inventory Levels.
We place orders with our manufacturers for some of our products prior to the time we receive
all of our customers’ orders. We do this to minimize purchasing costs, the time necessary to fill
customer orders and the risk of non-delivery. We also maintain an inventory of certain products
that we anticipate will be in greater demand. However, we may be unable to sell the products we
have ordered in advance from manufacturers or that we have in our inventory. Inventory levels in
excess of customer demand may result in inventory write-downs, and the sale of excess inventory at
discounted prices could significantly impair our brand image and have a material adverse effect on
our operating results and financial condition. Conversely, if we underestimate consumer demand for
our products or if our manufacturers fail to supply the quality products that we require at the
time we need them, we may experience inventory shortages. Inventory shortages might delay shipments
to customers, negatively impact retailer and distributor relationships, and diminish brand loyalty.
We Face Intense Competition, Including Competition From Companies With Significantly Greater
Resources Than Ours, And If We Are Unable To Compete Effectively With These Companies, Our Market
Share May Decline And Our Business Could Be Harmed.
We face intense competition in the footwear industry from other established companies. A
number of our competitors have significantly greater financial, technological, engineering,
manufacturing, marketing and distribution resources than we do. Their greater capabilities in these
areas may enable them to better withstand periodic downturns in the footwear industry, compete more
effectively on the basis of price and production and more quickly develop new products. In
addition, new companies may enter the markets in which we compete, further increasing competition
in the footwear industry.
We believe that our ability to compete successfully depends on a number of factors, including
the style and quality of our products and the strength of our brand name, as well as many factors
beyond our control. We may not be able to compete successfully in the future, and increased
competition may result in price reductions, reduced profit margins, loss of market share and an
inability to generate cash flows that are sufficient to maintain or expand our development and
marketing of new products, which would adversely impact the trading price of our Class A Common
Stock.
We Depend Upon A Relatively Small Group Of Customers For A Large Portion Of Our Sales.
During 2006, 2005 and 2004, our net sales to our five largest customers accounted for
approximately 24.9%, 25.4%, and 26.8% of total net sales, respectively. No customer accounted for
more than 10% of our net sales during 2006, 2005 and 2004. One customer accounted for 12.0% and
10.3% of net trade receivables at December 31, 2006 and December 31, 2005, respectively. Although
we have long-term relationships with many of our customers, our customers do not have a contractual
obligation to purchase our products and we cannot be certain that we will be able to retain our
existing major customers. Furthermore, the retail industry regularly experiences consolidation,
contractions and closings which may result in our loss of customers or our inability to collect
accounts receivable of major customers. If we lose a major customer, experience a significant
decrease in sales to a major customer or are unable to collect the accounts receivable of a major
customer, our business could be harmed.
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Our International Sales And Manufacturing Operations Are Subject To The Risks Of Doing Business
Abroad, Particularly In China, Which Could Affect Our Ability To Sell Or Manufacture Our Products
In International Markets, Obtain Products From Foreign Suppliers Or Control The Costs Of Our
Products.
Substantially all of our net sales during the year ended December 31, 2006 were derived from
sales of footwear manufactured in foreign countries, with most manufactured in China and, to a
lesser extent, in Italy, Vietnam and Brazil. We also sell our footwear in several foreign countries
and plan to increase our international sales efforts as part of our growth strategy. Foreign
manufacturing and sales are subject to a number of risks, including the following: political and
social unrest, including the military presence in Iraq; changing economic conditions; currency
exchange rate fluctuations; international political tension and terrorism; labor shortages and work
stoppages; electrical shortages, transportation delays; loss or damage to products in transit;
expropriation; nationalization; the imposition of domestic and international tariffs and trade
duties, import and export controls and other non-tariff barriers, exposure to different legal
standards (particularly with respect to intellectual property), compliance with foreign laws, and
changes in domestic and foreign governmental policies. We have not, to date, been materially
affected by any such risks, but we cannot predict the likelihood of such developments occurring or
the resulting long-term adverse impact on our business, results of operations or financial
condition.
In particular, because most of our products are manufactured in China, adverse changes in
trade or political relations with China, political instability in China, the occurrence of a
natural disaster such as an earthquake or typhoon in China or the outbreak of a pandemic disease
such as the Avian Flu in China could severely interfere with the manufacture of our products and
would have a material adverse effect on our operations. In addition, electrical shortages, labor
shortages or work stoppages may extend the production time necessary to produce our orders, and
there may be circumstances in the future where we may have to incur premium freight charges to
expedite the delivery of product to our customers. If we incur a significant amount of premium
charges to airfreight product for our customers, our gross profit will be negatively affected if we
are unable to collect those charges.
Also, our manufacturers located in China may be subject to the effects of exchange rate
fluctuations should the Chinese currency not remain stable with the U.S. dollar. The value of the
Chinese currency depends to a large extent on the Chinese government’s policies and China’s
domestic and international economic and political developments. Since 1994, the official exchange
rate for the conversion of the Chinese currency was pegged to the U.S. dollar at a virtually fixed
rate of approximately 8.28 Yuan per U.S. dollar. However, on July 21, 2005, the Chinese government
revalued the Yuan by 2.1%, setting the exchange rate at 8.11 Yuan per U.S. dollar, and adopted a
more flexible system based on a trade-weighted basket of foreign currencies of China’s main trading
partners. Under the new “managed float” policy, the exchange rate of the Yuan may shift each day up
to 0.3% in either direction from the previous day’s close, and as a result, the valuation of the
Yuan may increase incrementally over time should the China central bank allow it to do so, which
could significantly increase labor and other costs incurred in the production of our footwear in
China.
The Potential Imposition Of Additional Duties, Tariffs And Other Trade Restrictions Could Have An
Adverse Impact On Our Sales And Profitability.
All of our products manufactured overseas and imported into the United States, the European
Union (“EU”) and other countries are subject to customs duties collected by customs authorities.
Customs information submitted by us is routinely subject to review by customs authorities. We are
unable to predict whether additional customs duties, anti-dumping duties, quotas, safeguard
measures or other trade restrictions may be imposed on the importation of our products in the
future. Such actions could result in increases in the cost of our products generally and might
adversely affect the sales and profitability of Skechers and the imported footwear industry as a
whole.
We May Be Unable To Successfully Execute Our Growth Strategy Or Maintain Our Growth.
Although our company has generally exhibited steady growth since we began operations, we had a
decrease in net sales in the past and our rate of growth has declined at times as well, and we may
experience similar decreases in net sales or declines in rate of growth again in the future. Our
ability to grow in the future depends upon, among other things, the continued success of our
efforts to maintain our brand image and expand our footwear offerings and distribution channels.
Furthermore, as our business grows, we may need to improve and enhance our overall financial and
managerial controls, reporting systems and procedures to effectively manage our growth. We may be
unable to successfully implement our current growth strategy or other growth strategies or
effectively manage our growth, any of which would negatively impact our business, results of
operations and financial condition.
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Our Business May Be Negatively Impacted As A Result Of Changes In The Economy.
Our business depends on the general economic environment and levels of consumer spending that
affect not only the ultimate consumer, but also retailers, our primary direct customers. Purchases
of footwear tend to decline in periods of recession or uncertainty regarding future economic
prospects, when consumer spending, particularly on discretionary items, declines. During periods of
recession or economic uncertainty, we may not be able to maintain or increase our sales to existing
customers, make sales to new customers, open and operate new retail stores, maintain sales levels
at our existing stores, maintain or increase our international operations on a profitable basis, or
maintain or improve our earnings from operations as a percentage of net sales. As a result, our
operating results may be adversely and materially affected by downward trends in the economy or the
occurrence of events that adversely affect the economy in general. Furthermore, in anticipation of
continued increases in net sales, we have significantly expanded our infrastructure and workforce
to achieve economies of scale. Because these expenses are mostly fixed in the short term, our
operating results and margins will be adversely impacted if we do not continue to grow as
anticipated.
Economic, Political, Military Or Other Events In The United States Or In A Country Where We Make
Significant Sales Or Have Significant Operations Could Interfere With Our Success Or Operations
There And Harm Our Business.
We market and sell our products and services throughout the world. The September 11, 2001
terrorist attacks disrupted commerce throughout the United States and other parts of the world. The
continued threat of similar attacks throughout the world and the military action, or possible
military action, taken by the United States and other nations, in Iraq or other countries may cause
significant disruption to commerce throughout the world. To the extent that such disruptions
further slow the global economy or, more particularly, result in delays or cancellations of
purchase orders for our products, our business and results of operations could be materially
adversely affected. We are unable to predict whether the threat of new attacks or the responses
thereto will result in any long-term commercial disruptions or if such activities or responses will
have a long-term material adverse effect on our business, results of operations or financial
condition.
Our Quarterly Revenues And Operating Results Fluctuate As A Result Of A Variety Of Factors,
Including Seasonal Fluctuations In Demand For Footwear, Delivery Date Delays And Potential
Fluctuations In Our Annualized Tax Rate, Which May Result In Volatility Of Our Stock Price.
Our quarterly revenues and operating results have varied significantly in the past and can be
expected to fluctuate in the future due to a number of factors, many of which are beyond our
control. Our major customers generally have no obligation to purchase forecasted amounts and may
cancel orders, change delivery schedules or change the mix of products ordered with minimal notice
and without penalty. As a result, we may not be able to accurately predict our quarterly sales. In
addition, sales of footwear products have historically been somewhat seasonal in nature with the
strongest sales generally occurring in our second and third quarters for the back-to-school selling
season. Back-to-school sales typically ship in June, July and August, and delays in the timing,
cancellation, or rescheduling of these customer orders and shipments by our wholesale customers
could negatively impact our net sales and results of operations for our second or third quarters.
More specifically, the timing of when products are shipped is determined by the delivery schedules
set by our wholesale customers, which could cause sales to shift between our second and third
quarters. Because our expense levels are partially based on our expectations of future net sales,
our expenses may be disproportionately large relative to our revenues, and we may be unable to
adjust spending in a timely manner to compensate for any unexpected revenue shifts, which could
have a material adverse effect on our operating results.
Our annualized tax rate is based on projections of our domestic and international operating
results for the year, which we review and revise as necessary at the end of each quarter, and it is
highly sensitive to fluctuations in projected international earnings. Any quarterly fluctuations in
our annualized tax rate that may occur could have a material impact on our quarterly operating
results. As a result of these specific and other general factors, our operating results will likely
vary from quarter to quarter and the results for any particular quarter may not be necessarily
indicative of results for the full year. Any shortfall in revenues or net income from levels
expected by securities analysts and investors could cause a decrease in the trading price of our
Class A Common Stock.
We Rely On Independent Contract Manufacturers And, As A Result, Are Exposed To Potential
Disruptions In Product Supply.
Our footwear products are currently manufactured by independent contract manufacturers. During
2006 and 2005, the top four manufacturers of our products produced approximately 59.6% and 59.7% of
our total purchases, respectively. One manufacturer accounted for 30.8% and 32.4% of total
purchases during 2006 and 2005, respectively. Two other manufacturers each accounted for over
10.0% of our total purchases during 2006, and one other manufacturer accounted for over 10.0% of
our total purchases during
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2005. We do not have long-term contracts with our manufacturers, and we compete with other
footwear companies for production facilities. We could experience difficulties with these
manufacturers, including reductions in the availability of production capacity, failure to meet our
quality control standards, failure to meet production deadlines or increased manufacturing costs.
In particular, manufacturers in China are facing a labor shortage as migrant workers seek better
wages and working conditions in farming and other vocations, and if this trend continues, our
current manufacturers’ operations could be adversely affected.
If our current manufacturers cease doing business with us, we could experience an interruption
in the manufacture of our products. Although we believe that we could find alternative
manufacturers, we may be unable to establish relationships with alternative manufacturers that will
be as favorable as the relationships we have now. For example, new manufacturers may have higher
prices, less favorable payment terms, lower manufacturing capacity, lower quality standards or
higher lead times for delivery. If we are unable to provide products consistent with our standards
or the manufacture of our footwear is delayed or becomes more expensive, this could result in our
customers canceling orders, refusing to accept deliveries or demanding reductions in purchase
prices, any of which could have a material adverse effect on our business and results of
operations.
Our Business Could Be Harmed If Our Contract Manufacturers, Suppliers Or Licensees Violate Labor,
Trade Or Other Laws.
We require our independent contract manufacturers, suppliers and licensees to operate in
compliance with applicable United States and foreign laws and regulations. Manufacturers are
required to certify that neither convicted, forced or indentured labor (as defined under United
States law) nor child labor (as defined by the manufacturer’s country) is used in the production
process, that compensation is paid in accordance with local law and that their factories are in
compliance with local safety regulations. Although we promote ethical business practices and our
sourcing personnel periodically visit and monitor the operations of our independent contract
manufacturers, suppliers and licensees, we do not control them or their labor practices. If one of
our independent contract manufacturers, suppliers or licensees violates labor or other laws or
diverges from those labor practices generally accepted as ethical in the United States, it could
result in adverse publicity for us, damage our reputation in the United States or render our
conduct of business in a particular foreign country undesirable or impractical, any of which could
harm our business.
In addition, if we, or our foreign manufacturers, violate United States or foreign trade laws
or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and
the forfeiture of the products we are attempting to import or the loss of our import privileges.
Possible violations of United States or foreign laws or regulations could include inadequate record
keeping of our imported products, misstatements or errors as to the origin, quota category,
classification, marketing or valuation of our imported products, fraudulent visas or labor
violations. The effects of these factors could render our conduct of business in a particular
country undesirable or impractical and have a negative impact on our operating results.
Our Operating Results Could Be Negatively Impacted If Our Sales Are Concentrated In Any One Style
Or Group Of Styles.
If any one style or group of similar styles of our footwear were to represent a substantial
portion of our net sales, we could be exposed to risk should consumer demand for such style or
group of styles decrease in subsequent periods. We attempt to mitigate this risk by offering a
broad range of products, and no style comprised over 5% of our gross wholesale sales during 2006 or
2005. However, this may change in the future and fluctuations in sales of any given style that
represents a significant portion of our future net sales could have a negative impact on our
operating results.
Our Strategies Involve A Number Of Risks That Could Prevent Or Delay Any Successful Opening Of New
Stores As Well As Impact The Performance Of Our Existing Stores.
Our ability to open and operate new stores successfully depends on many factors, including,
among others, our ability to identify suitable store locations, the availability of which is
outside of our control; negotiate acceptable lease terms, including desired tenant improvement
allowances; source sufficient levels of inventory to meet the needs of new stores; hire, train and
retain store personnel; successfully integrate new stores into our existing operations; and satisfy
the fashion preferences in new geographic areas.
In addition, some or a substantial number of new stores could be opened in regions of the
United States in which we currently have few or no stores. Any expansion into new markets may
present competitive, merchandising and distribution challenges that are different from those
currently encountered in our existing markets. Any of these challenges could adversely affect our
business and results of operations. In addition, to the extent that any new store openings are in
existing markets, we may experience reduced net sales volumes in existing stores in those markets.
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Many Of Our Retail Stores Depend Heavily On The Customer Traffic Generated By Shopping And Factory
Outlet Malls Or By Tourism.
Many of our concept stores are located in shopping malls and some of our factory outlet stores
are located in manufacturers’ outlet malls where we depend on obtaining prominent locations and the
overall success of the malls to generate customer traffic. We cannot control the development of new
malls, the availability or cost of appropriate locations within existing or new malls or the
success of individual malls. Some of our concept stores occupy street locations that are heavily
dependent on customer traffic generated by tourism. Any substantial decrease in tourism resulting
from political, social or military events, a downturn in the economy or otherwise, is likely to
adversely affect sales in our existing stores, particularly those with street locations. The
effects of these factors could hinder our ability to open retail stores in new markets or reduce
sales of particular existing stores, which could negatively affect our operating results.
We Depend On Key Personnel To Manage Our Business Effectively In A Rapidly Changing Market, And If
We Are Unable To Retain Existing Personnel, Our Business Could Be Harmed.
Our future success depends upon the continued services of Robert Greenberg, Chairman of the
Board and Chief Executive Officer, Michael Greenberg, President, and David Weinberg, Executive Vice
President and Chief Operating Officer. The loss of the services of any of these individuals or any
other key employee could harm us. Our future success also depends on our ability to identify,
attract and retain additional qualified personnel. Competition for employees in our industry is
intense and we may not be successful in attracting and retaining such personnel.
The Disruption, Expense And Potential Liability Associated With Existing And Unanticipated Future
Litigation Against Us Could Have A Material Adverse Effect On Our Business, Results Of Operations
And Financial Condition.
We are subject to various legal proceedings and threatened legal proceedings from time to time
as part of our business. We are not currently a party to any legal proceedings or aware of any
threatened legal proceedings, the adverse outcome of which, individually or in the aggregate, we
believe would have a material adverse effect on our business, results of operations or financial
condition. However, any unanticipated litigation in the future, regardless of its merits, could
significantly divert management’s attention from our operations and result in substantial legal
fees to us. Further, there can be no assurance that any actions that have been or will be brought
against us will be resolved in our favor or, if significant monetary judgments are rendered against
us, that we will have the ability to pay such judgments. Such disruptions, legal fees and any
losses resulting from these claims could have a material adverse effect on our business, results of
operations and financial condition.
Our Trademarks, Design Patents And Other Intellectual Property Rights May Not Be Adequately
Protected Outside The United States.
We believe that our trademarks, design patents and other proprietary rights are important to
our success and our competitive position. We devote substantial resources to the establishment and
protection of our trademarks and design patents on a worldwide basis. In the course of our
international expansion, we have, however, experienced conflicts with various third parties that
have acquired or claimed ownership rights in certain trademarks similar to ours or have otherwise
contested our rights to our trademarks. We have in the past successfully resolved these conflicts
through both legal action and negotiated settlements, none of which we believe has had a material
impact on our financial condition and results of operations. Nevertheless, we cannot assure you
that the actions we have taken to establish and protect our trademarks and other proprietary rights
outside the United States will be adequate to prevent imitation of our products by others or to
prevent others from seeking to block sales of our products as a violation of the trademarks and
proprietary rights of others. Also, we cannot assure you that others will not assert rights in, or
ownership of, trademarks, designs and other proprietary rights of ours or that we will be able to
successfully resolve these types of conflicts to our satisfaction. In addition, the laws of certain
foreign countries may not protect proprietary rights to the same extent as do the laws of the
United States. We may face significant expenses and liability in connection with the protection of
our intellectual property rights outside the United States, and if we are unable to successfully
protect our rights or resolve intellectual property conflicts with others, our business or
financial condition may be adversely affected.
Our Ability To Compete Could Be Jeopardized If We Are Unable To Protect Our Intellectual Property
Rights Or If We Are Sued For Intellectual Property Infringement.
We use trademarks on nearly all of our products and believe that having distinctive marks that
are readily identifiable is an important factor in creating a market for our goods, in identifying
us and in distinguishing our goods from the goods of others. We
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consider our Skechers®, S in Shield Design® and Performance-S Shifted Design® trademarks to be
among our most valuable assets and we have registered these trademarks in many countries. In
addition, we own many other trademarks, which we utilize in marketing our products. We continue to
vigorously protect our trademarks against infringement. We also have a number of design patents and
a limited number of utility patents covering components and features used in various shoes. We
believe that our success depends primarily upon skills in design, research and development,
production and marketing rather than upon our patent position. However, we have followed a policy
of filing applications for United States and foreign patents on designs and technologies that we
deem valuable.
We believe that our patents and trademarks are generally sufficient to permit us to carry on
our business as presently conducted. We cannot, however, know whether we will be able to secure
patents or trademark protection for our intellectual property in the future or that protection will
be adequate for future products. Further, we face the risk of ineffective protection of
intellectual property rights in the countries where we source and distribute our products. We have
been sued for patent and trademark infringement and cannot be sure that our activities do not and
will not infringe on the proprietary rights of others. If we are compelled to prosecute infringing
parties, defend our intellectual property or defend ourselves from intellectual property claims
made by others, we may face significant expenses and liability and necessary management attention
to such matters, which could negatively impact our business or financial condition.
Natural Disasters Or A Decline In Economic Conditions In California Could Increase Our Operating
Expenses Or Adversely Affect Our Sales Revenue.
A substantial portion of our operations are located in California, including 40 of our retail
stores, our headquarters in Manhattan Beach and our domestic distribution center in Ontario.
Because a significant portion of our net sales is derived from sales in California, a decline in
the economic conditions in California, whether or not such decline spreads beyond California, could
materially adversely affect our business. Furthermore, a natural disaster or other catastrophic
event, such as an earthquake or wild fires affecting California, could significantly disrupt our
business including the operation of our only domestic distribution center. We may be more
susceptible to these issues than our competitors whose operations are not as concentrated in
California.
Failure By Us To Comply With Any Of The Financial Covenants In Our Long-Term Debt Agreements And
$150.0 Million Line Of Credit Facility Could Have A Material Adverse Impact On Our Business.
A significant decrease in our operating results could adversely affect our ability to maintain
required financial covenants under our various long-term debt agreements and our $150.0 million
credit facility. If these financial covenants are not maintained, the creditors will have the
option to require immediate repayment of all outstanding long-term debt and any amounts outstanding
under the credit facility, if any, and some of these agreements also contain cross-default
provisions. The most likely result would require us to renegotiate certain terms of these
agreements, obtain waivers from the creditors or obtain new debt agreements with other creditors,
which may contain less favorable terms. If we are unable to renegotiate acceptable terms, obtain
necessary waivers or obtain new debt agreements, this could have a material adverse effect on our
business, results of operations and financial condition.
One Principal Stockholder Is Able To Control Substantially All Matters Requiring A Vote Of Our
Stockholders And His Interests May Differ From The Interests Of Our Other Stockholders.
As of December 31, 2006, Robert Greenberg, Chairman of the Board and Chief Executive Officer,
beneficially owned 77.4% of our outstanding Class B Common Stock and members of Mr. Greenberg’s
immediate family beneficially owned the remainder of our outstanding Class B Common Stock. The
holders of Class A Common Stock and Class B Common Stock have identical rights except that holders
of Class A Common Stock are entitled to one vote per share while holders of Class B Common Stock
are entitled to ten votes per share on all matters submitted to a vote of our stockholders. As a
result, as of December 31, 2006, Mr. Greenberg beneficially owned approximately 64.3% of the
aggregate number of votes eligible to be cast by our stockholders, and together with shares
beneficially owned by other members of his immediate family, he beneficially owned approximately
83.1% of the aggregate number of votes eligible to be cast by our stockholders. Mr. Greenberg may
have different interests than our other stockholders, and because he is able to control
substantially all matters requiring approval by our stockholders, he may direct the operations of
our business in a manner contrary to the interests of our other stockholders. Matters that require
the approval of our stockholders include the election of directors and the approval of mergers or
other business combination transactions. Mr. Greenberg also has control over our management and
affairs. As a result of such control, certain transactions are not possible without the approval
of Mr. Greenberg, including proxy contests, tender offers, open market purchase programs or other
transactions that can give our stockholders the opportunity to realize a premium over the
then-prevailing market prices for their shares of our Class A Common Stock. The
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differential in the voting rights may adversely affect the value of our Class A Common Stock
to the extent that investors or any potential future purchaser view the superior voting rights of
our Class B Common Stock to have value.
Our Charter Documents And Delaware Law May Inhibit A Takeover, Which May Cause A Decline In The
Value Of Our Stock.
Provisions of Delaware law, our certificate of incorporation or our bylaws could make it more
difficult for a third party to acquire us, even if closing such a transaction would be beneficial
to our stockholders. Mr. Greenberg’s substantial beneficial ownership position, together with the
authorization of Preferred Stock, the disparate voting rights between our Class A Common Stock and
Class B Common Stock, the classification of our Board of Directors and the lack of cumulative
voting in our certificate of incorporation and bylaws, may have the effect of delaying, deferring
or preventing a change in control, may discourage bids for our Class A Common Stock at a premium
over the market price of the Class A Common Stock and may adversely affect the market price of our
Class A Common Stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our corporate headquarters and additional administrative offices are located at four premises
in Manhattan Beach, California, which consist of an aggregate of approximately 100,000 square feet.
We own and lease portions of our corporate headquarters and administrative offices. The property
leases expire between October 2010 and February 2012, with options to extend these leases in some
cases, and the current aggregate annual rent for the leased property is approximately $0.5 million.
Also, construction commenced in 2005 on another corporate facility in Manhattan Beach, California
that is expected to be approximately 55,000 square feet. This facility is scheduled to be
completed by the end of 2007.
Our U.S. distribution center consists of four leased facilities and one that we own, which are
located in Ontario, California. The four leased facilities aggregate approximately 1,407,000 square
feet, with an annual base rent of approximately $5.1 million. The owned distribution facility is
approximately 264,000 square feet. The property leases expire between November 2007 and May 2011,
and these leases contain rent escalation provisions. We believe that we have the capacity at our
Ontario distribution center to increase our current operations to meet any future growth plans, and
if we should ever need to expand our distribution facilities to allow for further growth, we
believe there is presently enough space available in close proximity that we may lease or purchase
in the foreseeable future.
Our European distribution center consists of a 240,000 square-foot facility in Liege, Belgium
under a 25-year operating lease with base rent of approximately $1.1 million per year. The lease
provides for first right of refusal on three facilities planned for development, allowing for
expansion up to a total of approximately 735,000 square feet. We believe that the capacity
available to us within our lease agreement should allow for further growth of our international
operations. The lease agreement also provides for early termination at five-year intervals
beginning in February 2007, pending notification as prescribed in the lease, which has not been
exercised.
All of our domestic retail stores and showrooms are leased with terms expiring between July
2007 and March 2018. The leases provide for rent escalations tied to either increases in the
lessor’s operating expenses, fluctuations in the consumer price index in the relevant geographical
area or a percentage of the store’s gross sales in excess of the base annual rent. Total base rent
expense related to our domestic retail stores and showrooms was $20.4 million for the year ended
December 31, 2006.
We also lease all of our international administrative offices, retail stores and showrooms
located in Canada, France, Germany, Switzerland, Italy, Spain, the Netherlands and the United
Kingdom. The property leases expire at various dates between November 2007 and September 2018.
Total rent for the leased properties aggregated approximately $6.3 million for the year ended
December 31, 2006.
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ITEM 3. LEGAL PROCEEDINGS
On March 25, 2003, a shareholder securities class action complaint captioned HARVEY SOLOMON v.
SKECHERS USA, INC. et al. was filed against Skechers and certain of its officers and directors in
the United States District Court for the Central District of California (Case No. 03-2094 DDP). On
April 2, 2003, a shareholder securities class action complaint captioned CHARLES ZIMMER v. SKECHERS
USA, INC. et al. was filed against our company and certain of its officers and directors in the
United States District Court for the Central District of California (Case No. 03-2296 PA). On April
15, 2003, a shareholder securities class action complaint captioned MARTIN H. SIEGEL v. SKECHERS
USA, INC. et al. was filed against our company and certain of its officers and directors in the
United States District Court for the Central District of California (Case No 03-2645 RMT). On May
6, 2003, a shareholder securities class action complaint captioned ADAM D. SAPHIER v. SKECHERS USA,
INC. et al. was served on our company and certain of its officers and directors in the United
States District Court for the Central District of California (Case No. 03-3011 FMC). On May 9,
2003, a shareholders securities class action complaint captioned LARRY L. ERICKSON v. SKECHERS USA,
INC. et al. was served on our company and certain of its officers and directors in the United
States District Court for the Central District of California (Case No. 03-3101 SJO). Each of these
class action complaints alleged violations of the federal securities laws on behalf of persons who
purchased our publicly traded securities between April 3, 2002 and December 9, 2002. In July 2003,
the court in these federal securities class actions, all pending in the United States District
Court for the Central District of California, ordered the cases consolidated and a consolidated
complaint to be filed and served. On September 25, 2003, the plaintiffs filed a consolidated
complaint entitled In re SKECHERS USA, Inc. Securities Litigation, Case No. CV-03-2094-PA in the
United States District Court for the Central District of California, consolidating all of the
federal securities actions above. The complaint names as defendants our company and certain
officers and directors and alleges violations of the federal securities laws and breach of
fiduciary duty on behalf of persons who purchased our publicly traded securities between April 3,
2002 and December 9, 2002. The complaint seeks compensatory damages, interest, attorneys’ fees and
injunctive and equitable relief. We moved to dismiss the consolidated complaint in its entirety. On
May 10, 2004, the court granted our motion to dismiss with leave for plaintiffs to amend the
complaint. On August 9, 2004, plaintiffs filed a first amended consolidated complaint for
violations of the federal securities laws. The allegations and relief sought were virtually
identical to the original consolidated complaint. We moved to dismiss the first amended
consolidated complaint and the motion was set for hearing on December 6, 2004. On March 21, 2005,
the court granted the motion to dismiss the first amended consolidated complaint with leave for
plaintiffs to amend one final time. On April 7, 2005, plaintiffs elected to stand on the first
amended consolidated complaint and requested entry of judgment so that an appeal from the court’s
ruling could be taken. On April 26, 2005, the court entered judgment in favor of our company and
the individual defendants, and on May 3, 2005, plaintiffs filed an appeal with the United States
Court of Appeals for the Ninth Circuit. As of the date of filing this annual report, all briefing
by the parties has been completed, and a hearing date has been scheduled for April 18, 2007.
Discovery has not commenced in the underlying action. While it is too early to predict the outcome
of the appeal and any subsequent litigation, we continue to believe the suit is without merit and
continue to vigorously defend against the claims.
On October 11, 2006, Violeta Gomez filed a lawsuit in the Superior Court of the State of
California, County of Los Angeles, VIOLETA PIZA GOMEZ V. TEAM-ONE STAFFING SERVICES, INC., AB/T1,
INC. AND SKECHERS U.S.A., INC. (Case No. BC360134). The complaint alleges wrongful termination
under the California Fair Employment and Housing Act, Government Code §12900, et seq., as a result
of discrimination against Ms. Gomez. The complaint seeks general, special, punitive and exemplary
damages, interest, attorneys’ fees and reinstatement of employment. We plan on defending the
allegations vigorously and believe the claims are without merit. Nonetheless, it is too early to
predict the outcome and whether the outcome will have a material adverse effect on our financial
condition or results of operations.
On January 26, 2007, ASICS America Corporation and ASICS Corporation (Japan) (collectively,
“ASICS”) filed a lawsuit in the U.S. District Court for the Central District of California against
our company, Zappos.com, Inc., Brown Shoe Company, Inc. dba Famousfootwear.com and Brown Group
Retail, Inc. dba Famous Footwear U.S.A., Inc. alleging trademark infringement, unfair competition,
trademark dilution and false advertising arising out of our alleged use of marks similar to ASICS’s
stripe design mark. The lawsuit seeks, inter alia, compensatory, treble and punitive damages,
profits, attorney’s fees and costs, and a permanent injunction against us to prevent any future
sales and distribution of shoes that allegedly bear a stripe design similar to the ASICS stripe
design. On February 26, 2007, we filed a lawsuit against ASICS in the United States District Court
for the Central District of California for trade libel, unfair competition and tortious
interference with prospective economic advantage and economic business relations. We seek
injunctive relief enjoining ASICS from engaging in further unlawful acts, disgorgement of ASICS’
profits, attorneys’ fees and $100 million in punitive damages. We also seek a declaration that none
of our designs infringe upon ASICS’ trademarks. While it is too early to predict the outcome of the
litigation, we believe that we have meritorious defenses to the claims asserted by ASICS and intend
to defend against those claims vigorously.
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We have no reason to believe that any liability with respect to pending legal actions,
individually or in the aggregate, will have a material adverse effect on our company’s consolidated
financial statements or results of operations. We occasionally become involved in litigation
arising from the normal course of business, and management is unable to determine the extent of any
liability that may arise from unanticipated future litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to our security holders to be voted on during the fourth quarter of
2006.
PART II
| ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Our Class A Common Stock trades on the New York Stock Exchange under the symbol “SKX.” The
following table sets forth, for the periods indicated, the high and low sales prices of our Class A
Common Stock.
| HIGH | LOW | |||||||
YEAR ENDED DECEMBER 31, 2006 |
||||||||
First Quarter |
$ | 25.04 | $ | 14.80 | ||||
Second Quarter |
28.35 | 21.19 | ||||||
Third Quarter |
26.00 | 19.70 | ||||||
Fourth Quarter |
33.58 | 23.51 | ||||||
YEAR ENDED DECEMBER 31, 2005 |
||||||||
First Quarter |
$ | 16.90 | $ | 12.80 | ||||
Second Quarter |
15.62 | 11.18 | ||||||
Third Quarter |
18.19 | 13.94 | ||||||
Fourth Quarter |
16.50 | 12.00 | ||||||
HOLDERS
As of March 1, 2007, there were 103 holders of record of our Class A Common Stock (including
holders who are nominees for an undetermined number of beneficial owners) and 17 holders of record
of our Class B Common Stock. These figures do not include beneficial owners who hold shares in
nominee name. The Class B Common Stock is not publicly traded but each share is convertible upon
request of the holder into one share of Class A Common Stock.
DIVIDEND POLICY
Since our conversion from an S Corporation to a C Corporation prior to the initial public
offering of our Class A Common Stock in 1999, earnings have been and will be retained for the
foreseeable future in the operations of our business. We have not declared or paid any cash
dividends on our Class A Common Stock and do not anticipate paying any cash dividends in the
foreseeable future. Our current policy is to retain all of our earnings to finance the growth and
development of our business.
EQUITY COMPENSATION PLAN INFORMATION
Our equity compensation plan information is provided as set forth in Part III, Item 12 of this
annual report.
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PERFORMANCE GRAPH
The following graph demonstrates the total return to stockholders of our company’s Class A
Common Stock from December 31, 2001 to December 31, 2006, relative to the performance of the
Russell 2000 Index, which includes our Class A Common Stock, and our peer group index, which
consists of eight companies believed to be engaged in similar businesses: Nike, Inc., Adidas AG,
K-Swiss Inc., The Stride Rite Corporation, Kenneth Cole Productions, Inc., Steven Madden, Ltd., The
Timberland Company and Wolverine World Wide, Inc.
The graph assumes an investment of $100 on December 31, 2001 in each of our company’s Class A
Common Stock and the stocks comprising each of the Russell 2000 Index and the customized peer group
index. Each of the indices assumes that all dividends were reinvested. The stock performance of
our company’s Class A Common Stock shown on the graph is not necessarily indicative of future
performance. We will not make nor endorse any predictions as to our future stock performance.
| Company/Index | 12/31/01 | 12/31/02 | 12/31/03 | 12/31/04 | 12/31/05 | 12/31/06 | ||||||||||||||||||||||||||
Skechers U.S.A., Inc. |
$ | 100.00 | $ | 58.07 | $ | 55.75 | $ | 88.65 | $ | 104.79 | $ | 227.84 | ||||||||||||||||||||
Russell 2000 |
100.00 | 79.52 | 117.09 | 138.55 | 144.86 | 171.47 | ||||||||||||||||||||||||||
Custom Peer Group |
100.00 | 88.44 | 126.85 | 166.93 | 178.49 | 196.07 | ||||||||||||||||||||||||||
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ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth our company’s selected consolidated financial data as of and
for each of the years in the five-year period ended December 31, 2006 and should be read in
conjunction with our audited consolidated financial statements and notes thereto included under
Part II, Item 8 of this annual report.
(In thousands, except net earnings (loss) per share)
| AS OF DECEMBER 31, | ||||||||||||||||||||
| STATEMENT OF EARNINGS DATA: | 2006 | 2005 | 2004 | 2003 | 2002 | |||||||||||||||
Net sales |
$ | 1,205,368 | $ | 1,006,477 | $ | 920,322 | $ | 834,976 | $ | 943,582 | ||||||||||
Gross profit |
523,346 | 420,482 | 370,857 | 317,686 | 386,673 | |||||||||||||||
Earnings (loss) from operations |
112,544 | 76,296 | 49,245 | (1,347 | ) | 82,655 | ||||||||||||||
Earnings (loss) before income taxes |
112,648 | 72,797 | 38,720 | (10,373 | ) | 75,341 | ||||||||||||||
Net earnings (loss) |
70,994 | 44,717 | 23,553 | (11,867 | ) | 47,036 | ||||||||||||||
Net earnings (loss) per share:(1) |
||||||||||||||||||||
Basic |
1.73 | 1.13 | 0.61 | (0.31 | ) | 1.26 | ||||||||||||||
Diluted |
1.59 | 1.06 | 0.59 | (0.31 | ) | 1.20 | ||||||||||||||
Weighted average shares:(1) |
||||||||||||||||||||
Basic |
41,079 | 39,686 | 38,638 | 37,840 | 37,275 | |||||||||||||||
Diluted |
46,139 | 44,518 | 39,800 | 37,840 | 40,854 | |||||||||||||||
| YEARS ENDED DECEMBER 31, | ||||||||||||||||||||
| BALANCE SHEET DATA: | 2006 | 2005 | 2004 | 2003 | 2002 | |||||||||||||||
Working capital |
$ | 450,787 | $ | 361,210 | $ | 313,883 | $ | 275,124 | $ | 286,760 | ||||||||||
Total assets |
737,053 | 581,957 | 518,653 | 466,533 | 483,156 | |||||||||||||||
Long-term debt, excluding current portion |
106,805 | 107,288 | 113,038 | 116,047 | 117,204 | |||||||||||||||
Stockholders’ equity |
449,087 | 343,830 | 294,895 | 255,654 | 259,236 | |||||||||||||||
| (1) | Basic earnings (loss) per share represents net earnings (loss) divided by the weighted-average number of common shares outstanding for the period. Diluted earnings (loss) per share, in addition to the weighted average determined for basic earnings per share, reflects the potential dilution that could occur if options to issue common stock were exercised or converted into common stock and assumes the conversion of our 4.50% convertible subordinated notes for the period outstanding since their issuance in April 2002, unless their inclusion would be anti-dilutive. |
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| ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION |
GENERAL
We design, market and sell contemporary footwear for men, women and children under the
Skechers brand as well as nine other fashion and street brands. Our footwear is sold through a wide
range of department stores and leading specialty retail stores, mid-tier retailers, boutiques, our
own retail stores, distributor-owned international retail stores and our e-commerce website. Our
objective is to continue to profitably grow our domestic operations, while leveraging our brand
name to expand internationally.
Our operations are organized along our distribution channels and have the following four
reportable sales segments — domestic wholesale sales, international wholesale sales, retail sales
and e-commerce sales. We evaluate segment performance based primarily on net sales and gross
margins. See detailed segment information in note 14 to our consolidated financial statements
included under Part II, Item 8 of this annual report.
FINANCIAL OVERVIEW
Skechers achieved record revenue and earnings during 2006. Our net sales for 2006 were
$1.205 billion, an increase of $198.9 million or 19.8% percent over net sales of $1.006 billion in
2005. Diluted earnings per share grew to a record $1.59, which reflected a 50.0% increase over
the $1.06 reported in the prior year. Working capital was $450.8 million at December 31, 2006, an
increase of $89.6 million from working capital of $361.2 million at December 31, 2005. Cash and
short-term investments increased by $23.5 million to $220.5 million in 2006 compared to $197.0
million at December 31, 2005, primarily due to our increased earnings.
Our higher net sales and profitability for 2006 as compared to 2005 are the result of our
dedicated efforts to consistently deliver trend-right styles, which has led to an increased demand
for our in-season product, continued growth in our fashion and street lines, increased margins due
to a shift in sales to our higher margin business units, increased international subsidiary and
retail sales, and a reduction in general and administrative expenses as a percentage of net sales.
Our domestic wholesale segment is our largest distribution channel comprising 64.1%, 63.0%, and
63.3% of our consolidated net sales for the years ended December 31, 2006, 2005 and 2004,
respectively. Our international wholesale sales comprised 15.2%, 16.3%, and 17.0% of our
consolidated net sales for the years ended December 31, 2006, 2005 and 2004, respectively. Retail
sales comprised 19.7%, 20.0%, and 19.2% of our consolidated net sales for the years ended December
31, 2006, 2005 and 2004, respectively, of which our domestic retail sales comprised 18.1%, 18.4%,
and 17.6% of our consolidated net sales for the years ended December 31, 2006, 2005 and 2004,
respectively. Our international retail sales did not comprise more than 10% of our consolidated
net sales in 2006, 2005 or 2004.
Domestic wholesale unit sales volume increased 15.6% to 39.8 million pairs in 2006 from 34.4
million pairs in 2005, and our average selling price per pair increased 5.4% to
$19.44 in 2006 from $18.45 in 2005. These increases in average selling price per pair and
increase in unit sales volume were due to the continued improvement and favorable response to our
in-season product in 2006.
2006 INITIATIVES
Our positive results for 2006 were driven by focusing on our core strengths and initiatives
which included:
New product design and delivery. Our success depends on our ability to frequently introduce
new styles and product lines as well as design products in anticipation of consumers’ ever-evolving
preferences. This includes building our existing product lines with updates to proven sellers as
well as creating new styles that we believe will become core to the line in upcoming seasons. Our
focus in 2006 was primarily on updating many key sellers in our current lines and growing our
fashion and street lines: 310 Motoring, Unltd. by Marc Ecko, Rhino Red, Kitson, Mark Nason, Siren
by Mark Nason and Michelle K. During 2006 we introduced two new fashion lines: Red by Marc Ecko
for women and Zoo York for men.
Building our brands. As a marketing-driven company, we consistently focus on advertising the
Skechers brand and our fashion and street brands in targeted publications, on key television
programming and in high traffic areas and key malls. During 2006, we focused on creating effective
and powerful advertising to communicate our message. We also continued our celebrity endorsee
driven ads with the launch of our new Skechers celebrity endorsee, platinum recording artist Ashlee
Simpson. We believe Ms. Simpson’s appeal and popularity has had a positive impact on our brand.
In addition, we have increased the use of television campaigns for our Skechers men’s, women’s and
children’s lines that we expect will further grow all of our brands.
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Our goal with our fashion and street lines is to increase brand recognition through the
continued presence of print and television advertising in targeted markets. Each brand has its own
print campaign and some may have additional forms of marketing, such as television. Of the nine
brands that comprise our fashion and street lines, Unltd. by Marc Ecko and Rhino Red are globally
recognized brands, Michelle K and Mark Nason are becoming more established through several years of
marketing efforts, and 310 Motoring, Kitson, Red by Marc Ecko, Zoo York and Avirex are brands with
rapidly growing recognition. In 2006, we signed Lost star Evangeline Lilly to support Michelle K.
With the appeal and uniqueness of the 310 Motoring brand, we were able to develop a signature line
of sneakers with multi-platinum hip hop recording artist The Game. In 2006, we continued our
marketing program featuring The Game and released a second Hurricane shoe. We believe that these
celebrity endorsee driven ad campaigns generated additional demand
for our fashion and street products in 2006.
Further grow our company-owned retail business. With a focus on profitably growing our retail
business, in 2006 we increased our store count by 20 stores, and we
saw double digit comparable store sales growth in our domestic retail business during 2006 and
believe that it will continue to grow as we expand into new domestic markets.
Building on our strong executive team. We strengthened our management team to support our
future growth. In January 2006, we promoted our Chief Financial Officer David Weinberg to the
position of Chief Operating Officer and appointed Fred Schneider, who had been a member of our
Board of Directors and Chairman of our Audit Committee, as our Chief Financial Officer. This
addition provides us with the management resources necessary to continue to manage the growth in
our operations and infrastructure.
Expand our e-commerce business. We believe the internet is an efficient and high margin
distribution channel which allows us to communicate with consumers and manage customer
relationships. Our e-commerce business supports our brands by improving our customer service and
providing feedback about customer tastes and preferences. Our websites also provide a platform
with strong growth potential while leveraging our existing distribution systems with modest capital
investments. During 2006, we continued to improve and expand our e-commerce business with the
redesign of the Skechers web site and fulfillment process as well as the introduction of our new
fashion brand website www.soholab.com.
Further develop our international businesses. In 2006, we continued to focus on improving our
international operations by (i) increasing our customer base within our subsidiary business, (ii)
increasing the product count within each account, (iii) delivering the right product into the right
markets, specifically with our distributor business and (iv) tailoring our product offerings
currently available to our international customers to increase demand for our product. Our
international business is supported by eight subsidiaries that sell direct to wholesale accounts in
11 countries in Europe plus Canada. We believe the continued strength of our international business
is a direct result of a broader acceptance of our trend-right product and increases in style
counts. During 2006, several of our distributors implemented appropriate product and marketing
efforts, which positioned them to improve their businesses during the year.
OUTLOOK FOR 2007
We will continue to broaden our product offering in 2007 with new lines that do not directly
compete with our existing brands and allow us the opportunity to broaden the targeted demographic
profile of our consumer base, increase our shelf space and enter into new doors without detracting
from existing business. For example, we recently announced a licensed line of footwear for Avirex,
which is an aviation-inspired brand that we introduced in Spring 2007. We believe that our
marketing campaign with Ashlee Simpson will continue to have a positive impact on the Skechers
brand and will create further demand for our product in 2007. Singer/actress JoJo became the new
face of Rhino Red with print ads and a television campaign that began in the first quarter of 2007,
and later this year, we will launch our second celebrity endorsee marketing program in support of
the 310 Motoring brand, this campaign featuring legendary rapper
Nas and his 310 signature shoe. We believe that these celebrity endorsee driven ad campaigns,
as well as the existing ones with The Game, Terrence Howard and
Evangeline Lilly, should continue to generate
additional demand for our fashion and street products in 2007. In our ongoing efforts to increase
our retail distribution channel, we opened four stores in the first two months of 2007 while
closing one store in Germany, bringing our domestic and international company-owned store count to
156. We plan to open another 20 to 25 company-owned stores in 2007.
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YEAR ENDED DECEMBER 31, 2006 COMPARED TO THE YEAR ENDED DECEMBER 31, 2005
Net sales
Net sales for 2006 were $1.205 billion, an increase of $198.9 million, or 19.8%, over net
sales of $1.006 billion in 2005. The increase in net sales was due to increased domestic wholesale
sales, retail sales and international wholesale sales. Our domestic wholesale segment increased
21.9%, or $138.6 million, to $772.9 million compared to $634.3 million in 2005. The increase in
domestic wholesale segment net sales came on a 15.6% unit sales volume increase to 39.8 million
pairs from 34.4 million pairs in 2005. Our average selling price per pair increased 5.4% to $19.44
from $18.45 in 2005. The increase in sales was a result of increased demand for our in-season
products and broader acceptance of our new lines, including sport fusion and casual fusion
footwear. The strongest increases came in our Women’s Active, Men’s USA, and Kids lines.
Our retail segment sales increased $35.8 million to $237.4 million in 2006, a 17.8% increase
over sales of $201.6 million in 2005. The increase in retail sales was due to a net increase of 20
stores, increased sales across all three store formats and positive comparable store sales. During
2006, we opened 22 new domestic stores, one international store and closed three other domestic
stores. These new stores contributed $10.0 million in net sales during 2006 as compared to new
store sales of $4.6 million for eleven other stores opened in 2005. Of our new store additions, 14
were concept stores, eight were outlet stores, and one was a warehouse store. In addition, during
2006, we realized positive comparable store sales increases in our domestic retail stores (those
opened at least one year) of 10.7% and 14.6% in our international retail stores. Our domestic
retail sales increased 17.3% due to positive comparable sales and having seven retail stores that
were opened in 2005 being open the entire year in 2006. Our international retail sales increased
22.6% in 2006 compared to 2005, due to increased comparable sales, the opening of one additional
store, as well as favorable currency translation adjustments.
We currently have 144 domestic retail stores as of February 28, 2007, and we believe that we
have a presence in most major domestic markets. We currently plan to open between approximately 20
to 25 domestic retail stores in 2007. During 2006 we closed three under-performing retail stores,
the same number in 2005. We periodically review all of our stores for impairment. During 2006, we
did not record an impairment charge. During 2005, we recorded an impairment charge of $0.9 million
related to leasehold improvements for two of our stores. Further, we carefully review our
under-performing
stores and may consider the non-renewal of leases upon completion of the current term of the
applicable lease.
Our international wholesale segment sales increased $20.2 million to $183.7 million in 2006, a
12.3% increase over sales of $163.5 million in 2005. Our international wholesale sales consist of
direct subsidiary sales — those we make to department stores and specialty retailers — and sales
to our distributors who in turn sell to department stores and specialty retailers in various
international regions where we do not sell direct. Direct subsidiary sales increased $10.7
million, or 12.8%, to $94.1 million compared to net sales of $83.4 million in 2005. The increase in
direct subsidiary sales was primarily due to increased sales into UK, Germany, Benelux, and Canada.
Our distributor sales increased $9.5 million to $89.6 million in 2006, an 11.8% increase over
sales of $80.1 million in 2005. This was primarily due to increased sales to our distributors in
Panama, Russia, and Serbia.
Our e-commerce sales increased $4.4 million to $11.4 million in 2006, a 61.3% increase over
sales of $7.0 million in 2005. Our
e-commerce sales made up less than 1% of our consolidated net sales in both 2006 and 2005.
Gross profit
Gross profit for 2006 increased $102.8 million to $523.3 million as compared to $420.5
million in 2005. Our domestic wholesale segment increased $68.8 million, or 29.6%, to $301.2
million in 2006 compared to $232.4 million in 2005. Gross profit as a percentage of net sales, or
gross margin, increased to 43.4% in 2006 from 41.8% in 2005.
This gross margin increase was the result of the increase in domestic wholesale margins, which
increased to 39.0% in 2006 from 36.6% for 2005 and an increase in retail margins to 63.8% in 2006
from 61.5% in 2005. This was partially offset by the decrease in international wholesale margins,
which decreased to 35.4% in 2006 from 37.2% in 2005. Increased margins were a result of increased
sales volume in our higher margin in-season products and broader acceptance of our new lines,
including sport fusion and casual fusion footwear.
Gross profit for our retail segment increased $27.5 million, or 22.2%, to $151.4 million in
2006 as compared to $123.9 million in 2005. This increase in
gross profit was due to eleven stores
that were opened in 2005 being open the entire year in 2006 and positive comparable store sales
increases of 14.6% and 10.7% in our international and domestic stores, respectively. During 2006,
we opened
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22 new domestic stores, one international store and closed three other domestic stores.
Gross margins increased to 63.8% in 2006 as compared to 61.5% in 2005. Again, increased margins
were a result of increased sales volume in our higher margin in-season products and broader
acceptance of our new lines, including sport fusion and casual fusion footwear.
Gross profit for our international wholesale segment increased $4.2 million, or 7.0%, to $65.0
million for 2006 compared to $60.8 million in 2005. Gross margins were 35.4%
for 2006 compared to 37.2% in 2005. International wholesale sales through our foreign
subsidiaries achieve higher gross margins than our international wholesale sales through our
foreign distributors. Gross margins for our direct subsidiary sales were 42.4% in 2006 as compared
to 44.0% in 2005. Gross margins for our distributor sales were 28.1% in 2006 as compared to 30.1%
in 2005. The decrease in gross margins was primarily due to increased discounts and allowances.
Our cost of sales includes the cost of footwear purchased from our manufacturers, royalties,
duties, quota costs, inbound freight (including ocean, air and freight from the dock to our
distribution centers), broker fees and storage costs. Because we include expenses related to our
distribution network in general and administrative expenses while some of our competitors may
include expenses of this type in cost of sales, our gross margins may not be comparable, and we may
report higher gross margins than some of our competitors in part for this reason.
Licensing
Net licensing royalties decreased $2.5 million, or 37.9%, to $4.1 million for 2006
compared to $6.6 million in 2005. The decrease in net licensing royalties is primarily the result
of decreased royalty revenue associated with our various licensing agreements.
Selling expenses
Selling expenses increased by $28.5 million, or 35.0%, to $109.9 million for 2006 from
$81.4 million in 2005. As a percentage of net sales, selling expenses were 9.1% and 8.1% in 2006
and 2005, respectively. Selling expenses consist primarily of the following accounts: sales
representative sample costs, sales commissions, trade shows, advertising and promotional costs,
which may include television and ad production costs, and expenses associated with marketing
materials. The increase in selling expenses was primarily due to increased media advertising
expenses of $22.1 million, increased sales commissions of $3.4 million due to higher revenues, and
higher trade show expenses of $2.8 million.
General and administrative expenses
General and administrative expenses increased by $35.6 million, or 13.2%, to $305.0
million for 2006 from $269.4 million in 2005. As a percentage of sales, general and administrative
expenses were 25.3% and 26.8% in 2006 and 2005, respectively. General and administrative expenses
consist primarily of the following: salaries, wages and related taxes, various overhead costs
associated with our corporate staff including stock-based compensation, domestic and international
retail operations, non-selling related costs of our international operations, costs associated with
our domestic and European distribution centers, professional fees related to both legal and
accounting, insurance, and depreciation and amortization, amongst other expenses. Our distribution
network related costs are included in general and administrative expenses and are not allocated to
segments.
The increase in general and administrative expenses was primarily due to increased salaries
and wages of $21.2 million, which includes stock compensation costs of $2.0 million due to the
adoption of SFAS 123(R) in January 2006, increased outside services of $3.5 million, higher rent
expense of $3.2 million due to the opening of 23 retail stores, and increased warehouse and
distribution costs of $3.0 million resulting from increased sales In addition, the expenses
related to our distribution network, including the functions of purchasing, receiving, inspecting,
allocating, warehousing and packaging of our products totaled $77.6 million and $70.5 million for
2006 and 2005, respectively. We did not record any impairment charges in 2006. In 2005,
impairment charges of $0.9 million related to the write-off of leasehold improvements at one of our
domestic retail stores and one international retail store.
We believe that we have established our presence in most major domestic and international
retail markets. We opened 22 domestic retail stores and one international retail store in 2006,
while closing three other domestic stores. We currently plan to open between 20 and 25 domestic
stores in 2007. In addition, we plan to continue to pursue opportunistic international retail
store locations.
We continue to review our cost structure to develop efficiencies within our operations;
however, we believe that our current cost structure is consistent with our anticipated sales levels
in 2007.
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Interest income
Interest income for 2006 increased $4.0 million to $8.4 million compared to $4.4 million for
the same period in 2005. The increase in interest income resulted from higher interest rates and
higher average cash and investment balances during 2006 when compared to the same period in 2005.
Interest expense
Interest expense was $9.2 million for 2006 and 2005. Interest expense is incurred on our
convertible notes, mortgages on our distribution center and our corporate office located in
Manhattan Beach, California, our capital lease obligations and interest on amounts owed to our
foreign manufacturers. We expect our interest expense to be lower in 2007 as compared to 2006 due
to the conversion of our 4.5% convertible subordinated notes to common stock as of February 20,
2007.
Other income (expense)
Other income, net decreased $0.3 million to $1.0 million for 2006, compared to $1.3 million in
2005. The decrease in other income was mainly due to lower recoveries related to the settlement of
various lawsuits during 2006 as compared to 2005, offset by foreign currency gains.
Income taxes
The effective tax rate for 2006 was 37.0% as compared to 38.6% in 2005. Income tax
expense for 2006 was $41.7 million compared to $28.1 million for 2005. The tax
provision was computed using the effective tax rates applicable to each of our domestic and
international taxable jurisdictions. The 2006 rate is slightly lower than the expected domestic
rate of approximately 40% due to our non-U.S. subsidiary earnings in lower tax rate jurisdictions
and our reinvestment of undistributed earnings from our non-U.S. subsidiaries, thereby indefinitely
postponing their remittance to the United States Internal Revenue Service. As such, we did not
provide for deferred income taxes on accumulated undistributed earnings of our non-U.S.
subsidiaries. As of December 31, 2006, withholding and U.S. taxes have not been provided on
approximately $6.0 million of cumulative undistributed earnings.
YEAR ENDED DECEMBER 31, 2005 COMPARED TO THE YEAR ENDED DECEMBER 31, 2004
Net sales
Net sales for 2005 were $1.006 billion, an increase of $86.2 million, or 9.4%, over net
sales of $920.3 million in 2004. The increase in net sales was due to increased domestic wholesale
sales, retail sales and increased direct international sales in Germany, Spain, Benelux, Italy and
Canada, offset by decreased sales in the United Kingdom and France. Our domestic wholesale segment
increased 8.9%, or $52.1 million, to $634.3 million compared to $582.2 million in 2004. The
increase in domestic wholesale segment net sales came on a 8.1% unit sales volume increase to 34.4
million pairs from 31.8 million pairs in 2004. Our average selling price per pair increased 0.7% to
$18.45 from $18.31 in 2004. The increase in sales was a result of increased demand for our
in-season products and broader acceptance of our new lines, including sport fusion and casual
fusion footwear. The strongest increases came in our Women’s Active, Mark Ecko Footwear, and Men’s
USA lines.
Our retail segment sales increased $24.8 million to $201.6 million in 2005, a 14.0% increase
over sales of $176.8 million in 2004. The increase in retail sales was due to a net increase of
eight stores, increased sales across all three store formats and positive comparable store sales.
During 2005, we opened ten new domestic stores, one international store and closed three other
domestic stores. These new stores contributed $4.6 million in net sales during 2005. Of our new
store additions, ten were outlet stores and one was a concept store. In addition, during 2005, we
realized positive comparable store sales increases in our domestic and international retail stores
of 16.9% in our concept stores comparable sales and 3.7% in our international store comparable
sales. Our domestic retail sales increased 14.7% due to positive comparable sales and having four
retail stores that were opened in 2004 being open the entire year in 2005. Our international retail
sales increased 6.7% in 2005 compared to 2004, due to increased comparable sales, the opening of
one additional store, as well as favorable currency translation adjustments. During 2005 we closed
three under-performing retail stores as compared to closing four retail stores in 2004. During
2005, we recorded an impairment charge of $0.9 million related to leasehold improvements for two of
our stores.
Our international wholesale segment sales increased $7.0 million to $163.5 million in 2005, a
4.5% increase over sales of $156.5 million in 2004. Our international wholesale sales consist of
direct subsidiary sales — those we make to department stores and
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specialty
retailers — and sales to our distributors who in turn sell to department stores and specialty
retailers in various international regions where we do not sell direct. The increase in
international wholesale sales was primarily due to increased direct subsidiary sales, which were
partially offset by reduced distributor sales. Direct subsidiary sales increased $11.1 million, or
15.4%, to $83.4 million compared to net sales of $72.3 million in 2004. The increase in direct
subsidiary sales was primarily due to increased sales into Germany, Canada, Spain and Italy. Our
distributor sales decreased $4.1 million to $80.1 million in 2005, a 4.9% decrease over sales of
$84.2 million in 2004. This was primarily due to decreased sales into Japan.
Our e-commerce sales increased $2.2 million to $7.0 million in 2005, a 46.0% increase over
sales of $4.8 million in 2004. Our
e-commerce sales made up less than 1% of our consolidated net sales in both 2005 and 2004.
Gross profit
Gross profit for 2005 increased $49.6 million to $420.5 million as compared to $370.9
million in 2004. Our domestic wholesale segment increased $18.0 million, or 8.4%, to $232.4
million in 2005 compared to $214.4 million in 2004. Gross profit as a percentage of net sales, or
gross margin, increased to 41.8% in 2005 from 40.3% in 2004. This gross margin increase was the
result of the increase in international wholesale margins, which increased to 37.2% in 2005 from
34.6% for 2004, and as a result of retail sales becoming a larger portion of consolidated net
sales, which achieve higher gross margins than our wholesale sales. Increased margins was also a
result of increased demand for our in-season products and broader acceptance of our new lines,
including sport fusion and casual fusion footwear.
Gross profit for our retail segment increased $22.5 million, or 22.2%, to $123.9 million in
2005 as compared to $101.4 million in 2004. This increase in gross profit was due to four stores
that were opened in 2004 being open the entire year in 2005 and positive comparable store sales
increases of 3.7% and 16.9% in our international and domestic stores, respectively. During 2005,
we opened ten new domestic stores, one international store and closed three other domestic stores.
Gross margins increased to 61.5% in 2005 as compared to 57.4% in 2004. The increase in margin was
primarily due to a larger portion of our retail sales coming from our higher margin concept stores
and positive comparable store sales increases.
Gross profit for our international wholesale segment increased $6.7 million, or 12.4%, to
$60.8 million for 2005 compared to $54.1 million in 2004. Gross margins were 37.2% for 2005
compared to 34.6% in 2004. The increase in gross margins was primarily due to increased margins in
our distributor business. The increase in distributor gross margins was primarily due to stronger
sales of in-line merchandise and better product sell-throughs. International wholesale sales
through our foreign subsidiaries achieve higher gross margins than our international wholesale
sales through our foreign distributors. Gross margins for our direct subsidiary sales were 42.4%
for both 2005 and 2004.
Licensing
Net licensing royalties decreased $0.5 million, or 7.0%, to $6.6 million for 2005
compared to $7.1 million in 2004. The decrease in net licensing royalties is primarily the result
of decreased royalty revenue associated with our various licensing agreements.
Selling expenses
Selling expenses increased by $1.7 million, or 2.1%, to $81.4 million for 2005 from $79.7
million in 2004. As a percentage of net sales, selling expenses were 8.1% and 8.7% in 2005 and
2004, respectively. The increase in selling expenses was primarily due to increased media
advertising expenses of $3.2 million and increased sales commissions of $1.0 million, partially
offset by lower sales representative samples of $1.6 million and trade show and catalog expenses of
$0.9 million.
General and administrative expenses
General and administrative expenses increased by $20.4 million, or 8.2%, to $269.4
million for 2005 from $249.0 million in 2004. As a percentage of sales, general and administrative
expenses were 26.8% and 27.1% in 2005 and 2004, respectively. The increase in general and
administrative expenses was primarily due to increased salaries and wages and related payroll costs
of $11.2 million, increased depreciation and repairs and maintenance for our stores of $2.5
million, and increased warehouse and distribution costs of $1.7 million. We did not record any
stock compensation costs in 2005. In addition, expenses related to our distribution network,
including the functions of purchasing, receiving, inspecting, allocating, warehousing and packaging
our products totaled $70.5 million and $71.3 million for 2005 and 2004, respectively. Impairment
charges related to the write-off of leasehold improvements at one of our domestic and one
international retail stores was $0.9 million in 2005 as compared to $40,000 for the same period
last year.
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Interest income
Interest income for 2005 increased $3.2 million to $4.4 million compared to $1.2 million for
the same period in 2004. The increase in interest income resulted from higher interest rates and
higher average cash and investment balances during 2005 when compared to the same period in 2004.
Interest expense
Interest expense was $9.2 million for 2005 and 2004. Interest expense is incurred on our
convertible notes, mortgages on our distribution center and our corporate office located in
Manhattan Beach, California, our capital lease obligations and interest on amounts owed to our
foreign manufacturers.
Other income (expense)
Other income, net increased $3.9 million to $1.3 million for 2005, compared to $2.6 million
expense in
year 2004. The increase in other income was due to recoveries related to the settlement of
various lawsuits for $1.6 million during 2005 as compared to settlement payments of $2.3 million in
2004.
Income taxes
The effective tax rate for 2005 was 38.6% as compared to 39.2% in 2004. Income tax
expense for 2005 was $28.1 million compared to $15.2 million for 2004. The tax provision was
computed using the effective tax rates applicable to each of our domestic and international taxable
jurisdictions. The 2005 rate is slightly lower than the expected domestic rate of approximately
40%, due to our non-U.S. subsidiary earnings in lower tax rate jurisdictions and our reinvestment
of undistributed earnings from our non-U.S. subsidiaries, thereby indefinitely postponing their
remittance to the United States Internal Revenue Service. As such, we did not provide for deferred
income taxes on accumulated undistributed earnings of our non-U.S. subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES
Our working capital at December 31, 2006 was $450.8 million, an increase of $89.6 million
from working capital of $361.2 million at December 31, 2005. Our cash and cash equivalents at
December 31, 2006 were $160.5 million compared to $197.0 million at December 31, 2005. The decrease
in cash and cash equivalents of $36.5 million was the result of utilizing excess cash to purchase
$60.0 million of short-term investments, additional inventory of $64.4 million and capital
expenditures of $27.6 million which were offset by our cash flow from operations of $26.0 million,
and proceeds of $19.0 million from stock options exercised.
During 2006, our operating activities generated $26.0 million in net cash compared to cash
provided by operating activities of $75.5 million for 2005. The significant reduction in our
operating cash flows for 2006, when compared to 2005, was mainly the result of increased inventory
and accounts receivable balances partially offset by increased cashflow from operations and an
increase in accounts payable. We increased our inventory levels to accommodate the higher demand
for our products and our receivables increased due to our increase in net sales.
Net cash used in investing activities was $87.6 million for 2006 as compared to $13.6 million
in 2005. During 2006, we purchased $60.0 million in short-term investments to better utilize our
cash balances. Capital expenditures for 2006 were approximately $27.6 million, of which $12.5
million related to the construction of our new corporate headquarters and the balance primarily
consisted of new store openings and remodels. This was compared to capital expenditures of $13.6
million in the prior year, which primarily consisted of new store openings and remodels and
warehouse equipment upgrades. During 2005, we entered into a construction agreement with Morley
Construction Company for the construction of our third corporate facility in Manhattan Beach,
California. The agreement has a maximum payment clause in which Morley agrees that the
construction cost of the facility will not exceed $18.1 million, of which $14.5 million was
incurred as of December 31, 2006. We expect the building to be completed by the end of 2007.
Excluding the construction of our corporate headquarters,
we expect our ongoing capital expenditures for 2007 to be approximately $15.0 million, which
includes opening between 20 to 25 domestic retail stores, capital improvements at our distribution
centers and investments in information technology. We currently anticipate that our capital
expenditure requirements for 2007 will be funded through our operating cash flows or current cash
on hand, or available lines of credit.
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Net cash provided by financing activities was $22.9 million during 2006 compared to net cash
used by financing activities of $0.7 million during 2005. The increase in cash provided by
financing activities was due to increased cash provided from the issuance of Class A Common Stock
upon the exercise of stock options in 2006 as compared to the prior year and a balloon repayment of
our long-term debt of $4.6 million in 2005.
In April 2002, we issued $90.0 million aggregate principal amount of 4.50% convertible
subordinated notes due April 15, 2007. Interest on the notes is paid semi-annually in April and
October of each year. Discount and issuance costs of approximately $3.4 million are being
amortized to interest expense over the term of the notes. The notes were convertible at the option
of the holders into shares of Class A Common Stock at a conversion rate of 38.5089 shares of Class
A Common Stock per $1,000 principal amount of notes, which is equivalent to a conversion price of
approximately $25.968 per share. The notes were unsecured and subordinated to our present and
future senior debt as well as indebtedness and other liabilities of our subsidiaries. The indenture
did not restrict our incurrence of indebtedness, including senior debt, or our subsidiaries’
incurrence of indebtedness.
On January 19, 2007, we called these notes for redemption. The redemption date was February
20, 2007. The aggregate principal amount of notes outstanding was $90.0 million. Holders of
$89.969 million principal amount of the notes, which included $2.5 million of principal amount of
the notes held by us, converted their notes into shares of our Class A Common Stock prior to the
redemption date. As a result of these conversions, 3,464,594 shares of Class A Common Stock were
issued to holders of the notes, which included 96,272 shares issued to us that were immediately
retired. In connection with these conversions, we paid approximately $500 in cash to holders who
elected to convert their notes, which represented cash paid in lieu of fractional shares. In
addition, we paid approximately $32,000 to holders who redeemed their notes, which represented the
redemption price of 100.9% of $31,000 principal amount of the notes plus accrued interest.
On May 31, 2006, we amended our secured line of credit, which permits our company and certain
of our subsidiaries to borrow up to $150.0 million based upon eligible accounts receivable and
inventory, which line can be increased to $250.0 million at our request. Borrowings bear interest
at the borrowers’ election based on either the prime rate or the London Interbank Offered Rate
(“LIBOR”). Prime rate loans will bear interest at a rate equal to JPMorgan Chase Bank’s publicly
announced prime rate less up to 0.50%. LIBOR loans will bear interest at a rate equal to the
applicable LIBOR plus up to an additional 1.75%. We pay a monthly unused line of credit fee of
0.25% per annum. The loan agreement, which expires on May 31, 2011, provides for the issuance of
letters
of credit up to a maximum of $30.0 million. The loan agreement contains customary affirmative
and negative covenants for secured credit facilities of this type, including a financial covenant
requiring a fixed charge coverage ratio of not less than 1.1 at the end of each quarter if excess
availability of eligible account receivable and inventory is less than $50.0 million at any time
during such quarter. Excess availability was not less than $50.0 million during the year-ended
December 31, 2006; hence, the fixed charge ratio requirement was not applicable at such date. No
amounts were outstanding and we were in compliance with all other covenants of the loan agreement
at December 31, 2006.
We believe that anticipated cash flows from operations, available borrowings under our secured
line of credit, cash on hand, short-term investments and our financing arrangements will be
sufficient to provide us with the liquidity necessary to fund our anticipated working capital and
capital requirements through 2007. However, in connection with our current strategies, we will
incur significant working capital requirements and capital expenditures. Our future capital
requirements will depend on many factors, including, but not limited to, the levels at which we
maintain inventory, the market acceptance of our footwear, the success of our international
operations, the levels of promotion and advertising required to promote our footwear, the extent to
which we invest in new product design and improvements to our existing product design, acquisition
of other brands or companies, and the number and timing of new store openings. To the extent that
available funds are insufficient to fund our future activities, we may need to raise additional
funds through public or private financing of debt or equity. We cannot be assured that additional
financing will be available or that, if available, it can be obtained on terms favorable to our
stockholders and us. Failure to obtain such financing could delay or prevent our planned expansion,
which could adversely affect our business, financial condition and results of operations. In
addition, if additional capital is raised through the sale of additional equity or convertible
securities, dilution to our stockholders could occur.
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DISCLOSURE ABOUT CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following table aggregates all material contractual obligations and commercial commitments
as of December 31, 2006:
| Payments Due by Period (In Thousands) | ||||||||||||||||||||
| Less than | One to | Three to | More Than | |||||||||||||||||
| One | Three | Five | Five | |||||||||||||||||
| Total | Year | Years | Years | Years | ||||||||||||||||
Long-term obligations (1) |
$ | 90,000 | $ | 90,000 | — | — | — | |||||||||||||
Other long-term debt |
22,865 | 1,783 | $ | 3,567 | $ | 17,515 | — | |||||||||||||
Capital lease obligations |
216 | 216 | — | — | — | |||||||||||||||
Operating lease obligations (2) |
241,582 | 37,766 | 68,662 | 56,341 | $ | 78,813 | ||||||||||||||
Purchase obligations (3) |
210,331 | 210,331 | — | — | — | |||||||||||||||
Construction contract (4) |
4,038 | 4,038 | — | — | — | |||||||||||||||
Minimum payments related to our
licensing arrangements |
8,855 | 4,375 | 2,240 | 2,240 | — | |||||||||||||||
Financed insurance premiums |
1,304 | 1,304 | — | — | — | |||||||||||||||
| $ | 579,191 | $ | 349,813 | $ | 74,469 | $ | 76,096 | $ | 78,813 | |||||||||||
| (1) | The long-term notes consists of our 4.50% convertible notes due April 15, 2007, of which $89.969 million were redeemed and converted to equity as of February 20, 2007. | |
| (2) | Operating lease commitments consists primarily of real property leases for our retail stores, corporate offices and distribution centers. These leases frequently include options that permit us to extend beyond the terms of the initial fixed term. Payments for these lease terms are provided for by cash flows generated from operations or, if needed, by our $150.0 million secured line of credit, for which no amounts were outstanding at December 31, 2006. | |
| (3) | Purchase obligations includes the following: (i) accounts payable balances for the purchase of footwear of $85.0 million, (ii) outstanding letters of credit of $10.0 million and (iii) open purchase commitments with our foreign manufacturers for $115.3 million. We currently expect to fund these commitments with cash flows from operations and/or cash on hand. | |
| (4) | During 2005, we entered into a construction agreement with Morley Construction Company for the construction of our third corporate facility in Manhattan Beach, California. The agreement has a maximum payment clause in which Morley agrees that the construction cost of the facility will not exceed $18.1 million, of which $14.5 million was incurred at December 31, 2006. We expect the building to be completed by the end of 2007. |
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any relationships with unconsolidated entities or financial partnerships such
as entities often referred to as structured finance or special purpose entities that would have
been established for the purpose of facilitating off-balance-sheet arrangements or for other
contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity,
market or credit risk that could arise if we had engaged in such relationships.
CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES
Management’s Discussion and Analysis of Financial Condition and Results of Operations is
based upon our consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States of America. The preparation of these
financial statements requires us to make estimates and judgments that affect the reported amounts
of assets, liabilities, sales and expenses, and related disclosure of contingent assets and
liabilities. We base our estimates on historical experience and on various other assumptions that
are believed to be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these estimates under different assumptions or
conditions.
We believe the following critical accounting estimates are affected by more significant
judgments used in the preparation of our consolidated financial statements: revenue recognition,
allowance for bad debts, returns, sales allowances and customer chargebacks, inventory write-downs,
valuation of long-lived assets, litigation reserves, valuations of deferred income taxes, foreign
currency translation and stock-based compensation.
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Revenue Recognition. We derive income from the sale of footwear and royalties earned from
licensing the Skechers brand. Domestically, goods are shipped Free on Board (“FOB”) shipping point
directly from our domestic distribution center in Ontario, California. For our European
international wholesale accounts, product is shipped FOB shipping point direct from our
distribution center in Liege, Belgium. For our distributor sales, the goods are delivered directly
from the independent factories to our distributors’ freight forwarders on a Free Named Carrier
(FCA) basis. We recognize revenue on wholesale sales when products are shipped and the customer
takes title and assumes risk of loss, collection of relevant receivable is probable, persuasive
evidence of an arrangement exists and the sales price is fixed or determinable. This generally
occurs at time of shipment. Allowances for estimated returns, discounts, doubtful accounts and
chargebacks are provided for when related revenue is recorded. Related costs paid to third-party
shipping companies are recorded as a cost of sales. We recognize revenue from retail sales at the
point of sale.
Royalty income is earned from our licensing arrangements. Upon signing a new licensing
agreement, we receive up-front fees, which are generally characterized as prepaid royalties. These
fees are initially deferred and recognized as revenue as earned (i.e., as licensed sales are
reported to the company or on a straight line basis over the term of the agreement). The first
calculated royalty payment is based on actual sales of the licensed product. Typically, at each
quarter end we receive correspondence from our licensees indicating what the actual sales for the
period were. This information is used to calculate and accrue the related royalties currently
receivable based on the terms of the agreement.
Allowance for bad debts, returns, sales allowances and customer chargebacks. We provide a
reserve against our receivables for estimated losses that may result from our customers’ inability
to pay. To minimize the likelihood of uncollectibility, customers’ credit-worthiness is reviewed
periodically based on external credit reporting services and our experience with the account, and
it is adjusted accordingly. Should a customer’s account become past due, we generally place a hold
on the account and discontinue further shipments to that customer, minimizing further risk of loss.
We determine the amount of the reserve by analyzing known uncollectible accounts, aged receivables,
economic conditions in the customers’ country or industry, historical losses and our customers’
credit-worthiness. Amounts later determined and specifically identified to be uncollectible are
charged or written off against this reserve.
We also reserve for potential disputed amounts or chargebacks with our customers. Our
chargeback reserve is based on a collectibility percentage based on factors such as historical
trend, current economic conditions, and nature of the chargeback receivables. We also reserve for
potential sales returns and allowances based on historical trends.
The likelihood of a material loss on an uncollectible account would be mainly dependent on
deterioration in the overall economic conditions in a particular country or environment. Reserves
are fully provided for all probable losses of this nature. For receivables that are not
specifically identified as high risk, we provide a reserve based upon a percent of sales for the
last two months. This percentage is based on our historical loss rate. Gross trade accounts
receivable balance was $188.3 million and the allowance for bad debts, returns, sales allowances
and customer chargebacks was $10.6 million at December 31, 2006.
Inventory write-downs. Inventories are stated at the lower of cost or market. We review our
inventory on a regular basis for excess and slow moving inventory. Our review is based on inventory
on hand, prior sales and our expected net realizable value. Our analysis includes a review of
inventory quantities on hand at period end in relation to year-to-date sales and projections for
sales in the near future. The net realizable value, or market value, is determined based on our
estimate of sales prices of such inventory through off-price or discount store channels. A
write-down of inventory is considered permanent and creates a new cost basis for those units. The
likelihood of any material inventory write-down is dependent primarily on our expectation of future
consumer
demand for our product. A misinterpretation or misunderstanding of future consumer demand for
our product or of the economy, or other failure to estimate correctly, could result in inventory
valuation changes, either favorably or unfavorably, compared to the requirement determined to be
appropriate as of the balance sheet date. At December 31, 2006, our gross inventory value was
$201.5 million and our inventory reserve was $0.6 million.
Valuation of long-lived assets. When circumstances warrant, we assess the impairment of
long-lived assets that require us to make assumptions and judgments regarding the carrying value of
these assets. The assets are considered to be impaired if we determine that the carrying value may
not be recoverable based upon our assessment of the following events or changes in circumstances:
| • | the asset’s ability to continue to generate income; | ||
| • | any loss of legal ownership or title to the asset(s); |
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| • | any significant changes in our strategic business objectives and utilization of the asset(s); or | ||
| • | the impact of significant negative industry or economic trends. |
If the assets are considered to be impaired, the impairment we recognize is the amount by
which the carrying value of the assets exceeds the fair value of the assets. In addition, we base
the useful lives and related amortization or depreciation expense on our estimate of the period
that the assets will generate revenues or otherwise be used by us. If a change were to occur in any
of the above-mentioned factors or estimates, the likelihood of a material change in our reported
results would increase. In addition, we prepare a summary of store contribution from our domestic
retail stores to assess potential impairment of the fixed assets and leasehold improvements. Stores
with negative contribution opened in excess of twenty-four months are then reviewed in detail to
determine if impairment exists. For the year ended December 31, 2006, we did not record an
impairment charge.
Litigation reserves. Estimated amounts for claims that are probable and can be reasonably
estimated are recorded as liabilities in our consolidated balance sheets. The likelihood of a
material change in these estimated reserves would depend on new claims as they may arise and the
favorable or unfavorable outcome of the particular litigation. Both the amount and range of loss on
a large portion of the remaining pending litigation is uncertain. As such, we are unable to make a
reasonable estimate of the liability that could result from unfavorable outcomes in litigation. As
additional information becomes available, we will assess the potential liability related to our
pending litigation and revise our estimates. Such revisions in our estimates of the potential
liability could materially impact our results of operations and financial position.
Valuation of deferred income taxes. We record a valuation allowance when necessary to reduce
our deferred tax assets to the amount that is more likely than not to be realized. The likelihood
of a material change in our expected realization of our deferred tax assets depends on future
taxable income and the effectiveness of our tax planning strategies amongst the various domestic
and international tax jurisdictions in which we operate. We evaluate our projections of taxable
income to determine the recoverability of our deferred tax assets and the need for a valuation
allowance. As of December 31, 2006, we had net deferred tax assets of $21.5 million and a
valuation allowance of $0.5 million against losses not expected to be utilized by certain foreign
subsidiaries. See “—Future Accounting Changes” for a discussion of the application of FIN 48.
Foreign currency translation. Our international operations generally use their respective
local currencies as their functional currency. In accordance with Statement of Financial Accounting
Standards No. 52, “Foreign Currency Translation” (“SFAS 52”), revenues and expenses from our
international subsidiaries are translated using the monthly average exchange rates in effect for
the period in which such revenues and expenses occur. International subsidiaries that use their
local currency as their functional currency translate their assets and liabilities using current
rates of exchange at the balance sheet date. The resulting translation gains and losses for such
subsidiaries are included within accumulated other comprehensive income as a separate component of
stockholders’ equity. One international subsidiary has a functional currency of the U.S. dollar.
Resulting remeasurement gains and losses from this subsidiary are included in the determination of
net earnings. A substantial portion of our intercompany loans are considered long-term investments
and the gains or losses from currency fluctuations are included as a component of translation
adjustment in other comprehensive income.
Stock-based compensation. Beginning on January 1, 2006, we implemented and adopted a new
critical accounting policy, Financial Accounting Standards No. 123 (revised 2004), “Share-Based
Payment” (“SFAS 123(R)”), which requires us to recognize compensation for stock options, nonvested
shares and employee stock purchase plan (ESPP) shares at fair value. Under the fair value
recognition provisions for SFAS 123(R), stock-based compensation cost is estimated at the grant
date based on the fair value of the awards expected to vest and recognized as expense ratably over
the requisite service period of the award. We have used the Black-Scholes valuation model to
estimate the fair value of our stock option awards, which requires various judgmental assumptions
including estimating stock price volatility, forfeiture rates, and expected life. Our computation
of expected volatility is based on historical volatility. In addition, we consider many factors
when estimating expected forfeitures and expected life, including types of awards, employee class,
and historical experience. If any of the assumptions used in the Black-Scholes model change
significantly, stock-based compensation expense may differ materially in the future from that
recorded in the current period. We adopted SFAS 123(R) using the modified prospective method which
requires the application of the accounting standard as of January 1, 2006. Our consolidated
financial statements for the year-ended December 31, 2006 reflect the impact of SFAS 123(R). Stock
compensation expense as a result of SFAS 123(R) was recorded to general and
administrative expenses and was $2.0 million for the year ended December 31, 2006. In
accordance with the modified prospective method, the consolidated financial statements for prior
periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). The
impact of the adoption is discussed in note 7 to the Consolidated Financial Statements.
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INFLATION
We do not believe that the relatively moderate rates of inflation experienced in the
United States over the last three years have had a significant effect on our sales or
profitability. However, we cannot accurately predict the effect of inflation on future operating
results. Although higher rates of inflation have been experienced in a number of foreign countries
in which our products are manufactured, we do not believe that inflation has had a material effect
on our sales or profitability. While we have been able to offset our foreign product cost increases
by increasing prices or changing suppliers in the past, we cannot assure you that we will be able
to continue to make such increases or changes in the future.
EXCHANGE RATES
We receive U.S. dollars for substantially all of our product sales and our royalty
income. Inventory purchases from offshore contract manufacturers are primarily denominated in U.S.
dollars; however, purchase prices for our products may be impacted by fluctuations in the exchange
rate between the U.S. dollar and the local currencies of the contract manufacturers, which may have
the effect of increasing our cost of goods in the future. During 2006 and 2005, exchange rate
fluctuations did not have a material impact on our inventory costs. We do not engage in hedging
activities with respect to such exchange rate risk.
FUTURE ACCOUNTING CHANGES
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157 “Fair
Value Measurements”, (“SFAS 157”). The standard provides guidance for using fair value to measure
assets and liabilities. The standard also responds to investors’ requests for expanded information
about the extent to which companies measure assets and liabilities at fair value, the information
used to measure fair value, and the effect of fair value measurements on earnings. The standard
applies whenever other standards require (or permit) assets or liabilities to be measured at fair
value. The standard does not expand the use of fair value in any new circumstances. Statement 157
is effective for financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. Early adoption is permitted. We are currently
evaluating the impact of this standard on our Consolidated Financial Statements; however, we do not
expect that the adoption of SFAS 157 will have a material impact on our financial condition or
results of operations.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects
of Prior Year Misstatements when Quantifying Misstatements in Current Year
Financial Statements” (“SAB 108”). SAB 108 provides guidance on how prior year misstatements
should be taken into consideration when quantifying misstatements in current year financial
statements for purposes of determining whether the current year’s financial statements are
materially misstated. SAB 108 permits companies to record the cumulative effect of initial adoption
by recording the necessary “correcting” adjustments to the carrying values of assets and
liabilities as of the beginning of that year with the offsetting adjustment recorded to the opening
balance of retained earnings only if material under the dual method. We adopted the provisions of
SAB 108 on December 31, 2006 and such adoption did not have a material impact on our consolidated
financial statements.
In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes,” (“FIN 48”) an interpretation of FASB Statement No. 109, “Accounting for Income
Taxes”. FIN 48 requires that a position taken or expected to be taken in a tax return be recognized
in the financial statements when it is more likely than not (i.e. a likelihood of more than fifty
percent) that the position would be sustained upon examination by tax authorities. A recognized tax
position is then measured at the largest amount of benefit that is greater than fifty percent
likely of being realized upon ultimate settlement. Upon adoption, the cumulative effect of applying
the recognition and measurement provisions of FIN 48, if any, shall be reflected as an adjustment
to the opening balance of retained earnings.
FIN 48 requires that subsequent to initial adoption a change in judgment that results in
subsequent recognition, derecognition or change in a measurement of a tax position taken in a prior
annual period (including any related interest and penalties) be recognized as a discrete item in
the period in which the change occurs. Currently, we record such changes in judgment, including
audit settlements, as a component of our annual effective rate except for reversals due to statute
of limitation expirations which are recorded as discrete items during the quarter they expire.
Thus, our reported quarterly income tax rate may become more volatile upon adoption of FIN 48. This
change will not impact the manner in which we record income tax expense on an annual basis.
FIN 48 also requires expanded disclosures including identification of tax positions for which
it is reasonably possible that total amounts of unrecognized tax benefits will significantly change
in the next twelve months, a description of tax years that remain subject to examination by major
tax jurisdiction, a tabular reconciliation of the total amount of unrecognized tax benefits at the
37
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beginning and end of each annual reporting period, the total amount of unrecognized tax benefits
that, if recognized, would affect the effective tax rate and the total amounts of interest and
penalties recognized in the balance sheet and statement of earnings. FIN 48 is effective for
fiscal years beginning after December 15, 2006. We are currently evaluating the impact of this
standard on our Consolidated Financial Statements, however, we do not expect the adoption of FIN 48
will have a material impact on our financial condition or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK
We do not hold any derivative securities that require fair value presentation under FASB
Statement No. 133.
Market risk is the potential loss arising from the adverse changes in market rates and prices,
such as interest rates and foreign currency exchange rates. Changes in interest rates and changes
in foreign currency exchange rates have and will have an impact on our results of operations.
Interest rate fluctuations. The interest rate charged on our line of credit facility is based
on either the prime rate of interest or the LIBOR, and changes in the either of these rates of
interest could have an effect on the interest charged on our outstanding balances. At December 31,
2006, no amounts were outstanding that were subject to changes in interest rates.
Foreign exchange rate fluctuations. We face market risk to the extent that changes in foreign
currency exchange rates affect our non-U.S. dollar functional currency foreign subsidiary’s
revenues, expenses, assets and liabilities. In addition, changes in foreign exchange rates may
affect the value of our inventory commitments. Also, inventory purchases of our products may be
impacted by fluctuations in the exchange rates between the U.S. dollar and the local currencies of
the contract manufacturers, which could have the effect of increasing the cost of goods sold in the
future. We manage these risks by primarily denominating these purchases and commitments in U.S.
dollars. We do not engage in hedging activities with respect to such exchange rate risks.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| Page | ||||
| 40 | ||||
| 42 | ||||
| 43 | ||||
| 44 | ||||
| 45 | ||||
| 46 | ||||
39
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Skechers U.S.A., Inc.:
Skechers U.S.A., Inc.:
We have audited the accompanying consolidated balance sheets of Skechers U.S.A., Inc. and
subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of earnings,
stockholders’ equity and comprehensive income, and cash flows for each of the years in the
three-year period ended December 31, 2006. In connection with our audits of the consolidated
financial statements, we also have audited the related financial statement schedule. 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 the standards of the Public Company Accounting
Oversight Board (United States). 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 Skechers U.S.A., Inc. and subsidiaries as of December
31, 2006 and 2005, and the results of their operations and their cash flows for each of the years
in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted
accounting principles. Also in our opinion, the related 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.
As discussed in note 7 to the consolidated financial statements, effective January 1, 2006 the
Company adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised
2004), Share-Based Payment.
We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of Skechers U.S.A. Inc’s., internal control over
financial reporting as of December 31, 2006, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), and our report dated March 14, 2007 expressed an unqualified opinion on
management’s assessment of, and the effective operation of, internal control over financial
reporting.
/s/ KPMG LLP
Los Angeles, California
March 14, 2007
March 14, 2007
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Skechers U.S.A., Inc.:
Skechers U.S.A., Inc.:
We have audited management’s assessment, included in the accompanying Management’s Report on
Internal Control Over Financial Reporting appearing under Item 9A, that Skechers U.S.A., Inc.
maintained effective internal control over financial reporting as of December 31, 2006, based on
criteria established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Skechers U.S.A., Inc’s. management is
responsible for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting. Our responsibility is
to express an opinion on management’s assessment and an opinion on the effectiveness of the
Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management’s assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinion.
A company’s internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting
principles. A company’s internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s assets that could have
a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Skechers U.S.A., Inc. maintained effective
internal control over financial reporting as of December 31, 2006, is fairly stated, in all
material respects, based on criteria established in Internal Control—Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our
opinion, Skechers U.S.A., Inc. maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2006, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Skechers U.S.A., Inc. and
subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of earnings,
stockholders’ equity and comprehensive income, and cash flows for each of the years in the
three-year period ended December 31, 2006, and the related financial statement schedule, and our
report dated March 14, 2007 expressed an unqualified opinion on those consolidated financial
statements and financial statement schedule.
/s/ KPMG LLP
Los Angeles, California
March 14, 2007
March 14, 2007
41
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SKECHERS U.S.A., INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
| December 31, | December 31, | |||||||
| 2006 | 2005 | |||||||
ASSETS |
||||||||
Current Assets: |
||||||||
Cash and cash equivalents |
$ | 160,485 | $ | 197,007 | ||||
Short-term investments |
60,000 | — | ||||||
Trade accounts receivable, less allowances of $10,558 in 2006 and $7,196 in 2005 |
177,740 | 134,600 | ||||||
Other receivables |
8,035 | 6,888 | ||||||
Total receivables |
185,775 | 141,488 | ||||||
Inventories |
200,877 | 136,171 | ||||||
Prepaid expenses and other current assets |
15,321 | 11,628 | ||||||
Deferred tax assets |
9,490 | 5,755 | ||||||
Total current assets |
631,948 | 492,049 | ||||||
Property and equipment, at cost, less accumulated depreciation and amortization |
87,645 | 72,945 | ||||||
Intangible assets, less accumulated amortization |
633 | 1,131 | ||||||
Deferred tax assets |
11,984 | 9,337 | ||||||
Other assets, at cost |
4,843 | 6,495 | ||||||
TOTAL ASSETS |
$ | 737,053 | $ | 581,957 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY |
||||||||
Current Liabilities: |
||||||||
Current installments of long-term borrowings |
576 | 1,040 | ||||||
Accounts payable |
161,150 | 108,395 | ||||||
Accrued expenses |
19,435 | 21,404 | ||||||
Total current liabilities |
181,161 | 130,839 | ||||||
4.50% convertible subordinated notes |
89,969 | 90,000 | ||||||
Long-term borrowings, excluding current installments |
16,836 | 17,288 | ||||||
Total liabilities |
287,966 | 238,127 | ||||||
Commitments and contingencies |
||||||||
Stockholders’ equity: |
||||||||
Preferred Stock, $.001 par value; 10,000 authorized; none issued and outstanding |
— | — | ||||||
Class A
Common Stock, $.001 par value; 100,000 shares authorized; 28,103 and 23,382 shares issued and outstanding at
December 31, 2006 and 2005, respectively |
28 | 23 | ||||||
Class B Common Stock, $.001 par value; 60,000 shares authorized; 13,768 and
16,651 shares issued and outstanding at December 31, 2006 and 2005, respectively |
14 | 17 | ||||||
Additional paid-in capital |
156,374 | 126,274 | ||||||
Accumulated other comprehensive income |
11,200 | 7,039 | ||||||
Retained earnings |
281,471 | 210,477 | ||||||
Total stockholders’ equity |
449,087 | 343,830 | ||||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY |
$ | 737,053 | $ | 581,957 | ||||
See accompanying notes to consolidated financial statements.
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SKECHERS U.S.A., INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(In thousands, except per share data)
| 2006 | 2005 | 2004 | ||||||||||
Net sales |
$ | 1,205,368 | $ | 1,006,477 | $ | 920,322 | ||||||
Cost of sales |
682,022 | 585,995 | 549,465 | |||||||||
Gross profit |
523,346 | 420,482 | 370,857 | |||||||||
Royalty income, net |
4,114 | 6,628 | 7,060 | |||||||||
| 527,460 | 427,110 | 377,917 | ||||||||||
Operating expenses: |
||||||||||||
Selling |
109,886 | 81,378 | 79,673 | |||||||||
General and administrative |
305,030 | 269,436 | 248,999 | |||||||||
| 414,916 | 350,814 | 328,672 | ||||||||||
Earnings from operations |
112,544 | 76,296 | 49,245 | |||||||||
Other income (expense): |
||||||||||||
Interest income |
8,351 | 4,368 | 1,179 | |||||||||
Interest expense |
(9,227 | ) | (9,154 | ) | (9,152 | ) | ||||||
Other, net |
980 | 1,287 | (2,552 | ) | ||||||||
| 104 | (3,499 | ) | (10,525 | ) | ||||||||
Earnings before income taxes |
112,648 | 72,797 | 38,720 | |||||||||
Income tax expense |
41,654 | 28,080 | 15,167 | |||||||||
Net earnings |
$ | 70,994 | $ | 44,717 | $ | 23,553 | ||||||
Net earnings per share: |
||||||||||||
Basic |
$ | 1.73 | $ | 1.13 | $ | 0.61 | ||||||
Diluted |
$ | 1.59 | $ | 1.06 | $ | 0.59 | ||||||
Weighted average shares: |
||||||||||||
Basic |
41,079 | 39,686 | 38,638 | |||||||||
Diluted |
46,139 | 44,518 | 39,800 | |||||||||
See accompanying notes to consolidated financial statements.
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SKECHERS U.S.A., INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
(In thousands)
| SHARES | AMOUNT | ACCUMULATED | ||||||||||||||||||||||||||||||
| CLASS A | CLASS B | CLASS A | CLASS B | ADDITIONAL | OTHER | TOTAL | ||||||||||||||||||||||||||
| COMMON | COMMON | COMMON | COMMON | PAID-IN | COMPREHENSIVE | RETAINED | STOCKHOLDERS’ | |||||||||||||||||||||||||
| STOCK | STOCK | STOCK | STOCK | CAPITAL | INCOME | EARNINGS | EQUITY | |||||||||||||||||||||||||
Balance at December 31, 2003 |
19,116 | 18,886 | 19 | 19 | 105,272 | 8,137 | 142,207 | 255,654 | ||||||||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||||
Net earnings |
— | — | — | — | — | — | 23,553 | 23,553 | ||||||||||||||||||||||||
Foreign currency translation adjustment |
— | — | — | — | — | 3,868 | — | 3,868 | ||||||||||||||||||||||||
Total comprehensive |
27,421 | |||||||||||||||||||||||||||||||
Deferred compensation |
— | — | — | — | 129 | — | — | 129 | ||||||||||||||||||||||||
Contribution of common stock to the 401(k)
Plan |
94 | — | — | — | 763 | — | — | 763 | ||||||||||||||||||||||||
Proceeds from issuance of common stock
under the employee stock purchase plan |
165 | — | — | — | 1,384 | — | — | 1,384 | ||||||||||||||||||||||||
Proceeds from issuance of common stock
under the employee stock option plan |
984 | — | 1 | — | 7,521 | — | — | 7,522 | ||||||||||||||||||||||||
Tax benefit of stock options exercised |
— | — | — | — | 2,022 | — | — | 2,022 | ||||||||||||||||||||||||
Conversion of Class B Common Stock into
Class A Common Stock |
1,875 | (1,875 | ) | 2 | (2 | ) | — | — | — | — | ||||||||||||||||||||||
Balance at December 31, 2004 |
22,234 | 17,011 | $ | 22 | $ | 17 | $ | 117,091 | $ | 12,005 | $ | 165,760 | $ | 294,895 | ||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||||
Net earnings |
— | — | — | — | — | — | 44,717 | 44,717 | ||||||||||||||||||||||||
Foreign currency translation adjustment |
— | — | — | — | — | (4,966 | ) | — | (4,966 | ) | ||||||||||||||||||||||
Total comprehensive income |
39,751 | |||||||||||||||||||||||||||||||
Contribution of common stock to the 401(k)
Plan |
59 | — | — | — | 767 | — | — | 767 | ||||||||||||||||||||||||
Proceeds from issuance of common stock
under the employee stock purchase plan |
135 | — | — | — | 1,550 | — | — | 1,550 | ||||||||||||||||||||||||
Proceeds from issuance of common stock
under the employee stock option plan |
594 | — | 1 | — | 5,365 | — | — | 5,366 | ||||||||||||||||||||||||
Tax benefit of stock options exercised |
— | — | — | — | 1,501 | — | — | 1,501 | ||||||||||||||||||||||||
Conversion of Class B Common Stock into
Class A Common Stock |
360 | (360 | ) | — | — | — | — | — | — | |||||||||||||||||||||||
Balance at December 31, 2005 |
23,382 | 16,651 | $ | 23 | $ | 17 | $ | 126,274 | $ | 7,039 | $ | 210,477 | $ | 343,830 | ||||||||||||||||||
Comprehensive income: |
||||||||||||||||||||||||||||||||
Net earnings |
— | — | — | — | — | — | 70,994 | 70,994 | ||||||||||||||||||||||||
Foreign currency
translation adjustment |
— | — | — | — | — | 4,161 | — | 4,161 | ||||||||||||||||||||||||
Total comprehensive income |
75,155 | |||||||||||||||||||||||||||||||
Stock compensation expense |
— | — | — | — | 2,029 | — | — | 2,029 | ||||||||||||||||||||||||
Proceeds from issuance of common stock
under the employee stock purchase plan |
122 | — | 1 | — | 1,907 | — | — | 1,908 | ||||||||||||||||||||||||
Proceeds from issuance of common stock
under the employee stock option plan |
1,716 | — | 1 | — | 17,054 | — | — | 17,055 | ||||||||||||||||||||||||
Tax benefit of stock options exercised |
— | — | — | — | 9,110 | — | — | 9,110 | ||||||||||||||||||||||||
Conversion of Class B Common Stock into
Class A Common Stock |
2,883 | (2,883 | ) | 3 | (3 | ) | — | — | — | — | ||||||||||||||||||||||
Balance at December 31, 2006 |
28,103 | 13,768 | $ | 28 | $ | 14 | $ | 156,374 | $ | 11,200 | $ | 281,471 | $ | 449,087 | ||||||||||||||||||
See accompanying notes to consolidated financial statements
44
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SKECHERS U.S.A., INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
| 2006 | 2005 | 2004 | ||||||||||
Cash flows from operating activities: |
||||||||||||
Net earnings |
$ | 70,994 | $ | 44,717 | $ | 23,553 | ||||||
Adjustments to reconcile net earnings to net cash
provided by operating activities: |
||||||||||||
Depreciation and amortization of property and equipment |
16,203 | 22,070 | 20,523 | |||||||||
Amortization of deferred financing costs |
765 | 765 | 765 | |||||||||
Amortization of intangible assets |
502 | 523 | 490 | |||||||||
Provision for bad debts and returns |
4,591 | 2,882 | 4,871 | |||||||||
Tax benefits from stock-based compensation |
4,144 | 1,501 | 2,022 | |||||||||
Non cash stock compensation |
2,030 | — | 129 | |||||||||
Provision for deferred taxes |
(6,382 | ) | (6,322 | ) | (3,150 | ) | ||||||
Loss on disposal of equipment |
299 | 170 | 163 | |||||||||
(Increase) decrease in assets: |
||||||||||||
Receivables |
(47,994 | ) | (22,106 | ) | (24,150 | ) | ||||||
Inventories |
(64,364 | ) | 13,202 | (11,560 | ) | |||||||
Prepaid expenses and other current assets |
(3,530 | ) | (871 | ) | 216 | |||||||
Other assets |
1,340 | (2,476 | ) | 93 | ||||||||
Increase (decrease) in liabilities: |
||||||||||||
Accounts payable |
49,563 | 13,777 | 16,387 | |||||||||
Accrued expenses |
(2,122 | ) | 7,664 | 2,694 | ||||||||
Net cash provided by operating activities |
26,039 | 75,496 | 33,046 | |||||||||
Cash flows used in investing activities: |
||||||||||||
Capital expenditures |
(27,560 | ) | (13,627 | ) | (15,875 | ) | ||||||
Purchases of short-term investments |
(113,100 | ) | — | — | ||||||||
Maturities of short-term investments |
53,100 | — | — | |||||||||
Purchase of intellectual property |
— | — | (125 | ) | ||||||||
Proceeds from the sales of property and equipment |
— | — | 35 | |||||||||
Net cash used in investing activities |
(87,560 | ) | (13,627 | ) | (15,965 | ) | ||||||
Cash flows from financing activities: |
||||||||||||
Net proceeds from the issuances of stock through employee
stock purchase plan and the exercise of stock options |
18,963 | 6,916 | 8,906 | |||||||||
Excess tax benefits from stock-based compensation |
4,966 | — | — | |||||||||
Payments on long-term debt |
(1,008 | ) | (7,660 | ) | (3,043 | ) | ||||||
Net cash provided by (used in) financing activities |
22,921 | (744 | ) | 5,863 | ||||||||
Net increase (decrease) in cash and cash equivalents |
(38,600 | ) | 61,125 | 22,944 | ||||||||
Effect of exchange rates on cash and cash equivalents |
2,078 | (1,771 | ) | 1,230 | ||||||||
Cash and cash equivalents at beginning of year |
197,007 | 137,653 | 113,479 | |||||||||
Cash and cash equivalents at end of year |
$ | 160,485 | $ | 197,007 | $ | 137,653 | ||||||
Supplemental disclosures of cash flow information: |
||||||||||||
Cash paid during the year for: |
||||||||||||
Interest |
$ | 8,560 | $ | 8,374 | $ | 8,190 | ||||||
Income taxes |
47,064 | 27,914 | 15,761 | |||||||||
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
The Company issued 59,203, and 93,692 shares of Class A Common Stock to the Company’s 401(k)
plan, with a value of $767,000, and $763,000 for the years ended December 31, 2005 and 2004,
respectively. No shares of Class A Common Stock were issued to the Company’s 401(k) plan in 2006.
See accompanying notes to consolidated financial statements.
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SKECHERS U.S.A., INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006, 2005 and 2004
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
| (a) | The Company |
Skechers U.S.A., Inc. (the “Company”) designs, develops, markets and distributes footwear. The
Company also operates retail stores and an e-commerce business.
The consolidated financial statements have been prepared in accordance with accounting
principles generally accepted in the United States and include the accounts of the Company and its
wholly owned subsidiaries. All significant intercompany balances and transactions have been
eliminated in consolidation. Certain reclassifications have been made to prior year amounts to
conform to the current year’s presentation.
| (b) | Use of Estimates |
Management 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 accounting principles generally
accepted in the United States. Significant areas requiring the use of management estimates relate
primarily to the revenue recognition, valuation allowances, inventory reserves, valuation of
intangible and long-lived assets, litigation accruals, valuations of deferred income taxes,
accruals for tax exposures, foreign currency translation and stock-based compensation. Actual
results could differ from those estimates.
| (c) | Business Segment Information |
Skechers operations and segments are organized along its distribution channels and consists of
the following: domestic wholesale, international wholesale, retail and e-commerce sales.
Information regarding these segments is summarized in Note 14 to the Consolidated Financial
Statements.
| (d) | Revenue Recognition |
The Company recognizes revenue on wholesale sales when products are shipped and the customer
takes ownership and assumes risk of loss, collection of the relevant receivable is probable,
persuasive evidence of an arrangement exists and the sales price is fixed or determinable. This
generally occurs at the time of shipment. Allowances for estimated returns, sales allowances,
discounts, doubtful accounts and chargebacks are provided for when related revenue is recorded.
Related costs paid to third-party shipping companies are recorded as a cost of sales.
The Company recognizes revenue from retail sales at the point of sale.
Net royalty income is earned from our licensing arrangements. Upon signing a new licensing
agreement, we receive up-front fees, which are generally characterized as prepaid royalties. These
fees are initially deferred and recognized as revenue as earned based on
the terms of the contract (i.e., as licensed sales are reported to the company or on a
straight line basis over the term of the agreement). The first calculated royalty payment is based
on actual sales of the licensed product. Typically, at each quarter end we receive correspondence
from our licensees indicating what the actual sales for the period were. This information is used
to calculate and accrue the related royalties based on the terms of the agreement.
| (e) | Cash and Cash Equivalents |
Cash and cash equivalents consist primarily of certificates of deposit with an initial term of
less than three months. For purposes of the consolidated statements of cash flows, the Company
considers all highly liquid debt instruments with original maturities of three months or less to be
cash equivalents.
| (f) | Short–Term Investments |
In general, investments with original maturities of greater than three months and remaining
maturities of less than one year are classified as short-term investments. Highly liquid
investments with maturities beyond one year may also be classified as short-term based on their
liquidity, management’s intentions and because such marketable securities represent the investment
of cash that is available for current operations. Short-term investments consist of auction rate
securities and corporate and municipal debt securities. Auction rate securities have an underlying
long-term maturity; however, they are traded and interest rates reset through a modified
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Dutch
auction at predetermined short-term intervals of usually 7, 28, or 35 days, which makes them highly
liquid by nature. Corporate and municipal debt securities typically have maturities or interest
rate resets of less than 180 days. Fair market values of short-term investments are based on
quoted market prices. These securities are considered available-for-sale and recorded on the
Company’s books at fair market value, with the unrealized gains and losses, net of tax, included in
stockholders’ equity.
| (g) | Foreign Currency Translation |
In accordance with Statement of Financial Accounting Standards No. 52, Foreign Currency
Translation (“SFAS 52”), certain international operations use the respective local currencies as
their functional currency, while other international operations use the U.S. Dollar as their
functional currency. The Company considers the U.S. dollar as its functional currency. The
Company operates internationally through the following foreign subsidiaries: Skechers USA Ltd.,
located in the United Kingdom, with a functional currency of the British Pound; Skechers USA
Canada, Inc., located in Canada, with a functional currency of the Canadian dollar; Skechers USA
Iberia, SL located in Spain, Skechers USA Deutschland GmbH located in Germany, Skechers USA France
S.A.S. located in France, Skechers EDC SPRL located in Belgium, Skechers USA Benelux B.V. located
in the Netherlands, Skechers USA Italia S.r.l., located in Italy, all with a functional currency of
the Euro. Translation adjustments for these subsidiaries are included in other comprehensive
income. Additionally, one international subsidiary, Skechers S.a.r.l. located in Switzerland,
operates with a functional currency of the U.S. dollar. Resulting remeasurement gains and losses
from this subsidiary are included in the determination of net earnings (loss). Assets and
liabilities of the foreign operations denominated in local currencies are translated at the rate of
exchange at the balance sheet date. Revenues and expenses are translated at the weighted average
rate of exchange during the period. Translation of intercompany loans of a long-term investment
nature are included as a component of translation adjustment in other comprehensive income.
| (h) | Inventories |
Inventories, principally finished goods, are stated at the lower of cost (based on the
first-in, first-out method) or market. The Company provides for estimated losses from obsolete or
slow-moving inventories and writes down the cost of inventory at the time such determinations are
made. Reserves are estimated based upon inventory on hand, historical sales activity, and the
expected net realizable value. The net realizable value is determined based upon estimated sales
prices of such inventory through off-price or discount store channels.
| (i) | Income Taxes |
The Company accounts for income taxes in accordance with Statement of Financial Accounting
Standards No. 109, Accounting for Income Taxes (“SFAS 109”), which requires that the Company
recognize deferred tax liabilities and assets based on the differences between the financial
statement carrying amounts and the tax bases of assets and liabilities, using enacted tax rates in
effect in the years the differences are expected to reverse. Deferred income tax benefit (expense)
results from the change in net deferred tax assets
or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that
some or all or any deferred tax assets will not be realized.
We record liabilities for probable income tax assessments based on our estimate of potential
tax related exposures. Recording of these assessments requires significant judgment as
uncertainties often exist in respect to new laws, new interpretations of existing laws and rulings
by taxing authorities. Differences between actual results and our assumptions, or changes in our
assumptions in future periods, are recorded in the period they become known.
| (j) | Depreciation and Amortization |
Depreciation and amortization of property and equipment is computed using the straight-line
method based on the following estimated useful lives:
Buildings
|
20 years | |
Building improvements
|
10 years | |
Furniture, fixtures and equipment
|
5 years | |
Leasehold improvements
|
Useful life or remaining lease term, which ever is shorter |
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| (k) | Intangible Assets |
Goodwill and indefinite-lived intangible assets are measured for impairment at least annually,
and more often when events indicate that impairment exists. Intangible assets with finite lives
continue to be amortized over their useful lives ranging from 5–10 years, generally on a
straight-line basis. Intangible assets, all subject to amortization, as of December 31, 2006 and
2005 are as follows (in thousands):
| 2006 | 2005 | |||||||
Intellectual property |
$ | 1,250 | $ | 1,250 | ||||
Other intangibles |
1,000 | 1,000 | ||||||
Trademarks |
1,050 | 1,050 | ||||||
Less accumulated amortization |
(2,667 | ) | (2,169 | ) | ||||
Total Intangible Assets |
$ | 633 | $ | 1,131 | ||||
| (l) | Long-Lived Assets |
Long-lived assets such as property, plant, and equipment, and purchased intangibles subject to
amortization, are reviewed for impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and
used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted
future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds
its estimated future cash flows, an impairment charge is recognized by the amount by which the
carrying amount of the asset exceeds the fair value of the asset. The Company recognized impairment
charges of approximately $0.9 million, and $40,000 for the years ended December 31, 2005 and 2004,
respectively. The Company did not record an impairment charge in 2006. The impairment charges in
2005 and 2004 related to the write down of leasehold improvements at six under-performing company
owned retail stores. Fair value was based on estimated future cash flows.
| (m) | Advertising Costs |
Advertising costs are expensed in the period in which the advertisements are first run or over
the life of the endorsement contract. Advertising expense for the years ended December 31, 2006,
2005 and 2004 was approximately $83.0 million, $58.2 million, and $56.0 million, respectively.
Prepaid advertising costs at December 31, 2006 and 2005 were $3.0 million and $2.4 million,
respectively. Prepaid amounts outstanding at December 31, 2006 and 2005 represent the unamortized
portion of endorsement contracts and advertising in trade publications which had not run as of
December 31, 2006 and 2005, respectively.
| (n) | Earnings Per Share |
Basic earnings per share represents net earnings divided by the weighted average number of
common shares outstanding for the period. Diluted earnings per share, in addition to the weighted
average determined for basic earnings per share, includes potential common shares which would arise
from the exercise of stock options using the treasury stock method, and the conversion of the
Company’s 4.50% convertible subordinated notes for the period outstanding since their issuance in
April 2002, if their effects are dilutive.
The following is a reconciliation of net earnings and weighted average common shares
outstanding for purposes of calculating earnings per share (in thousands):
| Year Ended December 31, | ||||||||||||
| Basic earnings per share | 2006 | 2005 | 2004 | |||||||||
Net earnings |
$ | 70,994 | $ | 44,717 | $ | 23,553 | ||||||
Weighted average common shares outstanding |
41,079 | 39,686 | 38,638 | |||||||||
Basic earnings per share |
$ | 1.73 | $ | 1.13 | $ | 0.61 | ||||||
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| Year Ended December 31, | ||||||||||||
| Diluted earnings per share | 2006 | 2005 | 2004 | |||||||||
Net earnings |
$ | 70,994 | $ | 44,717 | $ | 23,553 | ||||||
After tax effect of interest expense on 4.50%
convertible subordinated notes |
2,553 | 2,487 | — | |||||||||
Earnings for purposes of
computing diluted earnings per share |
$ | 73,547 | $ | 47,204 | $ | 23,553 | ||||||
Weighted average common shares outstanding |
41,079 | 39,686 | 38,638 | |||||||||
Dilutive stock options |
1,594 | 1,366 | 1,162 | |||||||||
Weighted average assumed conversion of
4.50% convertible subordinated notes |
3,466 | 3,466 | — | |||||||||
Weighted average common shares outstanding |
46,139 | 44,518 | 39,800 | |||||||||
Diluted earnings per share |
$ | 1.59 | $ | 1.06 | $ | 0.59 | ||||||
Options to purchase 764,500, and 1,689,717 shares of Class A common stock at prices ranging
from $2.78 to $24.00 that were outstanding at December 31, 2005 and 2004, respectively were not
included in the computation of diluted earnings per share because the options’ exercise price was
greater than the average market price of the common shares and therefore their inclusion would be
anti-dilutive. There were no options were excluded from the calculation at December 31, 2006. The
impact from the assumed conversion of the 4.50% convertible subordinated notes in 2004 was
anti-dilutive and, was therefore excluded from those calculations.
| (o) | Product Design and Development Costs |
The Company charges all product design and development costs to expense when incurred. Product
design and development costs aggregated approximately $8.3 million, $6.0 million, and $5.7 million
during the years ended December 31, 2006, 2005 and 2004, respectively.
| (p) | Fair Value of Financial Instruments |
The carrying amount of the Company’s financial instruments, which principally include cash and
cash equivalents, short-term investments, accounts receivable, accounts payable and accrued
expenses, approximates fair value due to the relatively short maturity of such instruments.
The fair value of the Company’s long-term borrowings reflects the fair value based upon
current rates available to the Company for similar debt. The fair value of the Company’s 4.50%
Convertible Subordinated Notes at December 31, 2006 was $115.4 million, based on the price of the
debt in the public market, which was above the carrying value of $90.0 million.
| (q) | New Accounting Standards |
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157 “Fair
Value Measurements”, (“SFAS 157”). The standard provides guidance for using fair value to measure
assets and liabilities. The standard also responds to investors’ requests for expanded information
about the extent to which companies measure assets and liabilities at fair value, the information
used to measure fair value, and the effect of fair value measurements on earnings. The standard
applies whenever other standards require (or permit) assets or liabilities to be measured at fair
value. The standard does not expand the use of fair value in any new circumstances. Statement 157
is effective for financial statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. Early adoption is permitted. We are currently
evaluating the impact of this standard on our Consolidated Financial Statements; however, we do not
expect that the adoption of SFAS 157 will have a material impact on our financial condition or
results of operations.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects
of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”
(“SAB 108”). SAB 108 provides guidance on how prior year misstatements should be taken into
consideration when quantifying misstatements in current year financial statements for purposes of
determining whether the current year’s financial statements are materially misstated. SAB 108
permits companies to record the cumulative effect of initial adoption by recording the necessary
“correcting” adjustments to the carrying values of assets and liabilities as of the beginning of
that year with the offsetting adjustment recorded to the opening balance of retained earnings only
if material
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under the dual method. We adopted the provisions of SAB 108 on December 31, 2006 and
such adoption did not have any impact on our consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes,” (“FIN 48”) an interpretation of FASB Statement No. 109, “Accounting for Income
Taxes”. FIN 48 requires that a position taken or expected to be taken in a tax return be recognized
in the financial statements when it is more likely than not (i.e. a likelihood of more than fifty
percent) that the position would be sustained upon examination by tax authorities. A recognized tax
position is then measured at the largest amount of benefit that is greater than fifty percent
likely of being realized upon ultimate settlement. Upon adoption, the cumulative effect of applying
the recognition and measurement provisions of FIN 48, if any, shall be reflected as an adjustment
to the opening balance of retained earnings.
FIN 48 requires that subsequent to initial adoption a change in judgment that results in
subsequent recognition, derecognition or change in a measurement of a tax position taken in a prior
annual period (including any related interest and penalties) be recognized as a discrete item in
the period in which the change occurs. Currently, we record such changes in judgment, including
audit settlements, as a component of our annual effective rate except for reversals due to statute
of limitation expirations which are recorded as discrete items during the quarter they expire.
Thus, our reported quarterly income tax rate may become more volatile upon adoption of FIN 48. This
change will not impact the manner in which we record income tax expense on an annual basis.
FIN 48 also requires expanded disclosures including identification of tax positions for which
it is reasonably possible that total amounts of unrecognized tax benefits will significantly change
in the next twelve months, a description of tax years that remain subject to examination by major
tax jurisdiction, a tabular reconciliation of the total amount of unrecognized tax benefits at the
beginning and end of each annual reporting period, the total amount of unrecognized tax benefits
that, if recognized, would affect the effective tax rate and the total amounts of interest and
penalties recognized in the balance sheet and statement of earnings. FIN 48 is effective for fiscal
years beginning after December 15, 2006. We are currently evaluating the impact of this standard on
our Consolidated Financial Statements, however, we do not expect the adoption of FIN 48 will have a
material impact on our financial condition or results of operations.
In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections, a
replacement of Accounting Principles Board Opinion (APB) No. 20, Accounting Changes, and FASB
Statement No. 3, Reporting Accounting Changes in Interim Financial Statements” (“SFAS 154”). This
Statement requires retrospective application to prior periods’ financial statements of a change in
accounting principle. It applies both to voluntary changes and to changes required by an accounting
pronouncement if the pronouncement does not include specific transition provisions. APB 20
previously required that most voluntary changes in accounting principles be recognized by recording
the cumulative effect of a change in accounting principle. SFAS 154 is effective for fiscal years
beginning after December 15, 2005. We adopted this statement on January 1, 2006. The adoption of
SFAS 154 did not have a significant impact on our financial position or results of operations.
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs” (“SFAS 151”), an amendment
of ARB No. 43, Chapter 4. SFAS 151 clarifies the accounting for abnormal amounts of idle facility
expense, freight, handling costs and wasted material. SFAS
151 is effective for inventory costs incurred during fiscal years beginning after June 15,
2005. We adopted this statement on January 1, 2006. The adoption of SFAS 151 did not have a
significant impact our financial position or results of operations.
(2) SHORT TERM INVESTMENTS
Short-term investments consist of certain marketable equity securities and other investments
aggregating $60.0 million at December 31, 2006, and are included in current assets in the
accompanying consolidated balance sheet. Unrealized gains and losses related to marketable equity
securities at December 31, 2006, were negligible.
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(3) PROPERTY AND EQUIPMENT
Property and equipment at December 31, 2006 and 2005 is summarized as follows (in thousands):
| 2006 | 2005 | |||||||
Land |
$ | 14,358 | $ | 14,358 | ||||
Buildings and improvements |
49,454 | 33,536 | ||||||
Furniture, fixtures and equipment |
81,164 | 74,034 | ||||||
Leasehold improvements |
66,708 | 56,177 | ||||||
Total property and equipment |
211,684 | 178,105 | ||||||
Less accumulated depreciation and amortization |
124,039 | 105,160 | ||||||
Property and equipment, net |
$ | 87,645 | $ | 72,945 | ||||
The Company capitalized $0.3 million of interest expense during 2006 relating to the
construction of our corporate headquarters.
(4) ACCRUED EXPENSES
Accrued expenses at December 31, 2006 and 2005 is summarized as follows (in thousands):
| 2006 | 2005 | |||||||
Accrued inventory purchases |
$ | 4,678 | $ | 4,535 | ||||
Accrued payroll and related taxes |
13,914 | 10,140 | ||||||
Income taxes payable |
— | 5,885 | ||||||
Accrued interest |
843 | 844 | ||||||
Accrued expenses |
$ | 19,435 | $ | 21,404 | ||||
(5) SHORT-TERM BORROWINGS
On May 31, 2006, the Company amended its secured line of credit, which permits the Company and
certain of its subsidiaries to borrow up to $150.0 million based upon eligible accounts receivable
and inventory, which line can be increased to $250.0 million at our request. Borrowings bear
interest at the borrowers’ election based on either the prime rate or the London Interbank Offered
Rate (“LIBOR”). Prime rate loans will bear interest at a rate equal to JPMorgan Chase Bank’s
publicly announced prime rate less up to 0.50%. LIBOR loans will bear interest at a rate equal to
the applicable LIBOR plus up to an additional 1.75%. The Company pays a monthly unused line of
credit fee of 0.25% per annum. The loan agreement, which expires on May 31, 2011, provides for the
issuance of letters of credit up to a maximum of $30.0 million. The loan agreement contains
customary affirmative and negative covenants for secured credit facilities of this type, including
a financial covenant requiring a fixed charge coverage ratio of not less than 1.1 at the end of
each quarter if excess availability of eligible account receivable and inventory is less than $50.0
million at any time during such quarter. Excess availability was not less than $50.0 million
during the three months ended December 31, 2006; hence, the fixed charge ratio requirement was not
applicable at such date. No amounts were outstanding and the Company was in compliance with all
other covenants of the loan agreement at December 31, 2006. The Company had $10.0 million of
outstanding letters of credit as of December 31, 2006.
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(6) LONG-TERM BORROWINGS
Long-term debt at December 31, 2006 and 2005 is as follows (in thousands):
| 2006 | 2005 | |||||||
4.50% convertible subordinated notes due April 15,
2007 (see below) |
$ | 90,000 | $ | 90,000 | ||||
Note payable to bank, due in monthly installments of
$82.2 (includes principal and interest), fixed rate
interest at 7.79%, secured by property, balloon
payment of $8,716 due January 2011 |
9,790 | 10,004 | ||||||
Note payable to bank, due in monthly installments of
$57.6 (includes principal and interest), fixed rate
interest at 7.89%, secured by property, balloon
payment of $6,776 due February 2011 |
7,383 | 7,420 | ||||||
Capital lease obligation, due in quarterly
installments of $171.6 (includes principal and
interest), fixed rate of interest at 7.0%, secured by
property, through July 2007 (see note 13) |
206 | 805 | ||||||
Capital lease obligations, interest rates from
7.12%-7.9%, secured by equipment, maturing in various
installments through January 2007 (see note 13) |
2 | 99 | ||||||
Subtotal |
107,381 | 108,328 | ||||||
Less current installments |
576 | 1,040 | ||||||
Total long-term debt |
$ | 106,805 | $ | 107,288 | ||||
The aggregate maturities of long-term borrowings at December 31, 2006 are as follows:
2007 (Includes $89.969 million converted to equity as of February 20, 2007.) |
$ | 90,545 | ||
2008 |
363 | |||
2009 |
394 | |||
2010 |
426 | |||
2011 |
15,653 | |||
| $ | 107,381 | |||
On January 19, 2007, we called our 4.5% convertible subordinated notes for redemption. The
redemption date was February 20, 2007. The aggregate principal amount of notes outstanding was
$90.0 million. Holders of $89.969 million principal amount of the notes, which included $2.5
million of principal amount of the notes held by us, converted their notes into shares of our Class
A Common Stock prior to the redemption date. As a result of these conversions, 3,464,594 shares of
Class A Common Stock were issued to holders of the notes, which included 96,272 shares issued to
the Company that were immediately retired. In connection with these conversions, the Company paid
approximately $500 in cash to holders who elected to convert their notes, which represented cash
paid in lieu of fractional shares. In addition, the Company paid approximately $32,000 to holders
who redeemed their notes, which represented the redemption price of 100.9% of $31,000 principal
amount of the notes plus accrued interest. As a result of the subsequent conversion of $89.969
million of the notes into equity, the Company has classified such amount as a long-term liability
at December 31, 2006, under Statement of Financial Accounting Standards No. 6, Classification of
Short-Term Obligations Expected to Be Refinanced an amendment of ARB No. 43, Chapter 3.
The Company’s long-term debt obligations contain both financial and non-financial covenants,
including cross default provisions. The Company is in compliance with all its material
non-financial covenants, including any cross default provisions, and financial covenants of our
long-term debt as of December 31, 2006.
(7) STOCK COMPENSATION
| (a) | Impact of the adoption of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”) |
On January 1, 2006, the Company adopted SFAS 123(R) using the modified prospective transition
method. Previously, the Company had followed Accounting Principles Board, Opinion No. 25,
“Accounting for Stock Issued to Employees,” (“APB 25”), and
accounted for employee stock options at intrinsic value. Accordingly, during the year ended
December 31, 2006, we
recorded
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stock-based compensation expense for awards granted prior to, but
not yet vested as of, January 1, 2006, as if the fair value method required for pro forma
disclosure under SFAS 123 were in effect for expense recognition purposes, adjusted for estimated
forfeitures. For stock-based awards granted after January 1, 2006, we have recognized compensation
expense based on the grant date fair value using the Black-Scholes valuation model. For these
awards, we have recognized compensation expense on a straight-line basis. As SFAS 123(R) requires
that stock-based compensation expense be based on awards that are ultimately expected to vest,
stock-based compensation for the year-ended December 31, 2006 has been reduced for estimated
forfeitures. For the year ended December 31, 2006, stock compensation expense as a result of SFAS
123(R) was $2.0 million and was recorded to general and administrative expenses which represented a
reduction of earnings before income taxes in the same amount. The impact to 2006 net income was a
reduction of $1.6 million. No stock compensation expense was recorded during 2004 or 2005.
| (b) | Equity Incentive Plan |
In January 1998, the Board of Directors of the Company adopted the 1998 Stock Option, Deferred
Stock and Restricted Stock Plan for the grant of qualified incentive stock options (ISO), stock
options not qualified and deferred stock and restricted stock (the “Equity Incentive Plan”). The
exercise price for any option granted may not be less than fair value (110% of fair value for ISOs
granted to certain employees). In June 2001, the stockholders approved an amendment to the plan to
increase the number of shares of Class A Common Stock authorized for issuance under the plan to
8,215,154. In May 2003, stockholders approved an amendment to the plan to increase the number of
Class A Common Stock authorized for issuance under the plan to 11,215,154. Option awards are
generally granted with an exercise price equal to the market price of the Company’s stock at the
date of grant. Stock option awards generally become exercisable over a four-year graded vesting
period and expire ten years from the date of grant.
Prior to adopting SFAS 123(R), we presented all tax benefits resulting from the exercise of
stock options as operating cash flows in the Statement of Cash Flows. SFAS 123(R) requires cash
flows resulting from excess tax benefits to be classified as a part of cash flows from financing
activities. Excess tax benefits are realized from tax deductions for exercised options and vesting
of nonvested stock in excess of the deferred tax assets attributable to stock compensation costs
for such options. As a result of adopting SFAS 123(R), $5.0 million of excess tax benefits for the
year-ended December 31, 2006 have been classified as a financing cash inflow. Cash received from
stock option exercises for the year-ended December 31, 2006, 2005 and 2004 was $17.1 million, $5.4
million and $7.5 million, respectively. The actual tax benefit realized for the tax deductions
from option exercise of stock options and vesting of nonvested shares totaled $9.3 million, $1.5
million and $2.0 million for the year-ended December 31, 2006, 2005 and 2004, respectively. The
total income tax benefit recognized for stock-based compensation costs was $0.4 million for the
year-ended December 31, 2006. No income tax benefit for stock-based compensation costs was
recognized for the year ended December 31, 2005 or 2004. The impact of SFAS 123(R) stock-based
compensation expense was a reduction of $0.05 earnings per basic and $0.04 per diluted share for
the year ended December 31, 2006. The Company plans to issue new shares for stock options
exercised and nonvested shares that vest.
| (c) | Valuation Assumptions |
For pro forma net earnings purposes, the fair value of each option is estimated on the date of
grant using the Black-Scholes option pricing model that uses the assumptions noted in the following
table. Expected volatility is based on historical share price data. The Company uses historical
employee exercise and cancellation data to estimate expected term and forfeiture rates. The
risk-free rate is based on U.S. Treasury yields in effect at the time of grant. Employees that
have similar historical exercise behavior are considered separately for valuation purposes. Option
valuation methods require the input of highly subjective assumptions including the expected stock
price volatility, expected term and forfeiture rate. Because the Black-Scholes based option
valuation models incorporate ranges of assumptions for inputs, those inputs are disclosed in the
table as follows:
| 2006 | 2005 | 2004 | ||||||||||
Dividend yield |
— | — | — | |||||||||
Expected volatility |
62 | % | 71 | % | 73 | % | ||||||
Risk-free interest rate |
4.52 | % | 3.88 | % | 3.23 | % | ||||||
Expected life of option |
7 | 5 | 5 | |||||||||
Using the Black-Scholes option valuation model the weighted-average fair value per share of
options granted during 2006, 2005 and 2004 was $12.70, $8.28, and $5.39, respectively. The total
intrinsic value of options exercised during 2006, 2005 and 2004 was $25.5 million, $4.0 million,
and $5.2 million, respectively.
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| (d) | Stock-Based Payment Awards |
Shares subject to option under the Equity Incentive Plan were as follows:
| WEIGHTED | ||||||||
| SHARES | OPTION EXERCISE PRICE | |||||||
Outstanding at December 31, 2003 |
5,232,487 | $ | 10.75 | |||||
Granted |
905,000 | 8.47 | ||||||
Exercised |
(983,947 | ) | 7.75 | |||||
Canceled |
(178,199 | ) | 11.40 | |||||
Outstanding at December 31, 2004 |
4,975,341 | 10.90 | ||||||
Granted |
35,000 | 13.52 | ||||||
Exercised |
(593,671 | ) | 9.04 | |||||
Canceled |
(207,233 | ) | 14.89 | |||||
Outstanding at December 31, 2005 |
4,209,437 | 10.98 | ||||||
Granted |
15,000 | 19.49 | ||||||
Exercised |
(1,711,945 | ) | 9.96 | |||||
Canceled |
(26,910 | ) | 10.35 | |||||
Outstanding at December 31, 2006 |
2,485,582 | $ | 11.74 | |||||
Options available for grant at December 31, 2006 |
3,238,757 | |||||||
As of December 31, 2006, there was approximately $0.6 million of total unrecognized
compensation cost related to unvested share-based compensation arrangements (i.e. stock options and
restricted stock) granted under our Equity Incentive Plan. That cost is expected to be recognized
over a weighted average period of 1.3 years. The total fair value of shares vested during the
period ended December 31, 2006 was $1.6 million.
The following table summarizes information about stock options outstanding and exercisable at
December 31, 2006:
| OPTIONS OUTSTANDING | OPTIONS EXERCISABLE | |||||||||||||||||||
| WEIGHTED | ||||||||||||||||||||
| NUMBER | WEIGHTED | WEIGHTED | NUMBER | AVERAGE | ||||||||||||||||
| RANGE OF | OUTSTANDING | AVERAGE REMAINING | AVERAGE | EXERCISABLE AT | EXERCISE | |||||||||||||||
| EXERCISE PRICE | DECEMBER 31, 2006 | CONTRACTUAL LIFE | EXERCISE PRICE | DECEMBER 31, 2006 | PRICE | |||||||||||||||
$2.78 to $3.94 |
41,783 | 3.0 years | $ | 3.94 | 41,783 | $ | 3.94 | |||||||||||||
$6.95 to $8.35 |
860,439 | 6.4 years | 7.44 | 687,939 | 7.34 | |||||||||||||||
$9.07 to $11.00 |
507,941 | 4.1 years | 10.68 | 498,191 | 10.68 | |||||||||||||||
$12.31 to $19.49 |
855,919 | 3.7 years | 14.07 | 814,294 | 13.99 | |||||||||||||||
$21.60 to $24.00 |
219,500 | 4.4 years | 23.45 | 219,500 | 23.45 | |||||||||||||||
| 2,485,582 | 4.8 years | $ | 11.74 | 2,261,707 | $ | 11.97 | ||||||||||||||
As of December 31, 2006, 2005 and 2004, the number of options exercisable for each year was
2,261,707, 3,718,812, and 3,889,109, respectively. The weighted-average exercise price of those
options was $11.97, $11.27, and $11.00, respectively. The total intrinsic value of options
outstanding and exercisable at December 31, 2006 was $29.2 million and $27.1 million, respectively.
The aggregate intrinsic value is calculated as the difference between the exercise price of the
underlying awards and the quoted price of our common stock for the 2.3 million options that were
in-the-money at December 31, 2006.
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A summary of the status and changes of our nonvested shares related to our Equity Incentive
Plan as of and during the period ended December 31, 2006 is presented below:
| WEIGHTED AVERAGE | ||||||||
| GRANT-DATE FAIR | ||||||||
| SHARES | VALUE | |||||||
Nonvested at December 31, 2005 |
— | — | ||||||
Granted |
22,000 | $ | 16.52 | |||||
Vested |
(4,667 | ) | 17.01 | |||||
Nonvested at December 31, 2006 |
17,333 | $ | 16.38 | |||||
The nonvested shares generally vest over a four-year graded vesting period and expire ten
years from the date of grant.
| (e) | Stock Purchase Plan |
Effective July 1, 1998, the Company adopted the 1998 Employee Stock Purchase Plan (the
“ESPP”). The ESPP provides that a total of 2,781,415, shares of Class A Common Stock are reserved
for issuance under the plan. The ESPP, which is intended to qualify as an “employee stock purchase
plan” under Section 423 of the Internal Revenue Code of 1986, as amended, is implemented utilizing
six-month offerings with purchases occurring at six-month intervals. The ESPP administration is
overseen by the Board of Directors. Employees are eligible to participate if they are employed by
the Company for at least 20 hours per week and more than five months in any calendar year. The
ESPP permits eligible employees to purchase Class A Common Stock through payroll deductions, which
may not exceed 15% of an employee’s compensation. The price of Class A Common Stock purchased
under the ESPP is 85% of the lower of the fair market value of the Class A Common Stock at the
beginning of each six-month offering period or on the applicable purchase date. Employees may end
their participation in an offering at any time during the offering period. The Board may at any
time amend or terminate the ESPP, except that no such amendment or termination may adversely affect
shares previously granted under the ESPP. During 2006, 2005 and 2004, 121,378, 135,387, and
164,502 shares were issued, respectively, under the ESPP for which the Company received
approximately $1.9 million, $1.6 million, and $1.4 million, respectively.
| (f) | Pro Forma Information for Periods Prior to the Adoption of SFAS 123(R) |
The following table illustrates the effects on net earnings if compensation cost for the
Company’s stock option plans and its stock purchase plans had been determined based on the
estimated fair value at the grant dates for awards under those plans consistent with the fair value
method of SFAS 123 utilizing the Black-Scholes option-pricing model in each period (in thousands):
| 2005 | 2004 | |||||||
Net earnings, as reported |
$ | 44,717 | $ | 23,553 | ||||
Deduct total stock-based employee compensation
expense under fair value-based method for all
awards, net of related tax effects |
(1,853 | ) | (4,012 | ) | ||||
Pro forma net earnings for basic pro
forma earnings per share |
42,864 | 19,541 | ||||||
Add back interest on 4.50% debentures, net of tax |
2,487 | — | ||||||
Pro forma net earnings for diluted pro forma
earnings per share |
$ | 45,351 | $ | 19,541 | ||||
Pro forma net earnings per share: |
||||||||
Basic |
$ | 1.08 | $ | 0.51 | ||||
Diluted |
1.02 | 0.49 | ||||||
Pro forma basic net earnings per share represents net pro forma earnings divided by the
weighted average number of common shares outstanding for the period. Pro forma diluted earnings per
share, in addition to the weighted average determined for pro forma basic earnings per share,
includes the dilutive effect of common stock equivalents which would arise from the exercise of
stock options using the treasury stock method, and assumes the conversion of the Company’s 4.50%
convertible subordinated notes if their effects are dilutive.
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(8) STOCKHOLDERS’ EQUITY
Stock Issuances
The authorized capital stock of the Company consists of 100,000,000 shares of Class A Common
Stock, par value $.001 per share, 60,000,000 shares of Class B Common Stock, par value $.001 per
share, and 10,000,000 shares of preferred stock, $.001 par value per share.
The Class A Common Stock and Class B Common Stock have identical rights other than with
respect to voting, conversion and transfer. The Class A Common Stock is entitled to one vote per
share, while the Class B Common Stock is entitled to ten votes per share on all matters submitted
to a vote of stockholders. The shares of Class B Common Stock are convertible at any time at the
option of the holder into shares of Class A Common Stock on a share-for-share basis. In addition,
shares of Class B Common Stock will be automatically converted into a like number of shares of
Class A Common Stock upon any transfer to any person or entity which is not a permitted transferee.
During 2006, 2005 and 2004 certain Class B stockholders converted 2,883,000, 360,000, and
1,875,372 shares, respectively, of Class B Common Stock to Class A Common Stock.
(9) TOTAL OTHER INCOME (EXPENSE), NET
Other income (expense), net at December 31, 2006, 2005 and 2004 is summarized as follows (in
thousands):
| 2006 | 2005 | 2004 | ||||||||||
Gain (loss) on foreign currency transactions |
$ | 116 | $ | (351 | ) | $ | (258 | ) | ||||
Legal settlements |
864 | 1,638 | (2,294 | ) | ||||||||
Total other income, net |
$ | 980 | $ | 1,287 | $ | (2,552 | ) | |||||
(10) INCOME TAXES
The provisions for income tax expense were as follows (in thousands):
| 2006 | 2005 | 2004 | ||||||||||
Federal: |
||||||||||||
Current |
$ | 38,252 | $ | 27,562 | $ | 15,060 | ||||||
Deferred |
(4,451 | ) | (4,157 | ) | (2,328 | ) | ||||||
Total federal |
33,801 | 23,405 | 12,732 | |||||||||
State: |
||||||||||||
Current |
7,398 | 5,417 | 3,087 | |||||||||
Deferred |
(586 | ) | (588 | ) | (1,415 | ) | ||||||
Total state |
6,812 | 4,829 | 1,672 | |||||||||
Foreign : |
||||||||||||
Current |
2,192 | 1,423 | 170 | |||||||||
Deferred |
(1,151 | ) | (1,577 | ) | 593 | |||||||
Total foreign |
1,041 | (154 | ) | 763 | ||||||||
Total income taxes |
$ | 41,654 | $ | 28,080 | $ | 15,167 | ||||||
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Income taxes differ from the statutory tax rates as applied to earnings before income taxes as
follows (in thousands):
| 2006 | 2005 | 2004 | ||||||||||
Expected income tax expense |
$ | 39,427 | $ | 25,479 | $ | 13,552 | ||||||
State income tax, net of federal benefit |
4,611 | 3,585 | 1,296 | |||||||||
Rate differential on foreign income |
(379 | ) | (720 | ) | 721 | |||||||
Non-deductible expenses |
689 | 321 | 301 | |||||||||
Change in valuation allowance |
(967 | ) | (974 | ) | (288 | ) | ||||||
Other |
(1,727 | ) | 389 | (415 | ) | |||||||
Total provision for income taxes |
$ | 41,654 | $ | 28,080 | $ | 15,167 | ||||||
The tax effects of temporary differences that give rise to significant portions of deferred
tax assets and deferred tax liabilities at December 31, 2006 and 2005 are presented below (in
thousands):
| DEFERRED TAX ASSETS: | 2006 | 2005 | ||||||
Deferred tax assets — current: |
||||||||
Inventory adjustments |
$ | 2,991 | $ | 2,037 | ||||
Accrued expenses |
4,661 | 4,160 | ||||||
Allowances for bad debts and chargebacks |
4,732 | 2,293 | ||||||
Total current assets |
12,384 | 8,490 | ||||||
Deferred tax assets — long term: |
||||||||
Depreciation on property and equipment |
9,633 | 8,351 | ||||||
Loss carryforwards |
2,737 | 2,441 | ||||||
Valuation allowance |
(488 | ) | (1,455 | ) | ||||
Stock-based compensation |
102 | — | ||||||
Total long term assets |
11,984 | 9,337 | ||||||
Total deferred tax assets |
24,368 | 17,827 | ||||||
Deferred tax liabilities — current: |
||||||||
Prepaid expenses |
2,710 | 2,551 | ||||||
Other |
184 | 184 | ||||||
Total deferred tax liabilities |
2,894 | 2,735 | ||||||
Net deferred tax assets |
$ | 21,474 | $ | 15,092 | ||||
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.
Consolidated U.S. income before income taxes was $104.8 million, $66.0 million, and $35.0
million for the years ended December 31, 2006, 2005 and 2004, respectively. The corresponding
income before income taxes for non-U.S. based operations was $7.8 million, $6.8 million, and $3.7
million for the years ended December 31, 2006, 2005 and 2004, respectively.
As of December 31, 2006 and 2005, Skechers had combined foreign operating loss carry-forwards
to reduce future taxable income of approximately $7.4 million and $6.7 million, respectively. Some
of these net operating losses expire beginning in 2008 and several can be carried forward
indefinitely. As of December 31, 2006 and 2005, a valuation allowance of $0.5 million and $1.5
million, respectively, had been set up for those carryforwards not expected to be utilized before
their expiration date.
As of December 31, 2006, withholding and U.S. taxes have not been provided on approximately
$6.0 million of cumulative undistributed earnings of the Company’s non-U.S. subsidiaries because
the Company intends to indefinitely reinvest these earnings in its non-U.S. subsidiaries.
(11) BUSINESS AND CREDIT CONCENTRATIONS
The Company operates in the footwear industry and generates most of its sales in the United
States, although its products are sold into various foreign countries. The footwear industry is
impacted by the general economy. Changes in the marketplace may significantly affect management’s
estimates and the Company’s performance. Management performs regular evaluations concerning
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the
ability of its customers to satisfy their obligations and provides for estimated doubtful accounts.
Domestic accounts receivable, which generally do not require collateral from customers, amounted
to $141.7 million and $103.9 million before allowances for bad debts and sales returns, and
chargebacks at December 31, 2006 and 2005, respectively. Foreign accounts receivable, which
generally are collateralized by letters of credit, amounted to $46.6 million and $37.9 million
before allowance for bad debts, sales returns, and chargebacks at December 31, 2006 and 2005,
respectively. International net sales amounted to $203.3 million, $179.6 million, and $171.5
million for the years ended December 31, 2006, 2005 and 2004, respectively. The Company’s credit
losses due to write-off’s for the years ended December 31, 2006, 2005 and 2004 were $4.6 million,
$2.9 million, and $4.9 million respectively, and did not significantly differ from management’s
expectations.
Net sales to customers in North America exceeded 80% of total net sales for each of the years
in the three-year period ended December 31, 2006. Assets located outside the United States consist
primarily of cash, accounts receivable, inventory, property and equipment, and other assets. Net
assets held outside the United States were $119.1 million and $106.1 million at December 31, 2006
and 2005, respectively.
During 2006, 2005, and 2004, no customer accounted for 10% or more of net sales. One customer
accounted for 12.0% and 10.3% of net trade receivables at December 31, 2006 and 2005, respectively.
During 2006, 2005 and 2004, our net sales to our five largest customers accounted for
approximately 24.9%, 25.4%, and 26.8%, respectively.
During 2006, the Company had four manufacturers, each of which accounted for between 8.9% and
30.8% of total purchases. During 2005, the Company had four manufacturers, each of which accounted
for between 7.9% and 32.4% of total purchases. During 2004, the Company had four manufacturers,
each of which accounted for between 7.9% and 28.2% of total purchases.
Most of the Company’s products are produced in China. The Company’s operations are subject to
the customary risks of doing business abroad, including, but not limited to, currency fluctuations,
custom duties and related fees, various import controls and other monetary barriers, restrictions
on the transfer of funds, labor unrest and strikes and, in certain parts of the world, political
instability. The Company believes it has acted to reduce these risks by diversifying manufacturing
among various factories. To date, these risk factors have not had a material adverse impact on the
Company’s operations.
(12) BENEFIT PLAN
The Company has adopted a profit sharing plan covering all employees who are 21 years of age
and have completed six months of service. Employees may contribute up to 15.0% of annual
compensation. Company contributions to the plan are discretionary and vest over a six year period.
The Company’s contributions to the plan amounted to $1.1 million, $0.8 million, and $0.8
million for the years ended December 31, 2006, 2005 and 2004, respectively. For 2006, the Company
made a cash contribution. For its contribution to the plan for 2005 and 2004, the Company issued
59,203, and 93,692 shares of its Class A Common Stock, respectively. The shares contributed to the
plan contain certain restrictions regarding the subsequent sales of those shares.
(13) COMMITMENTS AND CONTINGENCIES
| (a) | Construction |
During 2005, we entered into a construction agreement with Morley Construction Company for the
construction of our third corporate facility in Manhattan Beach, California. The agreement has a
maximum payment clause in which Morley agrees that the construction cost of the facility will not
exceed $18.1 million, of which $14.5 million was incurred as of December 31, 2006. We expect the
building to be completed by the end of 2007.
| (b) | Leases |
The Company leases facilities under operating lease agreements expiring through July 2027. The
Company pays taxes, maintenance and insurance in addition to the lease obligation. The Company also
leases certain equipment and automobiles under
operating lease agreements expiring at various dates through April 2007. Rent expense for the
years ended December 31, 2006, 2005 and 2004 approximated $40.4 million, $37.2 million, and $31.4
million, respectively.
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The Company also leases certain property and equipment under capital lease agreements
requiring monthly installment payments through July 2007. The cost of this property and equipment
was $2.0 million with a net book value of $0.5 million at December 31, 2006. The cost of this
property and equipment was $2.8 million with a net book value of $1.1 million at December 31, 2005.
Amortization of these assets is included in depreciation expense in the accompanying consolidated
statements of cash flows.
Minimum lease payments, which takes into account escalation clauses, are recognized on a
straight-line basis over the minimum lease term. Subsequent adjustments to our lease payments due
to changes in an existing index, usually the consumer price index, are typically included in our
calculation of the minimum lease payments when the adjustment is known. Reimbursements for
leasehold improvements are recorded as liabilities and are amortized over the lease term. Lease
concessions, in our case usually a free rent period, are considered in the calculation of our
minimum lease payments for the minimum lease term.
Future minimum lease payments under noncancellable leases at December 31, 2006 are as follows (in
thousands):
| CAPITAL | OPERATING | |||||||
| LEASES | LEASES | |||||||
Year ending December 31: |
||||||||
2007 |
$ | 216 | $ | 37,766 | ||||
2008 |
— | 35,590 | ||||||
2009 |
— | 33,072 | ||||||
2010 |
— | 31,264 | ||||||
2011 |
— | 25,077 | ||||||
Thereafter |
— | 78,813 | ||||||
| 216 | $ | 241,582 | ||||||
Less imputed interest |
8 | |||||||
Present value of net minimum lease payments |
$ | 208 | ||||||
| (c) | Litigation |
The Company recognizes legal expense in connection with loss contingencies as incurred.
On March 25, 2003, a shareholder securities class action complaint captioned HARVEY SOLOMON v.
SKECHERS USA, INC. et al. was filed against the Company and certain of its officers and directors
in the United States District Court for the Central District of California (Case No. 03-2094 DDP).
On April 2, 2003, a shareholder securities class action complaint captioned CHARLES ZIMMER v.
SKECHERS USA, INC. et al. was filed against the Company and certain of its officers and directors
in the United States District Court for the Central District of California (Case No. 03-2296 PA).
On April 15, 2003, a shareholder securities class action complaint captioned MARTIN H. SIEGEL v.
SKECHERS USA, INC. et al. was filed against the Company and certain of its officers and directors
in the United States District Court for the Central District of California (Case No 03-2645 RMT).
On May 6, 2003, a shareholder securities class action complaint captioned ADAM D. SAPHIER v.
SKECHERS USA, INC. et al. was served on the Company and certain of its officers and directors in
the United States District Court for the Central District of California (Case No. 03-3011 FMC). On
May 9, 2003, a shareholders securities class action complaint captioned LARRY L. ERICKSON v.
SKECHERS USA, INC. et al. was served on the Company and certain of its officers and directors in
the United States District Court for the Central District of California (Case No. 03-3101 SJO).
Each of these class action complaints alleged violations of the federal securities laws on behalf
of persons who purchased publicly traded securities of the Company between April 3, 2002 and
December 9, 2002. In July 2003, the court in these federal securities class actions, all pending in
the United States District Court for the Central District of California, ordered the cases
consolidated and a consolidated complaint to be filed and served. On September 25, 2003, the
plaintiffs filed a consolidated complaint entitled In re SKECHERS USA, Inc. Securities Litigation,
Case No. CV-03-2094-PA in the United States District Court for the Central District of California,
consolidating all of the federal securities actions above. The complaint names as defendants the
Company and certain officers and directors and alleges violations of the federal securities laws
and breach of fiduciary duty on behalf of persons who purchased publicly traded securities of the
Company between April 3, 2002 and December 9, 2002. The complaint seeks compensatory damages,
interest, attorneys’ fees and injunctive and equitable relief. The Company moved to dismiss the
consolidated complaint in its entirety. On May 10, 2004, the court granted the Company’s motion to
dismiss with leave for plaintiffs to amend the complaint. On August 9, 2004, plaintiffs filed a
first amended consolidated complaint for violations of the federal securities laws. The allegations
and relief sought were virtually identical to the original consolidated complaint. The Company
has moved to dismiss the first amended consolidated complaint and the motion was set for
hearing on December 6, 2004. On March 21, 2005, the court granted the motion to dismiss the first
amended consolidated complaint with leave for plaintiffs to amend one final time. On April 7, 2005,
plaintiffs elected to stand on the first amended consolidated complaint and requested entry of
judgment so that
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an appeal from the court’s ruling could be taken. On April 26, 2005, the court
entered judgment in favor of the Company and the individual defendants, and on May 3, 2005,
plaintiffs filed an appeal with the United States Court of Appeals for the Ninth Circuit. As of the
date of filing this annual report, all briefing by the parties has been completed, and a hearing
date has been scheduled for April 18, 2007. Discovery has not commenced in the underlying action.
While it is too early to predict the outcome of the appeal and any subsequent litigation, the
Company continues to believe the suit is without merit and continues to vigorously defend against
the claims.
On October 11, 2006, Violeta Gomez filed a lawsuit in the Superior Court of the State of
California, County of Los Angeles, VIOLETA PIZA GOMEZ V. TEAM-ONE STAFFING SERVICES, INC., AB/T1,
INC. AND SKECHERS U.S.A., INC. (Case No. BC360134). The complaint alleges wrongful termination
under the California Fair Employment and Housing Act, Government Code §12900, et seq., as a result
of discrimination against Ms. Gomez. The complaint seeks general, special, punitive and exemplary
damages, interest, attorneys’ fees and reinstatement of employment. The Company plans on defending
the allegations vigorously and believes the claims are without merit. Nonetheless, it is too early
to predict the outcome and whether the outcome will have a material adverse effect on the Company’s
financial condition or results of operations.
On January 26, 2007, ASICS America Corporation and ASICS Corporation (Japan) (collectively,
“ASICS”) filed a lawsuit in the U.S. District Court for the Central District of California against
Skechers, Zappos.com, Inc., Brown Shoe Company, Inc. dba Famousfootwear.com and Brown Group Retail,
Inc. dba Famous Footwear U.S.A., Inc. alleging trademark infringement, unfair competition,
trademark dilution and false advertising arising out of the Company’s alleged use of marks similar
to ASICS’ stripe design mark. The lawsuit seeks, inter alia, compensatory, treble and punitive
damages, profits, attorney’s fees and costs, and a permanent injunction against the Company to
prevent any future sales and distribution of shoes that allegedly bear a stripe design similar to
the ASICS stripe design. On February 26, 2007, the Company filed a lawsuit against ASICS in the
United States District Court for the Central District of California for trade libel, unfair
competition and tortious interference with prospective economic advantage and economic business
relations. The Company seeks injunctive relief enjoining ASICS from engaging in further unlawful
acts, disgorgement of ASICS’ profits, attorneys’ fees and $100 million in punitive damages. The
Company also seeks a declaration that none of its designs infringe upon ASICS’ trademarks. While it
is too early to predict the outcome of the litigation, the Company believes that it has meritorious
defenses to the claims asserted by ASICS and intends to defend against those claims vigorously.
The Company has no reason to believe that any liability with respect to pending legal actions,
individually or in the aggregate, will have a material adverse effect on the Company’s consolidated
financial statements or results of operations. The Company occasionally becomes involved in
litigation arising from the normal course of business, and management is unable to determine the
extent of any liability that may arise from unanticipated future litigation.
| (d) | Product and Other Financing |
The Company finances production activities in part through the use of interest-bearing open
purchase arrangements with certain of its international manufacturers. These arrangements currently
bear interest at rates between 0% and 1.5% per 30 to 60 day term. The amounts outstanding under
these arrangements at December 31, 2006 and 2005 were $85.0 million and $57.8 million,
respectively, which are included in accounts payable in the accompanying consolidated balance
sheets. Interest expense incurred by the Company under these arrangements amounted to $3.7 million
in 2006, $2.8 million in 2005, and $3.1 million in 2004. The Company has contractual commitments
relating to licensing arrangements of $8.9 million through 2011 and financed insurance premiums of
$1.3 million through 2007.
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(14) SEGMENT INFORMATION
In accordance with the requirement of SFAS 131, “Disclosures about Segments of an Enterprise
and Related Information,” the Company’s reportable business segments and respective accounting
policies of the segments are the same as described in note 1. We have four reportable segments –
domestic wholesale sales, international wholesale sales, retail sales, and e-commerce sales.
Management evaluates segment performance based primarily on net sales and gross margins.
All costs and expenses of the Company are analyzed on an aggregate basis, and these costs are
not allocated to the Company’s segments. Net sales, gross margins and identifiable assets for the
domestic wholesale segment, international wholesale, retail, and the e-commerce segment on a
combined basis were as follows (in thousands):
| 2006 | 2005 | 2004 | ||||||||||
Net sales |
||||||||||||
Domestic wholesale |
$ | 772,920 | $ | 634,294 | $ | 582,240 | ||||||
International wholesale |
183,687 | 163,523 | 156,470 | |||||||||
Retail |
237,390 | 201,610 | 176,783 | |||||||||
E-commerce |
11,371 | 7,050 | 4,829 | |||||||||
Total |
$ | 1,205,368 | $ | 1,006,477 | $ | 920,322 | ||||||
| 2006 | 2005 | 2004 | ||||||||||
Gross profit |
||||||||||||
Domestic wholesale |
$ | 301,215 | $ | 232,401 | $ | 214,356 | ||||||
International wholesale |
65,034 | 60,758 | 54,128 | |||||||||
Retail |
151,456 | 123,928 | 101,402 | |||||||||
E-commerce |
5,641 | 3,395 | 971 | |||||||||
Total |
$ | 523,346 | $ | 420,482 | $ | 370,857 | ||||||
| 2006 | 2005 | |||||||
Identifiable assets |
||||||||
Domestic wholesale |
$ | 563,956 | $ | 417,859 | ||||
International wholesale |
108,210 | 95,285 | ||||||
Retail |
64,634 | 68,649 | ||||||
E-commerce |
253 | 164 | ||||||
Total |
$ | 737,053 | $ | 581,957 | ||||
| 2006 | 2005 | |||||||
Additions to property, plant and equipment |
||||||||
Domestic wholesale |
$ | 17,453 | $ | 5,989 | ||||
International wholesale |
348 | 394 | ||||||
Retail |
9,759 | 7,244 | ||||||
Total |
$ | 27,560 | $ | 13,627 | ||||
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Geographic Information
The following summarizes our operations in different geographic areas for the year indicated:
| 2006 | 2005 | 2004 | ||||||||||
Net Sales (1) |
||||||||||||
United States |
$ | 1,002,022 | $ | 826,920 | $ | 748,818 | ||||||
Canada |
25,276 | 18,350 | 14,406 | |||||||||
Europe (2) |
178,070 | 161,207 | 157,098 | |||||||||
Total |
$ | 1,205,368 | $ | 1,006,477 | $ | 920,322 | ||||||
| 2006 | 2005 | |||||||
Long-lived Assets |
||||||||
United States |
$ | 81,161 | $ | 63,840 | ||||
Canada |
764 | 717 | ||||||
Europe (2) |
5,720 | 8,388 | ||||||
Total |
$ | 87,645 | $ | 72,945 | ||||
| (1) | The Company has subsidiaries in Canada, United Kingdom, Germany, France, Spain, Italy, and the Netherlands that generate net sales within those respective countries and in some cases the neighboring regions. The Company also has a subsidiary in Switzerland that generates net sales to that region in addition to net sales to our distributors located in numerous non-European countries. Net sales are attributable to geographic regions based on the location of the Company subsidiary headquarters. | |
| (2) | Europe consists of Switzerland, United Kingdom, Germany, France, Spain, Italy, and the Netherlands. |
(15) RELATED PARTY TRANSACTIONS
The Company had net sales to R. Siskind & Company in the amount of $0.9 million for the year
ended December 31, 2004. The Company had no outstanding accounts receivable from R. Siskind &
Company at December 31, 2006 and 2005, respectively. Mr. Siskind, who is a director of the
Company, founded R. Siskind & Company, which is a business that purchases brand name men’s and
women’s apparel and accessories and redistributes those items to off-price retailers, and he is its
sole shareholder, Chief Executive Officer, President and sole member of its Board of Directors.
The Company paid approximately $177,000 and $47,000 during 2006 and 2005, respectively to the
Manhattan Inn Operating Company, LLC (“MIOC”) for lodging, food and events including the Company’s
holiday party at the Shade Hotel, which is owned and operated by MIOC. Michael Greenberg,
President and a director of the Company, owns a 12.5% beneficial ownership interest in MIOC, and
four other officers, directors and vice presidents of the Company own in aggregate an additional
5.0% beneficial ownership in MIOC. The Company had no outstanding accounts receivable or payable
with MIOC or the Shade Hotel at December 31, 2006.
The
Company had receivables from officers and employees of $0.5 million and $0.5 million at
December 31, 2006 and 2005, respectively. These amounts primarily relate to travel advances and
incidental personal purchases on Company-issued credit cards that are not business-related
expenses. These receivables are short-term and are expected to be repaid within a reasonable
period of time.
We had no other significant transactions with or payables to officers, directors or
significant shareholders of the Company.
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(16) SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Summarized unaudited financial data are as follows (in thousands):
| 2006 | MARCH 31 | JUNE 30 | SEPTEMBER 30 | DECEMBER 31 | ||||||||||||
Net sales |
$ | 277,565 | $ | 292,183 | $ | 331,126 | $ | 304,494 | ||||||||
Gross profit |
118,374 | 130,736 | 146,303 | 127,933 | ||||||||||||
Net earnings |
16,598 | 17,616 | 22,199 | 14,582 | ||||||||||||
Net earnings per share: |
||||||||||||||||
Basic |
$ | 0.41 | $ | 0.43 | $ | 0.54 | $ | 0.35 | ||||||||
Diluted |
0.38 | 0.40 | 0.49 | 0.33 | ||||||||||||
| 2005 | MARCH 31 | JUNE 30 | SEPTEMBER 30 | DECEMBER 31 | ||||||||||||
Net sales |
$ | 246,219 | $ | 263,928 | $ | 272,836 | $ | 223,494 | ||||||||
Gross profit |
100,436 | 111,536 | 115,473 | 93,037 | ||||||||||||
Net earnings |
10,267 | 15,917 | 12,632 | 5,901 | ||||||||||||
Net earnings per share: |
||||||||||||||||
Basic |
$ | 0.26 | $ | 0.40 | $ | 0.32 | $ | 0.15 | ||||||||
Diluted |
0.25 | 0.38 | 0.30 | 0.14 | ||||||||||||
| ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
| ITEM 9A. | CONTROLS AND PROCEDURES |
Attached as exhibits to this annual report on Form 10-K are certifications of our Chief
Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), which are required in accordance
with Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This
“Controls and Procedures” section includes information concerning the controls and controls
evaluation referred to in the certifications.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
The term “disclosure controls and procedures” refers to the controls and other procedures of a
company that are designed to provide reasonable assurance that information required to be disclosed
by a company in the reports that it files or submits under the Exchange Act, is recorded,
processed, summarized and reported within required time periods. We have established disclosure
controls and procedures to ensure that material information relating to Skechers and its
consolidated subsidiaries is made known to the officers who certify our financial reports, as well
as other members of senior management and the Board of Directors, to allow timely decisions
regarding required disclosures. As of the end of the period covered by this annual report on Form
10-K, we carried out an evaluation under the supervision and with the participation of our
management, including our CEO and CFO, of the effectiveness of the design and operation of our
disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based upon that
evaluation, our CEO and CFO concluded that our disclosure controls and procedures are effective.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Internal
control over financial reporting includes those policies and procedures that (i)
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pertain to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that our receipts and expenditures are being
made only in accordance with authorizations of our management and directors; and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or
disposition of our assets that could have a material effect on our financial statements.
We conducted an evaluation of the effectiveness of our internal control over financial
reporting based on the framework in Internal Control – Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). Based on our evaluation under the
framework in Internal Control- Integrated Framework, our management has concluded that as of
December 31, 2006, our internal control over financial reporting is effective.
Our independent registered public accountants, KPMG LLP, audited the financial statements
included in this annual report on Form 10-K and have issued an attestation report on management’s
assessment of, and the effectiveness of our internal control over financial reporting as of
December 31, 2006, which is included in Part II, Item 8 of this annual report on Form 10-K.
INHERENT LIMITATIONS ON EFFECTIVENESS OF CONTROLS
Our management, including our Chief Executive Officer and Chief Financial Officer, does
not expect that our disclosure controls and procedures or our internal control over financial
reporting will prevent or detect all error and all fraud. A control system, no matter how well
designed and operated, can provide only reasonable, not absolute, assurance that the control
system’s objectives will be met. The design of a control system must reflect the fact that there
are resource constraints, and the benefits of controls must be considered relative to their costs.
Further, because of the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that misstatements due to error or fraud will not occur or that all
control issues and instances of fraud, if any, within the company have been detected. These
inherent limitations include the realities that judgments in decision-making can be faulty and that
breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the
individual acts of some persons, by collusion of two or more people, or by management override of
the controls. The design of any system of controls is based in part on certain assumptions about
the likelihood of future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions. Projections of any evaluation of
controls effectiveness to future periods are subject to risks. Over time, controls may become
inadequate because of changes in conditions or deterioration in the degree of compliance with
policies or procedures.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no significant changes to our internal controls over financial reporting that have
materially affected, or are reasonably likely to materially affect, our internal controls over
financial reporting during the fourth quarter of 2006, we have completed our efforts regarding
compliance with Section 404 of the Sarbanes-Oxley Act of 2002 for the year ended December 31, 2006.
The results of our evaluation are discussed above in Management’s Report on Internal Control Over
Financial Reporting.
| ITEM 9B. | OTHER INFORMATION |
None.
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PART III
| ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNACE |
The information required by this Item 10 is hereby incorporated by reference from our
definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of
our 2006 fiscal year.
| ITEM 11. | EXECUTIVE COMPENSATION |
The information required by this Item 11 is hereby incorporated by reference from our
definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of
our 2006 fiscal year.
| ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
The information required by this Item 12 is hereby incorporated by reference from our
definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of
our 2006 fiscal year.
| ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE |
The information required by this Item 13 is hereby incorporated by reference from our
definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of
our 2006 fiscal year.
| ITEM 14. | PRINCIPAL ACCOUNTING FEES AND SERVICES |
The information required by this Item 14 is hereby incorporated by reference from our
definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of
our 2006 fiscal year.
PART IV
| ITEM 15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES |
| 1. | Financial Statements: See “Index to Consolidated Financial Statements” in Part II, Item 8 on page 39 of this annual report on Form 10-K. |
| 2. | Financial Statement Schedule: See “Schedule II—Valuation and Qualifying Accounts” on page 66 of this annual report on Form 10-K. |
| 3. | Exhibits: The exhibits listed in the accompanying “Index to Exhibits” are filed or incorporated by reference as part of this Form 10-K. |
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SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
(in thousands)
Years Ended December 31, 2006, 2005 and 2004
| BALANCE AT | CHARGED TO | DEDUCTIONS | BALANCE | |||||||||||||
| BEGINNING OF | COSTS AND | AND | AT END | |||||||||||||
| DESCRIPTION | PERIOD | EXPENSES | WRITE-OFFS | OF PERIOD | ||||||||||||
Year-ended December 31, 2004: |
||||||||||||||||
Allowance for chargebacks |
$ | 1,020 | $ | 1,858 | $ | (2,300 | ) | $ | 578 | |||||||
Allowance for
doubtful accounts |
1,199 | 1,814 | (1,126 | ) | 1,887 | |||||||||||
Reserve for sales returns and
allowances |
5,642 | 1,199 | (3,263 | ) | 3,578 | |||||||||||
Year-ended December 31, 2005: |
||||||||||||||||
Allowance for chargebacks |
$ | 578 | $ | 368 | $ | (323 | ) | $ | 623 | |||||||
Allowance for doubtful accounts |
1,887 | 870 | (792 | ) | 1,965 | |||||||||||
Reserve for sales returns and
allowances |
3,578 | 1,644 | (614 | ) | 4,608 | |||||||||||
Year-ended December 31, 2006: |
||||||||||||||||
Allowance for chargebacks |
$ | 623 | $ | 1,237 | $ | (359 | ) | $ | 1,501 | |||||||
Allowance for doubtful accounts |
1,965 | 1,307 | (573 | ) | 2,699 | |||||||||||
Reserve for sales returns and
allowances |
4,608 | 2,047 | (297 | ) | 6,358 | |||||||||||
See accompanying report of independent registered public accounting firm
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INDEX TO EXHIBITS
| EXHIBIT | ||
| NUMBER | DESCRIPTION OF EXHIBIT | |
3.1
|
Amended and Restated Certificate of Incorporation dated April 29, 1999 (incorporated by reference to exhibit number 3.1 of the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on May 12, 1999). | |
3.2
|
Bylaws dated May 28, 1998 (incorporated by reference to exhibit number 3.2 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed with the Securities and Exchange Commission on July 29, 1998). | |
3.2(a)
|
Amendment to Bylaws dated as of April 8, 1999. | |
4.1
|
Form of Specimen Class A Common Stock Certificate (incorporated by reference to exhibit number 4.1 of the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on May 12, 1999). | |
4.2
|
Indenture, dated April 9, 2002, between the Registrant and Wells Fargo Bank, National Association, as Trustee, relating to the 4.5% Convertible Subordinated Notes (incorporated by reference to exhibit number 4.2 of the Registrant’s Form 10-Q for the quarter ended June 30, 2002). | |
4.3
|
Form of Specimen Restricted Global Security (incorporated by reference to exhibit number 4.3 of the Registrant’s Form 10-Q for the quarter ended June 30, 2002). | |
10.1**
|
Amended and Restated 1998 Stock Option, Deferred Stock and Restricted Stock Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed with the Securities and Exchange Commission on July 29, 1998). | |
10.1(a)**
|
Amendment No. 1 to Amended and Restated 1998 Stock Option, Deferred Stock and Restricted Stock Plan (incorporated by reference to exhibit number 4.4 of the Registrant’s Registration Statement on Form S-8 (File No. 333-71114), filed with the Securities and Exchange Commission on October 5, 2001). | |
10.1(b)**
|
Amendment No. 2 to Amended and Restated 1998 Stock Option, Deferred Stock and Restricted Stock Plan (incorporated by reference to exhibit number 4.5 of the Registrant’s Registration Statement on Form S-8 (File No. 333-135049), filed with the Securities and Exchange Commission on June 15, 2006). | |
10.1(c)**
|
Amendment No. 3 to Amended and Restated 1998 Stock Option, Deferred Stock and Restricted Stock Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on February 23, 2007). | |
10.2**
|
Amended and Restated 1998 Employee Stock Purchase Plan (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 10-Q, for the quarter ended June 30, 2000). | |
10.3-10.5
|
[Reserved]. | |
10.6**
|
Indemnification Agreement dated June 7, 1999 between the Registrant and its directors and executive officers (incorporated by reference to exhibit number 10.6 of the Registrant’s Form 10-K for the year ended December 31, 1999). | |
10.6(a)**
|
List of Registrant’s directors and executive officers who entered into Indemnification Agreement referenced in Exhibit 10.6 with the Registrant (incorporated by reference to exhibit number 10.6(a) of the Registrant’s Form 10-K for the year ended December 31, 2005). | |
10.7
|
Registration Rights Agreement dated June 9, 1999, between the Registrant, the Greenberg Family Trust and Michael Greenberg (incorporated by reference to exhibit number 10.7 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). |
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| EXHIBIT | ||
| NUMBER | DESCRIPTION OF EXHIBIT | |
10.8
|
Tax Indemnification Agreement dated June 8, 1999, between the Registrant and certain shareholders (incorporated by reference to exhibit number 10.8 of the Registrant’s Form 10-Q for the quarter ended June 30, 1999). | |
10.9
|
Second Amended and Restated Loan and Security Agreement, dated May 31, 2006, by and among the Registrant and certain of its subsidiaries that are also borrowers under the Agreement, certain of its subsidiaries who are guarantors under the Agreement, and certain lenders including The CIT Group/Commericial Services, Inc., which acts as agent for the lenders (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on June 6, 2006). | |
10.10
|
Promissory Note, dated December 27, 2000, between the Registrant and Washington Mutual Bank, FA, for the purchase of property located at 225 South Sepulveda Boulevard, Manhattan Beach, California (incorporated by reference to exhibit number 10.23 of the Registrant’s Form 10-K for the year ended December 31, 2000). | |
10.11
|
Loan Agreement, dated December 21, 2000, between Yale Investments, LLC, and MONY Life Insurance Company, for the purchase of property located at 1670 South Champagne Avenue, Ontario, California (incorporated by reference to exhibit number 10.25 of the Registrant’s Form 10-K for the year ended December 31, 2000). | |
10.12
|
Promissory Note, dated December 21, 2000, between Yale Investments, LLC, and MONY Life Insurance Company, for the purchase of property located at 1670 Champagne Avenue, Ontario, California (incorporated by reference to exhibit number 10.26 of the Registrant’s Form 10-K for the year ended December 31, 2000). | |
10.13
|
Agreement dated August 25, 2005 between Duncan Investments, LLC, a wholly owned subsidiary of the Registrant, and Morley Construction Company regarding 330 South Sepulveda Boulevard, Manhattan Beach, California (incorporated by reference to exhibit number 10.1 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on August 29, 2005). | |
10.14
|
General Conditions of the Contract for Construction regarding 330 South Sepulveda Boulevard, Manhattan Beach, California (incorporated by reference to exhibit number 10.2 of the Registrant’s Form 8-K filed with the Securities and Exchange Commission on August 29, 2005). | |
10.15
|
Lease Agreement, dated November 21, 1997, between the Registrant and The Prudential Insurance Company of America, regarding 1661 South Vintage Avenue, Ontario, California (incorporated by reference to exhibit number 10.14 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed with the Securities and Exchange Commission on July 29, 1998). | |
10.15(a)
|
First Amendment to Lease Agreement, dated April 26, 2002, between the Registrant and ProLogis California I LLC, regarding 1661 South Vintage Avenue, Ontario, California (incorporated by reference to exhibit number 10.14(a) of the Registrant’s Form 10-K for the year ended December 21, 2002). | |
10.16
|
Lease Agreement, dated November 21, 1997, between the Registrant and The Prudential Insurance Company of America, regarding 1777 South Vintage Avenue, Ontario, California (incorporated by reference to exhibit number 10.15 of the Registrant’s Registration Statement on Form S-1 (File No. 333-60065) filed with the Securities and Exchange Commission on July 29, 1998). | |
10.16(a)
|
First Amendment to Lease Agreement, dated April 26, 2002, between the Registrant and Cabot Industrial Properties, L.P., regarding 1777 South Vintage Avenue, Ontario, California (incorporated by reference to exhibit number 10.15(a) of the Registrant’s Form 10-K for the year ended December 21, 2002). | |
10.17
|
Lease Agreement, dated April 10, 2001, between the Registrant and ProLogis California I LLC, regarding 4100 East Mission Boulevard, Ontario, California (incorporated by reference to exhibit number 10.28 of the Registrant’s Form 10-K for the year ended December 31, 2001). |
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| EXHIBIT | ||
| NUMBER | DESCRIPTION OF EXHIBIT | |
10.17(a)
|
First Amendment to Lease Agreement, dated October 22, 2003, between the Registrant and ProLogis California I LLC, regarding 4100 East Mission Boulevard, Ontario, California (incorporated by reference to exhibit number 10.28(a) of the Registrant’s Form 10-K for the year ended December 31, 2003). | |
10.18
|
Lease Agreement, dated February 8, 2002, between Skechers International, a subsidiary of the Registrant, and ProLogis Belgium II SPRL, regarding ProLogis Park Liege Distribution Center I in Liege, Belgium (incorporated by reference to exhibit number 10.29 of the Registrant’s Form 10-K for the year ended December 31, 2002). | |
21.1
|
Subsidiaries of the Registrant. | |
23.1
|
Consent of Independent Registered Public Accounting Firm. | |
31.1
|
Certification of the Chief Executive Officer pursuant Securities Exchange Act Rule 13a-14(a). | |
31.2
|
Certification of the Chief Financial Officer pursuant Securities Exchange Act Rule 13a-14(a). | |
32.1
|
Certification pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| ** | Management contract or compensatory plan or arrangement required to be filed as an exhibit. |
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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, in the City of Manhattan Beach, State of California on the 16th day of March 2007.
| SKECHERS U.S.A., INC. | ||||||
| By: | /S/ ROBERT GREENBERG | |||||
| Chairman of the Board and | ||||||
| Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed by the following persons on behalf of the Registrant and in the capacities and on the dates
indicated.
| SIGNATURE | TITLE | DATE | ||
/S/ ROBERT GREENBERG
|
Chief Executive Officer (Principal Executive Officer) | March 16, 2007 | ||
/S/ MICHAEL GREENBERG
|
President and Director | March 16, 2007 | ||
/S/ DAVID WEINBERG
|
Executive Vice President, Chief Operating Officer and Director | March 16, 2007 | ||
/S/ FREDERICK H. SCHNEIDER
|
Chief Financial Officer (Principal Financial and Accounting Officer) | March 16, 2007 | ||
/S/ JEFFREY GREENBERG
|
Director | March 16, 2007 | ||
/S/ J. GEYER KOSINSKI
|
Director | March 16, 2007 | ||
/S/ MORTON D. ERLICH
|
Director | March 16, 2007 | ||
/S/ RICHARD SISKIND
|
Director | March 16, 2007 | ||
70