Deckers Brands - 10-Q quarterly report FY

 

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     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

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

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Table of Contents

Condensed Consolidated Balance Sheets

(Unaudited)

(amounts in thousands, except par value)

See accompanying notes to condensed consolidated financial statements.

Condensed Consolidated Statements of Income

(Unaudited)

(amounts in thousands, except per share data)

See accompanying notes to condensed consolidated financial statements.

Condensed Consolidated Statements of Income

(Unaudited)

(amounts in thousands, except per share data)

See accompanying notes to condensed consolidated financial statements.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(amounts in thousands)

See accompanying notes to condensed consolidated financial statements.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

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

Notes to Condensed Consolidated Financial Statements
(Unaudited)
(amounts in thousands, except share quantity and per share data)

In May 2006, the Company adopted the 2006 Equity Incentive Plan (the “2006 Plan”). The primary purpose of the 2006 Plan is to encourage ownership in the Company by key personnel, whose long-term service is considered essential to the Company’s continued progress. The 2006 Plan provides for 2,000,000 new shares of common stock that are reserved for issuance to employees, directors, or consultants. The maximum aggregate number of shares that may be issued under the 2006 Plan through the exercise of incentive stock options is 1,500,000. The 2006 Plan supersedes the 1993 Plan, which was subsequently terminated for new grants.

Beginning December 2004, the Company replaced its annual employee stock option grants with grants of nonvested stock units (“NSUs”). The NSUs granted pursuant to the 1993 Plan and the 2006 Plan entitle the employee recipients to receive shares of common stock in the Company, which vest in quarterly increments between the third and fourth anniversary of the grant. Many of these awards include vesting that is also subject to achievement of certain performance targets.

In August 1995, the Company adopted the 1995 Employee Stock Purchase Plan (the “ESPP”). The ESPP is intended to qualify as an Employee Stock Purchase Plan under Section 423 of the Internal Revenue Code. Under the terms of the ESPP, as amended, 300,000 shares of common stock are reserved for issuance to employees who have been employed by the Company for at least six months. The ESPP provides for employees to purchase the Company’s common stock at a discount below market value, as defined by the ESPP. Under the ESPP, 8,000 shares were issued in the nine months ended September 30, 2006. The ESPP was terminated in September 2006, and no new shares will be issued under the ESPP.

Prior to January 1, 2006, in accordance with APB 25, the intrinsic value of the NSUs was recorded to compensation expense over the vesting period. Awards with performance conditions were accounted as variable with the intrinsic value remeasured at each reporting date. All NSUs are recorded as equity-based awards under SFAS 123R, whereby the fair value of the NSU is calculated based on the closing stock price on the grant date.

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

As a result of our January 1, 2006 adoption of SFAS 123R, the impact to the condensed consolidated financial statements for the nine months ended September 30, 2006 on income before taxes and on net income were reductions of $133 and $79, respectively. There was a $0.01 impact on both basic and diluted earnings per share for the nine months ended September 30, 2006. In addition, prior to the adoption of SFAS 123R, the Company presented the tax benefit of stock option exercises as operating cash flows. Upon the adoption of SFAS 123R, tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options are classified as financing cash flows.

Notes to Condensed Consolidated Financial Statements
(Unaudited)
(amounts in thousands, except share quantity and per share data)

The table below summarizes certain stock compensation amounts recognized in the three and nine months ended September 30, 2006 and 2005:

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

During the nine months ended September 30, 2006 and 2005, stock options exercised totaled 97,000 and 144,000 shares, respectively, with a total intrinsic value of $2,468 and $4,904, respectively. There were no stock options granted during the nine months ended September 30, 2006 and 2005.

Notes to Condensed Consolidated Financial Statements
(Unaudited)
(amounts in thousands, except share quantity and per share data)

During the nine months ended September 30, 2006, the Company granted 8,000 NSUs under the 2006 Plan and the remaining NSUs under the 1993 Plan. As of September 30, 2006, there was $4,156 of total unrecognized compensation cost related to stock options and NSUs that will vest in the future, over a weighted-average vesting period of 2.9 years. Tax benefit realized from stock options exercised during the three months ended September 30, 2006 and 2005 was $234 and $89, respectively. The tax benefit realized for the nine months ended September 30, 2006 and 2005 was $1,012 and $1,965, respectively.

Pro forma information regarding the effect on net income and basic and diluted income per share for the three and nine months ended September 30, 2005, had the Company applied the fair value recognition provisions of SFAS No. 123, is as follows:

Notes to Condensed Consolidated Financial Statements
(Unaudited)
(amounts in thousands, except share quantity and per share data)

All options outstanding as of September 30, 2006 were included in the computation of diluted income per share for the three and nine months ended September 30, 2006. For the three and nine months ended September 30, 2005, the Company excluded 20,000 and 10,000 options, respectively, from diluted income per

Notes to Condensed Consolidated Financial Statements
(Unaudited)
(amounts in thousands, except share quantity and per share data)

Notes to Condensed Consolidated Financial Statements
(Unaudited)
(amounts in thousands, except share quantity and per share data)

Notes to Condensed Consolidated Financial Statements
(Unaudited)
(amounts in thousands, except share quantity and per share data)

Notes to Condensed Consolidated Financial Statements
(Unaudited)
(amounts in thousands, except share quantity and per share data)

Business segment asset information as of September 30, 2006 and December 31, 2005 is summarized as follows:

The assets allocable to each reporting segment generally include accounts receivable, inventories, intangible assets, and certain other assets that are specifically identifiable with one of the Company’s business segments. Unallocated corporate assets are the assets not specifically related to one of the segments and generally include the Company’s cash and cash equivalents, short-term investments, deferred tax assets and various other assets shared by the Company’s segments.

Reconciliations of total assets from reportable segments to the condensed consolidated balance sheets at September 30, 2006 and December 31, 2005 are as follows:

The Company sells its footwear products principally to customers throughout the U.S. The Company also sells its footwear products to foreign customers located in Europe, Canada, Australia, Asia, and Latin America among other regions. International sales to unaffiliated customers were 10.9% and 13.2% of net sales for the three months ended September 30, 2006 and 2005, respectively. International sales were 15.9% and 16.5% of net sales for the nine months ended September 30, 2006 and 2005, respectively. The Company does not consider international operations a separate segment, as management reviews such operations in the aggregate with the aforementioned segments. Management performs regular evaluations concerning the ability of its customers to satisfy their obligations and records a provision for doubtful accounts based upon these evaluations. An upscale department store based on the West Coast of the U.S., which is a significant customer for each of our three brands, accounted for 11.2% of our net sales for both the nine months ended September 30, 2006 and 2005. No other customer accounted for more than 10% of net sales in the nine months ended September 30, 2006 and 2005. As of September 30, 2006 and December 31, 2005, the Company had one customer representing 19.6% and 27.6%, respectively, of net trade accounts receivable.

As of September 30, 2006, approximately $17,000 of trademarks and $466 of goodwill are held in Hong Kong by a subsidiary of the Company. Substantially all other long-lived assets are held in the U.S.

The Company’s production and sourcing is concentrated primarily in the Far East, with the vast majority being produced at five independent contractor factories in China. The Company’s operations are subject to the customary risks of doing business abroad, including, but not limited to, currency fluctuations, customs

Notes to Condensed Consolidated Financial Statements
(Unaudited)
(amounts in thousands, except share quantity and per share data)

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

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

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

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

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

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

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

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

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

From fiscal 2001 to 2004, Teva’s wholesale net sales increased at a compound annual growth rate of 10.9%. However, for the fiscal year 2005 and the nine months ended September 30, 2006, Teva wholesale net sales decreased by approximately 3.6% and 9.8%, respectively, compared to the year ago periods. We attribute this decline in sales primarily to a lack of new product innovation, coupled with a significant increase in competitor activity. We have begun to address this situation by dedicating significantly greater resources to product planning, design, and development and our efforts began to take effect in the current quarter. We also had higher full price sales in the current quarter. For the third quarter of 2006, Teva’s wholesale net sales increased

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

by 1.0% compared to the third quarter of 2005. However, given the lead times required for new products to yield results, we do not expect growth for Teva in 2006, but expect to return to positive year over year growth in 2007.

Despite the decrease in sales for 2006, we expect Teva will finish the year in a much stronger position than it was in 2005. In the second half of 2005, steps were taken to reduce inventory of old Teva product. Beginning in the first quarter of 2006, we significantly increased our investment in measurable media (advertising and in-store display materials). We shifted the target of our advertising to a younger, trend-setting consumer. We also introduced a modest collection of new styles for both Spring and Fall 2006. As a result, closeout sales represented a significantly smaller percentage of total sales.

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

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

UGG has been a well-known brand in California for many years and over the past few years has become a recognized brand throughout the remainder of the country. Since early 2003, our UGG brand has received increased media exposure including increased print media in national ads and coop advertising with our customers, which contributed to broader public awareness of the UGG brand and significantly increased demand for the collection. We believe that the increased media focus and demand on UGG was driven by the following:

We believe the luxury and comfort features of UGG products will continue to drive long-term consumer demand. Recognizing that there is a significant fashion element to UGG and that footwear fashions fluctuate, our strategy seeks to prolong the longevity of the brand by offering a broader product line suitable for wear in a variety of climates and occasions and by limiting distribution to selected higher-end retailers. As part of this strategy, we have doubled our product line to approximately 100 styles in 2006 from approximately 50 styles in 2002. This product line expansion includes our significantly expanded Spring and Fall 2006 Fashion Collection and Men’s offering, as well as new styles in our Driving Collection, our newly introduced Surf Collection, our Cold Weather Collection and our luxury slipper category. Nevertheless, we cannot assure investors that UGG sales will continue to grow at their recent pace or that revenue from UGG products will not at some point decline. For the three months ended September 30, 2006, UGG wholesale sales increased 15.4%

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

over the same period in 2005. For the nine months ended September 30, 2006, UGG wholesale sales increased 5.5% compared to the same period in 2005.

Simple Shoes began in 1991 as an alternative to all the over-built, over-priced, and over-hyped products in the marketplace. The brand’s foundation was built on the Old School Sneaker and the New Original Clog. In 2005, the Simple product line focused on rebuilding the segments that made the brand successful: clogs and sneakers. In Fall 2005, as a response to the massive amount of waste produced by the footwear industry, Simple launched a new collection of ecologically friendly footwear called Green Toe, a product collection that consists of 100% sustainable materials and is revolutionizing the footwear industry. We have re-positioned the brand to be the world leader in sustainable footwear and accessories. In 2005, we also hired an in-house public relations manager, increased our print media campaigns, as well as improved our distribution initiatives through the establishment of dedicated sales representatives in key markets. These strategies, combined with innovative products and unique marketing, have created greater trust amongst our retailers, which is something that previously marked a challenge for the brand based on past performance. It is more apparent now that the brand is dedicated to creating a cohesive and consistent message to both the retailer and consumer. In the first nine months of 2006, our men’s and women’s products performed well at retail, and demand continues to increase for our Green Toe products. We increased our account base both domestically and internationally. We also expanded our presence into additional retail stores with our key accounts. These efforts resulted in an increase of Simple’s wholesale net sales of 105.9% and 65.1% in the three and nine months ended September 30, 2006, respectively, compared to the same periods in 2005. Simple’s mission is to be the world leader in sustainable footwear and accessories as we continue to bring fresh product designs to the market and successfully implement our sales strategy to expand distribution channels.

Our Consumer Direct business includes our internet and catalog retailing operations as well as our retail outlet stores. We acquired our internet and catalog retailing business in November 2002 as part of the acquisition of the Teva rights. In addition, we have opened two new retail outlet stores, one in Camarillo, California and one in Wrentham, Massachusetts, along with our existing store in Ventura, California. Based on the success of the existing stores, we currently expect to open two to three additional retail outlet stores in select premium outlet malls in the U.S. by the end of 2007, as well as an UGG concept store in New York City by the end of 2006. Our Consumer Direct business, which today sells all three of our brands, enables us to meet the growing demand for these products, to sell the products at retail prices and to provide us with significant incremental operating income. From the time we initiated our Consumer Direct business through the third quarter of 2006, we have had significant revenue growth, much of which occurred as the underlying brands gained popularity, as consumers have continued to increase reliance on the internet for footwear and other purchases and as we began to open retail outlet stores. Net sales of the Consumer Direct business increased 72.8% and 38.0%, in the three and nine months ended September 30, 2006, respectively, compared to the same periods in 2005.

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

DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
(amounts in thousands, except share quantity and per share data)

In 2004, we embarked on a strategy to license our footwear brands to complementary products outside of footwear, generally in the apparel and accessories categories. We currently have eleven licensing agreements with six licensees for Teva and UGG combined. The activity is very small in relation to the consolidated operations. We do not expect significant incremental net sales and profits from licensing in the near future.

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

Given our expectations for each of our brands in 2006, we currently expect this seasonality trend to continue. Nonetheless, actual results could differ materially depending upon consumer preferences, whether the UGG brand will continue to grow at the rate it has experienced in the recent past, availability of product, competition, and our customers continuing to carry and promote our various product lines, among other risks and uncertainties. Please refer to our Annual Report on Form 10-K under Item 1A. Risk Factors and this quarterly report on Form 10-Q under Item 1A. Risk Factors.

DECKERS OUTDOOR CORPORATION
AND SUBSIDIARIES
(amounts in thousands, except share quantity and per share data)

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

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

The following table sets forth certain operating data as a percentage of net sales for the periods indicated, and the increase (decrease) in each item of operating data between the periods.

Overview. For the three months ended September 30, 2006, we had net sales of $82,322 and income from operations of $17,308 compared to net sales of $69,193 and income from operations of $14,018 for the three months ended September 30, 2005. These improved results were primarily due to an increase in UGG and Simple sales. Income from operations increased as a result of increased net sales and gross margins, partially offset by the increase in selling, general and administrative expenses.

Net Sales. Net sales increased by $13,129 or 19.0%, for the three months ended September 30, 2006 compared to the three months ended September 30, 2005. This increase is due primarily to the increase in UGG and Simple sales. In addition, our weighted-average wholesale selling price per unit increased 1.7% to $40.46 for the three months ended September 30, 2006 from $39.77 for the three months ended September 30, 2005, resulting primarily from higher UGG sales, which generally carry a higher average selling price, as well as lower closeout sales during the three months ended September 30, 2006. During the quarter, we experienced increases in the number of units sold of UGG and Simple, as well as a slight increase in the number of

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

sold of Teva resulting in a 16.9% overall increase in the volume of footwear sold to 2.0 million pairs for the three months ended September 30, 2006 from 1.7 million pairs for the three months ended September 30, 2005.

Net wholesale sales of Teva increased by $83, or 1.0%, for the three months ended September 30, 2006 compared to the three months ended September 30, 2005 primarily due to higher full price sales and higher weighted-average wholesale selling prices per unit. Teva’s performance was driven by a positive reaction to a limited introduction of closed toe footwear combined with solid sales of our traditional sandals. See “— Overview — Teva Overview” above.

Net wholesale sales of UGG increased by $8,541, or 15.4%, for the three months ended September 30, 2006 compared to the three months ended September 30, 2005, due primarily to strong consumer demand for our new Fall product line and new introductions combined with a strong reorder business for core products. See “— Overview — UGG Overview” above.

Net wholesale sales of Simple increased by $2,055, or 105.9%, for the three months ended September 30, 2006 compared to the three months ended September 30, 2005. This increase was largely due to strong demand for our sandal and sneaker product lines. Additionally, the Green Toe collection experienced strong retail sell-through across all channels of distribution and in all geographic regions. See “— Overview — Simple Overview” above.

Net sales of the Consumer Direct business increased by $2,450, or 72.8%, for the three months ended September 30, 2006 compared to the three months ended September 30, 2005. For the three months ended September 30, 2006, net sales of the Consumer Direct business included retail sales of Teva of $1,501, UGG of $3,898 and Simple of $417. For the three months ended September 30, 2005, the breakdown consisted of sales of Teva of $1,316, UGG of $1,878 and Simple of $172. The increase in net sales of the Consumer Direct business occurred due to the greater demand for products and the additional sales of our retail outlet stores, which were not in place in the same period in 2005. See “— Overview — Consumer Direct Overview” above.

International sales for all of our products combined decreased by $157, or 1.7%, for the three months ended September 30, 2006 compared to the three months ended September 30, 2005, representing 10.9% of net sales for the three months ended September 30, 2006 and 13.2% of net sales for the three months ended September 30, 2005. The decrease in international sales resulted from timing of certain orders that shipped in the second quarter of the current year, or the three months ended June 30, 2006, versus shipping in the third quarter in the prior year, or three months ended September 30, 2005.

Gross Profit. Gross profit increased by $8,103, or 27.9%, to $37,173 for the three months ended September 30, 2006, from $29,070 for the three months ended September 30, 2005. As a percentage of net sales, gross margin was 45.2% for the three months ended September 30, 2006, compared to 42.0% for the three months ended September 30, 2005, primarily due to increased full price sales, and increased UGG and Consumer Direct sales, which both carry higher gross margins. Our gross margins fluctuate based on several factors and we expect to return to a normal range of 42.0% to 44.0% in 2007.

Selling, General and Administrative Expenses. Selling, general and administrative expenses, or SG&A, increased by $4,813, or 32.0%, to $19,865 for the three months ended September 30, 2006 from $15,052 for the three months ended September 30, 2005. As a percentage of net sales, SG&A increased to 24.1% for the three months ended September 30, 2006 from 21.8% for the three months ended September 30, 2005. The increase in SG&A expenses was largely due to an increase in payroll, marketing, and international division expenses, as part of our strategic initiatives to support future growth.

Income from Operations. Income from operations increased by $3,290, or 23.5%, for the three months ended September 30, 2006 from $14,018 in the three months ended September 30, 2005. This increase was due primarily to the increase in net sales and gross profit, partially offset by the increase in SG&A.

DECKERS OUTDOOR CORPORATION
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Income from operations of Teva wholesale decreased by $130, or 10.5%, for the three months ended September 30, 2006 compared to the three months ended September 30, 2005. This decrease was primarily due to increased marketing expenses and a decreased gross margin mainly due to lower margins on closeouts, partially offset by lower bad debt expenses.

Income from operations of UGG wholesale increased by $5,591, or 30.3%, for the three months ended September 30, 2006, compared to the three months ended September 30, 2005. The increase was primarily the result of the higher sales volumes with higher average selling prices and higher gross margins due to lower inventory write-downs and higher margins on fewer closeouts, partially offset by increased marketing expenses and higher bad debt expense.

Loss from operations of Simple wholesale was $648 for the three months ended September 30, 2006 compared to a loss of $260 for the three months ended September 30, 2005. In spite of achieving higher net sales for the third quarter of 2006, we had increased closeouts with negative margins, plus we increased the direct sales and marketing expenses to expand the distribution of this product throughout the market, resulting in a loss from operations for the third quarter of 2006. We expect to begin generating income from operations of Simple beginning in early to mid 2007.

Income from operations of our Consumer Direct business increased by $457, or 79.2%, for the three months ended September 30, 2006, compared to the three months ended September 30, 2005. This was largely due to increased net sales and higher gross margins, partially offset by higher operating costs primarily from the opening of two new retail stores.

Unallocated overhead costs increased by $2,240 or 37.4%, for the three months ended September 30, 2006 compared to the three months ended September 30, 2005, resulting primarily from higher corporate payroll costs, international division costs, and warehouse expenses.

Other (Income) Expense, net. Net interest income was $673 for the three months ended September 30, 2006, compared to net interest expense of $167 for the three months ended September 30, 2005. The interest income in 2006 resulted primarily from the investment of our higher cash and short-term investments balances, as well as higher rates of return in the current year compared to the same period a year ago. Additionally, we had interest expense from outstanding balances of long-term debt in the three months ended September 30, 2005. Other expense exclusive of net interest income was not material in either period.

Income Taxes. For the three months ended September 30, 2006, income tax expense was $7,352, representing an effective income tax rate of 41.0%. For the three months ended September 30, 2005, income tax expense was $5,701 representing an effective income tax rate of 41.2%. The effective tax rate is subject to ongoing review and evaluation by management and can change from quarter to quarter.

Net Income. Our net income increased 30.0% to $10,599 from $8,150 as a result of the items discussed above. Our earnings per diluted share increased 31.7% to $0.83 for the three months ended September 30, 2006 versus $0.63 in the same period of 2005, primarily as a result of the increase in net income.

Overview. For the nine months ended September 30, 2006, we had net sales of $180,047 and income from operations of $30,230 compared to net sales of $173,797 and income from operations of $33,094 for the nine months ended September 30, 2005. These improved results were primarily due to an increase in UGG and Simple sales, partially offset by a decrease in Teva sales. Income from operations decreased as a result of increased SG&A expenses.

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Net Sales. Net sales increased by $6,250 or 3.6%, for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005. The increase was due primarily to increases in UGG and Simple sales, partially offset by lower Teva sales, as discussed below. The main driver of the increased sales was the increase in our weighted-average wholesale selling price per unit, which increased 2.1% to $26.09 for the nine months ended September 30, 2006 from $25.55 for the nine months ended September 30, 2005, resulting primarily from higher UGG sales. During the first nine months of 2006, we experienced a decrease in the number of units sold of Teva, partially offset by an increase in the number of units sold of Simple and UGG, resulting in the volume of footwear sold remaining relatively consistent at approximately 6.5 million pairs for both the nine months ended September 30, 2006 and 2005.

Net wholesale sales of Teva decreased by $6,860, or 9.8%, for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005 due to increased competition, a recent lack of meaningful product innovation, and a decline in sales in the international markets. See “— Overview — Teva Overview” above.

Net wholesale sales of UGG increased by $4,717, or 5.5%, for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005, due primarily to the brand’s inaugural Spring line and our kids’ and infants’ product line. The increase was partially offset by approximately $10,000 of Fall 2004 holiday sales that did not ship until the first quarter of 2005, which caused net sales of UGG to be slightly higher in the first quarter of 2005. See “— Overview — UGG Overview” above.

Net wholesale sales of Simple increased by $3,900, or 65.1%, for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005. This increase was largely due to the greater demand of our sandal collection and the introduction of our Green Toe collection, as well as an increase in sales of our core sneaker product line. See “— Overview — Simple Overview” above.

Net sales of the Consumer Direct business increased by $4,493, or 38.0%, for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005. For the nine months ended September 30, 2006, net sales of the Consumer Direct business included retail sales of Teva of $4,576, UGG of $10,665 and Simple of $1,090. For the nine months ended September 30, 2005, the breakdown consisted of sales of Teva of $4,200, UGG of $6,986 and Simple of $652. The increase in net sales of the Consumer Direct business occurred due to the greater demand for our products and the additional sales of our retail outlet stores, which were not in place in the same period in 2005. See “— Overview — Consumer Direct Overview” above.

International sales for all of our products combined decreased by $47, or 0.2%, for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005, representing 15.9% of net sales for the nine months ended September 30, 2006 and 16.5% of net sales for the nine months ended September 30, 2005. The decrease in international sales resulted from a decrease in Teva sales, partially offset by increased sales of UGG and Simple products, as a result of the items discussed above.

Gross Profit. Gross profit increased by $6,308, or 8.5%, to $80,914 for the nine months ended September 30, 2006, from $74,606 for the nine months ended September 30, 2005. As a percentage of net sales, gross margin increased to 44.9% for the nine months ended September 30, 2006, compared to 42.9% for the nine months ended September 30, 2005, primarily due to an increase in the UGG wholesale gross margin, related to higher initial sell-in margins, and lower inventory write-offs, partially offset by increased closeout sales. Our gross margins fluctuate based on several factors and we expect to return to a normal range of 42.0% to 44.0% in 2007.

Selling, General and Administrative Expenses. SG&A increased by $9,172, or 22.1%, to $50,684 for the nine months ended September 30, 2006 from $41,512 for the nine months ended September 30, 2005. As a percentage of net sales, SG&A increased to 28.2% for the nine months ended September 30, 2006 from 23.9%

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

for the nine months ended September 30, 2005. The increase in SG&A was largely due to an increase in payroll, marketing, and international division expenses, in support of our planned strategic growth initiatives.

Income from Operations. Income from operations decreased by $2,864, or 8.7%, in the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005. This was due primarily to the increase in SG&A.

Income from operations of Teva wholesale decreased by $3,022, or 14.5%, for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005. This decrease was largely due to the decrease in net sales as well as an increase in marketing expenses, partially offset by lower selling commissions related to the lower sales volume and lower divisional sales expenses.

Income from operations of UGG wholesale increased by $5,751, or 20.9%, for the nine months ended September 30, 2006, compared to the nine months ended September 30, 2005. The increase was primarily the result of increased sales volumes and gross margins as well as decreased selling commissions, partially offset by higher marketing expenses.

Loss from operations of Simple wholesale was $892 for the nine months ended September 30, 2006 compared to a loss of $27 for the nine months ended September 30, 2005. In spite of achieving higher net sales for the first nine months of 2006, Simple experienced lower gross margins from increased closeouts with negative margins along with higher marketing and selling costs.

Income from operations of our Consumer Direct business increased by $1,363, or 54.4%, for the nine months ended September 30, 2006, compared to the nine months ended September 30, 2005. This increase was largely due to the increase in net sales, partially offset by higher operating costs.

Unallocated overhead costs increased by $6,091, or 34.2%, for the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005, resulting primarily from higher corporate payroll costs, international division costs, and warehouse expenses, which are not allocated to the brands.

Other Income, Net. Net interest income was $1,940 for the nine months ended September 30, 2006, compared to net interest expense of $104 for the nine months ended September 30, 2005. The interest income in 2006 resulted primarily from the investment of our higher cash balances and short-term investments as well as higher rates of return in the first nine months of 2006 compared to the same period a year ago. Additionally, we had interest expense from outstanding balances of long-term debt in the nine months ended September 30, 2005. Other income exclusive of net interest income was not material in either period.

Income Taxes. For the nine months ended September 30, 2006, income tax expense was $13,178, representing an effective income tax rate of 41.0%. For the nine months ended September 30, 2005, income tax expense was $13,224 representing an effective income tax rate of 40.1%. The increase in the effective tax rate was primarily due to a higher projected annual pre-tax income for our domestic operating unit, which bears a higher tax rate than that of our international subsidiaries, resulting in a higher blended effective tax rate for the full year 2006. The effective tax rate is subject to ongoing review and evaluation by management and can change from quarter to quarter.

Net Income. Our net income decreased 4.0% to $18,979 from $19,769 as a result of the items discussed above. Our earnings per diluted share decreased 3.9% to $1.48 from $1.54, primarily as a result of the decrease in net income.

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

We have two types of off-balance sheet arrangements. See “— Contractual Obligations” below. We do not believe that these arrangements are material to our current or future financial condition, results of operations, liquidity, capital resources or capital expenditures.

We finance our working capital and operating needs using a combination of our cash and cash equivalents, short-term investments, cash generated from operations and the credit availability under our revolving credit facility.

The seasonality of our business requires us to build inventory levels in anticipation of the sales for the coming season. Teva generally begins to build inventory levels beginning in the fourth quarter and first quarter in anticipation of the Spring selling season that occurs in the first and second quarters, whereas UGG generally builds its inventories in the second and third quarters to support sales for the Fall and Winter selling seasons, which historically occur during the third and fourth quarters.

Our cash flow cycle includes the purchase of these inventories, the subsequent sale of the inventories and the eventual collection of the resulting accounts receivable. As a result, our working capital requirements begin when we purchase the inventories and continue until we ultimately collect the resulting receivables. Given the seasonality of our Teva and UGG brands, our working capital requirements fluctuate significantly throughout the year. The cash required to fund these working capital fluctuations is generally provided using a combination of our internal cash flows and borrowings under our revolving credit facility.

Cash from Operating Activities. Net cash used in operating activities was $6,535 for the nine months ended September 30, 2006 compared to net cash used in operating activities of $17,700 for the nine months ended September 30, 2005. The change in net cash from operating activities was primarily due to a lesser increase in inventories in the first nine months of 2006 compared to a more significant increase in inventory in the first nine months of 2005. The lower increase in inventories is a result of tighter inventory management and buying closer to the required shipping dates. This was partially offset by a greater increase in accounts receivable in the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005, which resulted from increased sales. Net working capital improved by $21,518 to $128,638 as of September 30, 2006 from $107,120 as of December 31, 2005, primarily as a result of higher inventory balances and increased accounts receivable along with lower accounts payable. The increase in working capital was partially offset by a decrease in cash and cash equivalents and an increase in income taxes payable. The changes in working capital are due to our normal seasonality and timing of cash receipts and cash payments.

Cash from Investing Activities. For the nine months ended September 30, 2006, net cash used in investing activities was $28,831, which was comprised primarily of the net purchases of short-term investments. In addition, we used $3,329 for capital expenditures, primarily related to our new racking for the distribution center in Camarillo, California, the replacement and upgrading of certain computer equipment, our new Teva trade show booth, and the initial build-out of the new retail outlet store in Wrentham, Massachusetts. For the nine months ended September 30, 2005, net cash provided by investing activities was $11,876, which was comprised primarily of the proceeds from sales of short-term investments. This was partially offset by cash used for capital expenditures, primarily related to the opening of an additional distribution center, the replacement and upgrading of certain computer equipment and trade show booths, and the purchase of promotional vehicles for the Teva marketing team.

Cash from Financing Activities. For the nine months ended September 30, 2006, net cash provided by financing activities was $1,800 compared to net cash provided by financing activities of $14,460 for the nine months ended September 30, 2005. For the nine months ended September 30, 2006, the net cash provided by

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financing activities consisted primarily of cash received from the exercise of stock options as well as the excess tax benefits from stock-based compensation. For the nine months ended September 30, 2005, net cash provided by financing activities was made up primarily from cash received from net borrowings under the line of credit as well as cash received from the exercise of stock options.

Our working capital consists primarily of cash and cash equivalents, short-term investments, trade accounts receivable, inventories and a revolving credit facility. At September 30, 2006, working capital was $128,638 including $17,141 of cash and cash equivalents and $28,110 of short-term investments. Trade accounts receivable increased by 22.0% to $49,937 at September 30, 2006 from $40,918 at December 31, 2005, largely due to normal seasonality. Accounts receivable turnover increased to 7.2 times in the twelve months ended September 30, 2006 from 6.9 times in the twelve months ended December 31, 2005.

Inventories increased 54.4% to $51,530 at September 30, 2006 from $33,374 at December 31, 2005, reflecting a $21,235 increase in UGG inventory, a $2,584 decrease in Teva inventory, and a $494 decrease in Simple inventory. Overall, inventory turnover increased slightly to 3.4 times for the twelve months ended September 30, 2006 from 3.2 times for the twelve months ended December 31, 2005 due in part to higher sales during the twelve months ended September 30, 2006 compared to net sales in the twelve months ended December 31, 2005. The increase in UGG inventory at September 30, 2006 was due to normal seasonality as well as the high sell-through of UGG products in the nine months ended September 30, 2006. The decrease in Teva inventory occurred largely due to normal seasonality. The decrease in Simple inventory was largely due to higher closeout sales in the nine months ended September 30, 2006.

Our revolving credit facility with Comerica Bank (the “Facility”) provides for a maximum availability of $20,000. In September 2006, we amended the Facility, eliminating the borrowing base formula requirement, extending the maturity date, and changing certain covenant requirements. Up to $10,000 of borrowings may be in the form of letters of credit. The Facility bears interest at the lender’s prime rate (8.25% at September 30, 2006) or, at our option, at the London Interbank Offered Rate, or LIBOR, (5.32% at September 30, 2006) plus 1.0% to 2.5%, depending on our ratio of liabilities to earnings before interest, taxes, depreciation and amortization, and is secured by substantially all of our assets. The Facility includes annual commitment fees of $60 per year and now expires on June 1, 2008. At September 30, 2006, we had no outstanding borrowings under the Facility, no foreign currency reserves for outstanding forward contracts, and outstanding letters of credit of $52. As a result, $19,948 was available under the Facility at September 30, 2006.

The agreements underlying the Facility contain certain financial covenants including a quick ratio requirement, profitability requirements and a tangible net worth requirement, among others, as well as a prohibition on the payment of dividends. We were in compliance with all covenants at September 30, 2006, and remain so as of the date of this report.

We currently have no material commitments for future capital expenditures but estimate that the remaining capital expenditures for 2006 will range from approximately $2,300 to $2,500 and may include additional costs associated with upgrades to our distribution centers and the build-out of new retail outlet stores. The actual amount of capital expenditures for the remainder of 2006 may differ from this estimate, largely depending on any unforeseen needs to replace existing assets and the timing of expenditures.

We believe that internally generated funds, the available borrowings under our existing Facility, cash and cash equivalents, and short-term investments will provide sufficient liquidity to enable us to meet our working capital requirements for at least the next twelve months. However, risks and uncertainties that could impact our ability to maintain our cash position include our growth rate, the continued strength of our brands, our ability to respond to changes in consumer preferences, our ability to collect our receivables in a timely manner, our ability to effectively manage our inventories and the volume of letters of credit used to purchase product, among others. Please refer to our Annual Report on Form 10-K under Item 1A.Risk Factors and this quarterly report on Form 10-Q under Item 1A. Risk Factors for a discussion of additional factors that may affect our working capital position. Furthermore, we may require additional cash resources due to changed business

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

conditions or other future developments, including any investments or acquisitions we may decide to pursue. If these sources are insufficient to satisfy our cash requirement, we may seek to sell debt securities or additional equity securities or to obtain a new facility or draw on our existing facility. The sale of convertible debt securities or additional equity securities could result in additional dilution to our stockholders. The incurrence of indebtedness would result in incurring debt service obligations and could result in operating and financial covenants that would restrict our operations. In addition, there can be no assurance that any additional financing will be available on acceptable terms, if at all. Although there are no present understandings, commitments or agreements with respect to the acquisition of any other businesses, we may, from time to time, evaluate acquisitions of other businesses or brands.

Contractual Obligations. The following table summarizes our contractual obligations at September 30, 2006, and the effects such obligations are expected to have on liquidity and cash flow in future periods.

Our operating lease obligations consist primarily of building leases for our offices and retail locations. In September 2006, we entered into a purchase obligation with a movie production company for advertising services.

We believe that the relatively moderate rates of inflation in recent years have not had a significant impact on our net sales or profitability.

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

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

In July 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes – an interpretation of SFAS No. 109,” which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. FIN 48 also provides guidance on the derecognition, classification, accounting in interim periods, and disclosure requirements for uncertain tax positions. The provisions of FIN 48 are effective for us as of January 1, 2007. We are currently evaluating the impact of adopting FIN 48, if any, on our consolidated financial statements.

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

In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108 (SAB 108), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. It requires companies to quantify the misstatements using both a balance sheet and an income statement approach. SAB 108 is effective for our fiscal year ending December 31, 2006. We do not expect that SAB 108 will have a material impact on our consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 4. Controls and Procedures

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Pursuant to the requirements 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.