DECKERS FORM 10-K FOR DECEMBER 31, 2001


	o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Aggregate market value of the Common Stock of the registrant held by nonaffiliates of the registrant on February 28, 2002 based on the closing price of the Common Stock on the NASDAQ National Market System on such date was $27,050,345. The number of shares of the registrant’s Common Stock outstanding at February 28, 2002 was 9,340,357.

Portions of registrant’s definitive proxy statement relating to registrant’s 2002 annual meeting of shareholders, which will be filed pursuant to Regulation 14A within 120 days after the end of registrant’s fiscal year ended December 31, 2001, are incorporated by reference in Part III of this Form 10-K.

The Company builds niche products into global lifestyle brands by designing and marketing innovative, functional and fashion-oriented footwear, developed for both high performance outdoor activities and everyday casual lifestyle use. Currently, the Company offers three primary product lines under the following recognized brand names: Teva® — high-performance sports sandals and rugged outdoor footwear; Simple® — innovative shoes that combine the comfort elements of athletic footwear with casual styling; and Ugg® — authentic sheepskin boots and other footwear. Teva is a registered trademark of Mark Thatcher, the inventor and licensor of Teva Sport Sandals. Simple and Ugg are registered trademarks of the Company and its subsidiaries. All of the Company’s footwear possess the common features of high quality with a primary focus on functionality and comfort. In 2001, the Company sold approximately 3,705,000 pairs of footwear. Revenues from sales (domestic and international) of Teva products have been $61,221,000, $79,732,000 and $80,963,000 during 2001, 2000 and 1999, representing 66.9%, 70.1% and 72.9% of net sales, respectively. For financial information regarding the Company’s industry segments, see note 10 to the accompanying consolidated financial statements.

The casual, outdoor and athletic footwear market is comprised of footwear worn for casual everyday use and for outdoor and athletic activities such as hiking, boating, basketball, tennis, fitness and jogging. The market for such footwear has grown significantly during the last decade. The Company believes that the principal reasons for the growth in sales of such footwear have been the growing acceptance of athletic footwear as casual wear and the growing acceptance of casual wear, in general, including the trend toward casual dress in the workplace, increasingly active consumer lifestyles and the growing emphasis on comfort.

Over the last few years the overall footwear market has seen significant growth of the outdoor segment as well as the growing emphasis on comfort. Outdoor footwear includes shoes, boots and sandals for outdoor recreational activities such as hiking, river rafting, camping and casual wear. Companies engaged in the outdoor footwear market include Nike, Adidas, Timberland, Columbia and Salomon. The Company believes that the growth in outdoor footwear is driven by several factors including a general shift in consumer preferences and lifestyles to include more outdoor, sports and recreational activities such as hiking and camping. In addition, the increasing popularity of extreme sports, including skateboarding, snowboarding, kayaking and river rafting, among others, has created an additional emphasis and awareness of outdoor activities and lifestyles. As consumers engage in outdoor activities, they typically desire footwear specifically designed for these purposes, yet they demand the same level of quality and high performance that they have come to expect from traditional athletic footwear. In addition, more consumers are turning to an emphasis on casual and comfortable footwear and apparel, as evidenced by the trend toward casual workplaces in recent years. The Company believes that its products have benefited from this growing trend and that its footwear addresses consumers’ demands for highly functional footwear that is durable as well as comfortable and fashionable.

The casual, outdoor and athletic footwear markets are generally characterized by a high level of recognition of brand names, logos and trademarks. Unique and identifying features create brand awareness among consumers and allow a favorable reputation to be transferred to new products. The manufacture of casual, outdoor and athletic footwear is typically conducted overseas through independent manufacturers. Casual and athletic footwear is distributed through athletic footwear stores, department stores and specialty retailers. Outdoor footwear is generally distributed through these channels as well but is to a large extent distributed through outdoor specialty retailers. Retailers may purchase footwear on a “futures” basis (orders placed at a discount in advance of a season) or an “at once” basis (orders placed and filled immediately). Futures orders allow the Company to more accurately predict its manufacturing and sourcing needs. By placing futures orders, retailers are also able to reduce the risk that the Company will be unable to meet their

This Annual Report on Form 10-K contains a variety of forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including forward-looking statements in this “Risk Factors” section, the “Outlook” section, the last paragraph under “Liquidity and Capital Resources”, the discussion under “Seasonality” and other statements in this Annual Report. Forward-looking statements relating to sales, earnings per share, and the Company’s liquidity may be significantly impacted by future developments such as the possible non-renewal of the Teva license due to the Company’s potential failure to meet required sales minimums in 2004 or 2008, certain litigation, economic factors and world events, the Company’s dependence on foreign manufacturers, competition, the Company’s dependence upon key personnel, weather conditions, the possible acquisition of Teva and the impact of seasonality on the Company’s operations, among others. These forward-looking statements are based on the Company’s expectations as of March 2002. No one should assume that any forward-looking statement made by the Company will remain consistent with the Company’s expectations after the date the forward-looking statement is made. The Company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained in this Annual Report on Form 10-K. These forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievement of the Company, or industry results, to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. The factors listed below represent certain important factors the Company believes could cause such results to differ. These factors are not intended to represent a complete list of the general or specific risks that may affect the Company. Other risks may be significant, presently or in the future, and the risks set forth below may affect the Company to a greater extent than indicated.

The Company has been selling its Teva line of sports sandals and other footwear since 1985 pursuant to various exclusive licensing arrangements with Mark Thatcher, the inventor of the Teva sport sandal and owner of the Teva patents and trademark. In June 1999, the Company signed a new exclusive footwear license agreement with Mr. Thatcher. The agreement became effective January 1, 2000 and continues through December 31, 2004. If minimum annual sales levels are achieved in 2004, the license automatically renews for an additional four years, through December 31, 2008. If minimum annual sales levels are achieved in 2008, the license automatically renews again through December 31, 2011. However, if the minimum annual sales levels are not achieved in 2004 or 2008, the license expires and the Company will no longer be able to sell Teva footwear. These required minimum annual sales levels are $107.9 million in 2004 and $137.3 million in 2008, both of which are significantly greater than the annual sales of $61.2 million achieved by the Company in 2001. Also, Mr. Thatcher may terminate the licensing agreement if the Company breaches certain of its other obligations under the agreement. The Company believes it is unlikely to achieve the contractual minimum for 2004 and has begun discussions with the licensor to address this issue. However, the Company can provide no assurances that it will be successful in its efforts to reach an acceptable resolution. Sales of Teva footwear and apparel accounted for approximately 66.9%, 70.1% and 72.9% of the Company’s net sales for fiscal years 2001, 2000 and 1999, respectively. The termination of the license would have a material adverse effect on the Company’s results of operations.

The Company’s success is largely dependent on the continued strength of the Teva, Simple and Ugg brands (collectively, “Deckers Brands”) and on its ability to anticipate the rapidly changing fashion tastes of footwear customers and to provide merchandise that appeals to their preferences in a timely manner. There can be no assurance that consumers will continue to prefer the Deckers Brands or that the Company will respond in a timely manner to changes in consumer preferences or that the Company will successfully

introduce new models and styles of footwear. Achieving market acceptance for new products will also likely require substantial marketing and product development efforts and the expenditure of significant funds to create consumer demand. Decisions with respect to product designs often need to be made many months in advance of the time when consumer acceptance can be determined. As a result, the Company’s failure to anticipate, identify or react appropriately to changes in styles and features could lead to, among other things, excess inventories and higher markdowns and lower gross margins due to the necessity of providing discounts to retailers. Conversely, failure by the Company to anticipate consumer demand could result in inventory shortages, which can adversely affect the timing of shipments to customers, negatively impacting retailer and distributor relationships and diminishing brand loyalty. The failure to introduce new products that gain market acceptance would have a material adverse effect on the Company’s business, financial condition and results of operations, and could adversely affect the image of the Deckers Brands.

The footwear industry has relatively long lead times for design and production of product and, thus, the Company must commit to production tooling and to production in advance of orders. In addition, the industry is highly subject to fashion risks and changes in consumer preferences. This risk is exacerbated by the large number of models, colors and sizes in the Company’s three product lines. If the Company fails to accurately forecast consumer demand, or if there are changes in consumer preference or market demand after the Company has made such production commitments, the Company may encounter difficulty in filling customer orders or in liquidating excess inventory, which may have an adverse effect on the Company’s sales, margins and brand image.

In response to consumer demand, the Company also uses certain specialized materials in its footwear. The failure of products using such materials to perform to the Company’s specifications or customer satisfaction could result in a higher rate of customer returns and could adversely affect the image of the Deckers Brands, which could have a material adverse effect on the Company’s business, financial condition and results of operations.

The footwear industry historically has been subject to cyclical variation and can be negatively impacted by decreased consumer spending or softness in the retail market. This cyclicality could adversely affect the Company’s business. In addition, various retailers, including some of the Company’s customers, have experienced financial difficulties during the past several years, thereby increasing the risk that such retailers may not be able to pay for the Company’s products in a timely manner. No assurance can be given that the Company’s bad debt expense will not increase relative to net sales in the future. Any significant increase in the Company’s bad debt expense relative to net sales would adversely impact the Company’s net earnings and cash flow and could affect the Company’s ability to pay its obligations as they become due.

Virtually all of the Deckers footwear products are manufactured by third party suppliers in the Far East, Australia and New Zealand, with the vast majority of production occurring in China. There can be no assurance that the Company will not experience difficulties with such manufacturers, including reduction in the availability of production capacity, errors in complying with product specifications, inability to obtain sufficient raw materials, insufficient quality control, failure to meet production and delivery deadlines or increases in manufacturing costs. In addition, if the Company’s relationship with any of its manufacturers were to be interrupted or terminated, alternative manufacturing sources will have to be located. The establishment of new manufacturing relationships involves numerous uncertainties, and there can be no assurance that the Company would be able to obtain alternative manufacturing sources on terms satisfactory to it. If a change in its suppliers becomes necessary, the Company would likely experience increased costs, as well as substantial disruption and a resulting loss of sales.

Foreign manufacturing is subject to a number of risks, including work stoppage, transportation delays and interruptions, political instability, foreign currency fluctuations, changing economic conditions, expropriation, nationalization, imposition of tariffs, import and export controls and other non-tariff barriers (including quotas), restrictions on the transfer of funds, environmental regulation and other changes in governmental policies. The Company may also experience general risks associated with managing operations effectively and efficiently from a far distance and understanding and complying with local laws, regulations and customs. There can be no assurance that such factors will not materially adversely affect the Company’s business, financial condition and results of operations.

Products manufactured overseas and imported into the United States and other countries are subject to duties collected by the Customs Service in the applicable country. Customs information submitted by the Company is subject to review by the Customs Service. The Company is unable to predict whether additional customs duties, quotas or restrictions may be imposed on the importation of its products in the future. The enactment of any such duties, quotas or restrictions could result in increases in the cost of such products generally and might adversely affect the sales or profitability of the Company.

In 1997, the European Commission enacted anti-dumping duties of 49.2% on certain types of footwear imported into Europe from China and Indonesia. Dutch Customs has issued an opinion to the Company that certain popular Teva styles are covered by this anti-dumping duty legislation. The Company has been contesting the opinion and is working with Dutch Customs to resolve the situation. The Company has since obtained, and is using, alternative sourcing for the potentially impacted products from sources outside of China in an effort to reduce the potential risk in the future. In the event that Dutch Customs makes a final determination that the anti-dumping provisions are applicable, the Company would have an exposure for prior unpaid anti-dumping duties during 1997 of approximately $500,000, which has been fully accrued as of December 31, 2001.

The outdoor and footwear industries are both highly competitive, and the recent growth in the markets for sports sandals and casual footwear has encouraged the entry of many new competitors into the marketplace as well as increased competition from established companies. Many of the Company’s competitors have substantially greater financial, distribution and marketing resources, as well as greater brand awareness in the footwear market, than the Company. In addition, the general availability of offshore manufacturing capacity allows rapid expansion by competitors and new market entrants. The Company believes that it has been able to compete successfully because of the brand recognition, quality and selective distribution of its products. From time to time, the Company also discovers products in the marketplace that infringe upon patent and trademark rights held by or licensed to the Company. Under the Company’s licensing arrangement with the licensor of the Teva products, Mark Thatcher, Mr. Thatcher initially may bring proceedings to halt infringement of the Teva patents and trademark. If Mr. Thatcher elects not to bring such proceedings, the Company may initiate such proceedings, with the prior written consent of Mr. Thatcher. To date, Mr. Thatcher has vigorously pursued infringements following discovery. To the extent permitted in its agreement with Mr. Thatcher and to the extent considered necessary, the Company will vigorously pursue infringements in the event Mr. Thatcher elects not to do so. However, if Mr. Thatcher or the Company is unsuccessful in challenging a third party’s products on the basis of patent and trademark infringement, continued sales of such competing products by third parties could adversely impact the Company’s business, financial condition and results of operations. See “Business — Competition” and “Business — Legal Proceedings.”

The Company’s continued success will depend substantially upon its ability to retain Douglas B. Otto, its Chairman of the Board and Chief Executive Officer, Peter Benjamin, its President and Chief Operating Officer and a core group of key executive officers and employees. The Company believes that its future success will depend in large part on its ability to attract and retain highly skilled personnel. Competition for such personnel is intense, and there can be no assurance that the Company will be successful in attracting and

The Company believes that its trademarks, technologies and designs are of great value. From time to time, the Company may be the subject of litigation challenging its ownership of certain intellectual property. Loss of the Company’s Simple or Ugg trademark rights or the ability to use the licensed Teva trademarks could have a serious impact on the Company’s business. Because of the importance of such intellectual property rights, the Company’s business is subject to the risk of counterfeiting, parallel trade or intellectual property infringement.

The Company’s business is subject to economic conditions in its major markets, including, without limitation, recession, inflation, general weakness in retail markets and changes in consumer purchasing power and preferences. Adverse changes in such economic factors could have a negative effect on the Company’s business.

In addition, the Company’s results, and the domestic and international economies in general, may be further negatively impacted by the terrorist activities of September 11, 2001 and any subsequent terrorist acts, as well as the impact of the United States’ war efforts. The overall negative impact of these activities, including the effect on the economy and commerce in general, cannot currently be determined.

Sales of the Company’s products, particularly those under the Teva and Ugg lines, are very sensitive to weather conditions. Extended periods of unusually cold weather during the spring and summer could adversely impact demand for the Company’s Teva line. Likewise, unseasonably warm weather during the fall and winter months could adversely impact demand for the Company’s Ugg product line.

At December 31, 2001, Douglas B. Otto and all executive officers and directors of the Company, as a group, owned approximately 33.7% and 42.2%, respectively, of the outstanding shares of the Company’s Common Stock. Due to such ownership position, Mr. Otto, whether acting alone or together with one or more of the other executive officers of the Company, would likely be able to control the affairs and policies of the Company and would likely be able to elect a sufficient number of directors to control the Company’s Board of Directors and to approve or disapprove any matter submitted to a vote of the stockholders.

The Company adopted a shareholder rights plan in 1998 pursuant to a shareholder rights agreement (the “Rights Agreement”) to protect stockholders against unsolicited attempts to acquire control of the Company that do not offer what the Board of Directors of the Company believes to be an adequate price to all stockholders. As part of the plan, the Board of Directors of the Company declared a dividend so that one preferred share purchase right was and will be issued for each outstanding share of Common Stock of the Company until the expiration date of the Rights Agreement.

The ownership positions of Mr. Otto and the executive officers of the Company, as a group, together with the anti-takeover effects of certain provisions in the Delaware General Corporation Law (the “DGCL”), in the Company’s Certificate of Incorporation and Bylaws and in the Company’s shareholder rights plan would likely have the effect of delaying, deferring or preventing a change in control of the Company and could have a negative effect on the market price of the Company’s Common Stock.

The Company’s offices and distribution center are located in the state of California, which has experienced rolling electrical power outages in 2001. Depending on the occurrence, timing, length and

Also, during the year ended December 31, 2001, the Company implemented a new Enterprise Resource Planning (“ERP”) computer system to replace its legacy system. In connection with this conversion, the Company initially encountered various difficulties. The effectiveness of the system’s operation can impact the Company’s ability to receive and accept orders, monitor its inventory levels, and coordinate the shipment of products to customers, among other activities. In the event that significant difficulties are encountered in the future, the Company may experience lower sales and increased expenses, which would negatively impact the Company’s results of operations and cash flows.

The Company’s results of operations, financial condition and cash flows are also subject to risks and uncertainties with respect to the Company’s ability to secure and maintain adequate financing, to forecast its future sales, inventory needs and cash flows and to subsequently achieve those forecasts.

Management’s mission is to build niche products into global brands and its business strategy is to offer diverse lines of footwear that emphasize functionality, quality, comfort and technical performance tailored to a variety of activities and demographic groups. Specifically, the Company’s business strategy emphasizes the following elements:

Introduce New Categories and Styles under Existing Brands. The Company intends to leverage consumer recognition of its existing brands by developing and introducing additional innovative footwear products that satisfy the Company’s high standards of practicality, comfort and quality. The Company believes the introduction of additional products at a variety of price points, such as the range of new models in its Teva, Simple and Ugg lines being offered in the Company’s 2002 product offerings, have broadened the Company’s customer base, further diversified the Company’s product lines, and helped reduce the effects of seasonality on the Company’s sales. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Seasonality.” Over the last several years, the Teva product offering has been greatly expanded to include a variety of new sport sandal styles at a variety of price points and incorporating a range of new uppers and technologies. In addition, the Company has begun to leverage the success of the Teva brand in the outdoor markets by launching into several new categories of footwear, including amphibious footwear, hikers, trailrunners, cold-weather boots, and other rugged outdoor footwear. The Spring 2002 and Fall 2002 Teva product lines include a significant redesign and the introduction of several new styles and categories. One of the features prevalent in the Spring 2002 line is the use of the Wraptor technology, a patent-pending 360 degree continuous strapping system that simultaneously secures the instep and arch shank to the foot. Following on the success of this feature in the Company’s running sandals, the Company has also designed a line of hikers around this technology and has added it to certain styles of the Company’s high performance Guide offering for professional paddlers and adventurers. In addition, the Company continues to expand into the hiking, trailrunning and rugged outdoor arenas, where the aggregate market size is considerably greater than the market for sport sandals, the area in which the Teva brand was initially founded. By launching into these new areas of closed footwear, the Company hopes to increase sales while at the same time reducing the impact of seasonality on the Company’s business. In addition to its historically strong outdoor orientation, the 2002 line also includes athletically inspired styles aimed directly at the athletic distribution channels, another significant area where the Company hopes to gain distribution. In addition to these new categories for the brand, Teva has also re-designed its core sport sandal offering by adding many new features and styles, incorporating the latest technologies and innovations. The Company continues to use the knowledge and experience of Team Teva, an elite group of the world’s best male and female whitewater athletes, to enhance the development of future technical offerings in this category. As the Company moves to the future, it plans to strengthen existing categories and further expand into new channels of distribution.

The 2002 Simple product line includes a re-emphasis on the men’s footwear business, an area where the brand had been very successful several years ago, as well as a focus on athletically inspired designs. The 2002 Simple line also includes a collection of women’s casual styles featuring low profiles and sleek outsoles. The

Simple line continues to target consumers in the sixteen to twenty-five year old youth market. The line focuses on lifestyle comfort based products such as clogs, sandals, casuals and non-performance sneakers that are priced affordably. In 2002, the Company’s Ugg product offering continued to include its heritage boots and slippers, as well as an improved women’s Town Collection of casual, fashionable boots and clogs and a new Aspen Collection of rugged cold-weather footwear featuring seam sealed lugged outsoles and waterproof leathers combined with sheepskin linings.

Pursue Licensing of Brands. Given the strength of the Company’s brands, the Company is also pursuing the licensing of its brand names to other ancillary products, beyond the Company’s existing core footwear products. Through this type of brand extension, the Company hopes to generate additional revenues in the form of royalty income; to further increase awareness for the Company’s brands and their related products, and thereby increase sales of its footwear; and to build the long-term value of the brands. The Company’s business strategy currently includes the pursuit of brand extension through licensing for both the Ugg and Simple brands. The sublicensing of the Teva brand is not currently available under the existing Teva license agreement; however, in the event that the Company subsequently exercises its purchase option to acquire Teva, the licensing of the Teva trademarks to other products would be considered as part of the long-term strategy for the brand (See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources”). As part of this approach, the Company has recently signed agency agreements with BHPC Marketing, Inc. to assist in identifying candidates and coordinating the efforts for the licensing of the Ugg and Simple trademarks on various products ranging from sportswear and outerwear to housewares and accessories. Because the Company is currently in the early stages of pursuing licensing opportunities for its brands it cannot yet provide any assurances regarding how successful its efforts will be or how significant the market size will be.

Pursue Additional Market Opportunities. Management intends to continue to consider new markets for its existing line of products. For the years ended December 31, 2001, 2000 and 1999 international net sales totaled $21,096,000, $31,135,000 and $28,859,000, representing 23.1%, 27.4% and 26.0% of net sales, respectively. Management believes that significant opportunities exist to market its products abroad and intends to selectively expand its distribution worldwide. To bolster these efforts, the Company has entered into an agency arrangement, effective January 1, 2002, with a firm in the United Kingdom for the coordination of the sales, distribution, marketing and advertising efforts in the European markets. In addition, the Company has an office in Japan that facilitates the servicing of the Asian market.

The Company believes significant opportunities exist to expand distribution domestically too. For example, the Company’s Teva brand has had its roots in the outdoor market where it has successfully distributed its products for many years. The Company sees the potential for expansion into the athletic retail distribution channel as a significant opportunity for the Teva brand in future years. The Company intends to pursue this channel of distribution going forward and has recently designed product targeted at this market and has added sales personnel with significant experience in this market. In addition, the Ugg brand has historically been popular in California for many years. The Company believes that significant opportunities exist to expand distribution for this brand throughout the United States, especially in light of its suitability to a variety of climates. In recent years, the Company has been successful in expanding outside of California and expects to continue to pursue this expansion in the future.

Acquire or Develop New Brands. The Company intends to continue to focus on identifying and building new brands for growth. The Company has been successful in the past in taking the concepts of entrepreneurs for innovative, fashionable footwear targeted at niche markets and building the products into viable brands and intends to continue to identify concepts for potential future niche products which have the potential of developing into successful brands or product lines.

The Company currently offers three primary product lines: (1) Teva sport sandals and footwear; (2) Simple casual footwear; and (3) Ugg sheepskin footwear. Each of these lines, as well as individual models within these lines, is designed to appeal to various demographic groups. The Company’s footwear products

emphasize function, comfort and technical performance and are suitable for a variety of demanding outdoor and athletic activities, as well as casual and everyday use. The Company’s products are designed and marketed to promote a high level of brand name recognition and consumer appeal by combining functional and creative designs with quality materials and construction. The Teva footwear and the Simple footwear lines are generally previewed twice per year, once in the summer for deliveries that commence in the fall and once in the winter for the following back to school and fall season. The Ugg line of sheepskin footwear is generally previewed in the winter with most deliveries occurring in the following fall and winter. The following sets forth a summary description of each of the Company’s primary product lines:

Teva Sport Sandals and Footwear. The Teva sport sandal was one of the first sport sandals to be developed and remains popular among outdoor enthusiasts and the general public. The Company licenses the Teva patents and trademark from Mark Thatcher, a professional river guide who invented the Teva sport sandal. The terms of such licenses run through 2011, subject to achieving certain minimum sales levels beginning in 2004. Certain styles of the Teva sport sandal incorporate a variety of proprietary strapping configurations ideally suited for outdoor activities such as hiking, boating and river rafting. These strapping systems generally consist of high-quality nylon webbing or leather, are fully adjustable, and hold the foot firmly to the sandal’s durable, cellular rubber, molded EVA, polyurethane or leather footbed. Teva sport sandals are extremely durable, with many styles designed specifically for performance in and around the water. In addition, the Company has recently leveraged the brand’s success in the outdoor markets by launching into various natural progressions for the brand including hiking boots, trailrunning shoes, amphibious footwear and other rugged outdoor footwear styles. For Spring 2002, the Teva line has been redesigned to include numerous new styles, categories and features and now includes 86 different models spread across various categories and designed for a variety of uses. The Hydro Series, a category of sandals and other amphibious footwear built for high performance and rugged outdoor use, includes 14 models of men’s and women’s styles of sport sandals, neoprene and quick draining monofilament mesh watershoes and other outdoor footwear ideal for professional outdoorsmen and adventurers. The Terra Series, a line of 17 styles of sandals and hiking boots primarily designed for use on land, includes performance walking sandals and convertible sandals with removable heel straps that allow the sandal to be worn as a slide, as well as hiking boots and running sandals incorporating the patent-pending Wraptor technology, an upper which encircles the instep and continually adjusts to the movement of the foot to provide a consistently secure fit. The Originals Series has 16 styles of sandals and thongs that combine the elements of performance with casual everyday use and includes several of the most popular styles as well as new models with retro-1970’s inspired colors and stylings. Continuing on the success of recent years, the Spring 2002 line includes 15 styles of men’s and women’s leather casuals under the Nomad Series, including a variety of sandals, slides and clogs. The Sun and Moon Series includes 11 styles of slides and thongs offered in a variety of materials including waterproof leather, nylon, suede and airmesh. The Spring 2002 Children’s category is a collection of 13 styles at various price points and includes an assortment of sandals incorporating a variety of materials including leather, waterproof suede, nylon, neoprene and mesh as well as slip-on watershoes, hikers and other styles of amphibious footwear. In addition, for the Fall 2002 season, the Company has significantly expanded its Fall product offering with a variety of different types of closed footwear, including hiking boots, cold weather boots, trailrunners and an assortment of other rugged outdoor styles. The domestic manufacturer’s suggested retail prices for adult sizes of Spring 2002 Teva footwear products range from $20.00 to $130.00.

Simple Casual Footwear. The Simple line consists of casual shoes that combine the comfort and function of athletic footwear construction with the simple, understated styling of “back-to-basics,” casual lifestyle footwear. The Simple product line includes a variety of comfortable, fashionable, basic shoes for men and women including sneakers, sandals, slides, clogs and leather casuals. The Spring 2002 collection reflects the Company’s emphasis on a target consumer in the sixteen to twenty-five year old age group. For the 2002 line, the Company has added several new styles of clogs, sandals, sneakers and leather casuals to its offerings including several athletically inspired styles for men and women as well as a re-emphasis on the men’s footwear business, an area where the Company had considerable success in the past. The 2002 Simple line also includes a series of new, innovative styles of women’s footwear featuring models with low profiles and sleek lines. For Spring 2002, Simple is offering a total of 86 models including 46 styles for men and 40 for women. The Spring 2002 line includes 32 styles of sneakers with leather and suede uppers, 29 styles of sandals

Ugg Sheepskin Footwear. Ugg is a line of authentic sheepskin footwear, popularized in Australia in the 1960’s and 1970’s. These sheepskin boots, slippers and other footwear styles have high-grade fleece linings which act as a natural insulator, keeping feet warm and comfortable. The 2002 Ugg line offers a range of 52 models of casual, fashionable and streetwise styles in various colors, including several new styles of shoes and boots for men and women. The 2002 line includes several styles with new innovative fashionable uppers and several styles with water resistant leather treatments to address more inclement and cold weather conditions. The 2002 line continues the tradition of the highly successful Classic and Ultra boots, as well as the Home/ Spa Collection of slippers and other comfort footwear. In addition, for 2002, the line includes an expanded Town collection of men’s and women’s casual footwear, including the men’s Birch styles, the women’s Solvang styles, and the women’s Brooks styles featuring lug bottoms for traction combined with sleek profiles. The 2002 line also includes a new Aspen Collection of rugged cold-weather footwear featuring seam sealed lugged outsoles and waterproof leathers combined with sheepskin linings to prevent water from coming in and to prevent warmth from escaping. The domestic manufacturer’s suggested retail prices for adult sizes for the Ugg line range from $50.00 to $275.00.

The Company’s products are currently distributed throughout the United States by a network of approximately 32 independent sales representatives, organized geographically, who make sales, visit retail stores to train personnel and review sales of the Company’s footwear on a periodic basis. Beginning in 2000, the Company added a separate dedicated independent sales force for the Simple and Ugg brands as these products are sold through different distribution channels and are targeted toward a different consumer than the Company’s Teva brand. The Company’s sales managers for each brand manage their networks of representatives, recruit experienced sales representatives in the industry and coordinate sales to national accounts. The Company currently sells its products internationally through independent distributors. The Company’s goal is to promote retail sales of its products at attractive profit margins for its accounts through selective distribution and marketing, targeted toward distinct groups of consumers. As a result of this approach, the Company’s accounts have a strong incentive to devote greater selling space to the Company’s products, and the Company is better able to assess consumer preferences, the future ordering needs of its customers and inventory requirements.

The Company’s principal domestic customers include specialty retailers, upscale department stores, outdoor retailers and athletic footwear stores which market products consistent with the Company’s standards and, in the case of Teva, have been approved by the Company’s licensor. The Company’s five largest customers accounted for approximately 20.6% of the Company’s net sales for the year ended December 31, 2001, compared to 20.4% for the year ended December 31, 2000. No single customer accounted for more than 10% of the Company’s net sales for the years ended December 31, 2001 or 2000.

In order to encourage accounts to place orders early in the season the Company has continued with a preseason discount program under which accounts are offered discounts on preseason orders placed. The Company’s strategy is to emphasize this “futures” program, as compared to “at once” sales, in order to stabilize its supply arrangements, reduce the risk of customer cancellations and to benefit from the significant positive impact of the program on the Company’s inventory costs, sourcing schedule and allocation of marketing resources. Consistent with prior years, the Company offered an early delivery program for the spring 2002 season which was delivered the fourth quarter of 2001. This early delivery program allows the Company to reduce the impact of peak warehouse inventory levels during the spring and provides retailers the opportunity to have earlier sell through, lengthening the retail selling season and increasing the potential for inventory turns at retail.

Domestic deliveries generally originate from the Company’s 126,000 square foot warehouse facility in Ventura County, California. European deliveries originate from a distribution center in the Netherlands, while all other international deliveries originate from offshore factories.

The Company attempts to maximize the impact of its advertising, public relations and promotional expenditures by utilizing media that provide high visibility within targeted market segments. The Company’s brand names are generally advertised and promoted through a variety of consumer print advertising campaigns in addition to highly visible editorial coverage in both consumer and trade publications. Retail presence and “point of purchase” materials along with production packaging provide additional visible brand support. The Company’s in-house marketing departments for each brand work closely with targeted accounts in many aspects of these activities.

The Company continues to advertise its Teva brand through a national print advertising campaign targeted at various different demographic groups. For its core outdoor market, Teva advertises in several outdoor-related magazines, including Backpacker, Outside, National Geographic Adventurer, Paddler, and Sports Illustrated Women, among others. In addition, to promote its newly introduced Elden Trail trailrunner, Teva is advertising in Trail Runner and The Running Network, among other publications. With the broadened appeal of the Teva offerings, including the leather casual models, the Company has also focused its print advertising toward more mainstream print publications, including Shape and National Geographic Traveler. Teva will also target the alternative, youth market with advertisements in Stuff and Adrenaline. In addition, with the introduction of Teva’s first full Fall line in 2002, Teva will increase its advertising in the fall and winter months.

In order to maintain the Company’s historically high visibility among core outdoor enthusiasts such as professional river rafters, kayakers, mountain bikers and rock climbers, Teva products are given or sold at professional discounts to members of this group. In order to further bolster the loyalty of these individuals, the Company offers categories called “Hydro” and “Terra,” incorporating the latest technological developments and highest quality materials. The Company actively sponsors a group of the world’s best male and female whitewater athletes called Team Teva. Teva also sponsors teams from other outdoor disciplines including the Teva US Mountain Running Team and the SOBE Headshok Mountain Bike Team. By outfitting and sponsoring these highly visible athletes and teams, the Company creates awareness among targeted consumers at relatively low cost. In addition, the Company has traveling promotional and technical representatives who represent the Teva brand at a wide variety of festivals, outdoor sporting events and competitions. Teva is sponsoring over fifty events in 2002, including the Teva Tour, a series of whitewater rafting and kayaking events held between April and October at fourteen rivers across America. Internationally, the Company is also the title sponsor for events in Japan, Canada, Switzerland and Italy. Teva sponsors and promotes these events in order to increase the Company’s visibility for its core outdoor consumer, in addition to the significant marketing available to the more mainstream public with the increasing popularity of viewing these extreme sports. In addition to the Teva Tour, the Teva promotional team attends and sponsors other events including the Teva Mountain Games at Vail, Teva Mountain Running Series, Teva Liquid Lifestyles Film US Tour, Santa Cruz Surf Kayak Festival in Santa Cruz, California, Grandma’s Marathon in Duluth, Minnesota, The Telluride Bluegrass Festival in Telluride, Colorado, and Reggae on the River in Garberville, California, among others.

The Teva mobile promotions team attends the events in dedicated state of the art promotional vehicles where they showcase Teva products and provide consumers with the opportunity to see and try on the latest styles. The Teva brand has also recently initiated a partnership with Land Rover. Land Rover is now the official vehicle of Team Teva, outfitting the Team Teva athletes and the Teva Technical Representatives in Teva branded Land Rovers throughout the United States.

With respect to the Simple product line, the Company has continued its national print advertising campaign. Simple print advertisements will appear in niche art, music and style-related youth-focused consumer magazines such as Paper, URB, Surfer and FHM. In addition, the marketing effort focuses around grass roots advertising including wild postering, flyering, and “Go Cards.” As an extension of its grass roots efforts, Simple will launch a national road tour in March 2002 as part of its grass roots marketing campaign, The Stream of Consciousness. A Simple journalist will drive an Airstream trailer across America, visit and sponsor art-related events at universities and create a film documentary of his experiences on the road. A

rigorous public relations campaign will focus on obtaining magazine editorial placement in addition to newspaper and television coverage. Recent public relations coverage has appeared in Footwear News, Teen People, Nylon, YM, Footwear Plus, W Magazine, Lucky, Shuz, Shape, and Surfing Girl. These public relations efforts have also resulted in Simple products appearing on television shows such as Friends, Ally McBeal, Dawson’s Creek, and MTV.

Simple’s marketing efforts are performed internally by an in-house Simple marketing team which works to promote the Simple brand positioning of being “simple” and “down to earth”.

In 2002, the Company plans to continue to build on the success of the Ugg 2000 and 2001 national print advertising campaigns. The Company continues to target its Ugg products toward luxury consumers who seek high quality, luxurious and fashionable products for cold weather. The Company expects to advertise Fall 2002 Ugg products in upscale publications such as Vogue, In Style and O Magazine. In February 2002, Ugg’s were featured in the Opening and Closing Ceremonies of the 2002 Winter Olympic Games. 1,000 Ugg boots were used to outfit both the children in the Children of Light performances and the individuals presenting medals to athletes at all the events. Both the children and adults were outfitted in Ultra Short Ugg boots. Ugg also received Olympic exposure on the Today Show with Katie Couric the day after the opening ceremonies.

In addition to this national advertising campaign, the Ugg brand is being supported by national public relations and product placement efforts. In-house marketing personnel work closely with a public relations firm and a product placement agency to gain brand visibility in popular magazines, television shows and feature films. Recent editorial coverage includes articles in magazines such as Glamour, In Style, Cosmopolitan, Marie Claire, Maxim, Shape, Self, O Magazine and Real Simple. Television coverage of Ugg product includes shows such as Friends, Once and Again, Dawson’s Creek, E.R., Will and Grace, Ally McBeal, My Wife and Kids, Judging Amy, Alias, 7th Heaven and Everybody Loves Raymond. These public relations efforts have also resulted in Ugg product appearances in the following recent feature films: America’s Sweethearts, starring Julia Roberts, Snow Dogs, starring Cuba Gooding Jr., American Pie II, starring Sean William Scott, Dinner with Friends, starring Andie McDowell, Josie and the Pussycats, starring Tara Reid and Life as a House, starring Kevin Kline.

In 2001, 2000 and 1999, the Company incurred $6,087,000, $7,108,000 and $5,602,000 respectively, for advertising, marketing and promotional expenses. In addition to these expenditures, the Company’s 29 international distributors spend additional amounts for marketing the Company’s brands within their respective territories. The Company is required under its Teva License Agreement to spend a minimum amount for advertising and promoting Teva products, based on a percentage of sales. In addition to the minimum contractual marketing expenditures, the Company and the licensor have agreed to each contribute annually a certain percentage of sales toward the promotion of the Teva brand and trademark, with or without particular reference to individual Teva styles.

The design and product development staff for each of the Company’s brands creates and introduces new innovative footwear products that are consistent with the Company’s standards of high quality, combined with comfort and functionality. In addition to its internal design and development staff, the Company has begun to rely more heavily in recent years on outside design firms for a significant portion of the design function. By transitioning much of the design function to independent design firms, the Company has been able to eliminate certain positions, obtain efficiencies and reduce design and development costs considerably in recent years. As a result, research and development costs aggregated $1,034,000, $1,076,000 and $1,607,000 in 2001, 2000 and 1999, respectively, reflecting the operational efficiencies gained under this new approach.

With respect to Teva, in order to ensure that the Company’s high performance technical products continue to satisfy the requirements of its historical customer base of performance-oriented “core enthusiasts,” the Company’s design staff solicits comments and feedback from its licensor, its Team Teva whitewater athletes and other professional outdoorsmen, as well as several of its retailers, including REI, EMS, Galyans and L.L. Bean. Certain models are modified and technical innovations are developed in response to such comments and feedback. The Company adds new innovations, components and styles to its product line

continually. For example, the Company recently designed and introduced a new line of trailrunners incorporating the patented Liquid Frame technology and has incorporated its newly developed Wraptor technology into performance running sandals, an assortment of hikers and certain styles of its high performance Guide sport sandals specifically targeted at professional outdoorsmen and adventurers. In addition, for added traction and durability, the Company has recently incorporated various materials in its sandals, including Spider Rubber®— a sticky, non-slip rubber outsole material for use across wet and dry terrain, Traction Rubber^TM — a highly durable and abrasion resistant material designed specifically for the extra rigors of land use, and River Rubber® — a non-slip material designed to offer superior grip on smooth wet surfaces such as rocks, fiberglass and raft rubber.

While Teva continues to develop high performance sport sandals and other rugged outdoor footwear by continually updating and designing new styles for these categories, the Company also continues to increase its focus on the casual footwear market through its Teva, Simple and Ugg brands. The Company continues to introduce and offer new styles of leather and other casual footwear for men and women and has added several new styles of hikers, sport sandals, slip-ons and other shoes to its Teva children’s offering for Spring 2002. The Company has also added several new styles of clogs, sandals, sneakers and leather casuals to its offerings under the Simple line for 2002 including several athletically inspired styles for men and women as well as a re-emphasis on the men’s footwear business, an area where the Company had considerable success in the past. The 2002 Simple line also includes a series of new, innovative styles of womens’ footwear featuring models with low profiles and sleek lines. By monitoring changes in consumer lifestyles and preferences and then focusing first on function and practicality, the Company develops footwear designed to appeal to quality-minded consumers seeking comfortable casual footwear.

In recent years, the Company has taken steps to take Ugg’s longtime success in the Southern California market and duplicate that success across the United States. In support of this effort, the Company has taken steps in recent years to update the Ugg products in order to make them more functional for use in cold and wet climates. For example, the 2002 line includes a new Aspen Collection of cold weather boots, shoes and clogs featuring seam sealed lugged outsoles and waterproof leathers combined with sheepskin linings for high functionality and comfort. In addition, the Company has added a new Brooks Series to its women’s Town Collection, featuring styles with a new lugged outsole, contemporary styling and wool fleece linings which are designed to keep feet dry and comfortable in both warm and cold climates. The Ugg brand continues to design and offer more fashionable and unique upper styles to help differentiate Ugg from the low cost imitation brands.

Integral factors in the design and product development process include an evaluation of the availability and cost of raw materials, the capabilities of the factories that will manufacture products and the target retail price of new models and lines. The design and development staff works closely with brand management to develop new styles of footwear and components for their various product lines. Drawings and prototypes are utilized to produce samples of proposed new concepts. Throughout the development process, members of the design staff coordinate closely with each other and with the Company’s product development, manufacturing and sourcing personnel toward a common goal of developing and sourcing a high-quality product that will be delivered on a timely basis. The Company endeavors to minimize the risk of changing fashion trends by offering a diverse line of functional products and closely monitoring sales to its accounts after introduction.

The Company currently sources all of its Teva and Simple footwear and a portion of its Ugg footwear from independent contract manufacturers in the Far East. The Company imports the remainder of its Ugg footwear from independent contract manufacturers in Australia and New Zealand. The Company is not involved in the direct manufacture of footwear, but rather sources completed footwear, produced to required specifications, directly from these independent contractors. As the Company continues to grow, it expects to continue to rely heavily on its independent contractors for its sourcing needs.

The manufacturing of footwear by the Company’s independent contractors is performed in accordance with detailed specifications provided by the Company and is subject to quality control standards. In efforts to

ensure the production of high quality products, many of the materials and components used in production are purchased from independent suppliers designated by the Company. The Company believes that its completed footwear as well as the various raw materials and components used in the manufacture of the footwear, including rubber, leather, nylon webbing and sheepskin, are generally available from multiple sources at competitive prices.

The Company generally does not have any long-term agreements with the manufacturers or suppliers of its products, but does business based on individual purchase orders.

The Company has instituted inspections and other procedures to satisfy the high quality demanded by users of the Company’s products. The Company’s quality assurance program includes inspection procedures at the factory level as well as a final inspection upon arrival of product at the Company’s distribution center. The Company uses on-site inspectors at its independent suppliers who oversee the production process and perform quality assurance inspections. In addition, the products undergo further inspection procedures prior to being accepted at the Company’s domestic distribution center.

Teva License. The Company has been selling its Teva line of sport sandals and other footwear since 1985 pursuant to various license arrangements with Mark Thatcher, the inventor of the Teva sport sandal and the owner of the Teva patents and trademark. Mr. Thatcher owns seven United States patents on designs used in Teva footwear and has a United States trademark registration for the Teva mark.

On June 7, 1999, the Company signed a new license agreement (the “License Agreement”) for Teva, which became effective January 1, 2000. Under the License Agreement, the Company has the exclusive worldwide rights for the manufacture and distribution of Teva footwear through 2004. Apparel and other non-footwear products are not covered by the License Agreement. The License Agreement is automatically renewable through 2008 and through 2011 under two renewal options, provided that minimum required sales levels are achieved. These required minimum annual sales levels are $107.9 million in 2004 and $137.3 million in 2008, both of which are significantly greater than the annual sales of $61.2 million achieved by the Company in 2001. The Company believes it is unlikely to achieve the contractual minimum for 2004 and has begun discussions with the licensor to address this issue. However, the Company can provide no assurances that it will be successful in its efforts to reach an acceptable resolution.

As with the previous arrangement, the License Agreement provides for a sliding scale of royalty rates, depending on sales levels, and includes guaranteed minimum annual royalty amounts. Additionally, the License Agreement provides for an increase in the required amount of marketing expenditures, depending on sales levels and varying by territory. In addition to the minimum contractual marketing expenditures, the Company and the licensor have agreed to each contribute annually a certain percentage of sales toward the promotion of the Teva brand and trademark, with or without particular reference to individual Teva styles.

As additional consideration, the Company paid the licensor a licensing fee of $1,000,000 in 1999 and issued the licensor 428,743 shares of its previously unissued common stock valued at $1,608,000. The Company has recorded the license as an intangible asset equal to the cash and market value of the stock issued on the date of the License Agreement. These shares are subject to various contractual and other holding period requirements. In addition, the Company has agreed to grant the licensor not less than 50,000 stock options on the Company’s common stock annually, at an exercise price equal to the market value on the date of grant.

The licensor retains the rights to approve the quality of the licensed products produced, all marketing, advertising and promotional plans and materials, and the distribution channels and customers to whom the Company can sell the licensed products. In addition, the License Agreement provides for minimum annual research and development spending levels for the Company with respect to the Teva products and restricts the volume of closeouts and seconds which the Company is able to sell each year.

The License Agreement provides that the licensor, in his sole discretion, may take any action against parties believed to be infringing upon the licensor’s trademark, patents and other intellectual property. The licensor is fully responsible for any legal and other costs incurred in such actions and is entitled to any recovery resulting from the actions. The Company may not participate in any such action or in any other action regarding the infringement of the Teva intellectual property without the licensor’s prior written consent.

In the event that the license term is automatically renewed beyond 2004, the Company must achieve minimum annual sales levels for the years 2005 through 2011. These minimum annual sales levels are based upon certain percentages of net sales in the preceding calendar year. If the Company is not able to achieve the minimum annual sales levels for two years during a renewal term, the License Agreement can be terminated at the option of the licensor. Currently, annual sales of Teva products are substantially below the required minimums.

During the term of the License Agreement, including the renewal terms, the Company is prohibited from manufacturing, marketing, selling and distributing any sandals other than Teva sandals. In addition, for the two years following the termination of the License Agreement, the Company is prohibited from manufacturing, marketing, selling and distributing sandals, in general. However, the Company may continue to manufacture, market, sell and distribute all styles and models of sandals offered under its Simple product line which existed as of the date of the License Agreement as well as all styles subsequently approved by the licensor.

The License Agreement can be terminated under several circumstances, if they remain uncured for specific periods of time. These circumstances include the following, among others: if either party becomes insolvent or bankrupt; if the Company offers sandals which compete with the Teva products or otherwise engages in activities which compete with the Teva products; if the Company transfers substantially all of its property or stock to other parties; if the Company sells unapproved merchandise in violation of the License Agreement; or if the Company or the licensor otherwise violate or breach the terms of the License Agreement.

In connection with the execution of the most recent license agreement with Mark Thatcher, the Company received an option to buy Teva and virtually all of its assets, including all worldwide rights to Teva. The option price is based on formulas tied to net sales of Teva products and varies depending on when the option is exercised. For the first option period, January 1, 2000 through December 31, 2003, the option price is for an amount equal to the greater of (i) $61.6 million or (ii) 75% of the largest calendar year revenues since January 1, 2000 for the Teva brand, plus $1.6 million. In addition, the Company would issue to Mr. Thatcher 100,000 shares of common stock and options to purchase 100,000 shares of common stock. The purchase price for the second option period, January 1, 2006 to December 31, 2008, is equal to 110% of the average of the aggregate sales for all Teva products for the two calendar years since January 1, 2000 with the highest aggregate net sales. If the Company does not exercise its option to acquire Teva, the licensor has the option to acquire the Teva distribution rights from the Company for the period from January 1, 2010 to December 31, 2011, the end of the license term, and the option price is based on a formula tied to the Company’s earnings before interest, taxes, depreciation and amortization. The Company is currently evaluating the possibility of exercising the option in the January 1, 2000 to December 31, 2003 option period. The payment of the purchase price must be completed within 90 days of the exercise of the purchase option. If the Company exercises its purchase option, but subsequently fails to complete the purchase within the 90 day payment period, the purchase option and the Option Agreement will automatically be terminated.

The Company and Bob Eason, the designer and founder of Picante clothing, were parties to an agreement pursuant to which the Company owned 50% of Heirlooms, Inc. (“Heirlooms”), the manufacturer and distributor of Picante clothing. In January 2001, the Company sold its 50% interest in Heirlooms back to Mr. Eason for cash of approximately $1,200,000 and a note receivable of approximately $420,000, which was secured by a secondary security interest in the assets of Heirlooms. The selling price was for an amount that approximated the net carrying value of the underlying assets and, accordingly, the resulting gain on the sale was not significant.

Mr. Thatcher holds seven United States patents and one patent in each of Australia, New Zealand, Korea, Germany, France, China, Japan and the United Kingdom for Teva footwear. As a result of the expiration of the applicable period during which foreign patent applications were required to have been filed, Mr. Thatcher does not and cannot hold such patent rights in other countries. Mr. Thatcher also currently holds Teva trademark rights in the United States and in several other countries, including, among others, France, Germany, the United Kingdom, Japan and Australia. Mr. Thatcher’s patent and trademark rights are licensed to the Company under the License Agreement discussed previously. Both the Company and Mr. Thatcher regard such proprietary rights as valuable assets, and the Company cooperates with Mr. Thatcher in vigorously protecting such rights against infringement by third parties. To date, Mr. Thatcher has successfully enforced his patent and trademark rights in all 20 concluded lawsuits brought against such third parties. Under certain circumstances, if Mr. Thatcher declines to challenge a potential infringement, the Company may bring an infringement action at its own cost, with Mr. Thatcher’s prior written consent. See “Licenses — Teva License.”

The Company owns the Simple and Ugg trademarks and has applied for or received registrations for them in the United States and in many foreign countries. The Company has selectively registered style category names and marketing slogans. In addition, the Company holds two design patents for its footwear products.

The Company has acquired the patent and trademarks for Alp®sport sandals and has registered the Deckers trademark.

Historically, the Company has encouraged and has received a significant portion of its orders as preseason orders, which are generally placed by customers approximately four to eight months prior to shipment date. As discussed above, the Company has emphasized this “futures” business, as compared to “at once” sales, as it allows the Company to better forecast its inventory requirements and assists with the Company’s sourcing schedule. As a result, the Company provides its customers with incentives to participate in such preseason programs. Unfilled customer orders (“backlog”), as of any date, represent orders scheduled to be shipped at a future date and do not represent firm sales. The mix of future and immediate delivery orders can vary significantly from quarter to quarter and year to year. The backlog as of a particular date is affected by a number of factors, including seasonality and the scheduling of manufacture and shipment of products as well as variations in the quarter to quarter and year to year preseason incentive programs. As a result, comparisons of backlog from period to period are not meaningful and the Company’s backlog at any given time is generally not indicative of sales levels expected to be achieved in the future.

The casual, outdoor and athletic footwear markets are highly competitive. The Company believes that currently its largest competitors of the Teva line are Nike, Adidas, Timberland, Merrell, Columbia and Salomon. The principal competitors of Simple’s casual line include Steve Madden, Dr. Marten, Camper, and Kenneth Cole and of Simple’s sneaker/sandal line include Skechers, Diesel, Steve Madden, Puma, NM70 and Guess. Ugg’s competitors include Merrell, Rocket Dog, Acorn, Aussie Dogs, LB Evans and Timberland, as well as retailers’ private label footwear.

Competition in the Company’s footwear is primarily based on brand awareness, product quality, design, price points, fashion appeal, marketing, distribution, performance and brand positioning. The Company’s Teva line of footwear competes primarily on the basis of its authenticity as a recognized brand in the outdoor market, its consumer brand recognition as one of the first sandals of its kind, as well as its high performance nature and its diversity of styles offered. In addition, several of the most popular styles employ a distinctive patented strapping system, which contributes to performance and the brand’s consumer recognition. The Company competes through its Simple line as an alternative brand offering a diversity of simple, back-to-basics styles designed for a variety of recreational and leisure activities. Ugg competes primarily on the basis of

its authenticity as well as its brand name recognition as a high quality premium luxury brand, identifiable with the United States sheepskin footwear market. The Company believes its business strategy has resulted in increased awareness for its brands. However, no assurance can be given that in the future the Company will be able to maintain or further increase its brand awareness, maintain or increase its market share or respond to changing consumer preferences.

The Company’s operations are subject to the customary risks of doing business abroad, including, but not limited to, currency fluctuations, customs duties and related fees, various import controls and other non-tariff barriers (e.g., quotas), the cost of transportation, restrictions on the transfer of funds, labor unrest and strikes, and in certain parts of the world, political instability. Countries where the Company’s products are manufactured and sold may, from time to time, seek to increase customs duties or impose quotas, all of which have the potential to affect the Company’s operations and its ability to maintain or increase the current level of importation of the Company’s products. The Company is unable to predict the likelihood or frequency of the occurrence of any of these events.

The products imported by the Company into the United States are subject to various duty rates which are established by law. At the present time these duties range between 8.5% and 12.5% of the entered value of footwear with uppers made principally of leather or sheepskin, and 6.0% and 37.5%, plus $.90 per pair, of the entered value of footwear with uppers made principally of synthetic textiles or plastic. Certain products imported by the Company are exempt from duties pursuant to laws pertaining to products manufactured in certain beneficiary countries. “Entered value” means the value taken into account for purposes of determining the amount of any customs duties or any other duties which may be imposed on the importation of any property. In general, the entered value is normally based on the price paid or payable by the Company to the seller of the imported merchandise.

From time to time, the Company may be subject to claims for additional duties arising as a result of the United States Customs Service, or similar agencies of foreign countries, disagreeing with the classification and/or valuation used by the Company to enter various styles of footwear.

The European communities also impose quantitative limits on imports from China of certain leather upper and textile upper footwear. The Company is unable to predict how long the anti-dumping duty and import quota restrictions will remain in effect or changes in the scope or severity of such restrictions.

At December 31, 2001, the Company employed approximately 98 full-time employees in its U.S. facilities, 4 at its European subsidiary and 28 at its Hong Kong subsidiaries, none of whom is represented by a union. The Company believes its relationship with its employees is good.

The Company leases approximately 30,000 square feet for its corporate offices in Goleta, California and approximately 126,000 square feet for its warehouse facility in Ventura County, California. The Company also leases approximately 1,000 square feet of office space in the Netherlands for its European sales and marketing

efforts, approximately 2,000 square feet of office space in Macau and 2,600 square feet in China for its Far East staff and less than 1,000 square feet of office space in Japan to support the Asian sales efforts. The Company paid approximately $1,074,000 in rent for all of its facilities in 2001. The terms of the lease for the Company’s European facilities call for “at-will” termination and the Company expects to terminate the lease in April 2002. The term of the lease for the Company’s corporate office is currently on a month to month basis with a six month termination notice required. The lease for the Company’s Ventura County warehouse expires in December 2003 and the lease for the Company’s Macau office space expires in August 2003. The lease for the Company’s China office expires in June 2002. The Japanese office is rented on a month-to-month basis. The Company believes that its existing corporate, manufacturing and warehousing space will be adequate to meet its current and foreseeable requirements, or that suitable additional or alternative space for the Company’s corporate office will be available as needed on commercially reasonable terms.

An action was brought against the Company in 1995 by Molly Strong-Butts and Yetti by Molly, Ltd. (collectively, Molly) which alleged, among other things, that the Company violated a nondisclosure agreement and obtained trade secrets regarding a line of winter footwear which Deckers stopped producing in 1994. A jury verdict was obtained against the Company in district court in March 1999 aggregating $1,785,000 for the two plaintiffs. In August 2001 the United States Court of Appeals for the Ninth Circuit affirmed the district court’s decision for a judgment against the Company, resulting in a settlement of approximately $2.0 million, including interest, which the Company paid in November 2001. In addition, the court of appeals reversed the district court’s refusal to consider an award of exemplary damages or attorney fees and remanded to the district court for further proceedings. In the event that further legal fees and exemplary damages are subsequently awarded, the Company would have an exposure beyond the amounts provided for in the financial statements of up to an additional $2.5 million.

The Company is a party to litigation in the Netherlands with a former European distributor (the “Distributor”), alleging breach of contract related to the Company’s termination of the previous distributor arrangement. The Company denies the allegations and has filed a countersuit against the Distributor for breach of contract. In the event that the Company is not successful in this matter, the Company believes it would have a potential exposure beyond the amounts provided for in the financial statements of up to an additional $500,000.

The Company is also involved in routine litigation arising in the ordinary course of business. Such routine matters, if decided adversely to the Company, would not, in the opinion of management, have a material adverse effect on the financial condition or results of operations of the Company. From time to time, Mr. Thatcher and the Company are also involved in other legal proceedings to protect the Teva patents and trademarks from infringement by third parties. Any decision or settlement in any such infringement proceeding which allowed a third party to continue to manufacture and sell the products at issue could have an adverse effect on the Company’s sales to the extent such other similar competing products are purchased in lieu of the Company’s products.

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

The Company’s Common Stock is traded in the National Market System of the NASDAQ stock market (the “NMS”) under the symbol “DECK.”

As of February 28, 2002, the number of holders of record of the Common Stock was 156 and the number of beneficial owners was approximately 2,100.

The Company has never declared or paid cash dividends on its Common Stock and currently intends to retain any earnings for use in its business and does not anticipate paying any cash dividends in the foreseeable future. Payment of dividends is within the discretion of the Company’s Board of Directors and will depend upon, among other factors, dividend restrictions within the Company’s credit facilities, the Company’s earnings, financial condition and capital requirements. The Company’s credit facility currently prohibits the issuance of dividends. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

The following tables set forth selected consolidated financial data of the Company as of and for each of the years in the five-year period ended December 31, 2001.

The following discussion should be read in conjunction with the consolidated financial statements and notes thereto. This Annual Report on Form 10-K includes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 that involve risk and uncertainty, such as forward-looking statements relating to expectations regarding sales and earnings per share, expectations regarding the Company’s liquidity, the potential impact of certain litigation, the potential impact of the possible acquisition of Teva and the impact of seasonality on the Company’s operations. Actual results may vary. Some of the factors that could cause actual results to differ materially from those in the forward-looking statements are identified in the accompanying “Risk Factors” section, the last paragraph under “Liquidity and Capital Resources”, the discussion under “Seasonality” and other sections of this Annual Report on Form 10-K. These forward-looking statements are based on the Company’s expectations as of March 2002. No one should assume that any forward-looking statement made by the Company will remain consistent with the Company’s expectations after the date the forward-looking statement is made. The Company disclaims any obligation to update any such factors or to publicly announce the results of any revisions to any of the forward-looking statements contained in this Annual Report on Form 10-K.

The following table is derived from the Company’s statement of earnings and sets forth, for the periods indicated, certain operating data as a percentage of net sales.

Net sales decreased by $22,277,000, or 19.6%, between the years ended December 31, 2001 and 2000. The decrease is largely attributable to the weakness in the domestic economy, the softness in the retail environment, the reduction in international sales, an overall decrease in demand for sandals in 2001, delays in new product introductions for Teva, the colder weather during Spring 2001 in the Company’s key markets for Teva sandals and the reduction in sales to Track ‘n Trail, one of the Company’s largest customers, which filed for bankruptcy in April 2001. In addition, in January 2001, the Company sold its interest in Heirlooms, Inc., the distributor of Picante brand apparel, and approximately $2,316,000 of the decrease in sales is due to the exclusion of sales resulting from the Company’s sale of this brand. Aggregate net sales of Teva decreased to $61,221,000 for the year ended December 31, 2001 from $79,732,000 for the year ended December 31, 2000, a 23.2% decrease. Net sales of Teva represented 66.9% and 70.1% of net sales in the years ended December 31, 2001 and 2000, respectively. Net sales of footwear under the Simple product line decreased 33.5% to $10,853,000 from $16,328,000 from the year ended December 31, 2000. Net sales of Ugg increased 25.3% to a record $19,185,000 for the year ended December 31, 2001 from $15,310,000 for the year ended December 31, 2000 resulting from continued strength in the brand’s historically strong California market, a continuing expansion outside California, an overall increase in the popularity of the Ugg brand and the introduction of several new Ugg styles in 2001. Overall, international sales for all of the Company’s products decreased 32.2%

to $21,096,000 from $31,135,000, representing 23.1% of net sales in 2001 and 27.4% in 2000. The volume of footwear sold decreased 13.1% to 3,705,000 pairs during the year ended December 31, 2001 from 4,265,000 pairs during the year ended December 31, 2000, for the reasons discussed above.

The weighted-average wholesale price per pair sold during the year ended December 31, 2001 decreased 4.9% to $24.26 from $25.51 for the year ended December 31, 2000. The decrease was primarily due to an increase in the volume of closeout sales during 2001 compared to 2000. In addition, the Company experienced a change in sales mix away from certain higher priced styles, including the leather casuals, and toward styles with lower average selling prices, including thongs and several styles introduced in 2001 at lower price points. This was partially offset by the impact of a shift in sales mix toward domestic sales, which generally have a higher average selling price than sales in the international markets, and the Company sold a higher volume of Ugg products in 2001 at a much higher average selling price than Teva and Simple styles.

Cost of sales decreased by $10,637,000, or 16.7%, to $52,903,000 for the year ended December 31, 2001, compared with $63,540,000 for the year ended December 31, 2000. Gross profit decreased by $11,640,000, or 23.2%, to $38,558,000 for the year ended December 31, 2001 from $50,198,000 for the year ended December 31, 2000 and gross margin decreased to 42.2% from 44.1%. The decrease in gross margin was primarily due to an increased impact of closeout sales, as well as lower margins in the pricing of the 2001 product line compared to the 2000 line in response to competitive pressures, partially offset by a reduction in inventory write-downs.

The Company carries its inventories at the lower of cost or market, using a reserve for inventory obsolescence to adjust the carrying values to market where necessary based on ongoing reviews of estimated net realizable values of its inventories. For the year ended December 31, 2001, the Company had a net decrease in the reserve for inventory obsolescence of approximately $321,000, primarily due to the sale of domestic inventory for Teva and Simple product for which a write-down had previously been recorded, as well as the sale of the Company’s remaining Canadian inventory, for which a write-down had also previously been recorded in connection with the Company’s transition to a distributor in the Canadian market. For the year ended December 31, 2000, the Company had net additions to the reserve for inventory obsolescence of approximately $435,000, reflecting inventory write-downs to estimated market values for Teva and Simple in the United States and write-downs of Canadian Teva and Simple inventory in connection with the shift to a distributor for that territory.

Selling, general and administrative expenses decreased by $3,528,000, or 9.4%, to $34,040,000 for the year ended December 31, 2001, compared with $37,568,000 the year ended December 31, 2000, and increased as a percentage of net sales to 37.2% in 2001 from 33.0% in 2000. The decrease in selling, general and administrative expenses was primarily due to lower commissions and royalties on the lower sales levels, reductions in marketing costs, payroll costs and bad debt expense, as well as the elimination of selling, general and administrative expenses associated with the Company’s former Heirlooms subsidiary. In addition, during 2000 the Company had a non-recurring charge of approximately $400,000 for European anti-dumping duties dating back to 1997. These reductions were partially offset by additional amortization expense in 2001 resulting from the Company’s $1.6 million payment for an extension of the option term for the Company’s option to acquire Teva, which is being amortized over the three-year period ending December 31, 2003. Despite the overall decrease in dollar amounts, the selling, general and administrative expenses as a percentage of net sales increased for the year ended December 31, 2001 compared to the year ended December 31, 2000 as certain operating costs are fixed and did not decrease in proportion to the decrease in consolidated net sales.

During the year ended December 31, 2001, the United States Court of Appeals affirmed the March 17, 1999 judgment against the Company in connection with a case brought in Montana. As a result, the Company recorded a charge of approximately $2.2 million related to this litigation in 2001.

Earnings from operations for the Teva brand were $12,407,000 for the year ended December 31, 2001 compared to $19,953,000 for year ended December 31, 2000. The decrease is largely due to the decrease in sales in both the domestic and international markets, an increased impact of closeout sales, lower gross margins in the pricing of the 2001 line compared to the 2000 line, and increased amortization costs related to

the $1.6 million extension of the Teva purchase option, partially offset by a reduced impact of inventory write-downs and lower marketing costs. The Simple brand experienced earnings from operations of $241,000 for the year ended December 31, 2001 compared to $2,501,000 for the year ended December 31, 2000 as a result of the decrease in sales, the increased impact of closeout sales during the period, lower gross margins on certain newly introduced styles and the bad debt write-off for Track ‘n Trail. Earnings from operations for the Ugg brand were $3,674,000 for the year ended December 31, 2001 compared to earnings from operations of $2,863,000 for the year ended December 31, 2000 largely due to the increase in sales, partially offset by the bad debt write-off for Track ‘n Trail. Additionally, the earnings from operations for the Teva and Simple segments decreased versus that experienced in the year ago period as certain costs are fixed and did not decrease in proportion to the decrease in consolidated net sales.

Net interest income was $308,000 for the year ended December 31, 2001 compared with net interest expense of $67,000 for the year ended December 31, 2000, primarily due to the Company’s significantly improved cash position in 2001.

For the year ended December 31, 2001, income tax expense was $1,185,000, representing an effective income tax rate of 42.2%. For the year ended December 31, 2000, income tax expense was $5,320,000, representing an effective income tax rate of 43.1%. The decrease in the effective income tax rate in 2001 is largely attributed to the elimination of a previously existing valuation allowance against deferred tax assets in 2001 related to net operating loss and other income tax credit carryforwards being fully utilized, partially offset by the increased impact of non-deductible goodwill amortization in 2001.

For the year ended December 31, 2001, the Company’s net earnings decreased 76.8%, to $1,626,000 from $7,015,000 for the year ended December 31, 2000, for the reasons discussed above.

Net sales increased by $2,639,000, or 2.4%, between the years ended December 31, 2000 and 1999. Aggregate net sales of Teva decreased to $79,732,000 for the year ended December 31, 2000 from $80,963,000 for the year ended December 31, 1999, a 1.5% decrease. This decrease occurred as the Company sold significantly fewer products to the athletic retail channels as the Company did not target this distribution channel in 2000. However, given the renewed strength in the athletic market since that time, the Company has subsequently taken steps to return to this segment of the market for 2002 and beyond. This decrease in sales in the athletic retail channels was partially offset by an increase in sales in international markets and the introduction of hikers and other closed Teva footwear in the Fall of 2000. Net sales of Teva represented 70.1% and 72.9% of net sales in the years ended December 31, 2000 and 1999, respectively. Net sales of footwear under the Simple product line increased 5.1% to $16,328,000 from $15,529,000 from the year ended December 31, 1999. The increase in Simple sales was driven primarily by increased sales in the United States on strength in its clog and sandal categories, partially offset by weakness in the brand’s international markets. Net sales of Ugg increased 26.5% to $15,310,000 for the year ended December 31, 2000 from $12,104,000 for the year ended December 31, 1999. This increase was fueled by early cold weather and the introduction of new models in 2000, as well as endorsement on Oprah Winfrey’s television program and magazine. In addition, the Company was successful in its continued efforts to expand its Ugg business beyond its historically strong California business. Overall, international sales for all of the Company’s products increased 7.9% to $31,135,000 from $28,859,000, representing 27.4% of net sales in 2000 and 26.0% in 1999, reflecting Teva’s expansion in the European and Asian markets. The volume of footwear sold increased 2.9% to 4,265,000 pairs during the year ended December 31, 2000 from 4,143,000 pairs during the year ended December 31, 1999, for the reasons discussed above.

The weighted-average wholesale price per pair sold during the year ended December 31, 2000 increased 0.2% to $25.51 from $25.46 for the year ended December 31, 1999. The slight increase was primarily due to fewer discounted sales in 2000 and a higher volume of Ugg sales in 2000, which carry a much higher average selling price than Teva and Simple. This was partially offset by the impact of a shift in sales mix toward international sales, which generally have a lower average selling price than sales in the domestic market, as well as the Company sold a higher proportion of lower priced footwear such as children’s styles and thongs.

Cost of sales decreased by $2,511,000, or 3.8%, to $63,540,000 for the year ended December 31, 2000, compared with $66,051,000 for the year ended December 31, 1999. Gross profit increased by $5,150,000, or 11.4%, to $50,198,000 for the year ended December 31, 2000 from $45,048,000 for the year ended December 31, 1999 and gross margin increased to 44.1% from 40.5%. The increase was primarily the result of improved inventory management, the reduced impact of sales returns and discounted sales and improved pricing and sourcing.

The Company carries its inventories at the lower of cost or market, using a reserve for inventory obsolescence to adjust the carrying values to market where necessary based on ongoing reviews of estimated net realizable values of its inventories. For the year ended December 31, 2000, the Company had net additions to the reserve for inventory obsolescence of approximately $435,000, reflecting inventory write-downs to estimated market values for Teva and Simple in the United States and write-downs of Canadian Teva and Simple inventory in connection with the shift to a distributor for that territory. For the year ended December 31, 1999, the Company had a net decrease in the reserve for inventory obsolescence of approximately $2,127,000 as the Company sold the underlying inventory for which a write-down had previously been recorded. A substantial portion of the reduction of the inventory reserve was related to Simple finished goods that were reserved in 1998 and were subsequently sold at discounted prices in 1999.

Selling, general and administrative expenses decreased by $730,000, or 1.9%, to $37,568,000 for the year ended December 31, 2000, compared with $38,298,000 for the year ended December 31, 1999, and decreased as a percentage of net sales to 33.0% in 2000 from 34.5% in 1999. The decrease in selling, general and administrative expenses as a percentage of sales was primarily due to the non-recurrence of the special charges incurred in the first half of 1999 related to severance costs and litigation, as well as reductions in apparel operating costs, warehouse costs and European operating costs. These reductions were partially offset by increased marketing and promotional spending in 2000 compared to 1999 and the increase in the reserve for exposure to European anti-dumping duties in 2000.

Earnings from operations for the Teva brand were $19,953,000 for the year ended December 31, 2000 compared to $16,775,000 for year ended December 31, 1999. The increase is largely due to higher gross margins due to improvements in the pricing and sourcing of the 2000 line, fewer inventory write-downs in 2000 and lower apparel costs with the closing of the apparel business, partially offset by an increase in marketing expenses. The Simple brand experienced earnings from operations of $2,501,000 for the year ended December 31, 2000 compared to earnings from operations of $3,701,000 for the year ended December 31, 1999 as a result of increased inventory write-downs, increased marketing, bad debts and payroll costs. Earnings from operations for the Ugg brand were $2,863,000 for the year ended December 31, 2000 compared to earnings from operations of $1,189,000 for the year ended December 31, 1999 largely due to the increase in sales and fewer inventory write-downs.

Net interest expense decreased to $67,000 for the year ended December 31, 2000 from $1,404,000 for the year ended December 31, 1999, primarily due to significantly decreased average borrowings on the Company’s credit facility in 2000, partially offset by higher average interest rates.

For the year ended December 31, 2000, income tax expense was $5,320,000, representing an effective income tax rate of 43.1%. For the year ended December 31, 1999, income tax expense was $2,358,000, representing an effective income tax rate of 45.0%. The decrease in the effective income tax rate in 2000 is largely attributed to the reduced impact of the non-deductible goodwill amortization.

For the year ended December 31, 2000, the Company’s net earnings increased 143.2%, to $7,015,000 from $2,884,000 for the year ended December 31, 1999, for the reasons discussed above.

Sales and Earnings per Share Expectations. The Company currently expects its sales and earnings to be lower during the first half of 2002 in comparison to the same period last year due to weakness in the domestic and global economies compared to last year, coupled with the difficult retail environment and the uncertainties related to world events. However, given the continuing strength of the Ugg brand, which historically sells well

in the latter half of the year, the introduction of a new Teva fall line of hikers, trailrunners and rugged outdoor footwear styles, as well as some recent signs of improvement in the economy, the Company expects year over year gains in the third and fourth quarters of 2002. Overall, the Company currently expects net sales for the fiscal year ending December 31, 2002 to range from $88 million to $91 million. For the calendar year 2002, the Company currently expects sales of its Teva product line to range from $58 million to $60 million; Simple to be approximately $10 million; and Ugg to range from $20 million to $21 million. In addition, excluding the effects of the implementation of SFAS 142 (see discussion under “Recently Issued Pronouncements”), the Company currently expects its diluted earnings per share for the year ending December 31, 2002 to range from $0.17 to $0.20. Including the cumulative effect of the change in accounting principle for the goodwill impairment charge resulting from the implementation of SFAS 142, the Company expects its 2002 net loss per share to range from approximately $0.75 to $0.78.

The Company’s liquidity consists primarily of cash, trade accounts receivable, inventories and a revolving credit facility. At December 31, 2001, working capital was $42,165,000 including $16,689,000 of cash. Cash provided by operating activities aggregated $11,049,000 for the year ended December 31, 2001. Trade accounts receivable decreased 11.9% since December 31, 2000 due to the reduction in sales during the period. Inventories increased 7.5% since December 31, 2000 primarily due to an increase in Teva international inventories in transit from factories to distributors at year end resulting from logistical delays in shipping and customs clearance at December 31, 2001.

At December 31, 2001, the Company had a credit facility (“the Facility”) providing for a maximum availability of $50,000,000, subject to a borrowing base of up to 85% of eligible accounts receivables, as defined, and 65% of eligible inventory, as defined. The Facility was secured by substantially all assets of the Company and included a tangible net worth covenant, requiring the Company to maintain tangible net worth, as defined, of $30,000,000. The Company was in compliance with this covenant at December 31, 2001. At December 31, 2001, the Company had no outstanding borrowings under the Facility and had outstanding letters of credit aggregating $3,002,000. The Company had credit availability under the Facility of $8,699,000 at December 31, 2001.

On February 22, 2002, the Facility expired and was replaced with a new revolving credit facility with a new bank (the “New Facility”) which expires June 1, 2004. The New Facility provides for a maximum availability of $20,000,000, subject to a borrowing base only when outstanding borrowings, including outstanding letters of credit and foreign currency forward contracts, exceed $10 million. In general, the borrowing base is currently equal to 75% of eligible accounts receivable, as defined, and 50% of eligible inventory, as defined. The accounts receivable advance rate can increase or decrease depending on the Company’s accounts receivable dilution, which is calculated periodically. Up to $10 million of borrowings may be in the form of letters of credit. The New Facility bears interest at the bank’s prime rate minus 0.5%, or at the Company’s option, at LIBOR plus 1.375% to 1.625%, depending on the Company’s ratio of liabilities to effective tangible net worth, and is secured by substantially all assets of the Company’s domestic operations. The New Facility includes an annual commitment fee equal to 0.125% of the average unused line amount. The agreement underlying the New Facility includes several financial covenants including a quick ratio requirement, a requirement for liabilities to effective tangible net worth ratio, profitability requirements and, when borrowings exceed $10 million, a minimum inventory turnover requirement. The Company is in compliance will all covenants of the New Facility.

Capital expenditures totaled $2,455,000 for the year ended December 31, 2001. The Company’s capital expenditures related primarily to the Company’s implementation of a new computer system that was placed into service in 2001. The Company currently has no material future commitments for capital expenditures.

The Company’s Board of Directors has authorized the repurchase of up to 2,200,000 shares of common stock under a stock repurchase program. Such repurchases are authorized to be made from time to time in open market or in privately negotiated transactions, subject to price and market conditions, the Company’s cash availability and the terms of the Company’s new revolving credit facility. Under this program, the

Company repurchased approximately 973,000 shares for aggregate cash consideration of approximately $7,499,000 prior to 1999. No shares were repurchased during the years ended December 31, 1999, 2000 and 2001. At December 31, 2001, approximately 1,227,000 shares remain available for repurchase under the program.

The Company sells its Teva line of footwear pursuant to an exclusive licensing agreement. The agreement became effective January 1, 2000 and continues through December 31, 2004. If minimum annual sales levels are achieved in 2004, the license automatically renews for an additional four years, through December 31, 2008. If minimum annual sales levels are achieved in 2008, the license automatically renews again through December 31, 2011. However, if the minimum annual sales levels are not achieved in 2004 or 2008, the license expires and the Company will no longer be able to sell Teva footwear. These required minimum annual sales levels are $107.9 million in 2004 and $137.3 million in 2008, both of which are significantly greater than the annual sales of $61.2 million achieved by the Company in 2001. Also, Mr. Thatcher may terminate the licensing agreement if the Company breaches certain of its other obligations under the agreement. The Company believes it is unlikely to achieve the contractual minimum for 2004 and has begun discussions with the licensor to address this issue. However, the Company can provide no assurances that it will be successful in its efforts to reach an acceptable resolution. Sales of Teva footwear and apparel accounted for approximately 66.9%, 70.1% and 72.9% of the Company’s net sales for fiscal years 2001, 2000 and 1999, respectively. The termination of the license would have a material adverse effect on the Company’s results of operations.

The license agreement provides for royalties using a sliding scale ranging from 5.0% to 6.5% of annual sales, depending upon sales levels, and includes minimum annual royalties ranging from $4.4 million in 2002 to $7.6 million in 2011. The agreement also requires minimum advertising and promotional expenditures of 5.0% of annual sales for domestic sales and 6.5% for international sales. In addition to the minimum advertising and promotional costs, the Company and the licensor have agreed to each contribute annually 0.5% of annual sales toward the promotion of the Teva brand and trademark, with or without particular reference to individual styles.

In connection with the execution of the most recent license agreement with Mark Thatcher, the Company received an option to buy Teva and virtually all of its assets, including all worldwide rights to Teva. The option price is based on formulas tied to net sales of Teva products and varies depending on when the option is exercised. For the first option period, January 1, 2000 to December 31, 2003, the option price is for an amount equal to the greater of (i) $61.6 million or (ii) 75% of the largest calendar year revenues since January 1, 2000 for the Teva brand, plus $1.6 million. In addition, the Company would issue to Mr. Thatcher 100,000 shares of common stock and options to purchase 100,000 shares of common stock. The purchase price for the second option period, January 1, 2006 to December 31, 2008, is equal to 110% of the average of the aggregate net sales for all Teva products for the two calendar years since January 1, 2000 with the highest aggregate net sales. If the Company does not exercise its option to acquire Teva, the licensor has the option to acquire the Teva distribution rights from the Company for the period from January 1, 2010 to December 31, 2011, the end of the license term, and the option price is based on a formula tied to the Company’s earnings before interest, taxes, depreciation and amortization. The exercise of either option will require a significant amount of additional financing. There are no assurances that the additional financing will be available.

In the event that the Company exercises its option to acquire the Teva brand, the Company would acquire virtually all assets including all Teva patents, tradenames, trademarks and all other intellectual property. The Company currently has the worldwide license for Teva footwear and pays the licensor a royalty ranging from 6.5% to 5.0% of net sales of Teva products. By acquiring Teva, the Company would eliminate the payment of royalties to the licensor. In addition, the Company would own the Teva name and be able to pursue extension of the brand into other areas including apparel, outdoor gear and similar items, either through licensing to others or otherwise. The Company believes there are significant opportunities in this area given the strength of the Teva brand in the outdoor market. In conjunction with the Company, the licensor has already developed licensing arrangements for Teva apparel in certain markets. By acquiring Teva, the Company would receive these existing royalty income streams, as well as any royalties from additional future licensees. Also, upon exercise of the option, the Company would own the licensor’s growing and profitable catalog and internet retailing business.

The Company believes that by exercising its option to acquire Teva, it will be able to significantly improve its earnings before interest, taxes, depreciation and amortization (“EBITDA”). In 2001, the Company sold approximately $62 million of Teva products, paying a royalty of approximately $4.2 million and incurring approximately $0.3 million of additional costs that the Company believes could have been eliminated had the Company owned Teva outright. In addition, the licensor’s catalog/internet business yielded EBITDA of approximately $0.7 million in 2001. Accordingly, had the Company owned Teva in 2001, it would have been able to improve its EBITDA by approximately $5.2 million.

The Company believes that internally generated funds, the available borrowings under its existing credit facility, and the cash on hand will provide sufficient liquidity to enable it to meet its current and foreseeable working capital requirements (excluding the possible acquisition of Teva). However, risks and uncertainties which could impact the Company’s ability to maintain its cash position include the Company’s growth rate, its ability to collect its receivables in a timely manner, its ability to effectively manage its inventory, and the volume of letters of credit used to purchase product, among others.

Financial results for the outdoor and footwear industries are generally seasonal. Sales of each of the Company’s different product lines have historically been higher in different seasons with the highest percentage of Teva sales occurring in the first and second quarter of each year and the highest percentage of Ugg sales occurring in the fourth quarter, while the quarter with the highest percentage of annual sales for Simple has varied from year to year.

Historically, the Company’s sales have been greater in the first and second quarters, Teva’s strong selling season, than in the third and fourth quarters. However, given the Company’s current expectations for a decrease in Teva sales for the first half of 2002 compared to 2001 combined with the anticipated continuing increase in Ugg sales in the Fall of 2002 and the launch of the new Fall 2002 Teva and Simple product lines, the Company currently expects sales in the fourth quarter to equal or exceed the sales levels for the second quarter of 2002. The actual results could differ materially depending upon consumer preferences, availability of product, competition, and the Company’s customers continuing to carry and promote its various product lines, among other risks and uncertainties. See also the discussion regarding forward-looking statements under “Risk Factors”.

The Company believes that the relatively moderate rates of inflation in recent years have not had a significant impact on its net sales or profitability.

Principles of Consolidation. The consolidated financial statements include the accounts of Deckers Outdoor Corporation and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Revenue Recognition. The Company derives its revenue from the sale of its products. In general, revenue is recognized upon shipment of the merchandise. Domestically, goods are shipped directly from the Company’s domestic distribution center in California, and revenue is recognized upon shipment from the distribution center (FOB shipping point). For certain European accounts, product is shipped from the independent factories on a delivered duty paid basis (“DDP”) whereby the goods are delivered from the independent factories to a third party warehouse in the Netherlands where the goods are custom cleared and transferred to the distributors. In accordance with the DDP terms, the related revenue is recognized upon customs clearance. For virtually all other international accounts, the goods are delivered directly from the independent factories to the distributors on an FOB shipping point basis and revenue is recognized upon shipment from the factory.

Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures about contingent liabilities and the reported amounts of revenues and expenses during the reporting period. The Company bases these estimates and assumptions upon historical experience and existing, known circumstances. Actual results could differ from those estimates.


	Allowance for doubtful accounts. The Company provides a reserve against receivables for estimated losses that may result from its customers’ inability to pay. The Company determines the amount of the reserve by analyzing known uncollectible accounts, aged receivables, economic conditions, historical experience and the customers’ credit-worthiness. Receivables which are subsequently determined to be uncollectible are charged or written off against this reserve. Reserves have been fully established for all expected or probable losses of this nature. The gross trade accounts receivable balance was $22.4 million and the allowance for doubtful accounts was $2.0 million at December 31, 2001.

	Reserve for sales discounts. A significant portion of the Company’s domestic net sales and resulting accounts receivable have an associated discount which the customers may take, generally based upon meeting certain order, shipment and payment timelines. The Company estimates the amount of discounts which are expected to be taken against the period end accounts receivable, and records a corresponding reserve for sales discounts. The Company determines the amount of the reserve for sales discounts considering the amounts of available discounts in the period end accounts receivable aging and historical discount experience, among other factors. At December 31, 2001 the reserve for sales discounts was approximately $0.8 million.

	Allowance for estimated returns. The Company records an allowance for anticipated future returns of goods shipped prior to period-end. In general, the Company accepts returns for damaged or defective products, but discourages returns for other reasons. The amount of the allowance is determined based upon any approved customer requests for returns, historical returns experience, and any recent events which could result in a change in historical returns rates, among other factors. The allowance for returns at December 31, 2001 was $1.2 million.

	Inventory write-downs. Inventories are stated at lower of cost or market. The Company reviews the various items in inventory on a regular basis for excess, obsolete and impaired inventory. In doing so, the Company writes the inventory down to estimated future net selling prices. Inventories were stated at $18.4 million, net of a reserve for inventory write-downs of $0.9 million at December 31, 2001.

	Valuation of goodwill, intangible and other long-lived assets. The Company periodically assesses the impairment of goodwill, intangible and other long-lived assets based on assumptions and judgments regarding the carrying value of these assets. The assets are considered to be impaired if the Company determines that the carrying value may not be recoverable. Among other considerations, the following factors are considered:


	•	the asset’s ability to continue to generate income from operations and positive cash flow in future periods;

	•	the Company’s future plans regarding utilization of the asset;

	•	any changes in legal ownership of rights to the asset; and

	•	changes in customer demand or acceptance of the related brand names, products or features associated with the assets.


	If the assets are considered to be impaired, an impairment loss is recognized equal to the amount by which the carrying value of the assets exceeds the fair value of the assets. In addition, the Company bases the useful lives and related amortization or depreciation expense on the estimate of the period that the assets will generate revenues or otherwise be used by the Company.


	In 2002, Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” will become effective and as a result, the Company expects to record a goodwill impairment charge in the first quarter of 2002. See full discussion under “Recently Issued Pronouncements”.

	Litigation reserves. Estimated amounts for claims that are probable and that can be reasonably estimated are recorded as liabilities in the consolidated balance sheets. The likelihood of a material change in these estimated reserves would be dependent on new claims as they may arise and the favorable or unfavorable outcome of the particular litigation.

	Valuation of deferred income taxes. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The likelihood of a material change in the expected realization of these assets depends on future taxable income, the ability to deduct tax loss carryforwards against future taxable income, and the effectiveness of the Company’s tax planning.

Advertising, Marketing and Promotion Costs. Advertising production costs are expensed the first time the advertisement is run. All other costs of advertising, marketing and promotion are expensed as incurred. In 2001, approximately $6.1 million of advertising, marketing and promotion costs were charged to operations and approximately $0.7 million of prepaid advertising and promotion expenses were included in prepaid and other assets at December 31, 2001.

Derivatives. The Company may enter into foreign currency forward contracts in the ordinary course of business to mitigate the risk associated with foreign exchange rate fluctuations related to sales of goods in Eurodollars. Derivative financial instruments are not used for speculative purposes. At December 31, 2001, the Company had foreign currency forward contracts to purchase $4.8 million U.S. dollars for approximately 5.4 million Eurodollars.

In accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, these foreign currency cash flow hedges are recorded at fair value in the accompanying balance sheet with unrealized gains and losses on outstanding foreign currency forward contracts recorded in the financial statements as a component of other comprehensive income net of deferred taxes, to the extent they are effective hedges.

Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133 (“SFAS 133”), Accounting for Derivative Instruments and Hedging Activities. As a result, the Company recognizes financial instruments, such as foreign currency forward contracts, at fair value regardless of the purpose or intent for holding the instrument. Changes in the fair value of derivative financial instruments are either recognized periodically through the statement of earnings or through stockholders’ equity as a component of accumulated other comprehensive income or loss. The classification depends on whether the derivative financial instrument qualifies for hedge accounting, and if so, whether it qualifies as a fair value hedge or cash flow hedge. Generally, changes in fair values of derivatives designated as fair value hedges are matched in the statement of earnings against the respective gain or loss relating to the hedged items. Changes in fair values of derivatives accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in accumulated other comprehensive income net of deferred taxes. Changes in fair values of derivatives not qualifying as hedges are currently reported in earnings. The implementation of this standard did not have a significant impact on the Company’s financial statements.

approximately $809,000, $811,000 and $811,000 for fiscal years ended December 31, 2001, 2000 and 1999, respectively. The Company has evaluated the impact of SFAS 142 as of January 1, 2002 and currently expects an impairment charge of approximately $9.8 million ($9.0 million after tax benefit), or approximately $1.03 per share ($0.95 after tax benefit), will result from the Company’s implementation of this new standard, including approximately $7.8 million for impairment of Ugg’s intangible assets and approximately $2.0 million for impairment of Simple’s intangible assets. This preliminary information is unaudited and subject to final review by management. This charge will be recorded as a cumulative effect of an accounting change, net of the related tax impact, in the Company’s financial statements for the three months ending March 31, 2002.

In October 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 144 (“SFAS 144”), Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. While SFAS 144 supersedes Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, it retains many of the fundamental provisions of that statement. The standard is effective for fiscal years beginning after December 15, 2001. The Company expects that the adoption of SFAS 144 will not have a material impact on its financial position or results from operations.

Derivative Instruments. Beginning in the fourth quarter of 2001 and continuing at least through the fall 2002 season, a substantial portion of the Company’s European sales will be denominated in Euros. In order to mitigate the Company’s exposure to fluctuations in the foreign currency exchange rate, the Company has entered into forward contracts for approximately 5.4 million Euros. See Note 9 to the accompanying consolidated financial statements.

Market Risk. The Company’s market risk exposure with respect to financial instruments is to changes in the “prime rate” in the United States and changes in the Eurodollar rate. The Company’s credit facility provides for interest on outstanding borrowings at rates tied to prime rate, or at the Company’s election tied to the Eurodollar rate. At December 31, 2001, the Company had no outstanding borrowings under its credit facility.

See Item 14(a) and page 32 for an index to the consolidated financial statements and supplementary information included herein.

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

All other schedules are omitted because they are not applicable or the required information is shown in the Company’s consolidated financial statements or the related notes thereto.

We have audited the accompanying consolidated financial statements of Deckers Outdoor Corporation and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Deckers Outdoor Corporation and subsidiaries as of December 31, 2001 and 2000, and the results of their operations, and their cash flows for each of the years in the three-year period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As discussed in note(1)(r) to the consolidated financial statements, the Company changed its method of accounting for derivative instruments and hedging activities in 2001.


	In connection with the Teva license renewal in 1999, the Company issued 428,743 shares of common stock valued at $1,608,000.

	In connection with the exercise of nonqualified stock options, additional paid-in capital increased by $72,000, $17,000 and $109,000 in 2001, 2000 and 1999, respectively.

	In 2000, the Company incurred $715,000 of long-term debt in connection with the acquisition of $568,000 of property and equipment and $147,000 of prepaid expenses.

	In 2001, the Company had unrealized gains on hedging derivatives of $123,000.

The consolidated financial statements include the accounts of Deckers Outdoor Corporation and its wholly-owned subsidiaries (collectively referred to as the Company). All significant intercompany balances and transactions have been eliminated in consolidation.

The Company builds niche products into global lifestyle brands by designing and marketing innovative, functional, and fashion-oriented footwear, developed for both high performance outdoor activities and everyday casual lifestyle use.

Inventories are stated at the lower of cost (first-in, first-out) or market (net realizable value).

Revenue is recognized upon shipment of the merchandise. Allowances for estimated returns, discounts and bad debts are provided for when related revenue is recorded.

It is the Company’s policy to account for long-lived assets, including intangibles, at amortized cost. When circumstances or events trigger a review of the valuation and amortization of long-lived assets, management assesses the carrying value of such assets if facts and circumstances suggest that it may be impaired. If this review indicates that the long-lived assets will not be recoverable, as determined by a nondiscounted cash flow analysis over the remaining amortization period, the carrying value of the Company’s long-lived assets would be reduced to its estimated fair value based on discounted cash flows. As described in note (1)(r), the Company adopted SFAS No. 142, “Goodwill and Other Intangibles”, on January 1, 2002.

Depreciation of property and equipment is computed using the straight-line method based on estimated useful lives ranging from three to ten years. Leasehold improvements are amortized on the straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter.

Goodwill and other intangibles are amortized on the straight-line basis over periods of 20 to 30 years, and 5 to 15 years, respectively. Accumulated amortization at December 31, 2001 and 2000 was $8,756,000 and $6,680,000, respectively. As described in note (1)(r), the Company adopted SFAS No. 142, “Goodwill and Other Intangibles”, on January 1, 2002.

The fair values of the Company’s cash equivalents, trade accounts receivable, prepaid expenses and other current assets, refundable income taxes, trade accounts payable, and accrued expenses approximate the carrying values due to the relatively short maturities of these instruments.

The fair value of the Company’s revolving credit line approximates the carrying value due to variable interest rates associated with the credit line.

The fair values of the Company’s other notes payable are estimated by discounting future cash flows of each instrument at rates currently available to the Company for similar debt instruments of comparable maturities by the Company’s bankers. The fair values of these notes approximate the carrying value.

The Company accounts for stock-based compensation under the provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”). Under the provisions of SFAS 123, the Company has elected to continue to measure compensation cost for employees and nonemployee directors of the Company under APB No. 25 and comply with the pro forma disclosure requirements under SFAS 123. The Company applies the fair value techniques of SFAS 123 to measure compensation cost for options/warrants granted to nonemployees.

Management of the Company has made a number of estimates and assumptions relating to the reporting of assets, liabilities, revenues, and expenses and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Significant areas requiring the use of management estimates relate to inventory reserves, allowances for bad debts, returns and discounts, impairment reserves, deferred taxes, depreciation and amortization, litigation reserves, and hedging activities. Actual results could differ from these estimates.

Research and development costs are charged to expense as incurred. Such costs amounted to $1,034,000, $1,076,000 and $1,607,000 in 2001, 2000, and 1999, respectively.

Advertising production costs are expensed the first time the advertisement is run. All other costs of advertising, marketing and promotion are expensed as incurred. These expenses charged to operations for the years ended 2001, 2000, and 1999 were $6,087,000, $7,108,000, and $5,602,000, respectively. Included in prepaid and other current assets at December 31, 2001 and 2000 were $714,000 and $414,000, respectively, related to prepaid advertising and promotion expenses for programs that take place after December 31, 2001 and 2000, respectively.

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.

Basic earnings per share (EPS) is computed by dividing net earnings available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the

potential dilution from securities that could share in the earnings of the Company. Antidilutive securities are excluded from diluted EPS.

Options to purchase 282,000, 267,000, and 596,000 shares of common stock at prices ranging from $5.25 to $9.88, $5.50 to $13.75, and $3.00 to $13.75 were outstanding during 2001, 2000, and 1999, respectively, but 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 during the respective periods, and therefore their inclusion would be antidilutive.

The Company considers the U.S. dollar as the functional currency for all of its domestic and foreign operations. 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. Foreign currency translation adjustments were immaterial to the accompanying consolidated financial statements.

The Company may enter into foreign currency forward contracts in the ordinary course of business to mitigate the risk associated with foreign exchange rate fluctuations related to sales of goods in Eurodollars. Derivative financial instruments are not used for speculative purposes. At December 31, 2001, the Company had foreign currency forward contracts to purchase $4.8 million U.S. dollars for approximately 5.4 million Eurodollars.

Comprehensive income is the total of net earnings and all other nonowner changes in equity. Except for net earnings, foreign currency translation adjustments, and unrealized gains and losses as a result of hedging activities, the Company does not have any transactions and other economic events that qualify as comprehensive income as defined under SFAS No. 130.

Management of the Company has determined its reportable segments are strategic business units. Significant reportable business segments are the Teva, Simple, and Ugg brands. Information related to these segments is summarized in note 10.

Certain reclassifications have been made to the 1999 balances, specifically related to shipping and handling fees to conform to the 2000 and 2001 presentation. See note (1)(s).

Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133 (“SFAS 133”), Accounting for Derivative Instruments and Hedging Activities. As a result, the Company recognizes financial instruments, such as foreign currency forward contracts, at fair value regardless of the purpose or intent for holding the instrument. Changes in the fair value of derivative financial instruments are either recognized periodically through the statement of earnings or through stockholders’ equity as a component of accumulated other comprehensive income or loss. The classification depends on whether the derivative financial instrument qualifies for hedge accounting, and if so, whether it qualifies as a fair value hedge or cash flow hedge. Generally, changes in fair values of derivatives designated as fair value hedges are matched in the statement of earnings against the respective gain or loss relating to the hedged items. Changes in fair values of derivatives accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in accumulated other comprehensive income net of deferred taxes. Changes in fair values of derivatives not qualifying as hedges are currently reported in earnings. The implementation of this standard did not have a significant impact on the Company’s financial statements.

In July 2001, the FASB issued Statement of Financial Accounting Standards No. 141 (“SFAS 141”), Business Combinations, and Statement of Financial Accounting Standards No. 142 (“SFAS 142”), Goodwill and Other Intangible Assets. SFAS 141 requires that the purchase method be used for all business combinations initiated after June 30, 2001. SFAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized to earnings, but instead be reviewed for impairment in accordance with the provisions of SFAS 142. The amortization of goodwill and intangible assets with indefinite useful lives ceases upon adoption of SFAS 142 which is effective for fiscal years starting after December 15, 2001. Amortization of goodwill and intangible assets with indefinite useful lives was approximately $809,000, $811,000 and $811,000 for fiscal years ended December 31, 2001, 2000 and 1999, respectively. The Company has evaluated the impact of SFAS 142 as of January 1, 2002 and anticipates recording an impairment charge from the Company’s implementation of this new standard. This charge will be recorded as a cumulative effect of an accounting change, net of the related tax impact, in the Company’s financial statements for the three months ending March 31, 2002.

The Company adopted Emerging Issues Task Force Issue 00-10 (EITF 00-10), Accounting for Shipping and Handling Fees and Costs, effective October 1, 2000. EITF 00-10 established new guidelines for classification of shipping and handling costs billed to and collected from customers. Pursuant to EITF 00-10, amounts billed for shipping and handling costs are recorded as a component of revenue. Related costs paid to third-party shippers are recorded as a cost of sales.

The aggregate maturities of long-term debt as of December 31, 2001 are as follows:

At December 31, 2001, the Company had a credit facility (“the Facility”) providing for a maximum availability of $50,000,000, subject to a borrowing base of up to 85% of eligible accounts receivable, as defined, and 65% of eligible inventory, as defined. The Facility bore interest at the lenders’ prime rate or, at the Company’s election, an adjusted Eurodollar rate plus 2%, was secured by substantially all assets of the Company, and included a tangible net worth covenant, requiring the Company to maintain tangible net worth, as defined, of $30,000,000. The Company was in compliance with this covenant at December 31, 2001. At December 31, 2001, the Company had no outstanding borrowings under the Facility and had outstanding letters of credit aggregating $3,002,000. At December 31, 2001, $8,699,000 was available under the Facility.

On February 22, 2002, the Facility expired and was replaced with a new revolving credit facility with a new bank (the “New Facility”) which expires June 1, 2004. The New Facility provides for a maximum availability of $20,000,000, subject to a borrowing base only when outstanding borrowings, including outstanding letters of credit and foreign currency forward contracts, exceed $10 million. In general, the borrowing base is currently equal to 75% of eligible accounts receivable, as defined, and 50% of eligible inventory, as defined. The accounts receivable advance rate can increase or decrease depending on the Company’s accounts receivable dilution, which is calculated periodically. Up to $10 million of borrowings may be in the form of letters of credit. The New Facility bears interest at the bank’s prime rate minus 0.5%, or at the Company’s option, at LIBOR plus 1.375% to 1.625%, depending on the Company’s ratio of liabilities to effective tangible net worth, and is secured by substantially all assets of the Company’s domestic operations. The New Facility includes an annual commitment fee equal to 0.125% of the average unused line amount. The agreement underlying the New Facility includes several financial covenants including a quick ratio requirement, a requirement for liabilities to effective tangible net worth ratio, profitability requirements and, when borrowings exceed $10 million, a minimum inventory turnover requirement. At inception of the New Facility, the Company was in compliance with all covenants.

Actual income taxes differs from that obtained by applying the statutory federal income tax rate to earnings before income taxes as follows:

The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 2001 and 2000 are presented below:

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. During 2001, management reversed a valuation allowance of $228,000 as the net operating loss and other credit carryforwards were fully utilized.

Refundable income taxes as of December 31, 2001 and 2000 arise primarily from the overpayment of estimated taxes.

In February 2001, the Company amended the 1993 Stock Incentive Plan (1993 Plan). Under the terms of the amended 1993 Plan, 3,000,000 shares of common stock are reserved for issuance to officers, directors, employees, and consultants of the Company. Awards to 1993 Plan participants are not restricted to any specified form and may include stock options, securities convertible into or redeemable for stock, stock appreciation rights, stock purchase warrants, or other rights to acquire stock. Under the 1993 Plan, 162,344, 40,671, and 91,352 shares of common stock were issued to employees in 2001, 2000, and 1999, respectively. In 1997, 100,000 shares were issued under the 1993 plan to an officer of the Company, which was financed through the issuance of a note receivable of $624,000 to such officer (bearing interest at 6.39%, secured by the underlying Company stock, with principal and interest due April 18, 2002).

Common stock option activity under the 1993 Plan for the years ended December 31, 2001, 2000, and 1999 is as follows:

The per share weighted average fair value of stock options granted during 2001, 2000, and 1999 was $2.13, $1.95, and $1.54, respectively, on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: 2001 — expected dividend yield of 0%, stock volatility of 49.56%, risk-free interest rate of 3.3%, and an expected life of seven years; 2000 — expected dividend yield of 0%, stock volatility of 50.47%, risk-free interest rate of 5.8%, and an expected life of seven years; 1999 — expected dividend yield of 0%, stock volatility of 48.5%, risk-free interest rate of 5.3%, and an expected life of seven years.

The Company applies APB Opinion No. 25 in accounting for its stock option plans. Had the Company determined compensation cost based on the fair value of the options at the grant date under SFAS No. 123, the Company’s net earnings would have been changed to the pro forma amounts below:

In August 1995, the Company adopted the 1995 Employee Stock Purchase Plan (1995 Plan). The 1995 Plan is intended to qualify as an Employee Stock Purchase Plan under Section 423 of the Internal Revenue Code. Under the terms of the 1995 Plan 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 1995 Plan provides for employees to purchase the Company’s common stock at a discount below market value, as defined by the 1995 Plan. Under the 1995 Plan, 26,036, 30,301, and 22,231 shares were issued in 2001, 2000, and 1999, respectively. Consistent with the application of APB Opinion No. 25, no compensation has been recorded for stock purchases.

The Company adopted a stockholder rights plan in 1998 to protect stockholders against unsolicited attempts to acquire control of the Company that do not offer what the Company believes to be an adequate price to all stockholders. As part of the plan, the board of directors of the Company declared a dividend of one

preferred share purchase right (a Right) for each outstanding share of common stock, par value $0.01 per share (the Common Shares), of the Company.

The dividend was payable to stockholders of record on December 1, 1998 (the Record Date). In addition, one Right shall be issued with each Common Share that becomes outstanding (i) between the Record Date and the earliest of the Distribution Date, the Redemption Date, and the Final Expiration Date (as such terms are defined in the Rights Agreement) or (ii) following the Distribution Date and prior to the Redemption Date or Final Expiration Date, pursuant to the exercise of stock options or under any employee plan or arrangement or upon the exercise, conversion, or exchange of other securities of the Company, which options or securities were outstanding prior to the Distribution Date, in each case upon the issuance of the Company’s common stock in connection with any of the foregoing. Each right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series B Junior Participating Preferred Stock, par value $0.01 per share (the Preferred Shares), of the Company, at a price of $50.00, subject to adjustment.

The rights have no voting power and expire on November 11, 2008. The rights may be redeemed by the Company for $0.01 per right until the right becomes exercisable.

The Company’s board of directors has authorized the repurchase of up to 2,200,000 shares of common stock under a stock repurchase program. There were no shares repurchased under this program in 2001, 2000 or 1999. At December 31, 2001, 1,227,048 shares remained available for repurchase under the program.

The Company has been selling its Teva line of sport sandals and other footwear since 1985, pursuant to various license arrangements with Mark Thatcher, the inventor of the Teva sports sandal and owner of the Teva patents and trademark.

On June 7, 1999, the Company signed a new license agreement (the License Agreement) for Teva, which was effective January 1, 2000. Under the License Agreement, the Company received the exclusive worldwide rights for the manufacture and distribution of Teva footwear through 2004. The License Agreement is automatically renewable through 2008 and through 2011 under two renewal options, provided that minimum required sales levels are achieved. The Company is projecting that they may not attain the required sales levels under the agreement in 2004 which would impact future renewals of the agreement. As with the previous arrangement, the new license agreement provides for a sliding scale of royalty rates, depending on sales levels. Additionally, the License Agreement provides for an increase in the required amount of marketing expenditures, depending on sales levels and varying by territory. As additional consideration, the Company paid the licensor a licensing fee of $1,000,000 and issued the licensor 428,743 shares of its previously unissued common stock with a fair value of $1,608,000. The Company has recorded the license as an intangible asset for the value of the cash and common stock issued pursuant to the License Agreement and is amortizing this over the remaining term of the license. The shares are subject to various contractual and other holding period requirements. In addition, the Company has agreed to grant the licensor not less than 50,000 stock options on the Company’s common stock annually, with an exercise price at the market value on the date of grant. The fair value of options granted under the License Agreement aggregated $152,000 and $78,000 in 2001 and 2000, respectively.

In 1999, the Company received an option to buy Teva and virtually all of its assets, including all worldwide rights to Teva. The Company’s original option was exercisable during the period from January 1, 2000 to December 31, 2001 or during the period from January 1, 2006 to December 31, 2008. On January 22, 2001, the Company amended its option agreement, extending the first option window for two additional years. As a result, the first option window is January 1, 2000 through December 31, 2003. The Company agreed to pay Mr. Thatcher $1.6 million as consideration for this extension. The option price is based on formulas tied to net sales of Teva products and varies depending on when the option is exercised. For the first option period, the

option price is for an amount equal to the greater of (i) $61.6 million or (ii) 75% of the largest calendar year revenues since January 1, 2000 for the Teva brand, plus $1.6 million. In addition, the Company would issue to Mr. Thatcher 100,000 shares of common stock and options to purchase 100,000 shares of common stock. The purchase price for the second option period, January 1, 2006 to December 31, 2008, is equal to 110% of the average of the aggregate sales for all Teva products for the two calendar years since January 1, 2000 with the highest aggregate net sales. If the Company does not exercise its option to acquire Teva, the licensor has the option to acquire the Teva distribution rights from the Company for the period from January 1, 2010 to December 31, 2011, the end of the license term, and the option price is based on a formula tied to the Company’s earnings before interest, taxes, depreciation, and amortization. The Company is currently evaluating the possibility of exercising the option in the January 1, 2000 to December 31, 2003 period. The payment of the purchase price must be completed within 90 days of the exercise of the purchase option. If the Company exercises its purchase option, but subsequently fails to complete the purchase within the 90-day payment period, the purchase option and the option agreement will automatically be terminated.

Royalty expense related to Teva sales is included in selling, general, and administrative expenses in the accompanying consolidated financial statements and was $4,194,000, $4,307,000, and $4,128,000 during the years ended December 31, 2001, 2000, and 1999, respectively. Advertising expense, which is included in selling, general, and administrative expenses in the accompanying consolidated financial statements, related to Teva sales was $4,313,000, $4,829,000, and $3,378,000 during the years ended December 31, 2001, 2000, and 1999, respectively.

In the event that Deckers exercises its option to acquire Teva, Deckers would eliminate the royalty expense it currently pays on Teva footwear sales and would then own all Teva rights and assets worldwide.

The Company leases office facilities under operating lease agreements which expire through December 2003.

Total rent expense for the years ended December 31, 2001, 2000, and 1999 was approximately $1,074,000, $1,072,000, and $1,091,000, respectively.

Ninth Circuit affirmed the district court’s decision for a judgment against the Company, resulting in a settlement of approximately $2.0 million, including interest, which the Company paid in November 2001. In addition, the court of appeals reversed the district court’s refusal to consider an award of exemplary damages or attorney fees and remanded to the district court for further proceedings. In the event that further legal fees and exemplary damages are subsequently awarded, the Company would have an exposure beyond the amounts provided for in the financial statements of up to an additional $2.5 million.

The European Commission has enacted antidumping duties of 49.2% on certain types of footwear imported into Europe from China and Indonesia. Dutch Customs has issued an opinion to the Company that certain popular Teva styles are covered by this antidumping duty legislation. The Commission added explanatory language that more clearly identified shoe types which would be subject to antidumping duties. The Company believes that based on the new language it is probable that the Company will not prevail in its appeal. Therefore, the Company accrued $400,000 in 2000 and an additional $100,000 in 2001, which is the Company’s estimate of its exposure for antidumping levies. If Customs determines that these styles are covered by the revised legislation, the duty amounts could cause such products to be too costly to import into Europe from China in the future. As a precautionary measure, the Company has obtained, and is using, alternative sourcing for the potentially impacted products from sources outside of China in an effort to reduce the potential risk in the future.

The Company is currently involved in various other legal claims arising from the ordinary course of business. Management does not believe that the disposition of these matters will have a material effect on the Company’s financial position or results of operations.

The Company uses foreign currency forward contracts to hedge the foreign currency exposure associated with a portion of its forecasted transactions in foreign currency. These forward contracts are designated as foreign currency cash flow hedges and are recorded at fair value in the accompanying balance sheet. The effective portion of gains and losses resulting from recording forward contracts at fair value are deferred in accumulated other comprehensive income in the accompanying balance sheet until the underlying forecasted foreign currency transaction occurs. When the transaction occurs, the effective portion of the gain or loss from the derivative designated as a hedge of the transaction is reclassified from accumulated other comprehensive income to the same statement of earnings line item affected by the hedged forecasted transaction due to foreign currency fluctuations.

Because the amounts and the maturities of the derivatives approximate those of the forecasted transactions, changes in the fair value of the derivatives are expected to be highly effective in offsetting changes in the cash flows of the hedged items. Any ineffective portion of gains and losses resulting from changes in the fair value of the derivatives is recognized in current earnings. The ineffective portion of these gains and losses, which results primarily from the time value component of gains and losses on forward contracts, was immaterial for all periods presented.

At December 31, 2001, the Company had foreign currency forward contracts to purchase $4.8 million U.S. dollars for approximately 5.4 million Eurodollars, expiring through March 2002. An unrealized gain of

$123,000 has been recorded as of December 31, 2001 as a component of accumulated other comprehensive income.

The Company’s accounting policies of the segments below are the same as those described in the summary of significant accounting policies, except that the Company does not allocate interest, income taxes, or unusual items to segments. The Company evaluates performance based on net sales and profit or loss from operations. The Company’s reportable segments are strategic business units responsible for the worldwide operations of each of its brands. They are managed separately because each business requires different marketing, research and development, design, sourcing, and sales strategies. In 2001, the Company revised the structure for reporting the earnings from operations for each of the segments, removing the allocations of corporate overhead from each of the brands. The earnings from operations for each of the segments now includes only those costs which are specifically related to each brand, which consist primarily of cost of sales, costs for research and development, design, marketing, sales, commissions, royalties, bad debts, depreciation, amortization and the costs of employees directly related to the brands. Previously, corporate overhead costs were allocated to each segment based on each segment’s sales in relation to total net sales of all segments. The unallocated corporate overhead costs are the shared costs of the organization and include, among others, the following costs: costs of the distribution center, information technology, human resources, accounting and finance, credit and collections, executive compensation, facilities costs and the 2001 litigation costs. The segment data has been revised to reflect how the chief operating decision maker reviews the data. Management does not review information relating to the allocation of corporate overhead. All amounts for the

years ended December 31, 2000 and 1999 have been restated to conform to the 2001 presentation. Business segment information is summarized as follows:

The assets allocable to each reporting segment generally include accounts receivable, inventory, intangible assets and certain other assets which are specifically identifiable with one of the Company’s three brands — Teva, Simple and Ugg. Unallocated corporate assets are the assets not specifically related to one of the brands and generally include the Company’s cash, refundable and deferred tax assets and various other assets shared by the Company’s brands.

Reconciliations of total assets from reportable segments to the consolidated financial statements are as follows:

The Company sells its footwear products principally to customers throughout the United States. The Company also sells its footwear products to foreign customers located in Europe, Canada, Australia, and Asia, among other regions. International sales to unaffiliated customers were 23.1%, 27.4%, and 26.0% of net sales for the years ended December 31, 2001, 2000, and 1999, respectively. Management performs regular evaluations concerning the ability of its customers to satisfy their obligations and records a provision for doubtful accounts based upon these evaluations. For the years ended December 31, 2001, 2000, and 1999, the Company had no single customer exceeding 10% of consolidated net sales. As of December 31, 2001, the Company had one customer representing 16.4% of net trade accounts receivable. As of December 31, 2000, no single customer exceeded 10% of trade accounts receivable.

The Company’s production and sourcing is concentrated primarily in the Far East, with the vast majority being produced at several 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 duties, and related fees, various import controls and other nontariff barriers, restrictions on the transfer of funds, labor unrest, and strikes and, in certain parts of the world, political instability.

Information relating to Directors and Executive Officers of the Registrant is set forth in the Company’s definitive proxy statement relating to the Registrant’s 2002 annual meeting of shareholders, which will be filed pursuant to Regulation 14A within 120 days after the end of the Company’s fiscal year ended December 31, 2001, and such information is incorporated herein by reference.

Information relating to Executive Compensation is set forth in the Company’s definitive proxy statement relating to the Registrant’s 2002 annual meeting of shareholders, which will be filed pursuant to Regulation 14A within 120 days after the end of the Company’s fiscal year ended December 31, 2001, and such information is incorporated herein by reference.

Information relating to Security Ownership of Certain Beneficial Owners and Management is set forth in the Company’s definitive proxy statement relating to the Registrant’s 2002 annual meeting of shareholders, which will be filed pursuant to Regulation 14A within 120 days after the end of the Company’s fiscal year ended December 31, 2001, and such information is incorporated herein by reference.

Information relating to Certain Relationships and Related Transactions is set forth in the Company’s definitive proxy statement relating to the Registrant’s 2002 annual meeting of shareholders, which will be filed pursuant to Regulation 14A within 120 days after the end of the Company’s fiscal year ended December 31, 2001, and such information is incorporated herein by reference.

(a) Consolidated Financial Statements and Schedules required to be filed hereunder are indexed on page 32 hereof.

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


	DECKERS OUTDOOR CORPORATION
	(Registrant)

	/s/ DOUGLAS B. OTTO

	Douglas B. Otto
	Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

56 EX-10.21 3 v79832ex10-21.txt EXHIBIT 10.21 Exhibit 10.21 ================================================================================ REVOLVING CREDIT AGREEMENT dated as of February 21, 2002 among DECKERS OUTDOOR CORPORATION and UGG HOLDINGS, INC., as Borrowers, and COMERICA BANK -- CALIFORNIA, as Bank $20,000,000 ================================================================================ TABLE OF CONTENTS

i "Distributions"...............................................................6 "Dollars" or "$"..............................................................6 "Eligible Accounts"...........................................................6 "Eligible Assignee"...........................................................8 "Eligible Inventory"..........................................................8 "ERISA".......................................................................9 "ERISA Event".................................................................9 "ERISA Group".................................................................9 "Event of Default"............................................................9 "Excluded Subsidiaries"......................................................10 "Expenses"...................................................................10 "Fees".......................................................................10 "Financial Statement(s)".....................................................10 "Foreign Exchange Agreement".................................................10 "Foreign Exchange Reserve"...................................................10 "Foreign Exchange Sublimit"..................................................11 "GAAP".......................................................................11 "Governing Documents"........................................................11 "Governmental Authority".....................................................11 "Guaranties" and "Guaranty"..................................................11 "Guarantor(s)"...............................................................11 "Hazardous Materials"........................................................11 "Indemnified Person(s)"......................................................11 "Insolvency Proceeding"......................................................12 "Intangible Assets"..........................................................12 "Interest Payment Date"......................................................12 "Interest Period"............................................................12 "Internal Revenue Code"......................................................12 "Inventory"..................................................................12 "Inventory Sublimit".........................................................12 "Inventory Turnover Ratio"...................................................13 "ISP"........................................................................13 "Knowledge"..................................................................13 "Late Payment Fee"...........................................................13 "Lending Office".............................................................13 "Letter(s) of Credit"........................................................13 "Letter of Credit Application"...............................................13 "Letter of Credit Fee".......................................................13 "Letter of Credit Sublimit"..................................................13 "Letter of Credit Usage".....................................................13 "LIBOR"......................................................................13 "LIBOR Business Day".........................................................13 "LIBOR Lending Rate".........................................................13 "LIBOR Lending Rate Portion".................................................14 "LIBOR Reserve Percentage"...................................................14

ii "Lien".......................................................................14 "Loan Document(s)"...........................................................14 "Loans"......................................................................15 "Material Adverse Effect"....................................................15 "Multiemployer Plan".........................................................15 "Net Cash Proceeds"..........................................................15 "Note".......................................................................15 "Notice of Borrowing"........................................................15 "Notice of Conversion or Continuation".......................................15 "Obligations"................................................................15 "Old Lender".................................................................16 "Overadvance"................................................................16 "Participant"................................................................16 "Patent and Trademark Security Agreement"....................................16 "Pay-Off Letter".............................................................16 "PBGC".......................................................................16 "Permitted Debt".............................................................16 "Permitted Investments"......................................................16 "Permitted Liens"............................................................17 "Person".....................................................................17 "Plan".......................................................................17 "Purchase Money Lien"........................................................17 "Quick Ratio"................................................................18 "Regulation D"...............................................................18 "Reimbursement Obligations"..................................................18 "Reportable Event"...........................................................18 "Responsible Officer"........................................................18 "Retiree Health Plan"........................................................18 "Revolving Credit Commitment"................................................18 "Revolving Loans"............................................................18 "Revolving Loans Daily Balances".............................................18 "Revolving Loans Maturity Date"..............................................18 "SEC"........................................................................18 "Security Agreement".........................................................18 "Shareholder"................................................................18 "Solvent"....................................................................18 "Stock Pledge Agreement".....................................................19 "Subsidiary".................................................................19 "Swaps"......................................................................19 "Taxes"......................................................................19 "Teva License Agreement".....................................................19 "Teva Option Agreement"......................................................19 "UCC"........................................................................19 "Uniform Customs"............................................................20 "Unmatured Event of Default".................................................20

iii "Unused Revolving Commitment Fee"............................................20 1.2 Accounting Terms and Determinations..........................................20 1.3 Computation of Time Periods..................................................20 1.4 Construction.................................................................20 1.5 Exhibits and Schedules.......................................................20 1.6 No Presumption Against Any Party.............................................20 1.7 Independence of Provisions...................................................21 ARTICLE II TERMS OF THE CREDIT..............................................................21 2.1 Revolving Loans..............................................................21 2.2 Foreign Exchange Forward Contracts..........................................21 2.3 Reserved.....................................................................22 2.4 Interest Rates; Payments of Interest.........................................22 2.5 Notice of Borrowing Requirements.............................................23 2.6 Conversion or Continuation Requirements......................................24 2.7 Additional Costs.............................................................25 2.8 Illegality; Impossibility....................................................26 2.9 Disaster.....................................................................26 2.10 Increased Risk-Based Capital Cost............................................27 2.11 Note; Statements of Obligations..............................................27 2.12 Holidays.....................................................................27 2.13 Time and Place of Payments...................................................27 2.14 Mandatory Principal Reductions...............................................28 2.15 Fees.........................................................................28 ARTICLE III LETTERS OF CREDIT...............................................................29 3.1 Letters of Credit............................................................29 3.2 Procedure for Issuance of Letters of Credit..................................30 3.3 Fees, Commissions and Other Charges..........................................30 3.4 Reimbursement Obligations....................................................30 3.5 Obligations Absolute.........................................................31 3.6 Letter of Credit Payments....................................................31 3.7 Outstanding Letters of Credit Following Event of Default.....................32 3.8 Letter of Credit Applications................................................32 ARTICLE IV CONDITIONS PRECEDENT.............................................................32 4.1 Conditions to Initial Loans or Letter(s) of Credit...........................32 4.2 Conditions to all Loans and Letters of Credit................................34 ARTICLE V REPRESENTATIONS AND WARRANTIES....................................................34 5.1 Legal Status.................................................................35 5.2 No Violation; Compliance.....................................................35 5.3 Authorization; Enforceability................................................35 5.4 Approvals; Consents..........................................................36 5.5 Liens........................................................................36 5.6 Debt.........................................................................36

iv 5.7 Litigation...................................................................36 5.8 No Default...................................................................36 5.9 Subsidiaries.................................................................36 5.10 Taxes........................................................................36 5.11 Correctness of Financial Statements..........................................37 5.12 ERISA........................................................................37 5.13 Other Obligations............................................................37 5.14 Public Utility Holding Company Act...........................................37 5.15 Investment Company Act.......................................................37 5.16 Patents, Trademarks, Copyrights, and Intellectual Property, etc..............37 5.17 Environmental Condition......................................................38 5.18 Solvency.....................................................................38 5.19 Eligible Accounts............................................................38 5.20 Eligible Inventory...........................................................39 ARTICLE VI AFFIRMATIVE COVENANTS............................................................39 6.1 Punctual Payments............................................................39 6.2 Books and Records; Collateral Audits.........................................39 6.3 Collateral Reporting and Financial Statements................................40 6.4 Existence; Preservation of Licenses; Compliance with Law.....................41 6.5 Insurance....................................................................41 6.6 Assets.......................................................................42 6.7 Taxes and Other Liabilities..................................................42 6.8 Notice to Bank...............................................................43 6.9 Employee Benefits............................................................43 6.10 Further Assurances...........................................................44 6.11 Bank Accounts................................................................44 6.12 Environment..................................................................44 6.13 Additional Collateral........................................................45 6.14 Guarantors...................................................................45 6.15 Returns......................................................................45 ARTICLE VII NEGATIVE COVENANTS..............................................................45 7.1 Use of Funds; Margin Regulation..............................................45 7.2 Debt.........................................................................46 7.3 Liens........................................................................46 7.4 Merger, Consolidation, Transfer of Assets....................................46 7.5 Leases.......................................................................46 7.6 Sales and Leasebacks.........................................................46 7.7 Asset Sales..................................................................47 7.8 Investments..................................................................47 7.9 Character of Business........................................................47 7.10 Distributions................................................................48 7.11 Guaranty.....................................................................48 7.12 Capital Expenditures.........................................................48 7.13 Transactions with Affiliates.................................................48

v 7.14 Stock Issuance...............................................................49 7.15 Financial Condition..........................................................49 7.16 Transactions Under ERISA. Directly or indirectly:...........................49 ARTICLE VIII EVENTS OF DEFAULT AND REMEDIES.................................................50 8.1 Events of Default............................................................50 8.2 Remedies.....................................................................52 8.3 Setoff.......................................................................53 8.4 Appointment of Receiver or Trustee...........................................53 8.5 Remedies Cumulative..........................................................53 ARTICLE IX TAXES............................................................................53 9.1 Taxes on Payments............................................................53 9.2 Indemnification For Taxes....................................................54 9.3 Evidence of Payment..........................................................54 ARTICLE X MISCELLANEOUS.....................................................................54 10.1 Notices......................................................................54 10.2 No Waivers...................................................................54 10.3 Expenses; Documentary Taxes; Indemnification.................................55 10.4 Amendments and Waivers.......................................................55 10.5 Successors and Assigns; Participations; Disclosure...........................56 10.6 Confidentiality..............................................................57 10.7 Counterparts; Effectiveness; Integration.....................................57 10.8 Severability.................................................................57 10.9 Knowledge....................................................................57 10.10 Additional Waivers...........................................................58 10.11 Destruction Of Borrowers' Documents..........................................58 10.12 CHOICE OF LAW AND VENUE; JURY TRIAL WAIVER...................................58 ARTICLE XI JOINT AND SEVERAL LIABILITY; SINGLE LOAN ACCOUNT.................................59 11.1 Joint and Several Liability..................................................59 11.2 Primary Obligation; Waiver of Marshalling....................................60 11.3 Financial Condition of Borrowers.............................................60 11.4 Continuing Liability.........................................................60 11.5 Additional Waivers...........................................................60 11.6 Settlement or Releases.......................................................63 11.7 No Election..................................................................63 11.8 Indefeasible Payment.........................................................63 11.9 Single Loan Account..........................................................64 11.10 Apportionment of Proceeds of Loans...........................................64 11.11 Bank Held Harmless...........................................................64 11.12 Borrowers' Integrated Operations.............................................64

vi EXHIBITS AND SCHEDULES Exhibit 1.1B - Form of Borrowing Base Certificate Exhibit 1.1L-1 - Form of Commercial Letter of Credit Application and Agreement Exhibit 1.1L-2 - Form of Standby Letter of Credit Application and Agreement Exhibit 2.5(b) - Form of Notice of Borrowing Exhibit 2.6(b) - Form of Notice of Conversion or Continuation Exhibit 4.1(b) - Form of Opinions of Borrowers' Counsel Exhibit 6.3(d) - Form of Compliance Certificate Schedule 1.1E - Locations of Eligible Inventory Schedule 5.6 - Permitted Debt Schedule 5.7 - Litigation Schedule 5.9 - Subsidiaries Schedule 5.12 - Employee Benefit Plans Schedule 7.5 - Leases REVOLVING CREDIT AGREEMENT This REVOLVING CREDIT AGREEMENT, dated as of February 21, 2002, is entered into among Deckers Outdoor Corporation, a Delaware corporation ("Parent"), and UGG HOLDINGS, INC., California corporation ("UGG") (collectively sometimes referred to herein as "Borrowers" and individually as a "Borrower"), on the one hand, and Bank, on the other hand. The parties hereto hereby agree as follows: ARTICLE I DEFINITIONS AND INTERPRETATIONS 1.1 Definitions. The following terms, as used herein, shall have the following meanings: "ABL Borrowing Period" means any fiscal quarter of Parent in which the outstanding ABL Triggering Obligations as of the first day of such fiscal quarter, after giving effect to any Borrowings made, Letters of Credit issued and/or Currency Obligations incurred on such date, are equal to or greater than Ten Million Dollars ($10,000,000). "ABL Trigger Amount" means Ten Million Dollars ($10,000,000). "ABL Triggering Obligations" means, as of the date of determination, the sum of (i) the principal amount of all outstanding Revolving Loans, (ii) the outstanding Letter of Credit Usage, and (iii) the Foreign Exchange Reserve. "Account" and "Account Debtor" have the meanings given to such terms in the Security Agreement. "Affiliate" means any Person (i) that, directly or indirectly, controls, is controlled by or is under common control with any Borrower or any Subsidiary; (ii) which to the Knowledge of Parent, directly or indirectly beneficially owns or controls ten percent (10%) or more of any class of voting stock of any Borrower or any Subsidiary; or (iii) ten percent (10%) or more of the voting stock of which is directly or indirectly beneficially owned or held by any Borrower or any Subsidiary. For purposes of the foregoing, control (including controlled by and under common control with) shall mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a Person, whether through the ownership of voting securities, by contract or otherwise. "Agreement" means this Revolving Credit Agreement, as amended or restated from time to time in accordance with its terms. 1 "Applicable A/R Advance Rate" means the percentage set forth in the table below opposite the applicable Dilution:
- ------------------------------------- -------------------------------- Dilution Applicable A/R Advance Rate - ------------------------------------- -------------------------------- Equal to or less than 5% 80% - ------------------------------------- -------------------------------- Greater than 5% but less than or 75% equal to 10% - ------------------------------------- -------------------------------- Greater than 10% but less than or 70% equal to 15% - ------------------------------------- -------------------------------- Greater than 15% but less than or 65%(2) equal to 20%(1) - ------------------------------------- --------------------------------
"Applicable Base Lending Rate Margin" means the margin set forth below opposite the applicable Consolidated Total Liabilities to Consolidated Effective Tangible Net Worth Ratio disclosed in the latest Compliance Certificate delivered pursuant to Section 6.3(c):
- ------------------------- ----------------------- Consolidated Total Applicable Base Liabilities to Lending Rate Margin Consolidated Effective For All Revolving Tangible Net Worth Ratio Loans - ------------------------- ----------------------- Less than 0.50:1.0 -50 basis points - ------------------------- ----------------------- Greater than or equal -50 basis points to 0.50:1.0 - ------------------------- -----------------------
"Applicable LIBOR Lending Rate Margin" means the margin set forth below opposite the applicable Consolidated Total Liabilities to Consolidated Effective Tangible Net Worth Ratio disclosed in the latest Compliance Certificate delivered pursuant to Section 6.3(c): - -------- (1) For every 5% increase in Dilution over 20%, the Applicable A/R Advance Rate shall decrease by an additional 5%. (2) For every 5% increase in Dilution over 20%, the Applicable A/R Advance Rate shall decrease by an additional 5%. 2
- ------------------------- ----------------------- Consolidated Total Applicable LIBOR Liabilities to Lending Rate Margin Consolidated Effective For All Revolving Tangible Net Worth Ratio Loans - ------------------------- ----------------------- Less than 0.50:1.0 137.5 basis points - ------------------------- ----------------------- Greater than or equal 162.5 basis points to 0.50:1.0 - ------------------------- -----------------------
"Applicable Percentage" means the percentage set forth below opposite the applicable Consolidated Total Liabilities to Consolidated Effective Tangible Net Worth Ratio disclosed in the latest Compliance Certificate delivered pursuant to Section 6.3(c):
- ----------------------- ----------------------- Consolidated Total Liabilities to Consolidated Effective Tangible Applicable Net Worth Ratio Percentage - ----------------------- ----------------------- ~~Less than 0.50:1.0 1.375% - ----------------------- ----------------------- Greater than or equal 1.625% to 0.50:1.0 - ----------------------- -----------------------~~
"Asset" means any interest of a Person in any kind of property or asset, whether real, personal, or mixed real and personal, and whether tangible or intangible. "Asset Sale" means any sale, transfer or other disposition of any Borrower's or any Subsidiary's (other than an Excluded Subsidiary) businesses or Asset(s) now owned or hereafter acquired, including shares of stock and indebtedness of any Subsidiary (other than an Excluded Subsidiary), receivables and leasehold interests. "Audit Fee" has the meaning given to such term in Section 6.2. "Bank" means Comerica Bank -- California, a California banking corporation. "Bankruptcy Code" means The Bankruptcy Reform Act of 1978 (Pub. L. No. 95-598; 11 U.S.C.), as amended or supplemented from time to time, or any successor statute, and any and all rules and regulations issued or promulgated in connection therewith. "Base Lending Rate" means the variable per annum rate equal to the Base Rate plus the Applicable Base Lending Rate Margin. 3 "Base Lending Rate Portion" means any portion of any Loan designated by a Borrower as bearing interest at the Base Lending Rate pursuant to Section 2.5 or 2.6. "Base LIBOR" applicable to any Interest Period for a LIBOR Lending Rate Portion means the offered rate per annum (rounded upward to the nearest one-hundredth of one percent (.01%)), if any, to first-class banks in the LIBOR market quoted by Bank at 11:00 a.m. Pacific time, two (2) LIBOR Business Days prior to the first day of such Interest Period for Dollar deposits of an amount comparable to the principal amount of the LIBOR Lending Rate Portion for which the LIBOR Lending Portion is being determined with maturities comparable to the Interest Period for which such LIBOR Lending Rate will apply. "Base Rate" means the variable rate of interest announced by Bank at its corporate headquarters as its base rate and which serves as the basis upon which effective rates of interest are calculated for those loans making reference thereto. The Base Rate is determined by Bank from time to time as a means of pricing credit extensions to some customers and is neither directly tied to some external rate of interest or index nor necessarily the lowest rate of interest charged by Bank at any given time for any particular class of customers or credit extensions. "Borrowing" means a borrowing of Revolving Loans from Bank pursuant to the terms and conditions hereof. "Borrowing Base" means, as of the date of determination, the lesser of (a) the Revolving Credit Commitment and (b) (i) the Eligible Accounts times the Applicable A/R Advance Rate, plus (ii) the lesser of (x) 50% of the Eligible Inventory, (y) the Inventory Sublimit, and (z) the aggregate Dollar amount of outstanding Borrowings against Eligible Accounts; less the amount of outstanding Obligations and less the Foreign Exchange Reserve; provided, however, Bank may reduce the advance rates or create additional reserves against the Eligible Accounts and/or the Eligible Inventory, in its sole and absolute discretion, without declaring an Event of Default if it reasonably determines that there has occurred a Material Adverse Effect. "Borrowing Base Certificate" means a certificate from a Responsible Officer of Parent certifying the Borrowing Base, in the form of Exhibit 1.1B. "Business Day" means any day other than a Saturday, a Sunday, or a day on which commercial banks in the City of Los Angeles, California are authorized or required by law or executive order or decree to close. "Capital Expenditures" means expenditures made in cash, or financed with long term debt, by any Person for the acquisition of any fixed Assets or improvements, replacements, substitutions, or additions thereto that have a useful life of more than one (1) year, including the direct or indirect acquisition of such Assets by way of increased product or service charges, offset items, or otherwise, and the principal portion of payments with respect to Capital Lease Obligations, calculated in accordance with GAAP. 4 "Capital Lease" means any lease of an Asset by a Person as lessee which would, in conformity with GAAP, be required to be accounted for as an Asset and corresponding liability on the balance sheet of that Person. "Capital Lease Obligations" of a Person means the amount of the obligations of such Person under all Capital Leases which would be shown as a liability on a balance sheet of such Person prepared in accordance with GAAP. "Capital Stock" means any and all shares, interests, participations or other equivalents (however designated) of capital stock of a corporation, any and all equivalent ownership interests in a Person (other than a corporation) and any and all warrants or options to purchase any of the foregoing. "Change of Control" means the time at which Douglas B. Otto fails to be the beneficial owner (as defined in Rule 13d-3 under the Securities Exchange Act of 1934) of a percentage (based on voting power, in the event different classes of stock shall have different voting powers) of the voting stock of Parent equal to at least twenty-five percent (25%). "Closing Date" means the date when all of the conditions set forth in Section 4.1 have been fulfilled to the reasonable satisfaction of Bank and its counsel. "Collateral Access Agreement" has the meaning given to such term in the Security Agreement. "Compliance Certificate" means a certificate of compliance to be delivered quarterly in accordance with Section 6.3(c), substantially in the form of Exhibit 6.3(c). "Consolidated Effective Tangible Net Worth" means, as of any date of determination, the result of (a) Borrowers' and Subsidiaries consolidated total stockholder's equity, minus (b) the sum of (i) all Intangible Assets of Borrowers and Subsidiaries, and (ii) all amounts due to Borrowers from Affiliates (other than Subsidiaries). "Consolidated Net Profit" and "Consolidated Net Loss" mean, respectively, with respect to any period, the consolidated net profit, or loss, as applicable, of Borrowers and the Subsidiaries after all federal, state and local income taxes reflected on Borrowers' Financial Statement for such period, calculated in accordance with GAAP, plus any write-off of goodwill pursuant to FASB 142. "Consolidated Pretax Profit" means the consolidated annual profit of Borrowers and the Subsidiaries before all federal, state and local income taxes reflected on Borrowers' Financial Statement for such period, calculated in accordance with GAAP, plus any write-off of goodwill pursuant to FASB 142. "Consolidated Total Liabilities to Consolidated Effective Tangible Net Worth Ratio" means, as of the date of determination, the ratio of (i) Borrowers' and Subsidiaries consolidated total liabilities, calculated in accordance with GAAP; to (ii) Consolidated Effective Tangible Net Worth. 5 "Currency Obligation" has the meaning given to such term in the Foreign Exchange Agreement. "Current Liabilities" means, as of the date of determination, Borrowers' and Subsidiaries consolidated liabilities coming due within one year (including all amounts due to any Borrower's or Subsidiary's shareholders, officers and Affiliates), calculated in accordance with GAAP. "Debt" means, as of the date of determination, the sum, but without duplication, of any and all of a Person's: (i) indebtedness heretofore or hereafter created, issued, incurred or assumed by such Person (directly or indirectly) for or in respect of money borrowed; (ii) Capital Lease Obligations; (iii) obligations evidenced by bonds, debentures, notes, or other similar instruments; (iv) obligations for the deferred purchase price of property or services (including trade obligations except accounts payable to trade creditors for goods or services which are not aged more than 90 days from the billing date and current operating liabilities (other than for borrowed money) which are not more than 90 days past due, in each case incurred in the ordinary course of business, as presently conducted, and paid within the specified time, unless contested in good faith in appropriate proceedings (if applicable)); (v) current liabilities in respect of unfunded vested benefits under any Plan; (vi) obligations under letters of credit; (vii) obligations under acceptance facilities; (viii) obligations under all guaranties, endorsements (other than for collection or deposit in the ordinary course of business), and other contingent obligations to purchase, to provide funds for payment, or supply funds to invest in any other Person, or otherwise to assure a creditor against loss; (ix) obligations secured by any Lien on any Asset of such Person, whether or not such obligations have been assumed; and (x) Swaps. "Dilution" means, as of any date of determination, a percentage, based upon the experience of the immediately prior 365 days, as determined by Bank based upon Bank's most recent audit of the Accounts, that is the result of dividing the Dollar amount of (a) bad debt write-downs, discounts, advertising allowances, credits, or other dilutive items with respect to the Accounts during such period, by (b) Borrower's collections with respect to the Accounts during such period (excluding extraordinary items) plus the Dollar amount of clause (a). On the Closing date, Dilution is in excess of 5% but less than 10%. "Distributions" means dividends or distributions of earnings made by a Person to its shareholders, partners or members, as the case may be. "Dollars" or "$" means lawful currency of the United States of America. "Eligible Accounts" means those Accounts created by any Borrower in the ordinary course of business, that arise out of such Borrower's sale of goods or rendition of services, that strictly comply with each and all of the representations and warranties respecting Accounts made by Borrowers to Bank in this Agreement and the Loan Documents, and that are and at all times continue to be acceptable to Bank in all respects; provided, however, that standards of eligibility may be fixed and revised from time to time by Bank in Bank's reasonable credit judgment. In determining the amount to be included, Eligible Accounts shall be calculated net of customer deposits and unapplied cash remitted to any Borrower. Eligible Accounts shall not include the following: 6 (i) Accounts that the Account Debtor has failed to pay within 90 days of invoice date; provided that Accounts with selling terms up to 120 days from invoice date shall not be deemed ineligible under this clause (i) if the invoice is created from November 1 through January 31 of each year; provided, further, that any such Accounts shall no longer be eligible if they are past due one day; (ii) Accounts owed by an Account Debtor or its Affiliates where 25% or more of all Accounts owed by that Account Debtor (or its Affiliates) are deemed ineligible under clause (i) above; (iii) Accounts with respect to which the Account Debtor is an officer, director, shareholder, employee, Affiliate, or agent of any Borrower; (iv) Accounts with respect to which goods are placed on consignment, guaranteed sale, sale or return, sale on approval, bill and hold, or other terms by reason of which the payment by the Account Debtor may be conditional; (v) Accounts that are not payable in Dollars or with respect to which the Account Debtor: (i) does not maintain its chief executive office in the United States, or (ii) is not organized under the laws of the United States or any State thereof, or (iii) is the government of any foreign country or sovereign state, or of any state, province, municipality, or other political subdivision thereof, or of any department, agency, public corporation, or other instrumentality thereof, unless (y) the Account is supported by an irrevocable letter of credit reasonably satisfactory to Bank (as to form, substance, and issuer or domestic confirming bank) that must be directly drawn upon Bank, or (z) the Account is covered by credit insurance in form and amount, and by an insurer, reasonably satisfactory to Bank; (vi) Accounts with respect to which the Account Debtor is either (i) the United States or any department, agency, or instrumentality of the United States (exclusive, however, of Accounts with respect to which the applicable Borrower has complied, to the reasonable satisfaction of Bank, with the Assignment of Claims Act, 31 USC Section 3727), or (ii) any state of the United States (exclusive, however, of (y) Accounts owed by any state that does not have a statutory counterpart to the Assignment of Claims Act, or (z) Accounts owed by any state that does have a statutory counterpart to the Assignment of Claims Act as to which the applicable Borrower has complied to Bank's reasonable satisfaction), (vii) Accounts with respect to which the Account Debtor is a creditor of any Borrower, and either has or has asserted a right of setoff, has disputed its liability, or has made any claim with respect to the Account, to the extent of such setoff, dispute or claim; (viii) Accounts with respect to an Account Debtor whose total obligations owing to any Borrower exceed 20% of all Eligible Accounts, to the extent of the obligations owing by such Account Debtor in excess of such percentage; (ix) Accounts with respect to which the Account Debtor is subject to an Insolvency Proceeding, is not Solvent, has gone out of business, or as to which any Borrower 7 has received notice of an imminent Insolvency Proceeding or a material impairment of the financial condition of such Account Debtor, or whose credit standing is reasonably unacceptable to Bank and Bank has so notified Borrower; (x) Accounts the collection of which Bank, in its reasonable credit judgment, believes to be doubtful by reason of the Account Debtor's financial condition; (xi) Accounts which are in default or collection; (xii) Accounts on C.O.D. terms; (xiii) Accounts with respect to which the goods giving rise to such Account have not been shipped and billed to the Account Debtor, the services giving rise to such Account have not been performed and accepted by the Account Debtor, or the Account otherwise does not represent a final sale; (xiv) Accounts that are not subject to a valid and perfected first priority Lien in favor of Bank; (xv) Accounts with respect to which the Account Debtor is located in the states of New Jersey, Minnesota, Indiana, or West Virginia (or any other state that requires a creditor to file a Business Activity Report or similar document in order to bring suit or otherwise enforce its remedies against such Account Debtor in the courts or through any judicial process of such state), unless the applicable Borrower has qualified to do business in New Jersey, Minnesota, Indiana, West Virginia, or such other states, or has filed a Notice of Business Activities Report with the applicable division of taxation, the department of revenue, or with such other state offices, as appropriate, for the then-current year, or is exempt from such filing requirement; and (xvi) Accounts that represent progress payments or other advance billings that are due prior to the completion of performance by the applicable Borrower of the subject contract for goods or services. "Eligible Assignee" means (a) a commercial bank, commercial finance company or other asset based lender, having total assets in excess of $1,000,000,000; (b) any Affiliate of Bank, and (c) if an Event of Default exists, any Person reasonably acceptable to Bank. "Eligible Inventory" means Inventory consisting of shoes, footwear and apparel finished goods held for sale in the ordinary course of any Borrower's business located at one of any Borrower's business locations set forth on Schedule 1.1E (or in-transit between any such locations), that complies with each of the representations and warranties respecting Eligible Inventory made by Borrower in the Loan Documents, and that is not excluded as ineligible by virtue of the one or more of the criteria set forth below; provided, however, that such criteria may be fixed and revised from time to time by Bank in Bank's reasonable credit judgment to address the results of any audit or appraisal performed by Bank from time to time after the Closing Date. In determining the amount to be so included, Inventory shall be valued at the lower of cost or market on a basis consistent with Borrowers' historical accounting practices. An item of Inventory shall not be included in Eligible Inventory if: 8 (i) a Borrower does not have good, valid, and marketable title thereto, (ii) it is not located at one of the locations in the United States set forth on Schedule 1.1E or in transit from one such location to another such location, (iii) it is located on real property leased by a Borrower or in a contract warehouse, in each case, unless it is subject to a Collateral Access Agreement executed by the lessor, warehouseman, or other third party, as the case may be, and unless it is segregated or otherwise separately identifiable from goods of others, if any, stored on the premises, (iv) it is not subject to a valid and perfected first priority Lien in favor of Bank, (v) it consists of goods returned or rejected by the applicable Borrower's customers, or (vi) it consists of goods that are (x) obsolete or not in the following season's line and more than six (6) months old, (y) restrictive or custom items, work-in-process, or raw materials, or (z) goods that constitute spare parts, packaging and shipping materials, supplies used or consumed in a Borrower's business, bill and hold goods, defective goods, "seconds," or Inventory acquired on consignment. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time, or any successor statute, and any and all regulations thereunder. "ERISA Event" means (a) a Reportable Event with respect to a Plan or Multiemployer Plan, (b) the withdrawal of a member of the ERISA Group from a Plan during a plan year in which it was a substantial employer (as defined in Section 4001(a)(2) of ERISA), (c) the providing of notice of intent to terminate a Plan in a distress termination (as described in Section 4041(c) of ERISA), (d) the institution by the PBGC of proceedings to terminate a Plan or Multiemployer Plan, (e) any event or condition (i) that provides a basis under Section 4042(a)(1), (2), or (3) of ERISA for the termination of or the appointment of a trustee to administer, any Plan or Multiemployer Plan, of (ii) that may result in termination of a Multiemployer Plan pursuant to Section 4041A of ERISA, (f) the partial or complete withdrawal within the meaning of Sections 4203 and 4205 of ERISA of a member of the ERISA Group from a Multiemployer Plan, or (g) providing any security to any Plan under Section 401(a)(29) of the Internal Revenue Code by a member of the ERISA Group. "ERISA Group" means Borrowers and all members of a controlled group of corporations and all trades or business (whether or not incorporated) under common control which, together with Borrowers are treated as a single employer under Section 414 of the Internal Revenue Code. "Event of Default" has the meaning set forth in Section 8.1. 9 "Excluded Subsidiaries" means all Subsidiaries of Borrowers that: (i) are not organized under the laws of any state or any territory of the United States of America, or (ii) are not wholly owned by any Borrower or any Subsidiary. "Expenses" means (i) all out-of-pocket expenses of Bank paid or incurred in connection with their due diligence and investigation of Borrower, including appraisal, filing, recording, documentation, publication and search fees and other such expenses, and all attorneys' fees and expenses (including attorneys' fees incurred pursuant to proceedings arising under the Bankruptcy Code) incurred in connection with the structuring, negotiation, drafting, preparation, execution and delivery of this Agreement, the Loan Documents, and any and all other documents, instruments and agreements entered into in connection herewith; (ii) all out-of-pocket expenses of Bank, including attorneys' fees and expenses (including attorneys' fees incurred pursuant to proceedings arising under the Bankruptcy Code) paid or incurred in connection with the negotiation, preparation, execution and delivery of any waiver, forbearance, consent, amendment or addition to this Agreement or any Loan Document, or the termination hereof and thereof; (iii) all costs or expenses paid or advanced by Bank which are required to be paid by Borrowers under this Agreement or the Loan Documents, including taxes and insurance premiums of every nature and kind of Bank; and (iv) if an Event of Default occurs, all expenses paid or incurred by Bank, including attorneys' fees and expenses (including attorneys' fees incurred pursuant to proceedings arising under the Bankruptcy Code), costs of collection, suit, arbitration, judicial reference and other enforcement proceedings, and any other out-of-pocket expenses incurred in connection therewith or resulting therefrom, whether or not suit is brought, or in connection with any refinancing or restructuring of the Obligations and the liabilities of Borrowers under this Agreement, any of the Loan Documents, or any other document, instrument or agreement entered into in connection herewith in the nature of a workout. "Fees" means the Late Payment Fee, the Letter of Credit Fees, the Unused Revolving Commitment Fee and the Audit Fees. "Financial Statement(s)" means, with respect to any accounting period of any Person, statements of income and statements of cash flows of such Person for such period, and balance sheets of such Person as of the end of such period, setting forth in each case in comparative form figures for the corresponding period in the preceding fiscal year or, if such period is a full fiscal year, corresponding figures from the preceding annual audit, all prepared in reasonable detail and in accordance with GAAP, subject to year-end adjustments in the case of monthly Financial Statements. Financial Statement(s) shall include the schedules thereto and annual Financial Statements shall also include the footnotes thereto. "Foreign Exchange Agreement" means that certain Foreign Currency Exchange Master Agreement, dated as of January 11, 2002, between Parent and Bank, together with all other Bank's standard agreements, instruments and documents executed by a Borrower in connection therewith. "Foreign Exchange Reserve" means an amount equal to ten percent (10%) of the Dollar equivalent of all of Borrower's outstanding Currency Obligations. 10 "Foreign Exchange Sublimit" means Ten Million Dollars ($10,000,000). "GAAP" means generally accepted accounting principles in the United States of America, consistently applied, which are in effect as of the date of this Agreement. If any changes in accounting principles from those in effect on the date hereof are hereafter occasioned by promulgation of rules, regulations, pronouncements or opinions by or are otherwise required by the Financial Accounting Standards Board or the American Institute of Certified Public Accountants (or successors thereto or agencies with similar functions), and any of such changes results in a change in the method of calculation of, or affects the results of such calculation of, any of the financial covenants, standards or terms found herein, then the parties hereto agree to enter into and diligently pursue negotiations in order to amend such financial covenants, standards or terms so as to equitably reflect such changes, with the desired result that the criteria for evaluating financial condition and results of operations of Borrower and the Subsidiaries shall be the same after such changes as if such changes had not been made. "Governing Documents" means the certificate or articles or certificate of incorporation, by-laws, articles or certificate of organization, operating agreement, or other organizational or governing documents of any Person. "Governmental Authority" means any federal, state, local or other governmental department, commission, board, bureau, agency, central bank, court, tribunal or other instrumentality or authority or subdivision thereof, domestic or foreign, exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government. "Guaranties" and "Guaranty" means, individually or collectively as the context requires, each certain Continuing Guaranty executed by a Guarantor in favor of Bank. "Guarantor(s)" means, individually or collectively as the context requires, all Subsidiaries (other than Excluded Subsidiaries), and every other Person who hereafter executes a Guaranty in favor of Bank with respect to the Obligations. On the Closing Date there are no Guarantors. "Hazardous Materials" means all or any of the following: (a) substances that are defined or listed in, or otherwise classified pursuant to, any applicable laws or regulations as hazardous substances, hazardous materials, hazardous wastes, toxic substances, or any other formulation intended to define, list, or classify substances by reason of deleterious properties such as ignitability, corrosivity, reactivity, carcinogenicity, reproductive toxicity, or EP toxicity or are otherwise regulated for the protection of persons, property or the environment; (b) oil, petroleum, or petroleum derived substances, natural gas, natural gas liquids, synthetic gas, drilling fluids, produced waters, and other wastes associated with the exploration, development, or production of crude oil, natural gas, or geothermal resources; (c) any flammable substances or explosives or any radioactive materials; and (d) asbestos in any form or electrical equipment which contains any oil or dielectric fluid containing levels of polychlorinated biphenyls in excess of fifty (50) parts per million. "Indemnified Person(s)" has the meaning given to such term in Section 10.3(c). 11 "Insolvency Proceeding" means any proceeding commenced by or against any Person, under any provision of the Bankruptcy Code, or under any other bankruptcy or insolvency law, including, but not limited to, assignments for the benefit of creditors, formal or informal moratoriums, compositions, or extensions with some or all creditors. "Intangible Assets" means, with respect to any Person, that portion of the book value of all of such Person's assets that would be treated as intangibles under GAAP. "Interest Payment Date" means: (i) with respect to each Base Lending Rate Portion, the last day of each and every month commencing the first such day after the making of such Loan, and the Revolving Loans Maturity Date; and (ii) with respect to each LIBOR Lending Rate Portion, the earlier of: (1) the last day of the Interest Period with respect thereto, or (2) if the Interest Period has a duration of more than three months, every LIBOR Business Day that occurs during such Interest Period every three months from the first day of such Interest Period. "Interest Period" means, with respect to each LIBOR Lending Rate Portion, the period commencing on the date of such LIBOR Lending Rate Portion and ending on the numerically corresponding day one (1), two (2), three (3) or six (6) months thereafter as Parent may elect pursuant to the applicable Notice of Borrowing or Notice of Conversion or Continuation; provided, however, that: (i) any Interest Period which would otherwise end on a day which is not a LIBOR Business Day shall be extended to the next succeeding LIBOR Business Day unless such LIBOR Business Day falls in another calendar month in which case such Interest Period shall end on the immediately preceding LIBOR Business Day; (ii) any Interest Period which begins on the last LIBOR Business Day of the calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall end on the last LIBOR Business Day of the calendar month in which it would have ended if there were a numerically corresponding day in such calendar month; and (iii) no Interest Period may extend beyond the Revolving Loans Maturity Date. "Internal Revenue Code" means the Internal Revenue Code of 1986, as amended from time to time, or any successor statute, and any and all regulations thereunder. "Inventory" has the meaning given to such term in the Security Agreement. "Inventory Sublimit" means Seven Million Five Hundred Thousand Dollars ($7,500,000). 12 "Inventory Turnover Ratio" means, with respect to any fiscal quarter of Parent, the ratio of (i) Borrowers' consolidated aggregate cost of all Inventory sold during such period, to (ii) the Average Quarterly Inventory divided by four (4). As used herein, "Average Quarterly Inventory" means the result of: (x) the sum of (1) the consolidated aggregate value of all Inventory as of the first day of the subject fiscal quarter plus (2) the consolidated aggregate value of all Inventory as of the last day of the subject fiscal quarter, in each case valued at the lesser of cost or market value, divided by (y) two (2). "ISP" means the International Standby Practices (1998 version), and any subsequent versions or revisions approved by a Congress of the International Chamber of Commerce Publication 590 and adhered to by Bank. "Knowledge" has the meaning given to such term in Section 10.9. "Late Payment Fee" has the meaning given to such term in Section 2.15(b). "Lending Office" means Bank's office located at its address set forth on the signature pages hereof, or such other office of Bank as it may hereafter designate as its Lending Office by notice to Parent. "Letter(s) of Credit" has the meaning given to such term in Section 3.1(a). "Letter of Credit Application" means a Commercial Letter of Credit Application and Agreement or a Standby Letter of Credit Application and Agreement, as applicable, substantially in the forms of Exhibits 1.1L-1 and 1.1L-2, respectively. "Letter of Credit Fee" has the meaning given to such term in Section 3.3(a). "Letter of Credit Sublimit" means Ten Million Dollars ($10,000,000). "Letter of Credit Usage" means, on any date of determination, the aggregate maximum amounts available to be drawn under all outstanding Letters of Credit, without regard to whether any conditions to drawing could then be met. "LIBOR" means London interbank offered rate. "LIBOR Business Day" means any Business Day on which major commercial banks are open for international business (including dealings in Dollar deposits) in Los Angeles, California and London, England. "LIBOR Lending Rate" means, with respect to a LIBOR Lending Rate Portion, the rate per annum (rounded upwards if necessary to the nearest whole one-hundredth of one percent (.01%)), determined as the sum of: (a) the quotient of: (i) Base LIBOR for the relevant Interest Period of such LIBOR Lending Rate Portion; divided by (ii) the number equal to one hundred percent (100%) minus the LIBOR Reserve Percentage with respect to such Interest Period; plus (b) the Applicable LIBOR Lending Rate Margin. The LIBOR Lending Rate shall be adjusted automatically on the effective date of any change in the LIBOR Reserve Percentage, such adjustment to 13 affect any LIBOR Lending Rate Portion outstanding on such effective date to the extent such change is applied retroactively to eurocurrency funding of a member bank in the Federal Reserve System. Each determination of a LIBOR Lending Rate by Bank, including, but not limited to, any determination as to the applicability or allocability of reserves to eurocurrency liabilities or as to the amount of such reserves, shall be conclusive and final in the absence of manifest error. "LIBOR Lending Rate Portion" means any portion of any Loan designated by a Borrower as bearing interest at the LIBOR Lending Rate pursuant to Section 2.5 or 2.6. "LIBOR Reserve Percentage" means, for any Interest Period of any LIBOR Lending Rate Portion, the daily average of the stated maximum rate (rounded upward to the nearest one-hundredth of one percent (.01%)), as determined by Bank in accordance with its usual procedures (which determination shall be conclusive in the absence of manifest error), at which reserves are required to be maintained during such Interest Period by Bank (including supplemental, marginal, and emergency reserves) under Regulation D by Bank against Eurocurrency liabilities (as such term is defined in Regulation D), but without benefit or credit of proration, exemptions, or offsets that might otherwise be available to Bank from time to time under Regulation D. Without limiting the generality of the foregoing, LIBOR Reserve Percentage shall include any other reserves required to be maintained by Bank against (i) any category of liabilities that includes deposits by reference to which the LIBOR Lending Rate for a LIBOR Lending Rate Portion is being determined and (ii) any category of extension of credit or other assets that includes LIBOR Lending Rate Portion. "Lien" means any mortgage, deed of trust, pledge, security interest, hypothecation, assignment, deposit arrangement or other preferential arrangement, charge or encumbrance (including, any conditional sale or other title retention agreement, or finance lease) of any kind. "Loan Document(s)" means each of the following documents, instruments, and agreements individually or collectively, as the context requires: (i) the Note; (ii) the Security Agreement; (iii) the Letter of Credit Applications; (iv) the Guaranties; (v) the Stock Pledge Agreement; (vi) the Patent and Trademark Security Agreements; (vii) the Foreign Exchange Agreement; and (viii) such other documents, instruments, and agreements (including intellectual property security agreements, control agreements, financing statements and fixture filings) as Bank may reasonably request in connection with the transactions contemplated hereunder or to perfect or protect the liens and security interests granted to Bank in connection herewith. 14 "Loans" means the Revolving Loans (each, a "Loan"). "Material Adverse Effect" means a material adverse effect on (i) the business, Assets, condition (financial or otherwise), or results of operations of the Borrower and the Subsidiaries taken as a whole; (ii) the ability of any Borrower to perform its obligations under this Agreement and the Loan Documents to which it is a party (including, without limitation, repayment of the Obligations as they come due), or the ability of any Guarantor to perform its obligations under the Loan Documents to which it is a party, (iii) the validity or enforceability of this Agreement, the Loan Documents, or the rights or remedies of Bank hereunder and thereunder, (iv) the value of the Assets (taken as a whole) assigned or pledged to Bank as collateral, or (v) the priority of Bank's Liens with respect to the Assets assigned or pledged thereto as collateral. "Multiemployer Plan" means a multiemployer plan as defined in Section 4001(a)(3) of ERISA or Section 3(37) of ERISA to which any member of the ERISA Group has contributed, or was obligated to contribute, within the preceding six plan years (while a member of such ERISA Group) including for these purposes any Person which ceased to be a member of the ERISA Group during such six year period. "Net Cash Proceeds" means in connection with any Asset Sale, the cash proceeds (including any cash payments received by way of deferred payment whether pursuant to a note, installment receivable or otherwise, but only as and when actually received) from such Asset Sale, less any proceeds used to replace the Asset which is the subject of the Asset Sale and net of (i) attorneys' fees, accountants' fees, investment banking fees, brokerage commissions and amounts required to be applied to the repayment of any portion of the Debt secured by a Lien not prohibited hereunder on any Asset which is the subject of such sale, (ii) other customary fees, expenses and commissions incurred in connection with the Asset Sale, and (iii) taxes paid or reasonably estimated to be payable as a result of such Asset Sale. "Note" means, the Secured Promissory Note, dated as of even date herewith, executed by Borrowers to the order of Bank, in the principal amount of Twenty Million Dollars ($20,000,000). "Notice of Borrowing" means an irrevocable notice from a Borrower to Bank of such Borrower's request for a Borrowing pursuant to the terms of Section 2.5, substantially in the form of Exhibit 2.5(b). "Notice of Conversion or Continuation" means a written notice given pursuant to the terms of Section 2.6(b), substantially in the form of Exhibit 2.6(b). "Obligations" means any and all indebtedness, liabilities, and obligations of Borrower owing to Bank and to its successors and assigns, previously, now, or hereafter incurred, and howsoever evidenced, whether direct or indirect, absolute or contingent, joint or several, liquidated or unliquidated, voluntary or involuntary, due or not due, legal or equitable, whether incurred before, during, or after any Insolvency Proceeding and whether recovery thereof is or becomes barred by a statute of limitations or is or becomes otherwise unenforceable or unallowable as claims in any Insolvency Proceeding, together with all interest thereupon (including interest under 15 Section 2.4(b) and including any interest that, but for the provisions of the Bankruptcy Code, would have accrued during the pendency of an Insolvency Proceeding. The Obligations shall include, without limiting the generality of the foregoing, all principal and interest owing under the Loans, all Reimbursement Obligations, all Expenses, the Fees, any other fees and expenses due hereunder and under the Loan Documents (including any fees or expenses that, but for the provisions of the Bankruptcy Code, would have accrued during the pendency of an Insolvency Proceeding), and all other indebtedness evidenced by this Agreement and/or the Loan Documents. "Old Lender" means Congress Financial Corporation (Western). "Overadvance" has the meaning set forth in Section 2.1(c). "Participant" has the meaning set forth in Section 10.5(d). "Patent and Trademark Security Agreement" means each certain Patent and Trademark Security Agreement now or hereafter entered into by any Borrower and Bank. "Pay-Off Letter" means that certain letter, in form and substance reasonably satisfactory to Bank, from Old Lender respecting the amount necessary to repay in full all of the obligations of Borrowers or any Subsidiary owing to Old Lender and obtain a termination or release of all of the Liens existing in favor of Old Lender in and to the Assets of Borrowers and such Subsidiaries. "PBGC" means the Pension Benefit Guaranty Corporation or any entity succeeding to any or all of its functions under ERISA. "Permitted Debt" means (i) Debt owing to Bank in accordance with the terms of this Agreement and the Loan Documents, (ii) Debt listed on Schedule 5.6, but no renewals, extensions or refinancings thereof, (iii) Debt up to a maximum aggregate amount of Five Hundred Thousand Dollars ($500,000) outstanding at any one time incurred in the ordinary course of business, (iv) trade obligations and normal accruals in the ordinary course of its business not yet due and payable, or with respect to which such Borrower is contesting in good faith the amount of validity thereof by appropriate proceedings diligently pursued and available to such Borrower, and (v) obligations or indebtedness owing to another Borrower or Subsidiary to the extent permitted by Section 7.8, and (vi) Debt issued in connection with Parent's exercise of its purchase option as set forth in the Teva Option Agreement, provided that such Debt is on terms and conditions, and in such amount, satisfactory to Bank in its sole and absolute discretion, and is subordinated to the Obligations on terms and conditions satisfactory to Bank in its sole and absolute discretion. "Permitted Investments" means any of the following investments denominated and payable in Dollars, maturing within one year from the date of acquisition, selected by a Borrower: (i) marketable direct obligations issued or unconditionally guaranteed by the United States government or issued by any agency thereof and backed by the full faith and credit of the United States; (ii) marketable direct obligations issued by any state of the United States or any political subdivision of any such state or any public instrumentality thereof and, at the time of acquisition, having a credit rating obtainable from Standard & Poor's Corporation ("S&P") of not less than A-1 16 or not less than P-1 from Moody's Investors Service, Inc. ("Moody's"); (iii) commercial paper or corporate promissory notes bearing at the time of acquisition a credit rating of S&P of not less than A-1 or not less than P-1 from Moody's issued by United States, Canadian, European or Japanese bank holding companies or industrial or financial companies, with maturities of 180 days or less; (iv) certificates of deposit issued by and bankers acceptances of and interest bearing deposits with Bank; and (v) money market funds organized under the laws of the United States or any state thereof that invest predominantly in any of the foregoing investments permitted under clauses (i), (ii), (iii) and (iv). "Permitted Liens" means (i) Liens for current taxes, assessments or other governmental charges which are not delinquent or remain payable without any penalty, or are being contested in good faith by appropriate proceedings, provided that, if delinquent, adequate reserves have been set aside with respect thereto as required by GAAP and, by reason of nonpayment, no property is subject to a material risk of loss or forfeiture; (ii) Liens in favor of Bank, in accordance with the Loan Documents, (iii) statutory Liens, such as inchoate mechanics', inchoate materialmen's, landlord's, warehousemen's, and carriers' liens, and other similar liens, other than those described in clause (i) above, arising in the ordinary course of business with respect to obligations which are not delinquent or are being contested in good faith by appropriate proceedings, provided that, if delinquent, adequate reserves have been set aside with respect thereto as required by GAAP and, by reason of nonpayment, no property is subject to a material risk of loss or forfeiture; (iv) Liens relating to Capital Lease Obligations permitted hereunder and Liens securing any leases permitted in Section 7.5, (v) judgment Liens that do not constitute an Event of Default under Section 8.1(i), and (vi) Liens, if they constitute such, of any true lease and consignment UCC filings permitted hereunder, and (vii) Purchase Money Liens securing Debt described in clauses (ii) and (iii) of the definition of "Permitted Debt" hereinabove. "Person" means and includes natural persons, corporations, limited partnerships, general partnerships, limited liability companies, limited liability partnerships, joint stock companies, joint ventures, associations, companies, trusts, banks, trust companies, land trusts, business trusts, or other organizations, irrespective of whether they are legal entities, and governments and agencies and political subdivisions thereof. "Plan" means an employee benefit plan as defined in Section 3(3) of ERISA in which any personnel of any member of the ERISA Group participate or from which any such personnel may derive a benefit or with respect to which any member of the ERISA Group may incur liability, excluding any Multiemployer Plan, but including any plan either established or maintained by any member of the ERISA Group or to which such Person contributes under the laws of any foreign country. "Purchase Money Lien" means a Lien on any item of equipment of a Borrower; provided that (i) such Lien attaches only to that Asset and (ii) the purchase-money obligation secured by such item of equipment does not exceed one hundred percent (100%) of the purchase price of such item of equipment. 17 "Quick Ratio" means, as of the date of determination, the ratio of (i) Borrowers' consolidated accounts receivable plus Borrowers' consolidated cash on hand and marketable securities, to (ii) Current Liabilities plus outstanding Revolving Loans. "Regulation D" means Regulation D of the Board of Governors of the Federal Reserve System, as such regulation may be amended or supplemented from time to time. "Reimbursement Obligations" means the obligations of Borrowers to reimburse Bank pursuant to Section 3.4 amounts drawn under Letters of Credit. "Reportable Event" means any of the events described in Section 4043(c) of ERISA other than a Reportable Event as to which the provision of 30 days notice to the PBGC is waived under applicable regulations. "Responsible Officer" means either the Chief Executive Officer, Chief Financial Officer or Controller of a Person, or such other officer, employee, or Bank of such Person designated by a Responsible Officer in a writing delivered to Bank. "Retiree Health Plan" means an employee welfare benefit plan within the meaning of Section 3(1) of ERISA that provides benefits to individuals after termination of their employment, other than as required by Section 601 of ERISA. "Revolving Credit Commitment" means Twenty Million Dollars ($20,000,000). "Revolving Loans" has the meaning given to such term in Section 2.1. "Revolving Loans Daily Balances" means the amount determined by taking the amount of the obligations owed under the Revolving Loans at the beginning of a given day, adding any new Revolving Loans advanced or incurred on such date, and subtracting any payments or collections on the Revolving Loans which are deemed to be paid on that date under the provisions of this Agreement. "Revolving Loans Maturity Date" means June 1, 2004. "SEC" means United States Securities and Exchange Commission. "Security Agreement" means that certain Security Agreement, dated as of even date herewith, among Borrowers and Bank. "Shareholder" means a shareholder of any Borrower. "Solvent" means, with respect to any Person on the date any determination thereof is to be made, that on such date: (a) the present fair valuation of the Assets of such Person is greater than such Person's probable liability in respect of existing debts; (b) such Person does not intend to, and does not believe that it will, incur debts beyond such Person's ability to pay as such debts mature; and (c) such Person is not engaged in business or a transaction, and is not about to engage in business or a transaction, which would leave such Person with Assets remaining which would 18 constitute unreasonably small capital after giving effect to the nature of the particular business or transaction. For purposes of this definition (i) the fair valuation of any property or assets means the amount realizable within a reasonable time, either through collection or sale of such Assets at their regular market value, which is the amount obtainable by a capable and diligent Person from an interested buyer willing to purchase such property or assets within a reasonable time under ordinary circumstances; and (ii) the term debts includes any payment obligation, whether or not reduced to judgment, equitable or legal, matured or unmatured, liquidated or unliquidated, disputed or undisputed, secured or unsecured, absolute, fixed or contingent. "Stock Pledge Agreement" means that certain Security Agreement-Stock Pledge, dated as of even date herewith, between Parent and Bank. "Subsidiary" means any corporation, limited liability company, partnership, trust or other entity (whether now existing or hereafter organized or acquired) of which any Borrower or one or more Subsidiaries of any Borrower at the time owns or controls directly or indirectly more than 50% of the shares of stock or partnership or other ownership interest having general voting power under ordinary circumstances to elect a majority of the board of directors, managers or trustees or otherwise exercising control of such corporation, limited liability company, partnership, trust or other entity (irrespective of whether at the time stock or any other form of ownership of any other class or classes shall have or might have voting power by reason of the happening of any contingency). "Swaps" means payment obligations with respect to interest rate swaps, currency swaps and similar obligations obligating a Person to make payments, whether periodically or upon the happening of a contingency. For the purposes of this Agreement, the amount of the obligation under any Swap shall be the amount determined, in respect thereof as of the end of the then most recently ended fiscal quarter of Borrowers, based on the assumption that such Swap had terminated at the end of such fiscal quarter, and in making such determination, if any agreement relating to such Swap provides for the netting of amounts payable by and to each party thereto or if any such agreement provides for the simultaneous payment of amounts by and to each party, then in each such case, the amount of such obligation shall be the net amount so determined. "Taxes" has the meaning set forth in Section 9.1. "Teva License Agreement" means that certain Teva License Agreement, dated June 7, 1999, between Mark Thatcher, as licensor, and Parent, as licensee, wherein Parent licensed the right to manufacture, distribute, sell and advertise the Licensed Products (as defined therein) under the Teva(R) brand name. "Teva Option Agreement" means that certain Intellectual Property Option Agreement, dated June 7, 1999, between Mark Thatcher and Parent. "UCC" means the California Uniform Commercial Code, as amended or supplemented from time to time. 19 "Uniform Customs" means the Uniform Customs and Practice for Documentary Credits (1993 Revision), International Chamber of Commerce Publication No. 500, as the same may be amended from time to time. "Unmatured Event of Default" means any condition or event which with the giving of notice or lapse of time or both would, unless cured or waived, become an Event of Default. "Unused Revolving Commitment Fee" has the meaning set forth in Section 2.15(a). 1.2 Accounting Terms and Determinations. Unless otherwise specified herein, all accounting terms used herein shall be interpreted, all accounting determinations hereunder shall be made, and all financial statements required to be delivered hereunder shall be prepared in accordance with GAAP. 1.3 Computation of Time Periods. In this Agreement, with respect to the computation of periods of time from a specified date to a later specified date, the word from means from and including and the words to and until each mean to but excluding. Periods of days referred to in this Agreement shall be counted in calendar days unless otherwise stated. 1.4 Construction. Unless the context of this Agreement clearly requires otherwise, references to the plural include the singular and to the singular include the plural, references to any gender include any other gender, the part includes the whole, the term including is not limiting, and the term or has, except where otherwise indicated, the inclusive meaning represented by the phrase and/or. References in this Agreement to determination by Bank include good faith estimates by Bank (in the case of quantitative determinations), and good faith beliefs by Bank (in the case of qualitative determinations). The words hereof, herein, hereby, hereunder, and similar terms in this Agreement refer to this Agreement as a whole and not to any particular provision of this Agreement. Article, section, subsection, clause, exhibit and schedule references are to this Agreement, unless otherwise specified. Any reference in this Agreement or any of the Loan Documents to this Agreement or any of the Loan Documents includes any and all permitted alterations, amendments, changes, extensions, modifications, renewals, or supplements thereto or thereof, as applicable. 1.5 Exhibits and Schedules. All of the exhibits and schedules attached hereto shall be deemed incorporated herein by reference. 1.6 No Presumption Against Any Party. Neither this Agreement, any of the Loan Documents, any other document, agreement, or instrument entered into in connection herewith, nor any uncertainty or ambiguity herein or therein shall be construed or resolved using any presumption against any party hereto, whether under any rule of construction or otherwise. On the contrary, this Agreement, the Loan Documents, and the other documents, instruments, and agreements entered into in connection herewith have been reviewed by each of the parties and their counsel and shall be construed and interpreted according to the ordinary meanings of the words used so as to accomplish fairly the purposes and intentions of all parties hereto. 20 1.7 Independence of Provisions. All agreements and covenants hereunder, under the Loan Documents, and the other documents, instruments, and agreements entered into in connection herewith shall be given independent effect such that if a particular action or condition is prohibited by the terms of any such agreement or covenant, the fact that such action or condition would be permitted within the limitations of another agreement or covenant shall not be construed as allowing such action to be taken or condition to exist. ARTICLE II TERMS OF THE CREDIT 2.1 Revolving Loans. Provided that no Event of Default or Unmatured Event of Default has occurred and is continuing, and subject to the other terms and conditions hereof, Bank agrees to make revolving loans ("Revolving Loans") to Borrowers, upon notice in accordance with Section 2.5(b), from the Closing Date up to but not including the Revolving Loans Maturity Date, the proceeds of which shall be used only for the purposes allowed in Section 7.1(a), subject to the following conditions and limitations: (a) The outstanding ABL Triggering Obligations after giving effect to any proposed Borrowing shall not exceed the Revolving Credit Commitment; provided, however, during each and every ABL Borrowing Period, the outstanding ABL Triggering Obligations after giving effect to any proposed Borrowing shall not exceed the Borrowing Base; (b) Borrowers shall not be permitted to borrow, and Bank shall not be obligated to make, any Revolving Loans to Borrowers, unless and until all of the conditions for a Borrowing set forth in Section 4.2 have been met to the reasonable satisfaction of Bank; and (c) If, at any time or for any reason, the amount of the ABL Triggering Obligations is in excess of the ABL Trigger Amount and exceeds the Borrowing Base (an "Overadvance"), Borrowers shall immediately pay to Bank, upon Bank's election and demand, in cash, the amount of such Overadvance to be used by Bank to repay outstanding Borrowings. Borrowers may repay and, subject to the terms and conditions hereof, reborrow Revolving Loans. All such repayments shall be without penalty or premium except as otherwise required by Section 2.7 with respect to repayments of LIBOR Lending Rate Portions. Borrowers shall give Bank at least three (3) LIBOR Business Days' prior written notice of any repayment of a LIBOR Lending Rate Portion. On the Revolving Loans Maturity Date, Borrowers shall pay to Bank the entire unpaid principal balance of the Revolving Loans together with all accrued but unpaid interest thereon. 2.2 Foreign Exchange Forward Contracts. Provided that no Event of Default or Unmatured Event of Default has occurred and is continuing, and subject to the other terms and conditions of this Agreement and the Foreign Exchange Agreement, Parent may incur Currency Obligations from time to time from the Closing Date up to but not including the Revolving Loans Maturity Date, subject to the following conditions and limitations: 21 (a) Tenors for Parent's Currency Obligations shall not exceed the lesser of 365 days and the Revolving Loans Maturity Date; (b) The aggregate amount of Parent's Currency Obligations outstanding at any one time after giving effect to any proposed incurrence of a Currency Obligation by Parent shall not exceed the Foreign Exchange Sublimit; (c) The outstanding ABL Triggering Obligations after giving effect to any proposed incurrence of a Currency Obligation by Parent shall not exceed the Revolving Credit Commitment; provided, however, during each and every ABL Borrowing Period, the outstanding ABL Triggering Obligations after giving effect to such proposed incurrence of a Currency Obligation by Parent shall not exceed the Borrowing Base; (d) The Currency Obligations shall be incurred by Parent only for international transactions incurred in the ordinary course of business; and (e) In connection with all Currency Obligations, Borrowers shall pay all amounts due to Bank, including all fees, charges and expenses, in accordance with the terms of the Foreign Exchange Agreement. 2.3 Reserved. 2.4 Interest Rates; Payments of Interest. (a) Interest Rate Options. (i) Revolving Loans. Subject to the terms and conditions hereof, all Revolving Loans, or portions thereof, may be outstanding as either Base Lending Rate Portions or LIBOR Lending Rate Portions, by designating, in accordance with Sections 2.5(b) and 2.6(b), either the Base Lending Rate or the LIBOR Lending Rate to apply to all or any portion of the unpaid principal balance of the Revolving Loans. (ii) Limitations on LIBOR Lending Rate Portions. There shall be no more than three (3) LIBOR Lending Rate Portions outstanding at any time. LIBOR Lending Rate Portions shall be in minimum aggregate amounts each of One Million Dollars ($1,000,000). (b) Default Rate. Upon the occurrence and during the continuance of an Event of Default, in addition to and not in substitution of any of Bank's other rights and remedies with respect to such Event of Default, the entire unpaid principal balance of the Loans shall bear interest at the otherwise applicable rate plus three hundred (300) basis points. In addition, interest, Expenses, the Fees, and other amounts due hereunder not paid when due shall bear interest at the Base Lending Rate plus three hundred (300) basis points until such overdue payment is paid in full. (c) Computation of Interest. All computations of interest shall be calculated on the basis of a year of three hundred sixty (360) days for the actual days elapsed. In the event that the Base Rate announced is, from time to time, changed, adjustment in the rate of interest payable hereunder on all Base Lending Rate Portions shall be made as of 12:01 a.m. (Pacific time) 22 on the effective date of the change in the Base Rate. Interest shall accrue from the Closing Date to the date of repayment of the Loans in accordance with the provisions of this Agreement; provided, however, if a Loan is repaid on the same day on which it is made, then one (1) day's interest shall be paid on that Loan. Any and all interest not paid when due shall thereafter be deemed to be a Revolving Loan as a Base Lending Rate Portion made under Section 2.1 and shall bear interest thereafter as provided for in Section 2.4(b). (d) Change in Applicable Base Lending Rate Margin and Applicable LIBOR Lending Rate Margin. Changes in the Applicable Base Lending Rate Margin and Applicable LIBOR Lending Rate Margin resulting from a change in the Consolidated Total Liabilities to Consolidated Effective Tangible Net Worth Ratio, shall become effective on the first day of the calendar month following Bank's receipt of the latest Compliance Certificate, and shall be based on the Consolidated Total Liabilities to Consolidated Effective Tangible Net Worth Ratio disclosed in such Compliance Certificate; provided, however, for purposes of determining the aforementioned margins, (i) until such time as Parent has delivered to Bank the first accurately completed Compliance Certificate when due hereunder, the Consolidated Total Liabilities to Consolidated Effective Tangible Net Worth Ratio shall be presumed to be less than 0.50:1.0 until the applicable Compliance Certificate has been so completed and delivered to Bank, and (ii) if Parent fails to deliver to Bank an accurately completed Compliance Certificate when due hereunder, the Consolidated Total Liabilities to Consolidated Effective Tangible Net Worth Ratio shall be conclusively presumed to be greater than 0.75:1.0 until the applicable Compliance Certificate has been so completed and delivered to Bank. No reduction in the Applicable Base Lending Rate Margin or Applicable LIBOR Lending Rate Margin shall be granted if an Event of Default has occurred and is continuing. (e) Maximum Interest Rate. In no event shall the interest rate and other charges hereunder exceed the highest rate permissible under any law which a court of competent jurisdiction shall, in a final determination, deem applicable hereto. In the event that such a court determines that Bank has received interest and other charges hereunder in excess of the highest rate applicable hereto, such excess shall be deemed received on account of, and shall automatically be applied to reduce, the Obligations, other than interest, in the inverse order of maturity, and the provisions hereof shall be deemed amended to provide for the highest permissible rate. If there are no Obligations outstanding, Bank shall refund to Borrowers such excess. (f) Payments of Interest. All accrued but unpaid interest on the Loans, calculated in accordance with this Section 2.4, shall be due and payable, in arrears, on each and every Interest Payment Date. 2.5 Notice of Borrowing Requirements. (a) Each Borrowing of a Base Lending Rate Portion shall be made on a Business Day and each Borrowing of a LIBOR Lending Rate Portion shall be made on a LIBOR Business Day. (b) Each Borrowing shall be made upon telephonic notice given by a Responsible Officer of a Borrower, followed by a Notice of Borrowing, given by facsimile or 23 personal service, delivered to Bank at the address set forth in the Notice of Borrowing. If for a Base Lending Rate Portion, Bank shall be given such notice no later than 11:00 a.m., Pacific time, one (1) Business Day prior to the day on which such Borrowing is to be made, and, if for a LIBOR Lending Rate Portion, Bank shall be given notice no later than 9:00 a.m., Pacific time, three (3) LIBOR Business Days prior to the day on which such Borrowing is to be made, and such notice shall state the amount and purpose thereof (subject to the provisions of Section 2.1). (c) Bank shall not incur any liability to Borrowers in acting upon any telephonic notice which Bank believes in good faith to have been given by a Responsible Officer of any Borrower, or for otherwise acting in good faith under this Section 2.5, and in making any Loans pursuant to telephonic notice. (d) So long as all of the conditions for a Borrowing of a Loan set forth herein have been satisfied, Bank shall credit the proceeds of such Loan on the applicable Borrowing date into Borrowers' general deposit account number 1891922658 maintained with Bank. 2.6 Conversion or Continuation Requirements. (a) Parent shall have the option to: (i) convert, at any time, all or any portion of any of the outstanding Loans, subject to the limitations and requirements of Section 2.4(a), from a portion bearing interest at one of the interest rate options available pursuant to Section 2.4(a) to another; or (ii) upon the expiration of any Interest Period applicable to a LIBOR Lending Rate Portion, to continue all or any portion of such LIBOR Lending Rate Portion as a LIBOR Lending Rate Portion with the succeeding Interest Period(s) of such continued LIBOR Lending Rate Portion commencing on the expiration date of the Interest Period previously applicable thereto, subject in the following limitations: (i) a LIBOR Lending Rate Portion may only be converted to a Base Lending Rate Portion or continued as a LIBOR Lending Rate Portion on the expiration date of the Interest Period applicable thereto; (ii) no outstanding Loan, or portion thereof, may be continued as, or be converted into, a LIBOR Lending Rate Portion in the event that, on the earlier of the date of the delivery of the Notice of Conversion or Continuation or the telephonic notice in respect thereof, any Event of Default or Unmatured Event of Default has occurred and is continuing; (iii) if Parent fails to deliver the appropriate Notice of Conversion or Continuation or the telephonic notice in respect thereof pursuant to the required notice period before the expiration of the Interest Period of a LIBOR Lending Rate Portion, such LIBOR Lending Rate Portion shall automatically be converted to a Base Lending Rate Portion; and (iv) no outstanding Loan may be continued as, or be converted into, a LIBOR Lending Rate Portion in the event that, after giving effect to any such conversion or continuation, there would be more than three (3) LIBOR Lending Rate Portions outstanding. (b) Parent shall give telephonic notice of any proposed continuation or conversion pursuant to this Section 2.6 followed by a Notice of Conversion or Continuation, given 24 by facsimile or personal service, delivered to Bank at the address set forth in the Notice of Conversion or Continuation, no later than 11:00 a.m., Pacific time, on the Business Day which is the proposed conversion date (in the case of a conversion to a Base Lending Rate Portion) and no later than 9:00 a.m., Pacific time, three (3) LIBOR Business Days in advance of the proposed conversion or continuation date (in the case of a conversion to, or a continuation of, a LIBOR Lending Rate Portion). If such Notice of Conversion or Continuation is received by Bank not later than 11:00 a.m., Pacific time, on a LIBOR Business Day, such day shall be treated as the first LIBOR Business Day of the required notice period. In any other event, such notice will be treated as having been received at the opening of business of the next LIBOR Business Day. A Notice of Conversion or Continuation shall specify: (1) the proposed conversion or continuation date (which shall be a Business Day or a LIBOR Business Day, as applicable); (2) the amount of the Revolving Loan to be converted or continued; (3) the nature of the proposed conversion or continuation; and (4) in the case of a conversion to or continuation of a LIBOR Lending Rate Portion, the requested Interest Period. (c) Bank shall not incur any liability to Borrowers in acting upon any telephonic notice referred to above which Bank believes in good faith to have been given by a Responsible Officer of Parent or for otherwise acting in good faith under this Section 2.6. Any Notice of Conversion or Continuation (or telephonic notice in respect thereof) shall be irrevocable and Borrowers shall be bound to convert or continue in accordance therewith. 2.7 Additional Costs. (a) Borrowers shall reimburse Bank for any increase in Bank's costs (which shall include, but not be limited to, taxes, other than taxes imposed on the overall net income of Bank, fees or charges), or any loss or expense (including, without limitation, any loss or expense incurred by reason of the liquidation or re-employment of deposits or other funds acquired by Bank to fund or maintain outstanding the principal amount of the Loans) incurred by it directly or indirectly resulting from the making of any LIBOR Lending Rate Portion due to: (i) the modification, adoption, or enactment of any law, rule, regulation or treaty or the interpretation thereof by any governmental or other authority (whether or not having the force of law) which becomes effective after the date hereof; (ii) the modification or new application of any law, regulation or treaty or the interpretation thereof by any governmental or other authority (whether or not having the force of law) which becomes effective after the date hereof; (iii) compliance by Bank with any request or directive (whether or not having the force of law) of any monetary or fiscal agency or authority which becomes effective after the date hereof; (iv) violations by Borrowers of the terms of this Agreement; or (v) any prepayment of a LIBOR Lending Rate Portion at any time prior to the end of the applicable Interest Period, including pursuant to Section 8.2. (b) The amount of such costs, losses, or expenses shall be determined solely by Bank based upon the assumption that Bank funded one hundred percent (100%) of each LIBOR Lending Rate Portion in the LIBOR market. In attributing Bank's general costs relating to its eurocurrency operations to any transaction under this Agreement or averaging any costs over a period of time, Bank may use any reasonable attribution or averaging methods which it deems appropriate and practical. Bank shall notify Borrowers of the amount due Bank pursuant to this Section 2.7 and Borrowers shall pay to Bank the amount due within fifteen (15) days of its receipt 25 of such notice. A certificate as to the amounts payable pursuant to the foregoing sentence together with whatever detail is reasonably available to Bank shall be submitted by such Bank to Borrowers. Such determination shall, if not objected to within ten (10) days, be conclusive and binding upon Borrowers in the absence of manifest error. If Bank claims increased costs, loss, or expenses pursuant to this Section 2.7, then Bank, if requested by Borrower, shall use reasonable efforts to take such steps that Borrowers reasonably requests, including designating different Lending Offices, as would eliminate or reduce the amount of such increased costs, losses, or expenses, so long as taking such steps would not, in the reasonable judgment of Bank, otherwise be disadvantageous to Bank. Any recovery by Bank or its Lending Office of amounts previously borne by Borrowers pursuant to this Section 2.7 shall be promptly remitted, without interest (unless Bank received interest on such recovered amounts), to Borrowers by such Bank. 2.8 Illegality; Impossibility. Notwithstanding anything herein to the contrary, if Bank determines (which determination shall be conclusive absent manifest error) that any law, rule, regulation, treaty or directive, or any change therein, or any change in the interpretation or administration thereof by any Governmental Authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by Bank (or its Lending Office) with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency shall make it unlawful or impossible for Bank (or its Lending Office) to fund or maintain a LIBOR Lending Rate Portion in the LIBOR market or to continue such funding or maintaining, then Bank shall give notice of such circumstances to Borrowers and (i) in the case of each and every LIBOR Lending Rate Portion which is outstanding, Borrowers shall, if requested by Bank, prepay such LIBOR Lending Rate Portion(s) on or before the date specified in such request, together with interest accrued thereon, and the date so specified shall be deemed to be the last day of the Interest Period of that LIBOR Lending Rate Portion, and concurrent with any such prepayment, Bank shall make a Base Lending Rate Portion to Borrowers in the principal amount equal to the principal amount of the LIBOR Lending Rate Portions so prepaid, and (ii) Bank shall not be obligated to make any further LIBOR Lending Rate Portions until Bank determines that it would no longer be unlawful or impossible to do so. 2.9 Disaster. Notwithstanding anything herein to the contrary, if Bank determines (which determination shall be conclusive absent manifest error) that (i) Bank is unable to determine the LIBOR Lending Rate with respect to any Notice of Borrowing or Notice of Conversion or Continuation selecting the LIBOR Lending Rate because quotations of interest rates for the relevant deposits are not being provided in the relevant amounts or for the relative maturities or (ii) the LIBOR Lending Rate will not adequately reflect the cost to Bank of making or funding LIBOR Lending Rate Portions, then (x) the right of Borrowers to select the LIBOR Lending Rate shall be suspended until Bank notifies Borrowers that the circumstances causing such suspension no longer exist, and (y) Borrowers shall repay in full the then outstanding principal balance of all LIBOR Lending Rate Portions, together with interest accrued thereon, on the last day of the Interest Period applicable to each such LIBOR Lending Rate Portion, and concurrent with any such prepayment, Bank shall make a Base Lending Rate Portion to Borrowers in the principal amount equal to the principal amount of the LIBOR Lending Rate Portions so repaid. 26 2.10 Increased Risk-Based Capital Cost. If the amount of capital required or expected to be maintained by Bank or any Person directly or indirectly owning or controlling Bank (each a "Control Person"), shall be affected by: (a) the introduction or phasing in of any law, rule or regulation after the date hereof; (b) any change after the date hereof in the interpretation of any existing law, rule or regulation by any central bank or United States or foreign governmental authority charged with the administration thereof; or (c) compliance by Bank or such Control Person with any directive, guideline or request from any central bank or United States or foreign governmental authority (whether or not having the force of law) promulgated or made after the date hereof, and Bank shall have reasonably determined that such introduction, phasing in, change or compliance shall have had or will thereafter have the effect of reducing (x) the rate of return on Bank's or such Control Person's capital, or (y) the asset value to Bank or such Control Person of the Loans made or maintained by Bank, in either case to a level below that which Bank or such Control Person could have achieved or would thereafter be able to achieve but for such introduction, phasing in, change or compliance (after taking into account Bank's or such Control Person's policies regarding capital), in either case by an amount which Bank in its reasonable judgment deems material, then, on demand by Bank, Borrowers shall pay to Bank or such Control Person such additional amount or amounts as shall be sufficient to compensate Bank or such Control Person, as the case may be, for such reduction. 2.11 Note; Statements of Obligations. The Loans and Borrowers' obligation to repay the same shall be evidenced by the Note, this Agreement and the books and records of Bank. Bank shall render monthly statements of the Loans to Borrowers, including statements of all principal and interest owing on the Loans, and all Fees and Expenses owing, and such statements (absent manifest error) shall be presumed to be correct and accurate and constitute an account stated between Borrower and Bank's unless, within thirty (30) days after receipt thereof by Parent, Parent delivers to Bank, at the address specified in Section 10.1, written objection thereof specifying the error or errors, if any, contained in any such statement. 2.12 Holidays. Any principal or interest in respect of the Loans (other than in respect of a LIBOR Lending Rate Portion) which would otherwise become due on a day other than a Business Day, shall instead become due on the next succeeding Business Day and such adjustment shall be reflected in the computation of interest; provided, however, that in the event that such due date shall, subsequent to the specification thereof by Bank, for any reason no longer constitute a Business Day, Bank may change such specified due date in accordance with this Section 2.12. 2.13 Time and Place of Payments. (a) All payments due hereunder shall be made available to Bank in immediately available Dollars, not later than 12:00 p.m., Pacific time, on the day of payment, to the following address or such other address as Bank may from time to time specify by notice to Parent: 27 Comerica Bank -- California 15303 Ventura Boulevard Sherman Oaks, California 91403 Attention: Jason D. Brown (b) Borrowers hereby authorizes Bank to charge Borrowers' general demand deposit account number 1891922658 with Bank, or any other demand deposit account maintained by any Borrower with Bank, for the amount of any payment due or past due hereunder or under any Loan Document, for the full amount thereof. Should there be insufficient funds in any such demand deposit account to pay all such sums when due, the full amount of such deficiency shall be immediately due and payable in cash by Borrowers. (c) In addition, Borrowers hereby authorizes Bank at its option, without prior notice to Borrowers, to advance a Revolving Loan as a Base Lending Rate Portion for any payment due or past due hereunder, including principal and interest owing on the Loans, the Fees and all Expenses, and to pay the proceeds of such Revolving Loan to Bank for application toward such due or past due payment. 2.14 Mandatory Principal Reductions. Each Borrower shall pay to Bank, on the first Business Day following such Borrower's receipt thereof, one hundred percent (100%) of the Net Cash Proceeds derived from each and all of its Asset Sales (except to the extent such Net Cash Proceeds exceed the amount of all outstanding Revolving Loans on such date), other than Asset Sales permitted by Section 7.7; provided, however, in accordance with Section 7.7, Borrowers shall not conduct or consummate any Asset Sales unless and until the prior written consent of Bank has been obtained, or unless such Asset Sale is otherwise permitted by Section 7.7. In the event that any payments are applied toward outstanding Revolving Loans pursuant to this Section at any time when the outstanding Revolving Loans plus the Letter of Credit Usage is in excess of Ten Million Dollars ($10,000,000), the Revolving Credit Commitment shall be permanently reduced by the amount of such payments. 2.15 Fees. (a) Borrowers shall pay to Bank on a quarterly basis an unused commitment fee (the "Unused Revolving Commitment Fee") in an amount equal to one-eighth of one percent (0.125%) per annum times the difference of the Revolving Credit Commitment minus the sum of (i) the average daily outstanding Revolving Loans during the prior quarter plus (ii) the average daily Letter of Credit Usage during the prior quarter plus (iii) the average daily Foreign Exchange Reserve during the prior quarter. The Unused Commitment Fee shall begin to accrue on the Closing Date and shall be due and payable, in arrears, on the first Business Day of each and every December, March, June and September, and the Revolving Loans Maturity Date. The Unused Commitment Fee shall be calculated on the basis of a year of three hundred sixty (360) days for the actual days elapsed. No Unused Revolving Commitment Fee will be payable for periods after the Revolving Loans Maturity Date. (b) If any payment due hereunder, whether for principal, interest, or otherwise, is not paid on or before the tenth (10th) day after the date such payment is due, in addition 28 to and not in substitution of any of Bank's other rights and remedies with respect to such nonpayment, Borrowers shall pay to Bank a late payment fee (the "Late Payment Fee") equal to five percent (5%) of the amount of such overdue payment. The Late Payment Fee shall be due and payable on the eleventh (11th) day after the due date of the overdue payment with respect thereto. ARTICLE III LETTERS OF CREDIT 3.1 Letters of Credit. (a) Provided that no Event of Default or Unmatured Event of Default is continuing and subject to the other terms and conditions hereof, Bank agrees to issue standby and sight and usance commercial letters of credit ("Letters of Credit") for the account of Borrowers in such form as may be approved from time to time by Bank, subject to the following limitations: (i) The face amount of the Letter of Credit requested, if and when issued, must not cause the ABL Triggering Obligations to exceed the Revolving Credit Commitment; provided, however, during each and every ABL Borrowing Period the face amount of the Letter of Credit requested, if and when issued, must not cause the ABL Triggering Obligations to exceed the Borrowing Base; (ii) The face amount of the Letter of Credit requested if and when issued must not cause the Letter of Credit Usage to exceed the Letter of Credit Sublimit; (iii) Standby Letters of Credit may not have an expiry date or draw period which extends beyond the earlier of (x) 365 days following the date of issuance, or (y) the date which is thirty (30) days prior to the Revolving Loans Maturity Date; (iv) Commercial Letters of Credit may not have an expiry date or draw period which extends beyond the earlier of (x) 180 days following the date of issuance, or (y) the date which is thirty (30) days prior to the Revolving Loans Maturity Date; and (v) The conditions specified in Section 4.2 shall have been satisfied on the date of issuance of such Letter of Credit. (b) Each Letter of Credit shall (i) be denominated in Dollars or other currency acceptable to Bank, and (ii) be a standby or commercial letter of credit issued to support obligations of a Borrower, contingent or otherwise, in the ordinary course of business. (c) Each Letter of Credit shall be subject to the Uniform Customs or the ISP, as determined by Bank, in its sole discretion, and, to the extent not inconsistent therewith, the laws of the State of California. (d) Bank shall not at any time be obligated to issue any Letter of Credit hereunder if such issuance would conflict with, or cause the Bank to exceed any limits imposed by 29 its organizational or governing documents or by any applicable law, rule, regulation or treaty or determination of an arbitrator or a court or other governmental authority to which Bank is subject. 3.2 Procedure for Issuance of Letters of Credit. Any Borrower may request that the Bank issue a Letter of Credit at any time prior to the date which is thirty (30) days prior to the Revolving Loans Maturity Date by delivering to the Bank a Letter of Credit Application at its address for notices specified herein a Letter of Credit Application therefor, completed to the reasonable satisfaction of the Bank, together with such other certificates, documents and other papers and information as the Bank may reasonably request. Upon receipt of any Letter of Credit Application, the Bank will process such Letter of Credit Application and the certificates, documents and other papers and information delivered to it in connection therewith in accordance with its customary procedures and shall promptly issue the Letter of Credit requested thereby (but in no event shall the Bank be required to issue any Letter of Credit earlier than three (3) Business Days after its receipt of the Letter of Credit Application therefor and all such other certificates, documents and other papers and information relating thereto) by issuing the original of such Letter of Credit to the beneficiary thereof or as otherwise may be agreed by the Bank and such Borrower. The Bank shall furnish a copy of such Letter of Credit to such Borrower promptly following the issuance thereof. 3.3 Fees, Commissions and Other Charges. (a) Borrowers shall pay to Bank a fee in an amount equal to the face amount of each and every Letter of Credit times the Applicable Percentage (the "Letter of Credit Fee"). The Letter of Credit Fee shall be due and payable upon issuance of the applicable Letter of Credit. (b) In addition to the foregoing, Borrowers shall pay or reimburse the Bank for such normal and customary costs and expenses as are reasonably incurred or charged by the Bank in issuing, effecting payment under, amending or otherwise administering any Letter of Credit. 3.4 Reimbursement Obligations. (a) Borrowers agree to reimburse the Bank on the same Business Day on which a draft is presented under any Letter of Credit and paid by the Bank, provided that the Bank provides notice to Parent prior to 11:00 a.m., Pacific time, on such Business Day and otherwise Borrowers will reimburse the Bank on the next succeeding Business Day; provided, further, that the failure to provide such notice shall not affect Borrowers' absolute and unconditional obligation to reimburse the Bank when required hereunder for any draft paid under any Letter of Credit. The Bank shall provide notice to Borrower on such Business Day as a draft is presented and paid by the Bank indicating the amount of (i) such draft so paid and (ii) any taxes, fees, charges or other costs or expenses incurred by the Bank in connection with such payment. Each such payment shall be made to the Bank at its address specified on the signature pages hereof in lawful money of the United States of America and in immediately available funds. (b) Interest shall be payable on any and all amounts remaining unpaid by Borrowers under this Section from the date such amounts become payable (whether at stated 30 maturity, by acceleration or otherwise) until payment in full at the rate which would be payable on any outstanding Revolving Loans that are (i) in the case of the first day on which such amounts become payable (except where such amounts become payable by reason of the acceleration thereof), Base Lending Rate Portions which were not then overdue and (ii) in all cases to which clause (i) is not applicable, Base Lending Rate Portions which were then overdue. (c) Each drawing under any Letter of Credit shall constitute a request by Borrowers to Bank for a Borrowing of a Revolving Loan as a Base Lending Rate Portion. The date of such drawing shall be deemed the date on which such Borrowing is made. 3.5 Obligations Absolute. (a) Borrowers' obligations under this Article III shall be absolute and unconditional under any and all circumstances and irrespective of any set-off, counterclaim or defense to payment which any Borrower may have or have had against the Bank or any beneficiary of a Letter of Credit. (b) Borrowers also agree with the Bank that Borrowers' Reimbursement Obligations under Section 3.4 shall not be affected by, among other things, (i) the validity or genuineness of documents or of any endorsements thereon, even though such documents shall in fact prove to be invalid, fraudulent or forged, or (ii) any dispute between or among any Borrower and any beneficiary of any Letter of Credit or any other party to which such Letter of Credit may be transferred or (iii) any claims whatsoever of any Borrower against the beneficiary of such Letter of Credit or any such transferee. (c) Bank shall not be liable for any error, omission, interruption or delay in transmission, dispatch or delivery of any message or advice, however transmitted, in connection with any Letter of Credit, except for errors or omissions caused by the Bank's gross negligence or willful misconduct. (d) Borrowers agree that any action taken or omitted by the Bank under or in connection with any Letter of Credit or the related drafts or documents, if done in the absence of gross negligence or willful misconduct and in accordance with the standards of care specified in the UCC, shall be binding on Borrowers and shall not result in any liability of the Bank to Borrowers. 3.6 Letter of Credit Payments. If any draft shall be presented for payment under any Letter of Credit, the responsibility of the Bank to Borrowers in connection with such draft shall, in addition to any payment obligation expressly provided for in such Letter of Credit, be limited to determining that the documents (including each draft) delivered under such Letter of Credit in connection with such presentment are in conformity with such Letter of Credit. In determining whether to pay under any Letter of Credit, only the Bank shall be responsible for determining that the documents and certificates required to be delivered under the Letter of Credit have been delivered and that they comply on their face with the requirements of such Letter of Credit. 31 3.7 Outstanding Letters of Credit Following Event of Default. With respect to all Letters of Credit outstanding upon the occurrence of an Event of Default, Borrowers shall either replace such Letters of Credit, whereupon such Letters of Credit shall be canceled, with letters of credit issued by another issuer acceptable to the beneficiary of such Letter of Credit, or provide the Bank, as security for such Letters of Credit, with a cash collateral deposit in an amount equal to one hundred and five percent (105%) of the Letter of Credit Usage for so long as such Letters of Credit remain outstanding during the continuance of such Event of Default. Borrowers hereby grant to Bank a security interest in such cash collateral to secure all Obligations of Borrowers under this Agreement and the other Loan Documents. Amounts held in such cash collateral account shall be applied by Bank to the payment of drafts drawn under such Letters of Credit and the payment of customary costs and expenses charged or incurred by the Bank in connection therewith, and the unused portion thereof after all such Letters of Credit shall have expired or been fully drawn upon, if any, shall be applied to repay other Obligations. After all such Letters of Credit shall have expired or been fully drawn upon, all Reimbursement Obligations shall have been satisfied and all other Obligations shall have been paid in full in cash, and the obligations of Bank hereunder have terminated the balance, if any, in such cash collateral account shall be returned to Borrowers. Borrowers shall execute and deliver to Bank such further documents and instruments as Bank may request to evidence the creation and perfection of the within security interest in such cash collateral account. 3.8 Letter of Credit Applications. In the event of any conflict between the terms of this Article III and the terms of any Letter of Credit Application, the terms of such Letter of Credit Application shall govern and control any such conflict. ARTICLE IV CONDITIONS PRECEDENT 4.1 Conditions to Initial Loans or Letter(s) of Credit. Bank's obligation to make the initial Loans and/or to issue the initial Letter(s) of Credit is subject to and contingent upon the fulfillment of each of the following conditions to the satisfaction of Bank and its counsel: (a) receipt by Bank of this Agreement and each of the Loan Documents, all duly executed by Borrowers and/or the other Persons party thereto, acknowledged where required, and in form and substance satisfactory to Bank; (b) receipt by Bank, of a duly executed opinion of Borrowers' counsel, dated as of the Closing Date, covering the matters set forth in Exhibit 4.1(b) and otherwise in form and substance satisfactory to Bank; (c) with respect to each Borrower, receipt by Bank of a Certificate of the Secretary of such Borrower, dated as of the Closing Date, certifying (i) the incumbency and signatures of the Responsible Officers of such Borrower who are executing this Agreement and the Loan Documents on behalf of such Borrower; (ii) the By-Laws of such Borrower and all amendments thereto as being true and correct and in full force and effect; and (iii) the resolutions of the Board of Directors of such Borrower as being true and correct and in full force and effect, 32 authorizing the execution and delivery of this Agreement and the Loan Documents, and authorizing the transactions contemplated hereunder and thereunder, and authorizing the Responsible Officers of such Borrower to execute the same on behalf of such Borrower; (d) receipt by Bank of each Borrower's Articles or Certificate of Incorporation and all amendments thereto, certified by the Secretary of State of its state of organization and dated a recent date prior to the Closing Date; (e) receipt by Bank of a certificate of status and good standing for each Borrower, dated a recent date prior to the Closing Date, showing that such Borrower is in good standing under the laws of its state of organization; (f) receipt by Bank of certificates of foreign qualification and good standing for each Borrower, dated a recent date prior to the Closing Date, showing that such Borrower is in good standing under the laws of the states indicated in the table below opposite the name of such Borrower:
- -------------------- --------------------- Parent California - -------------------- --------------------- ~~UGG (not applicable) - -------------------- ---------------------~~
(g) receipt by Bank of a certificate signed by the President and Chief Financial Officer of each Borrower, dated as of the Closing Date, certifying that (i) both immediately before and immediately after giving effect to the transactions contemplated by this Agreement and the Loan Documents, such Borrower is and will be Solvent; (ii) to the best of their knowledge after due and diligent inquiry, the representations and warranties of such Borrower contained in this Agreement and the Loan Documents are true and correct, and (iii) to the best of their knowledge after due and diligent inquiry, both immediately before and immediately after giving effect to the transactions contemplated by this Agreement and the Loan Documents, no Event of Default or Unmatured Event of Default is continuing or shall occur; (h) receipt by Bank of Uniform Commercial Code and other public record searches with respect to Borrowers, in each case satisfactory to Bank; (i) receipt by Bank of the original certificates evidencing one hundred percent (100%) of the issued and outstanding Capital Stock of UGG, together with undated stock powers with respect thereto, duly executed in blank, and in form and substance reasonably satisfactory to Bank; (j) receipt by Bank of all Expenses owing on the Closing Date; (k) no Material Adverse Effect shall have occurred, as determined by Bank in its reasonable discretion; 33 (l) receipt by Bank of copies of insurance binders or insurance certificates evidencing Borrowers' having caused to be obtained insurance in accordance with Section 6.5, including the Bank's loss payee endorsements required by such Section; (m) receipt by Bank of the Pay-Off Letter from the Old Lender, and such UCC-2 Termination Statements and other Lien releases as Bank shall require, duly executed by such Old Lender, all of the foregoing in form and substance reasonably satisfactory to Bank; (n) receipt by Bank of duly executed Collateral Access Agreements with respect to 4880 Colt Street, Ventura, California, and 495-A South Fairview Avenue, Goleta, California; (o) receipt by Bank of such other documents, instruments and agreements as Bank may reasonably request in connection with the transactions contemplated hereunder or to perfect or protect the liens and security interests granted to Bank for the ratable benefit of Bank's in connection herewith; and (p) the Closing Date shall have occurred on or before February 28, 2002. 4.2 Conditions to all Loans and Letters of Credit. Bank's obligation hereunder to make any Loans to Borrowers (including the initial Loans), and/or to issue any Letters of Credit (including the initial Letter(s) of Credit), is further subject to and contingent upon the fulfillment of each of the following conditions to the satisfaction of Bank: (a) (i) in the case of a Borrowing, receipt by Bank of a Notice of Borrowing as required by Section 2.5(b) and written disbursement instructions to Bank consistent with Section 7.1, and (ii) in the case of a Letter of Credit, receipt by Bank of a Letter of Credit Application and the other papers and information required under Section 3.2; (b) the fact that, immediately before and after such Borrowing or issuance of Letter of Credit, as the case may be, no Event of Default or Unmatured Event of Default shall have occurred or be continuing; and (c) the fact that the representations and warranties of Borrowers contained in this Agreement shall be true on and as of the date of such Borrowing, or issuance of Letter of Credit, as the case may be (except for any representations and warranties made as of a specific earlier date, which shall remain true as of such date). ARTICLE V REPRESENTATIONS AND WARRANTIES In order to induce Bank to enter into this Agreement and to make Loans and/or issue any Letters of Credit, each Borrower represents and warrants to Bank that on the Closing Date and on the date of each Borrowing or issuance of a Letter of Credit: 34 5.1 Legal Status. Each Borrower is a corporation duly organized and existing under the laws of the state of its organization. Each Borrower and each Subsidiary has the power and authority to own its own Assets and to transact the business in which it is engaged, and is properly licensed, qualified to do business and in good standing in every jurisdiction in which it is doing business where failure to so qualify could have a Material Adverse Effect. 5.2 No Violation; Compliance. (a) The execution, delivery and performance of this Agreement and the Loan Documents to which each Borrower is a party are within such Borrower's powers, are not in conflict with the terms of the Governing Documents of such Borrower, and do not result in a breach of or constitute a default under any contract, obligation, indenture or other instrument to which such Borrower is a party or by which such Borrower is bound or affected, which breach or default could reasonably be expected to have a Material Adverse Effect. To the best Knowledge of Borrowers, there is no law, rule or regulation (including Regulations T, U and X of the Federal Reserve Board), nor is there any judgment, decree or order of any court or Governmental Authority binding on any Borrower which would be contravened by the execution, delivery, performance or enforcement of this Agreement and the Loan Documents to which any Borrower is a party. (b) The execution, delivery and performance of the Loan Documents to which each Guarantor is a party are within such Guarantor's powers, are not in conflict with the terms of the Governing Documents of such Guarantor, and do not result in a breach of or constitute a default under any contract, obligation, indenture or other instrument to which such Guarantor is a party or by which such Guarantor is bound or affected, which breach or default could reasonably be expected to have a Material Adverse Effect. To the best Knowledge of Borrowers, there is no law, rule or regulation (including Regulations T, U and X of the Federal Reserve Board), nor is there any judgment, decree or order of any court or Governmental Authority binding on any Guarantor which would be contravened by the execution, delivery, performance or enforcement of the Loan Documents to which such Guarantor is a party. 5.3 Authorization; Enforceability. (a) Each Borrower has taken all corporate action necessary to authorize the execution and delivery of this Agreement and the Loan Documents to which such Borrower is a party, and the consummation of the transactions contemplated hereby and thereby. Upon their execution and delivery in accordance with the terms hereof, this Agreement, and the Loan Documents to which each Borrower is a party will constitute legal, valid and binding agreements and obligations of such Borrower enforceable against such Borrower in accordance with their respective terms, except as enforceability may be limited by bankruptcy, insolvency, and similar laws and equitable principles affecting the enforcement of creditors' rights generally. (b) Each Guarantor has taken all corporate, partnership or limited liability company action, as applicable, necessary to authorize the execution and delivery of the Loan Documents to which such Guarantor is a party, and the consummation of the transactions contemplated thereby. Upon their execution and delivery in accordance with the terms hereof, the Loan Documents to which each Guarantor is a party will constitute legal, valid and binding 35 agreements and obligations of such Guarantor enforceable against such Guarantor in accordance with their respective terms, except as enforceability may be limited by bankruptcy, insolvency, fraudulent conveyance, and similar laws and equitable principles affecting the enforcement of creditors' rights generally. 5.4 Approvals; Consents. No approval, consent, exemption or other action by, or notice to or filing with, any Governmental Authority is necessary in connection with the execution, delivery, performance or enforcement of this Agreement or the Loan Documents. All requisite Governmental Authorities and third parties have approved or consented to the transactions contemplated by this Agreement and Loan Documents, and all applicable waiting periods have expired and there is no governmental or judicial action, actual or threatened, that has or could have a reasonable likelihood of restraining, preventing or imposing burdensome conditions on the transactions contemplated by this Agreement and Loan Documents. 5.5 Liens. Each Borrower and each of the Subsidiaries (other than the Excluded Subsidiaries) has good and marketable title to, or valid leasehold interests in, all of its Assets, free and clear of all Liens or rights of others, except for Permitted Liens. 5.6 Debt. Each Borrower and each of the Subsidiaries (other than the Excluded Subsidiaries) has no Debt other than Permitted Debt. 5.7 Litigation. Except as set forth in Schedule 5.7, there are no suits, proceedings, claims or disputes pending or, to the Knowledge of Borrowers, threatened, against or affecting any Borrower or any of Borrower's Assets, or any Subsidiary (other than the Excluded Subsidiaries) or any of such Subsidiary's (other than the Excluded Subsidiaries) Assets, which are not fully covered by applicable insurance and as to which no reservation of rights has been taken by the insurer thereunder. 5.8 No Default. No Event of Default or Unmatured Event of Default has occurred and is continuing or would result from the incurring of obligations by any Borrower or any Subsidiary (other than the Excluded Subsidiaries) under this Agreement or the Loan Documents. 5.9 Subsidiaries. Set forth in Schedule 5.9 is a complete and accurate list of the Subsidiaries, showing the jurisdiction of incorporation of each and showing the percentage of each Borrower's ownership of the Capital Stock of each Subsidiary. All of the outstanding Capital Stock of each Subsidiary has been validly issued, is fully paid and nonassessable, and is owned by Borrower free and clear of all Liens except Permitted Liens. 5.10 Taxes. All tax returns required to be filed by each Borrower and each of the Subsidiaries (other than the Excluded Subsidiaries) in any jurisdiction have in fact been filed, and all taxes, assessments, fees and other governmental charges upon each Borrower and each of the Subsidiaries (other than the Excluded Subsidiaries) or upon any of their Assets, income or franchises, which are due and payable have been paid. The provisions for taxes on the books of each Borrower and each of the Subsidiaries (other than the Excluded Subsidiaries) are adequate for all open years, and for each Borrower's and each of the Subsidiaries (other than the Excluded Subsidiaries) current fiscal period. 36 5.11 Correctness of Financial Statements. Borrowers' audited, consolidated Financial Statement as of its fiscal year ended December 31, 2000, and all other information and data furnished by Borrowers to Bank in connection therewith, are complete and correct in all material respects and accurately and fairly present in all material respects the financial condition and results of operations of Borrowers and the Subsidiaries as of their respective dates. Any forecasts of future financial performance delivered by Borrowers to Bank have been made in good faith and are based on reasonable assumptions and investigations by Borrowers. Said audited Financial Statement have been prepared in accordance with GAAP. Since the date of such audited Financial Statement, there has been no change in any Borrower's financial condition or results of operations sufficient to have a Material Adverse Effect. Borrowers and the Subsidiaries (other than the Excluded Subsidiaries) have no contingent obligations, liabilities for taxes or other outstanding financial obligations which are material in the aggregate, except as disclosed in such statements, information and data. 5.12 ERISA. Neither any Borrower nor any member of the ERISA Group maintains or contributes to any Plan or Multiemployer Plan, other than those listed on Schedule 5.12. Each Borrower and each member of the ERISA Group have satisfied the minimum funding standards of ERISA and the Internal Revenue Code with respect to each Plan and Multiemployer Plan to which it is obligated to contribute. No ERISA Event has occurred nor has any other event occurred that may result in an ERISA Event that reasonably could be expected to result in a Material Adverse Effect. None of Borrowers, any member of the ERISA Group, or any fiduciary of any Plan is subject to any direct or indirect liability with respect to any Plan that could reasonably be expected to result in a Material Adverse Effect (other than to make regularly scheduled required contributions and to pay Plan benefits in the normal course) under any applicable law, treaty, rule, regulation, or agreement. Neither Borrowers nor any member of the ERISA Group is required to provide security to any Plan under Section 401(a)(29) of the Internal Revenue Code. Each Plan will be able to fulfill its benefit obligations as they come due in accordance with the Plan documents and under GAAP. 5.13 Other Obligations. Neither any Borrower nor any Subsidiary (other than the Excluded Subsidiaries) is in default on any (i) Debt in the aggregate principal amount among all Borrowers in excess of $500,000 or (ii) any other lease, commitment, contract, instrument or obligation which is material to the operation of its business. 5.14 Public Utility Holding Company Act. No Borrower is a holding company, or an affiliate of a holding company or a subsidiary company of a holding company, within the meaning of the Public Utility Holding Company Act of 1935, as amended. 5.15 Investment Company Act. No Borrower is an investment company, or a company controlled by an investment company, within the meaning of the Investment Company Act of 1940, as amended. 5.16 Patents, Trademarks, Copyrights, and Intellectual Property, etc. Each Borrower and each Subsidiary (other than the Excluded Subsidiaries) has all necessary, patents, patent rights, licenses, trademarks, trademark rights, trade names, trade name rights, copyrights, permits, and franchises in order for it to conduct its business and to operate its Assets, without known conflict with the rights of third Persons. The consummation of the transactions contemplated by this Agreement will not alter or impair any of such rights of any Borrower or any Subsidiary 37 (other than the Excluded Subsidiaries). No adverse judgments or pending material claims have been made with respect to each Borrower's and each Subsidiary's (other than Excluded Subsidiaries) title to or the validity of any unexpired trademark, trademark registration, trade name, patent, copyright, copyright registration, except as may be as set forth on Schedule D to the Patent and Trademark Security Agreement. 5.17 Environmental Condition. (i) None of any Borrower's or any Subsidiary's (other than the Excluded Subsidiaries) Assets has ever been used by any Borrower or such Subsidiary (other than the Excluded Subsidiaries) or by previous owners or operators in the disposal of, or to produce, store, handle, treat, release, or transport, any Hazardous Materials; (ii) none of any Borrower's or any Subsidiary's (other than the Excluded Subsidiaries) Assets has ever been designated or identified in any manner pursuant to any environmental protection statute as a Hazardous Materials disposal site, or a candidate for closure pursuant to any environmental protection statute; (iii) no Lien arising under any environmental protection statute has attached to any revenues or to any real or personal property owned or operated by any Borrower or any Subsidiary; (other than the Excluded Subsidiaries) and (iv) neither Borrower nor any Subsidiary has received a summons, citation, notice, or directive from the Environmental Protection Agency or any other federal or state governmental agency concerning any action or omission by any Borrower or any Subsidiary (other than the Excluded Subsidiaries) resulting in the releasing or disposing of Hazardous Materials into the environment. 5.18 Solvency. Each Borrower and each Subsidiary (other than the Excluded Subsidiaries) is Solvent. No transfer of property is being made by any Borrower or any Subsidiary (other than the Excluded Subsidiaries) and no obligation is being incurred by any Borrower or any Subsidiary (other than the Excluded Subsidiaries) in connection with the transactions contemplated by this Agreement or the Loan Documents with the intent to hinder, delay, or defraud either present or future creditors of any Borrower any Subsidiary (other than the Excluded Subsidiaries). 5.19 Eligible Accounts. The Eligible Accounts are bona fide existing payment obligations of Account Debtors created by the sale and delivery of Inventory or the rendition of services to such Account Debtors in the ordinary course of a Borrower's business, and, to the Knowledge of Borrowers, are owed to such Borrower without defenses, disputes, offsets, counterclaims, or rights of return or cancellation. As to each Eligible Account, such Account is not, (a) owed by an employee, Affiliate, or agent of any Borrower, (b) on account of a transaction wherein goods were placed on consignment or were sold pursuant to a guaranteed sale, a sale or return, a sale on approval, a bill and hold, or on any other terms by reason of which the payment by the Account Debtor may be conditional, (c) payable in a currency other than Dollars, (d) owed by an Account Debtor that has or has asserted a right of setoff, has disputed its liability, or has made any claim with respect to its obligation to pay the Account, 38 (e) to the Knowledge of Borrowers, owed by an Account Debtor that is subject to any Insolvency Proceeding or is not Solvent or as to which any Borrower has received notice of an imminent Insolvency Proceeding or a material impairment of the financial condition of such Account Debtor, (f) on account of a transaction as to which the goods giving rise to such Account have not been shipped and billed to the Account Debtor or the services giving rise to such Account have not been performed and accepted by the Account Debtor, (g) a right to receive progress payments or other advance billings that are due prior to the completion of performance by the applicable Borrower of the subject contract for goods or services, and (h) an Account that has not been billed to the customer. 5.20 Eligible Inventory. All Eligible Inventory consists of shoes, footwear and apparel of good and merchantable quality, free from defects. As to each item of Eligible Inventory, such Inventory is (i) owned by the applicable Borrower free and clear of all Liens other than Permitted Liens; (ii) either located at one of the locations set forth on Schedule 1.1E or in transit from one such location to another such location; (iii) not located on real property leased by a Borrower or in a contract warehouse, in each case, unless subject to a Collateral Access Agreement executed by the lessor, the warehouseman, or other third party, as the case may be, and unless segregated or otherwise separately identifiable from goods of others, if any, stored on the premises; (iv) not goods that have been returned or rejected by the applicable Borrower's customers, and (v) not goods that are obsolete or slow moving, restrictive or custom items, raw materials work-in-process, or that constitute spare parts, packaging and shipping materials, supplies used or consumed in a Borrower's business, bill and hold goods, defective goods, "seconds," or Inventory acquired on consignment. ARTICLE VI AFFIRMATIVE COVENANTS Each Borrower covenants and agrees that from the Closing Date and thereafter until the indefeasible payment, performance and satisfaction in full of the Obligations, all of Bank's obligations hereunder have been terminated and no Letters of Credit are outstanding, such Borrower shall: 6.1 Punctual Payments. Punctually pay the interest and principal on the Loans, the Fees and all Expenses and any other fees and liabilities due under this Agreement and the Loan Documents at the times and place and in the manner specified in this Agreement or the Loan Documents. 6.2 Books and Records; Collateral Audits. Maintain, and cause each of the Subsidiaries (other than the Excluded Subsidiaries) to maintain, adequate books and records in accordance with GAAP, and permit any officer, employee or agent of Bank, at any time (upon one 39 (1) Business Day's notice unless an Event of Default has occurred and is continuing, in which event no notice shall be required) and from time to time during which the amount of the ABL Triggering Obligations is greater than the ABL Trigger Amount, (a) to inspect, audit and examine such books and records, and to make copies of the same, and/or (b) to audit the Accounts and the Inventory in order to verify such Borrower's financial condition or the amount, quality, value, condition of, or any other matter relating to, the Accounts and/or the Inventory. In connection therewith, Borrowers shall pay to Bank Bank's standard audit fee ("Audit Fee") for each audit plus all Expenses in connection therewith, payable upon demand. The Audit Fee shall in no event exceed $1,500 per auditor per day. 6.3 Collateral Reporting and Financial Statements. Deliver to Bank the following, all in form and detail reasonably satisfactory to Bank and in such number of copies as Bank may reasonably request: (a) (i) as soon as available but not later than thirty (30) days after the end of each fiscal quarter of Parent, (x) a detailed aging, by total, of the Accounts, and upon Bank's request, a reconciliation to the detailed calculation of the Borrowing Base previously provided to Bank, (y) a summary aging, by vendor, of Borrowers' accounts payable and any book overdraft, and (z) back log reports, approved purchase order reports, pre-sold Inventory reports, and Inventory reports; and (ii) during each and every ABL Borrowing Period, or at any time upon Bank's request, as soon as available but not later than twenty (20) days after the end of each month (x) a Borrowing Base Certificate, (y) an accrued vendor invoice report (or similar accounts payable and accrual report), and (z) an accrued Inventory recap report (or similar accounts payable and accrual report); (b) as soon as available but not later than forty-five (45) days after the end of each fiscal quarter of Parent (or not later than thirty (30) days after the end of each month during each and every ABL Borrowing period), a consolidating and consolidated internally prepared Financial Statement for Borrowers and the Subsidiaries which shall include Borrowers' and the Subsidiaries' consolidating and consolidated balance sheet as of the close of such period, and Borrowers' and the Subsidiaries' consolidating and consolidated statement of income and retained earnings and consolidated statement of cash flow for such period and year to date, certified by the Chief Financial Officer of Borrowers, to the best of his or her knowledge after due and diligent inquiry, as being complete and correct and fairly presenting in all material respects Borrowers' and its Subsidiaries' financial condition and results of operations for such period; (c) as soon as available but not later than forty-five (45) days after the end of each quarterly accounting period, a Compliance Certificate from the Chief Financial Officer of Borrowers, stating, among other things, that he or she has reviewed the provisions of this Agreement and the Loan Documents and that, to the best of his or her knowledge after due and diligent inquiry there exists no Event of Default or Unmatured Event of Default, and containing the calculations and other details necessary to demonstrate compliance with Sections 7.12 and 7.15; (d) as soon as available but not later than sixty (60) days after the end of each fiscal year, an annual operating budget for the following fiscal year; 40 (e) as soon as available but not later than one hundred twenty (120) days after the end of each fiscal year, a complete copy of Borrowers' and the Subsidiaries' consolidated and consolidating audited Financial Statement, which shall include at least Borrowers' and the Subsidiaries' balance sheet as of the close of such fiscal year, and Borrowers' and the Subsidiaries' statement of income and retained earnings and statement of cash flow for such fiscal year, certified by KPMG LLP or another certified public accountant selected by Borrower and reasonably satisfactory to Bank, which certificate shall not be qualified in any manner whatsoever; (f) as soon as available but not later than fifteen (15) days after filing thereof with the SEC, (i) copies of each annual or quarterly report, proxy or Financial Statement or other report or communications sent to the Shareholders of Parent, and (ii) copies of all annual, regular, periodic and special reports and registration statements which Parent may file or be required to file with the SEC; (g) promptly upon receipt by any Borrower, copies of any and all reports and management letters submitted to a Borrower or any Subsidiary by any certified public accountant in connection with any examination of any Borrower's or any Subsidiary's financial records made by such accountant; and (h) from time to time, operating statistics, operating plans and any other information as Bank may reasonably request, promptly upon such request. 6.4 Existence; Preservation of Licenses; Compliance with Law. Preserve and maintain, and cause each Subsidiary (other than the Excluded Subsidiaries) to preserve and maintain, its corporate existence and good standing in the state of its organization, qualify and remain qualified, and cause each Subsidiary (other than the Excluded Subsidiaries) to qualify and remain qualified, as a foreign corporation in every jurisdiction where the failure to be so qualified could have a Material Adverse Effect; and preserve, and cause each of the Subsidiaries (other than the Excluded Subsidiaries) to preserve, all of its licenses, permits, governmental approvals, rights, privileges and franchises required for its operations; and comply, and cause each of the Subsidiaries (other than the Excluded Subsidiaries) to comply, with the provisions of its Governing Documents; and comply, and cause each of the Subsidiaries (other than the Excluded Subsidiaries) to comply, with the requirements of all applicable laws, rules, regulations, orders of any Governmental Authority having authority or jurisdiction over it, except for such laws, rules and regulations where the failure to so comply could not have a Material Adverse Effect, and comply, and cause each of the Subsidiaries (other than the Excluded Subsidiaries) to comply, with all requirements for the maintenance of its business, insurance, licenses, permits, governmental approvals, rights, privileges and franchises. 6.5 Insurance. (a) Maintain, at Borrowers' expense, insurance respecting its Assets wherever located, covering loss or damage by fire, theft, explosion, and all other hazards and risks as ordinarily are insured against by other Persons engaged in the same or similar businesses. Borrowers also shall maintain business interruption, public liability, and product liability insurance, as well as insurance against larceny, embezzlement, and criminal misappropriation. All such policies 41 of insurance shall be in such amounts and with such insurance companies as are reasonably satisfactory to Bank. Borrowers shall deliver copies of all such policies to Bank with a satisfactory lender's loss payable endorsement naming Bank as sole loss payee or, in the case of equipment or real estate which is subject to a Purchase Money Lien, an additional insured, and shall contain a waiver of warranties; provided, however, that Bank shall be listed as an additional insured with respect to losses of any equipment that are subject to a Purchase Money Lien or otherwise financed by a lender other than under this Agreement. Every policy of insurance or endorsement shall contain a clause requiring the insurer to give not less than 30 days' prior written notice to Bank in the event of cancellation of the policy for any reason whatsoever, and the insurer's agreement that any loss payable thereunder shall be payable notwithstanding any act or negligence of any Borrower or Bank which might, absent such agreement, result in a forfeiture of all or a part of such insurance payment. (b) Original policies or certificates thereof satisfactory to Bank evidencing such insurance shall be delivered to Bank as soon as available but in no event less than one (1) day prior to the expiration of the existing or preceding policies. Parent shall give Bank prompt notice of any loss covered by such insurance in excess of $500,000. Upon the occurrence and during the continuance of an Event of Default, Bank shall have the exclusive right to adjust any losses payable under any such insurance policies, without any liability to Borrower whatsoever in respect of such adjustments. Any monies received as payment for any loss under any insurance policy mentioned above or as payment of any award or compensation for condemnation or taking by eminent domain, shall be paid over to Bank to be applied at the option of either to the prepayment of the Obligations without premium or shall be disbursed to Parent under staged payment terms reasonably satisfactory to Bank for application to the cost of repairs, replacements, or restorations. Any such repairs, replacements, or restorations shall be effected with reasonable promptness and shall be of a value at least equal to the value of the items or property destroyed prior to such damage or destruction. In the event of any prepayment of the Obligations pursuant to the foregoing prior to the Revolving Loans Maturity Date, the Revolving Credit Commitment shall be permanently reduced pro rata by the amount of such prepayment. Upon the occurrence of an Event of Default, Bank shall have the right to apply all prepaid premiums to the payment of the Obligations in such order or form as Bank shall determine. Borrowers shall, concurrently with the annual Financial Statements required to be delivered by Borrowers pursuant to Section 6.3(e), deliver to Bank, as Bank may request, copies of certificates describing all insurance of Borrowers and the Subsidiaries then in effect. 6.6 Assets. Maintain, keep and preserve, and cause each Subsidiary (other than the Excluded Subsidiaries) to maintain, keep and preserve, all of its Assets (tangible or intangible) which are necessary to its business in good repair and condition, and from time to time make necessary repairs, renewals and replacements thereto so that such Assets shall be fully and efficiently preserved and maintained. 6.7 Taxes and Other Liabilities. Pay and discharge when due, and cause each Subsidiary (other than the Excluded Subsidiaries) to pay and discharge when due, any and all assessments and taxes, both real or personal and including federal and state income taxes, and any and all other Permitted Debt. 42 6.8 Notice to Bank. Promptly, upon any Borrower acquiring Knowledge thereof, give written notice to Bank of: (a) all litigation affecting any Borrower or any Subsidiary (other than the Excluded Subsidiaries) where the amount in controversy is in excess of Five Hundred Thousand Dollars ($500,000); (b) any material dispute which may exist between any Borrower or any Subsidiary (other than the Excluded Subsidiaries), on the one hand, and any Governmental Authority, on the other; (c) any labor controversy resulting in or threatening to result in a strike against any Borrower or any Subsidiary (other than the Excluded Subsidiaries); (d) any proposal by any Governmental Authority to acquire the Assets or business, valued in the aggregate in excess of $500,000, of any Borrower or any Subsidiary (other than the Excluded Subsidiaries), or to compete with any Borrower or any Subsidiary (other than the Excluded Subsidiaries); (e) any reportable event under Section 4043(c)(5), (6) or (13) of ERISA with respect to any Plan, any decision to terminate or withdraw from a Plan, any finding made with respect to a Plan under Section 4041(c) or (e) of ERISA, the commencement of any proceeding with respect to a Plan under Section 4042 of ERISA, or any material increase in the actuarial present value of unfunded vested benefits under all Plans over the preceding year; (f) any Event of Default or Unmatured Event of Default; and (g) any other matter which has resulted or reasonably could be expected to have a Material Adverse Effect. 6.9 Employee Benefits. (a) (i) Promptly, and in any event within ten (10) Business Days after any Borrower obtains Knowledge that an ERISA Event has occurred that reasonably could be expected to result in a Material Adverse Effect, deliver or cause to be delivered a written statement of the Chief Financial Officer of Parent describing such ERISA Event and any action that is being taken with respect thereto by Borrowers or member of the ERISA Group, and any action taken or threatened by the Internal Revenue Service, Department of Labor, or PBGC. Each Borrower shall (i) be deemed to know all facts known by the administrator of any Plan of which it is the plan sponsor; (ii) promptly and in any event within three (3) Business Days after the filing thereof with the Internal Revenue Service, deliver or cause to be delivered a copy of each funding waiver request filed with respect to any Plan and all communications received by any Borrower or, to the knowledge of any Borrower, any member of the ERISA Group with respect to such request; and (iii) promptly and in any event within three (3) Business Days after receipt by Borrowers or, to the Knowledge of Borrowers, any member of the ERISA Group, of the PBGC's intention to terminate a Plan or to have a trustee appointed to administer a Plan, copies of each such notice. 43 (b) Cause to be delivered to Bank, upon Bank's request, each of the following: (i) a copy of each Plan (or, where any such plan is not in writing, complete description thereof) (and if applicable, related trust agreements of other funding instruments) and all amendments thereto, all written interpretations thereof and written descriptions thereof that have been distributed to employees or former employees of any Borrower or its Subsidiaries; (ii) the most recent determination letter issued by the IRS with respect to each Plan; (iii) for the three (3) most recent Plan years, annual reports on Form 5500 Series required to be filed with any governmental agency for each Plan; (iv) all actuarial reports prepared for the last three (3) Plan years for each Plan; (v) a listing of all Multiemployer Plans, with the aggregate amount of the most recent annual contributions required to be made by any Borrower or any member of the ERISA Group to each such plan and copies of the collective bargaining agreements requiring such contributions; (vi) any information that has been provided to any Borrower or any member of the ERISA Group regarding withdrawal liability under any Multiemployer Plan; and (vii) the aggregate amount of the most recent annual payments made to former employees of Borrowers under any Retiree Health Plan. 6.10 Further Assurances. Execute and deliver, or cause to be executed and delivered, upon the request of Bank and at Borrowers' expense, such additional documents, instruments and agreements as Bank may reasonably determine to be necessary or advisable to carry out the provisions of this Agreement and the Loan Documents, and the transactions and actions contemplated hereunder and thereunder. 6.11 Bank Accounts. Maintain, and cause each Subsidiary (other than the Excluded Subsidiaries) to maintain, its cash on hand and cash equivalent investments in deposit accounts at Bank or any of its Subsidiaries. Notwithstanding the foregoing, Borrowers and the Subsidiaries shall be permitted to maintain cash in deposit accounts other than at Bank, provided that (i) such deposit accounts are listed on Schedule 1 to the Security Agreement, (ii) the cash on deposit in all of such deposit accounts does not exceed $250,000, in the aggregate, at any time, and (iii) upon Bank's request, Borrowers shall promptly deliver to Bank such control agreements and/or other agreements, instruments and documents, fully and duly executed, as Bank shall reasonably require to perfect and maintain perfected Bank's security interest in such deposit accounts, all in form and substance reasonably satisfactory to Bank. 6.12 Environment. Be and remain, and cause each Subsidiary (other than the Excluded Subsidiaries) and each operator of any of any Borrower's or any Subsidiary's (other than the Excluded Subsidiaries) Assets to be and remain, in compliance with the provisions of all federal, state and local environmental, health and safety laws, codes and ordinances, and all rules and regulations issued thereunder; notify Bank immediately of any notice of a hazardous discharge or environmental complaint received from any Governmental Authority or any other Person; notify Bank immediately of any hazardous discharge from or affecting its premises; immediately contain and remove the same, in compliance with all applicable laws; promptly pay any fine or penalty assessed in connection therewith; permit Bank to inspect the premises, to conduct tests thereon, and to inspect all books, correspondence, and records pertaining thereto; and at Bank's request, and at Borrowers' expense, provide a report of a qualified environmental engineer, satisfactory in scope, form and content to Bank, and such other and further assurances reasonably satisfactory to Bank that the condition has been corrected. 44 6.13 Additional Collateral. With respect to any Assets (or any interest therein) acquired after the Closing Date by any Borrower or any Subsidiary (other than the Excluded Subsidiaries) that are of a type covered by the Lien created by any of the Loan Documents but which are not so subject, promptly (and in any event within thirty (30) days after the acquisition thereof): (i) execute and deliver, or cause such Subsidiary (other than the Excluded Subsidiaries) to execute and deliver, to Bank such amendments to the relevant Loan Documents or such other documents as Bank shall deem necessary or advisable to grant to Bank a Lien on such Assets (or such interest therein), (ii) take all actions, or cause such Subsidiary (other than the Excluded Subsidiaries) to take all actions, necessary or advisable to cause such Lien to be duly perfected in accordance with all applicable law, including, without limitation, the filing of financing statements in such jurisdictions as may be requested by Bank, (iii) if requested by Bank, deliver to Bank legal opinions relating to the matters described in the immediately preceding clauses (i) and (ii), which opinions shall be in form and substance, and from counsel, reasonably satisfactory to Bank, and (iv) if requested by Bank, deliver to Bank evidence of insurance as required by Section 6.5. 6.14 Guarantors. Cause each and every now existing and hereafter acquired or formed Subsidiary (other than any Borrower and the Excluded Subsidiaries) to execute and deliver to Bank a Guaranty and security agreement, in form and substance satisfactory to Bank. 6.15 Returns. Cause returns and allowances, as between any Borrower and its Account Debtors, to be on the same basis and in accordance with the usual customary practices of such Borrower, as they exist at the time of the execution and delivery of this Agreement. If, at a time when no Event of Default has occurred and is continuing, any Account Debtor returns any Inventory to any Borrower, such Borrower promptly shall determine the reason for such return and, if Borrower accepts such return, issue a credit memorandum (with a copy to be sent to Bank upon its request) in the appropriate amount to such Account Debtor. If, at a time when an Event of Default has occurred and is continuing, any Account Debtor returns any Inventory to any Borrower, such Borrower promptly shall determine the reason for such return and, if Bank consents (which consent shall not be unreasonably withheld), issue a credit memorandum (with a copy to be sent to Bank upon its request) in the appropriate amount to such Account Debtor. ARTICLE VII NEGATIVE COVENANTS Each Borrower further covenants and agrees that from the Closing Date and thereafter until the indefeasible payment, performance and satisfaction in full of the Obligations, all of Bank's, obligations hereunder have been terminated and no Letters of Credit are outstanding, such Borrower shall not: 7.1 Use of Funds; Margin Regulation. (a) Use any proceeds of the Revolving Loans for any purpose other than for working capital; or 45 (b) Use any portion of the proceeds of the Loans in any manner which might cause the Loans, the application of the proceeds thereof, or the transactions contemplated by this Agreement to violate Regulation T, U, or X of the Board of Governors of the Federal Reserve System, or any other regulation of such board, or to violate the Securities and Exchange Act of 1934, as amended or supplemented. 7.2 Debt. Create, incur, assume or suffer to exist, or permit any Subsidiary (other than the Excluded Subsidiaries) to create, incur, assume or suffer to exist, any Debt except Permitted Debt. 7.3 Liens. Create, incur, assume or suffer to exist, or permit any Subsidiary (other than the Excluded Subsidiaries) to create, incur, assume or suffer to exist, any Lien (including the lien of an attachment, judgment or execution) on any of its Assets, whether now owned or hereafter acquired, except Permitted Liens; or sign or file, or permit any Subsidiary (other than the Excluded Subsidiaries) to sign or file, under the UCC as adopted in any jurisdiction, a financing statement which names any Borrower or any Subsidiary (other than the Excluded Subsidiaries) as a debtor, except with respect to Permitted Liens, or sign, or permit any Subsidiary (other than the Excluded Subsidiaries) to sign, any security agreement authorizing any secured party thereunder to file such a financing statement, except with respect to Permitted Liens. 7.4 Merger, Consolidation, Transfer of Assets. Wind up, liquidate or dissolve, reorganize, reincorporate, merge or consolidate with or into any other Person, or acquire all or substantially all of the Assets or the business of any other Person, or permit any Subsidiary to do so; provided, however, upon prior written notice to Bank, any Subsidiary may merge into or consolidate with or transfer Assets to any Borrower or any other Subsidiary. 7.5 Leases. Create, incur, assume or suffer to exist, or permit any Subsidiary (other than the Excluded Subsidiaries) to create, incur, assume or suffer to exist, any obligation as a lessee for the rental or hire of any real or personal property, other than (i) leases that have been or should be capitalized in accordance with GAAP, (ii) leases (other than Capital Leases) that do not in the aggregate require payments (including taxes, insurance, maintenance, and similar expenses which any Borrower or any Subsidiary (other than the Excluded Subsidiaries) is required to pay under the terms of any lease) in excess of Five Hundred Thousand Dollars ($500,000) on a consolidated basis for Borrowers and the Subsidiaries (other than the Excluded Subsidiaries) in any fiscal year of Borrowers (or (x) One Million Dollars ($1,000,000) on a consolidated basis for Borrowers and the Subsidiaries (other than the Excluded Subsidiaries) in any fiscal year of Borrowers in the event that Parent shall, subject to the terms of the Security Agreement, relocate its chief executive office from the location listed on the signature page hereof, and/or (y) One Million Dollars ($1,000,000) on a consolidated basis for Borrowers and the Subsidiaries (other than the Excluded Subsidiaries) in any fiscal year of Borrowers in the event that Parent shall, subject to the terms of the Security Agreement, relocate its distribution center), and (iii) the leases identified on Schedule 7.5. 7.6 Sales and Leasebacks. Sell, transfer, or otherwise dispose of, or permit any Subsidiary (other than the Excluded Subsidiaries) to sell, transfer, or otherwise dispose of, any real 46 or personal property to any Person, and thereafter directly or indirectly leaseback the same or similar property. 7.7 Asset Sales. Conduct any Asset Sale, or permit any Subsidiary (other than the Excluded Subsidiaries) to do so, other than (i) sales of Inventory in the ordinary course of business, (ii) dispositions of obsolete, worn or nonfunctional equipment, (iii) sales of Assets generating aggregate Net Cash Proceeds of no more than $500,000 in any fiscal year, (iv) sales of marketable securities, (v) licensing of intellectual property in the ordinary course of business, and (vi) other Asset Sales approved in writing by Bank (which approval shall not be unreasonably withheld or delayed). 7.8 Investments. (a) Except as otherwise permitted by clauses (b), (c) and (d) of this Section 7.8, make any loans or advances to, or any investment in, any Person (other than Permitted Investments); or acquire, or permit any Subsidiary to acquire, any Capital Stock, (other than pursuant to Parent's stock buyback program), Assets, obligations, or other securities of, make any contribution to, or otherwise acquire any interest in, any Person; or acquire or form or permit any Subsidiary (other than the Excluded Subsidiaries) to acquire or form, any new Subsidiary (other than the Excluded Subsidiaries); or participate, or permit any Subsidiary to participate, as a partner or joint venturer with any other Person. (b) Notwithstanding the terms of Section 7.8(a), any Borrower may acquire or form, and permit any Subsidiary to acquire or form, any new Subsidiary or the Assets of another Person; provided that (i) the acquisition costs for all such acquisitions (including the total consideration paid to the seller(s), taxes, fees and other transaction costs), does not exceed, in the aggregate, Ten Million Dollars ($10,000,000), (ii) such acquisition is of a business engaged in the manufacture, design, marketing, distribution and/or sale (wholesale or retail) of apparel, shoes, footwear and/or outdoor sporting goods, (iii) Borrowers shall have complied with Sections 6.13 and 6.14, (iv) the acquisition shall not be hostile, and (v) prior to the consummation of the acquisition, Borrowers shall have demonstrated to the reasonable satisfaction of Bank that both before and, on a pro forma basis after giving effect to such acquisition, no Event of Default shall be continuing or will result therefrom. (c) Notwithstanding the terms of Section 7.8(a), Parent shall be permitted to exercise its purchase option set forth in the Teva Option Agreement. (d) Notwithstanding the terms of Section 7.8(a), Borrowers shall be permitted to make loans and advances (i) to their employees, provided that such loans and advances do not exceed Two Hundred Thousand Dollars ($200,000) in the aggregate outstanding at any time, (ii) to any Subsidiary and (iii) to any Excluded Subsidiary, provided that such loans and advances to Excluded Subsidiaries do not exceed Five Hundred Thousand Dollars ($500,000) in the aggregate outstanding at any time. 7.9 Character of Business. Engage in any business activities or operations substantially different from or unrelated to its present business activities and operations, or permit 47 any Subsidiary (other than the Excluded Subsidiaries) to do so (it being specifically acknowledged by Bank that Borrowers may directly or indirectly engage in the retail sale of apparel, footwear and shoes and in the licensing of intellectual property to be used in connection with the sale of consumer goods). 7.10 Distributions. (a) Except as otherwise permitted by Section 7.10(b), declare or pay any Distributions; or purchase, redeem, retire, or otherwise acquire for value any of its Capital Stock now or hereafter outstanding (other than pursuant to Parent's stock buyback program provided that the proceeds of the Loans may not be used for such purpose); or make any distribution of Assets to its shareholders, whether in cash, Assets, or in obligations of any Borrower; or allocate or otherwise set apart any sum for the payment of any Distribution on, or for the purchase, redemption or retirement of, any of its Capital Stock; or make any other distribution by reduction of capital or otherwise in respect of any of its Capital Stock; or permit any Subsidiary (other than the Excluded Subsidiaries) to purchase or otherwise acquire for value any Capital Stock of any Borrower or any other Subsidiary (other than the Excluded Subsidiaries). (b) Notwithstanding the terms of Section 7.10(a), any Borrower (other than Parent) may declare and pay Distributions to its parent. 7.11 Guaranty. Assume, guaranty (other than any guaranty of the Debt owing by Douglas B. Otto to Bank), endorse (other than checks and drafts received by a Borrower in the ordinary course of business so long as an Event of Default has not occurred), or otherwise be or become directly or contingently responsible or liable, or permit any Subsidiary (other than the Excluded Subsidiaries) to assume, guaranty, endorse, or otherwise be or become directly or contingently responsible or liable (including, any agreement to purchase any obligation, stock, Assets, goods, or services or to supply or advance any funds, Assets, goods, or services, or any agreement to maintain or cause such Person to maintain, a minimum working capital or net worth, or otherwise to assure the creditors of any Person against loss) for the obligations of any other Person (other than a Borrower); or pledge or hypothecate, or permit any Subsidiary (other than the Excluded Subsidiaries) to pledge or hypothecate, any of its Assets as security for any liabilities or obligations of any other Person (other than a Borrower). 7.12 Capital Expenditures. Make, or permit any Subsidiary (other than the Excluded Subsidiaries) to make, any Capital Expenditures, or any commitments therefor, in excess of Two Million Dollars ($2,000,000) in the aggregate, on a consolidated basis, in any fiscal year. 7.13 Transactions with Affiliates. Enter into any transaction, including borrowing or lending and the purchase, sale, or exchange of property or the rendering of any service (including management services), with any Affiliate (other than with Parent or with a Subsidiary that is not an Excluded Subsidiary), or permit any Subsidiary (other than the Excluded Subsidiaries) to enter into any transaction, including borrowing or lending and the purchase, sale, or exchange of property or the rendering of any service (including management services), with any Affiliate (other than with Parent or with a Subsidiary that is not an Excluded Subsidiary), other than in the ordinary course of and pursuant to the reasonable requirements of such Borrower's or such Subsidiary's business and 48 upon fair and reasonable terms no less favorable to such Borrower or such Subsidiary than would obtain in a comparable arm's length transaction with a Person not an Affiliate. 7.14 Stock Issuance. Permit any Subsidiary (other than the Excluded Subsidiaries) to issue any additional Capital Stock. 7.15 Financial Condition. Permit or suffer: (a) the Consolidated Total Liabilities to Consolidated Effective Tangible Net Worth Ratio, measured as of the end of each fiscal quarter of Parent, at any time to exceed 0.75:1.0. (b) the Quick Ratio, (i) measured as of the end of each first and fourth fiscal quarter of Parent, at any time to be less than 1.50:1.0 and (ii) measured as of the end of each second and third fiscal quarter of Parent, at any time to be less than 2.00:1.0. (c) Consolidated Net Loss for the fiscal quarter of Parent ended December 31, 2001 to be greater than $300,000, or Consolidated Net Profit at the end of each subsequent fiscal quarter of Parent (excluding the third fiscal quarter of each fiscal year of Parent) to be less than $50,000, or year-to-date Consolidated Net Profit at the end of the third fiscal quarter of each year of Parent to be less than zero; (d) Consolidated Pretax Profit for each fiscal year of Parent, commencing with the fiscal year ending December 31, 2002 to be less than $1,000,000; or (e) The Inventory Turnover Ratio, as of the end of each and every ABL Borrowing Period, to be less than 3.00:1.0. 7.16 Transactions Under ERISA. Directly or indirectly: (a) engage, or permit any member of the ERISA Group to engage, in any prohibited transaction which is reasonably likely to result in a civil penalty or excise tax described in Sections 406 of ERISA or 4975 of the Internal Revenue Code for which a statutory or class exemption is not available or a private exemption has not been previously obtained from the Department of Labor; (b) permit to exist with respect to any Plan any accumulated funding deficiency (as defined in Sections 302 of ERISA and 412 of the Internal Revenue Code), whether or not waived; (c) fail, or permit any member of the ERISA Group to fail, to pay timely required contributions or installments due with respect to any waived funding deficiency to any Plan; (d) terminate, or permit any member of the ERISA Group to terminate, any Plan where such event would result in any liability of any Borrower or any member of ERISA Group under Title IV of ERISA; 49 (e) fail, or permit any member of the ERISA Group to fail, to make any required contribution or payment to any Multiemployer Plan; (f) fail, or permit any member of the ERISA Group to fail, to pay to a Plan or Multiemployer Plan any required installment or any other payment required under Section 412 of the Internal Revenue Code on or before the due date for such installment or other payment; (g) amend, or permit any member of the ERISA Group to amend, a Plan resulting in an increase in current liability for the plan year such that either of any Borrower or any member of the ERISA Group is required to provide security to such Plan under Section 401(a)(29) of the Internal Revenue Code; or (h) withdraw, or permit any member of the ERISA Group to withdraw, from any Multiemployer Plan where such withdrawal is reasonably likely to result in any liability of any such entity under Title IV of ERISA; which, individually or in the aggregate, results in or reasonably would be expected to result in a claim against or liability of any Borrower, any of the Subsidiaries or any member of the ERISA Group in excess of Five Hundred Thousand Dollars ($500,000). ARTICLE VIII EVENTS OF DEFAULT AND REMEDIES 8.1 Events of Default. The occurrence of any one or more of the following events, acts or occurrences shall constitute an event of default (an "Event of Default") hereunder: (a) Borrowers fail to pay when due any payment of principal due on the Loans, or fail to pay within three (3) days of the due date thereof any interest due on the Loans, the Fees, any Expenses, or any other amount payable hereunder or under any Loan Document; (b) Borrowers fail to observe or perform any of the covenants and agreements set forth in Article VII; (c) Borrowers or any Guarantor fail to observe or perform any covenant or agreement set forth in this Agreement or the Loan Documents (other than those covenants and agreements described in Sections 8.1(a) and 8.1(b)), and such failure continues for fifteen (15) days after the earlier to occur of (i) Borrowers obtaining Knowledge of such failure or (ii) Bank's dispatch of notice to Borrowers of such failure; (d) Any representation, warranty or certification made by any Borrower or any Guarantor or any officer or employee of any Borrower or any Guarantor in this Agreement or any Loan Document, in any certificate, financial statement or other document delivered pursuant to this Agreement or any Loan Document proves to have been misleading or untrue in any material respect when made or if any such representation, warranty or certification is withdrawn; 50 (e) Any Borrower or any Guarantor fails to pay when due any payment in respect of its Debt in the aggregate principal amount in excess of $500,000 (other than under this Agreement) in the aggregate principal amount in excess of $500,000; (f) Any event or condition occurs that: (i) results in the acceleration of the maturity of any of any Borrower's or any Guarantor's Debt in the aggregate principal amount in excess of $500,000; or (ii) permits (or, with the giving of notice or lapse of time or both, would permit) the holder or holders of such Debt or any Person acting on behalf of such holder or holders to accelerate the maturity thereof; (g) Any Borrower or any Guarantor commences a voluntary Insolvency Proceeding seeking liquidation, reorganization or other relief with respect to itself or its Debt or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official over it or any substantial part of its property, or consents to any such relief or to the appointment of or taking possession by any such official in an involuntary Insolvency Proceeding or fails generally to pay its Debt as it becomes due, or takes any action to authorize any of the foregoing; (h) An involuntary Insolvency Proceeding is commenced against any Borrower or any Guarantor seeking liquidation, reorganization or other relief with respect to it or its Debt or seeking the appointment of a trustee, receiver, liquidator, custodian or other similar official of it or any substantial part of its property and any of the following events occur: (i) the petition commencing the Insolvency Proceeding is not timely controverted; (ii) the petition commencing the Insolvency Proceeding is not dismissed within forty-five (45) calendar days of the date of the filing thereof; (iii) an interim trustee is appointed to take possession of all or a substantial portion of the Assets of, or to operate all or any substantial portion of the business of, Borrower or such Guarantor; or (iv) an order for relief shall have been issued or entered therein; (i) Any Borrower or any Guarantor suffers (i) one or more money judgments in excess of $500,000 in the aggregate over applicable insurance coverage or (ii) one or more writs, warrants of attachment, or similar process involving Assets valued in the aggregate in excess of $500,000, and any of the foregoing shall continue in effect for a period of thirty (30) days without being vacated, discharged, satisfied, stayed or bonded pending appeal; (j) A judgment creditor obtains possession of any of the Assets valued in the aggregate in excess of $500,000 of any Borrower or any Guarantor by any means, including levy, distraint, replevin, or self-help, (k) Any order, judgment or decree is entered decreeing the dissolution of any Borrower or any Guarantor, or any Guarantor dies; (l) Any Borrower or any Guarantor is enjoined, restrained or in any way prevented by court order from continuing to conduct all or any material part of its business affairs; (m) A notice of lien, levy or assessment is filed of record with respect to any or all of any Borrower's or any Guarantor's Assets valued in the aggregate in excess of $500,000 by any Governmental Authority, or any taxes or debts owing at any time hereafter to any 51 Governmental Authority becomes a Lien, whether inchoate or otherwise, upon any or all of any Borrower's or any Guarantor's Assets valued in the aggregate in excess of $500,000 and the same is not paid on the payment date thereof; (n) If any Borrower's or any Guarantor's records are prepared and kept by an outside computer service bureau on the Closing Date or during the term of this Agreement such an agreement with an outside service bureau is entered into, and at any time thereafter, without first obtaining the written consent of Bank, such Borrower or Guarantor terminates, modifies, amends or changes its contractual relationship with said computer service bureau or said computer service bureau fails to provide Bank with any requested information or financial data pertaining to Bank's Collateral, such Borrower's or Guarantor's financial condition or the results of such Borrower's or Guarantor's operations; (o) Any reportable event, which Bank determines constitutes grounds for the termination of any Plan by the PBGC or for the appointment by the appropriate United States District Court of a trustee to administer any such Plan, shall have occurred and be continuing thirty (30) days after written notice of such determination shall have been given to Parent by Bank, or any such Plan shall be terminated within the meaning of Title IV of ERISA, or a trustee shall be appointed by the appropriate United States District Court to administer any such Plan, or the PBGC shall institute proceedings to terminate any Plan and in case of any event described in this Section 8.1(p), the aggregate amount of Borrowers' liability to the PBGC under Sections 4062, 4063 or 4064 of ERISA shall exceed five percent (5%) of the Consolidated Effective Tangible Effective Net Worth; (p) Any Change of Control occurs; (q) If the Teva License Agreement shall be terminated or cancelled, or fail to be in full force and effect in all material respects for any reason, or if a breach, default or event of default shall occur under the Teva License Agreement by either party thereto and is not cured within any applicable cure period therefor; (r) Any of the Loan Documents fails to be in full force and effect for any reason, or Bank fails to have a perfected, first priority Lien in and upon all of the collateral assigned or pledged to Bank thereunder, or a breach, default or an event of default occurs under any Loan Document; or (s) Any other Material Adverse Effect occurs. 8.2 Remedies. Upon the occurrence of any Event of Default described in Section 8.1(g) or 8.1(h), Bank's obligation hereunder to make Loans to Borrowers and/or Bank's to issue Letters of Credit shall immediately terminate and the Obligations shall become immediately due and payable without any election or action on the part of Bank, without presentment, demand, protest or notice of any kind, all of which each Borrower hereby expressly waives. Upon the occurrence and continuance of any other Event of Default, either or both of the following actions may be taken: (i) Bank may without notice of its election and without demand, immediately terminate the Revolving Credit Commitment, whereupon Bank's obligation to make Loans to 52 Borrowers and/or to issue Letters of Credit shall immediately cease; and (ii) Bank may, without notice of its election and without demand, declare the Obligations to be due and payable, whereupon the Obligations shall become immediately due and payable, without presentment, demand, protest or notice of any kind, all of which each Borrower hereby expressly waives. 8.3 Setoff. During the continuance of an Event of Default, Bank is hereby authorized at any time and from time to time, without notice to Borrowers (any such notice being expressly waived by each Borrower), to set off and apply any and all deposits (general or special, time or demand, provisional or final), at any time held and other indebtedness at any time owing by Bank to or for the credit or the account of Borrowers, against any and all of the Obligations owing to Bank, irrespective of whether Bank shall have made any demand under this Agreement or the Loan Documents, and although the Obligations may be unmatured. Bank agrees promptly to notify Borrowers after any such setoff and application, provided that the failure to give such notice shall not affect the validity of such setoff and application. 8.4 Appointment of Receiver or Trustee. Borrowers hereby irrevocably agree that Bank, has the right under this Agreement, upon the occurrence of an Event of Default, to seek the appointment of a receiver, trustee or similar official over Borrowers to effect the transactions contemplated by this Agreement, and that Bank is entitled to seek such relief. Borrowers hereby irrevocably agree not to object to such appointment on any grounds. 8.5 Remedies Cumulative. The rights and remedies of Bank herein and in the Loan Documents are cumulative, and are not exclusive of any other rights, powers, privileges, or remedies, now or hereafter existing, at law, in equity or otherwise. ARTICLE IX TAXES 9.1 Taxes on Payments. All payments in respect of the Obligations shall be made free and clear of and without any deduction or withholding for or on account of any present and future taxes, levies, imposts, deductions, charges, withholdings, assessments or governmental charges, and all liabilities with respect thereto, imposed by the United States of America, any foreign government, or any political subdivision or taxing authority thereof or therein, excluding any taxes imposed on Bank under the Internal Revenue Code or similar state and local laws and determined by such Bank's net income, and any franchise taxes imposed on Bank by any state (or any political subdivision thereof) (all such non-excluded taxes, levies, imposts, deductions, charges, withholdings, assessments, charges and liabilities being hereinafter referred to as "Taxes"). If any Taxes are imposed and required by law to be deducted or withheld from any amount payable to Bank, then Borrowers shall (i) increase the amount of such payment so that Bank will receive a net amount (after deduction of all Taxes) equal to the amount due hereunder, and (ii) pay such Taxes to the appropriate taxing authority for the account of Bank prior to the date on which penalties attach thereto or interest accrues thereon; provided, however, if any such penalties or interest shall become due, Borrowers shall make prompt payment thereof to the appropriate taxing authority. 53 9.2 Indemnification For Taxes. Borrowers shall indemnify Bank for the full amount of Taxes (including penalties, interest, expenses and Taxes arising from or with respect to any indemnification payment) arising therefrom or with respect thereto, whether or not the Taxes were correctly or legally asserted. This indemnification shall be made on demand. If Borrowers make a payment under Section 9.1 or this Section 9.2 for account of Bank and Bank reasonably determines that it has received or been granted a credit against or relief or remission for, or repayment of, any Tax paid or payable by it in respect of or calculated with reference to the deduction or withholding giving rise to such payment, Bank shall, to the extent that it can do so without prejudice to the retention of the amount of such credit, relief, remission or repayment, pay to Borrower such amount as Bank shall have reasonably determined to be attributable to such deduction or withholding. The amount paid by Bank to Borrowers pursuant to the immediately preceding sentence shall not exceed: (x) in the case of a refund of cash, the amount of cash refunded to Bank with respect to such Tax; or (y) in the case of a refund taking the form of a credit against Tax, the economic benefit to Bank with respect to the amount received as credit with respect to such Tax. Borrowers further agree promptly to return to Bank the amount of any credit or refund actually paid to Borrowers by Bank if Bank is required to repay it. 9.3 Evidence of Payment. Within thirty (30) days after the date of payment of any Taxes, Borrower shall furnish to Bank the original or a certified copy of a receipt evidencing payment thereof. If no Taxes are payable in respect of any payment due hereunder or under the Notes, Borrowers shall furnish to Bank a certificate from each appropriate taxing authority, or an opinion of counsel acceptable to Bank, in either case stating that such payment is exempt from or not subject to Taxes. ARTICLE X MISCELLANEOUS 10.1 Notices. All notices, requests and other communications to any party hereunder shall be in writing (including facsimile transmission or similar writing) and shall be given to such party at its address or facsimile number set forth on the signature pages hereof or such other address or facsimile number as such party may hereafter specify by notice to the other party in accordance with this Section 10.1. Each such notice, request or other communication shall be deemed given on the second (2nd) business day after mailing; provided that actual notice, however and from whomever given or received, shall always be effective on receipt; provided further that notices to Bank pursuant to Article II and Article III shall not be effective until received by a Responsible Officer of Bank; provided further that notices sent by Bank in connection with Bank's exercise of its enforcement rights against any of its collateral shall be deemed given when deposited in the mail or personally delivered, or, where permitted by law, transmitted by facsimile. 10.2 No Waivers. No failure or delay by Bank in exercising any right, power or privilege hereunder or under any Loan Document shall operate as a waiver thereof nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right, power or privilege. 54 10.3 Expenses; Documentary Taxes; Indemnification. (a) Borrowers shall pay all Expenses on demand. (b) Borrowers shall pay all and indemnify Bank against any and all transfer taxes, documentary taxes, assessments, or charges made by any Governmental Authority and imposed by reason of the execution and delivery of this Agreement, any of the Loan Documents, or any other document, instrument or agreement entered into in connection herewith. (c) Each Borrower shall and hereby agrees to indemnify, protect, defend and hold harmless Bank and their respective directors, officers, Banks, employees and attorneys (collectively, the "Indemnified Persons" and individually, an "Indemnified Person") from and against (i) any and all losses, claims, damages, liabilities, deficiencies, judgments, costs and expenses (including attorneys' fees and attorneys' fees incurred pursuant to proceedings arising under the Bankruptcy Code) incurred by any Indemnified Person (except to the extent that it is finally judicially determined to have resulted from the gross negligence or willful misconduct of any Indemnified Person) arising out of or by reason of any litigations, investigations, claims or proceedings (whether administrative, judicial or otherwise), including discovery, whether or not Bank is designated a party thereto, which arise out of or are in any way related to (1) this Agreement, the Loan Documents or the transactions contemplated hereby or thereby, (2) any actual or proposed use by Borrowers of the proceeds of the Loans, or (3) Bank's entering into this Agreement, the Loan Documents or any other agreements and documents relating hereto; (ii) any such losses, claims, damages, liabilities, deficiencies, judgments, costs and expenses arising out of or by reason of the use, generation, manufacture, production, storage, release, threatened release, discharge, disposal or presence on, under or about any Borrower's operations or property or property leased by any Borrower of any material, substance or waste which is or becomes designated as Hazardous Materials; and (iii) any such losses, claims, damages, liabilities, deficiencies, judgments, costs and expenses incurred in connection with any remedial or other action taken by any Borrower or Bank in connection with compliance by any Borrower with any federal, state or local environmental laws, acts, rules, regulations, orders, directions, ordinances, criteria or guidelines (except to the extent that it is finally judicially determined to have resulted from the gross negligence or willful misconduct of any Indemnified Person). If and to the extent that the obligations of Borrowers hereunder are unenforceable for any reason, Borrowers hereby agree to make the maximum contribution to the payment and satisfaction of such obligations to Bank which is permissible under applicable law. (d) Borrowers' obligations under this Section 10.3 and under Section 9.2 shall survive any termination of this Agreement and the Loan Documents and the payment in full of the Obligations, and are in addition to, and not in substitution of, any other of its obligations set forth in this Agreement. 10.4 Amendments and Waivers. Neither this Agreement nor any Loan Document, nor any terms hereof or thereof may be amended, supplemented or modified except in accordance with the provisions of this Section 10.4. Bank may from time to time, (a) enter into with Borrowers or any other Person written amendments, supplements or modifications hereto and to the Loan Documents or (b) waive, on such terms and conditions as Bank may specify in such instrument, any of the requirements of this Agreement or the Loan Documents or any Event Default or Unmatured 55 Event of Default and its consequences, if, but only if, such amendment, supplement, modification or waiver is in writing and is signed by the party asserted to be bound thereby, and then such amendment, supplement, modification or waiver shall be effective only in the specific instance and specific purpose for which given. Any such waiver and any such amendment, supplement or modification shall be binding upon Borrower, Bank and all future holders of the Loans. In the case of any waiver, Borrower and Bank shall be restored to their former positions and rights hereunder and under the Loan Documents, and any Event of Default or Unmatured Event of Default waived shall be deemed to be cured and not continuing; no such waiver shall extend to any subsequent or other Event of Default or Unmatured Event of Default or impair any right consequent thereon. Borrowers may, from time to time, prospectively amend any Schedule hereto or to any Loan Document. No such amendment shall be evidence, in and of itself, that the representations and warranties in the corresponding section of the applicable agreement previously made are no longer true and correct in all material respects, nor shall any such amendment cure any Event of Default caused by a misrepresentation previously made. 10.5 Successors and Assigns; Participations; Disclosure. (a) This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, except that Borrowers may not assign or transfer any of its rights or obligations under this Agreement without the prior written consent of all Bank's and any such prohibited assignment or transfer by Borrowers shall be void. (b) Bank may make, carry or transfer the Loans at, to or for the account of, any of its branch offices or the office of an Affiliate of Bank or to any Federal Reserve Bank, all without Borrowers' consent. (c) Bank may, at its own expense, assign to one or more banks or other Eligible Assignees all or a portion of its rights (including voting rights) and obligations under this Agreement and the Loan Documents. In the event of any such assignment by Bank pursuant to this Section 10.5(c), Bank's obligations under this Agreement arising after the effective date of such assignment shall be released and concurrently therewith, transferred to and assumed by Bank's assignee to the extent provided for in the document evidencing such assignment, and Bank shall give prompt notice of such assignment to Borrowers. The provisions of this Section 10.5 relate only to absolute assignments (whether or not arising as the result of foreclosure of a security interest) and that such provisions do not prohibit assignments creating security interests, including, without limitation, any pledge or assignment by Bank of any Loan or the Note to any Federal Reserve Bank in accordance with applicable law. (d) Bank may at any time sell to one or more banks or other financial institutions (each a "Participant") participating interests in the Loans, the Letters of Credit and in any other interest of Bank hereunder. In the event of any such sale by Bank of a participating interest to a Participant, Bank's obligations under this Agreement shall remain unchanged, Bank shall remain solely responsible for the performance thereof, and Borrowers shall continue to deal solely and directly with Bank in connection with Bank's rights and obligations under this Agreement. Each 56 Borrower agrees that each Participant shall, to the extent provided in its participation agreement, be entitled to the benefits of Article IX with respect to its participating interest. (e) Each Borrower authorizes Bank to disclose to any assignee under Section 10.5(c) or any Participant (either, a "Transferee") and any prospective Transferee any and all financial information in Bank's possession concerning Borrowers which has been delivered to Bank by Borrowers pursuant to this Agreement or which has been delivered to Bank by Borrowers in connection with Bank's credit evaluation prior to entering into this Agreement; provided that such Transferee or prospective Transferee has first agreed to be bound by the provisions of Section 11.6. (f) Each Borrower agrees that Bank may use Borrower's and the Subsidiaries' name(s) in advertising and promotional materials, and in conjunction therewith, Bank may disclose the amount of the Loans and the purpose thereof. 10.6 Confidentiality. Bank agrees to keep confidential any information relating to Borrower and the Subsidiaries previously delivered or delivered from time to time by Borrower hereunder; provided that nothing herein shall prevent Bank from disclosing such information: (a) to any Affiliate of Bank or any actual or potential Transferee that agrees to be bound by this Section 10.6, (b) upon order, subpoena, or other process of any court or administrative agency, (c) upon the request or demand of any regulatory agency or authority having jurisdiction over Bank, (d) which has been publicly disclosed (other than by Bank or any Transferee unless such disclosure was otherwise permitted hereunder), (e) which has been obtained from any Person that is not a party hereto or an Affiliate of any such party, (f) in connection with the exercise of any remedy, or the resolution of any dispute, hereunder or under any Loan Document, (g) to the legal counsel or certified public accountants for Bank or (h) as otherwise permitted by Borrower or as expressly contemplated by this Agreement. 10.7 Counterparts; Effectiveness; Integration. This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. This Agreement shall be effective when executed by each of the parties hereto. This Agreement constitutes the entire agreement and understanding among the parties hereto and supersedes any and all prior agreements and understandings, oral or written, relating to the subject matter hereof. 10.8 Severability. The provisions of this Agreement are severable. The invalidity, in whole or in part, of any provision of this Agreement shall not affect the validity or enforceability of any other of its provisions. If one or more provisions hereof shall be declared invalid or unenforceable, the remaining provisions shall remain in full force and effect and shall be construed in the broadest possible manner to effectuate the purposes hereof. 10.9 Knowledge. For purposes of this Agreement, an individual will be deemed to have knowledge of a particular fact or other matter if: (a) such individual is actually aware of such fact or other matter; or (b) a prudent individual could be expected to discover or otherwise become aware of such fact or other matter in the course of conducting a reasonably comprehensive investigation concerning the existence of such fact or other matter. Each Borrower will be deemed to have knowledge of a particular fact or other matter if the chief executive officer, chief operating 57 officer, chief financial officer, controller, treasurer, president, senior vice president or other such executive officer of such Borrower has, or at any time had, knowledge of such fact or other matter. Parent will be deemed to have knowledge of a partial fact or other matter if any other Borrower has knowledge of such fact or other matter. 10.10 Additional Waivers. (a) Each Borrower agrees that checks and other instruments received by Bank in payment or on account of the Obligations constitute only conditional payment until such items are actually paid to Bank and each Borrower waives the right to direct the application of any and all payments at any time or times hereafter received by Bank on account of the Obligations, and each Borrower agrees that Bank shall have the continuing exclusive right to apply and reapply such payments in any manner as Bank may deem advisable, notwithstanding any entry by Bank upon its books. (b) Each Borrower waives demand, protest, notice of protest, notice of default or dishonor, notice of payment and nonpayment, notice of any default, nonpayment at maturity, release, compromise, settlement, extension or renewal of any or all commercial paper, accounts, documents, instruments, chattel paper, and guarantees at any time held by Bank on which such Borrower may in any way be liable. (c) Bank shall not in any way or manner be liable or responsible for (a) the safekeeping of the Inventory or Equipment; (b) any loss or damage thereto occurring or arising in any manner or fashion from any cause; (c) any diminution in the value thereof; or (d) any act or default of any carrier, warehouseman, bailee, forwarding agency or other person whomsoever. All risk of loss, damage or destruction of Inventory shall be borne by Borrowers. (d) Each Borrower waives the right and the right to assert a confidential relationship, if any, it may have with any accountant, accounting firm and/or service bureau or consultant in connection with any information requested by Bank pursuant to or in accordance with this Agreement, and agrees that Bank may contact directly any such accountants, accounting firm and/or service bureau or consultant in order to obtain such information. 10.11 Destruction Of Borrowers' Documents. Any documents, schedules, invoices or other papers delivered to Bank may be destroyed or otherwise disposed of by Bank six (6) months after they are delivered to or received by Bank, unless Parent requests, in writing, the return of the said documents, schedules, invoices or other papers and makes arrangements, at Borrowers' expense, for their return. 10.12 CHOICE OF LAW AND VENUE; JURY TRIAL WAIVER. (a) THE VALIDITY OF THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS (UNLESS EXPRESSLY PROVIDED TO THE CONTRARY IN ANOTHER LOAN DOCUMENT IN RESPECT OF SUCH OTHER LOAN DOCUMENT), THE CONSTRUCTION, INTERPRETATION, AND ENFORCEMENT HEREOF AND THEREOF, AND THE RIGHTS OF THE PARTIES HERETO AND THERETO WITH RESPECT TO ALL MATTERS ARISING HEREUNDER OR THEREUNDER OR 58 RELATED HERETO OR THERETO SHALL BE DETERMINED UNDER, GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS OF THE STATE OF CALIFORNIA, WITHOUT REGARD FOR PRINCIPLES OF CONFLICTS OF LAWS. (b) THE PARTIES AGREE THAT ALL ACTIONS OR PROCEEDINGS ARISING IN CONNECTION WITH THIS AGREEMENT AND THE OTHER LOAN DOCUMENTS SHALL BE TRIED AND LITIGATED ONLY IN THE STATE AND FEDERAL COURTS LOCATED IN THE COUNTY OF LOS ANGELES, STATE OF CALIFORNIA, PROVIDED, HOWEVER, THAT ANY SUIT SEEKING ENFORCEMENT AGAINST ANY COLLATERAL OR OTHER PROPERTY MAY BE BROUGHT, AT BANK'S OPTION, IN THE COURTS OF ANY JURISDICTION WHERE BANK ELECTS TO BRING SUCH ACTION OR WHERE SUCH COLLATERAL OR OTHER PROPERTY MAY BE FOUND. BORROWERS AND BANK WAIVE, TO THE EXTENT PERMITTED UNDER APPLICABLE LAW, ANY RIGHT EACH MAY HAVE TO ASSERT THE DOCTRINE OF FORUM NON CONVENIENS OR TO OBJECT TO VENUE TO THE EXTENT ANY PROCEEDING IS BROUGHT IN ACCORDANCE WITH THIS SECTION 10.12. (c) THE BORROWERS AND BANK HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF THIS AGREEMENT OR ANY OF THE LOAN DOCUMENTS OR ANY OF THE TRANSACTIONS CONTEMPLATED HEREIN OR THEREIN, INCLUDING CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW OR STATUTORY CLAIMS. THE BORROWERS AND BANK REPRESENT THAT EACH HAS REVIEWED THIS WAIVER AND EACH KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL. IN THE EVENT OF LITIGATION, A COPY OF THIS AGREEMENT MAY BE FILED AS A WRITTEN CONSENT TO A TRIAL BY THE COURT. ARTICLE XI JOINT AND SEVERAL LIABILITY; SINGLE LOAN ACCOUNT 11.1 Joint and Several Liability. Each Borrower agrees that it is jointly and severally, directly and primarily liable to Bank for payment, performance and satisfaction in full of the Obligations and that such liability is independent of the duties, obligations, and liabilities of the other Borrower. Bank may bring a separate action or actions on each, any, or all of the Obligations against any Borrower, whether action is brought against the other Borrowers or whether the other Borrowers are joined in such action. In the event that any Borrower fails to make any payment of any obligation on or before the due date thereof, the other Borrowers immediately shall cause such payment to be made or each of such obligations to be made or each of such Obligations to be performed, kept, observed, or fulfilled. 59 11.2 Primary Obligation; Waiver of Marshalling. This Agreement and the Loan Documents to which Borrowers are a party are a primary and original obligation of each Borrower, are not the creation of a surety relationship, and are an absolute, unconditional, and continuing promise of payment and performance which shall remain in full force and effect without respect to future changes in conditions, including any change of law or any invalidity or irregularity with respect to this Agreement or the Loan Documents to which Borrowers are a party. Each Borrower agrees that its liability under this Agreement and the Loan Documents which Borrowers are a party shall be immediate and shall not be contingent upon the exercise or enforcement by Bank of whatever remedies they may have against the other Borrowers, or the enforcement of any lien or realization upon any security Bank may at any time possess. Each Borrower consents and agrees that Bank shall be under no obligation to marshal any assets of any Borrower against or in payment of any or all of the Obligations. 11.3 Financial Condition of Borrowers. Each Borrower acknowledges that it is presently informed as to the financial condition of the other Borrowers and of all other circumstances which a diligent inquiry would reveal and which bear upon the risk of nonpayment of the Obligations. Each Borrower hereby covenants that it will continue to keep informed as to the financial condition of the other Borrowers, the status of the other Borrowers and of all circumstances which bear upon the risk of nonpayment. Absent a written request from any Borrower to Bank for information, each Borrower hereby waives any and all rights it may have to require Bank to disclose to such Borrower any information which Bank may now or hereafter acquire concerning the condition or circumstances of the other Borrowers. 11.4 Continuing Liability. The liability of each Borrower under this Agreement and the Loan Documents to which Borrowers are a party includes Obligations arising under successive transactions continuing, compromising, extending, increasing, modifying, releasing, or renewing the Obligations, changing the interest rate, payment terms, or other terms and conditions thereof, or creating new or additional Obligations after prior Obligations have been satisfied in whole or in part. To the maximum extent permitted by law, each Borrower hereby waives any right to revoke its liability under this Agreement and Loan Documents as to future indebtedness, and in connection therewith, each Borrower hereby waives any rights it may have under Section 2815 of the California Civil Code. 11.5 Additional Waivers. Each Borrower absolutely, unconditionally, knowingly, and expressly waives: (a) (1) notice of acceptance hereof; (2) notice of any Loans or other financial accommodations made or extended under this Agreement and the Loan Documents to which Borrowers are a party or the creation or existence of any Obligations; (3) notice of the amount of the Obligations, subject, however, to each Borrower's right to make inquiry of Bank to ascertain the amount of the Obligations at any reasonable time; (4) notice of any adverse change in the financial condition of the other Borrowers or of any other fact that might increase such Borrower's risk hereunder; (5) notice of presentment for payment, demand, protest, and notice thereof as to any instruments among the Loan Documents to which Borrowers are a party; (6) notice of any Unmatured Event of Default or Event of Default; and (7) all other notices (except if such notice is 60 specifically required to be given to Borrowers hereunder or under the Loan Documents to which Borrowers are a party) and demands to which such Borrower might otherwise be entitled. (b) its right, under Sections 2845 or 2850 of the California Civil Code, or otherwise, to require Bank to institute suit against, or to exhaust any rights and remedies which Bank has or may have against, the other Borrowers or any third party, or against any collateral for the Obligations provided by the other Borrowers, or any third party. Each Borrower further waives any defense arising by reason of any disability or other defense (other than the defense that the Obligations shall have been fully and finally performed and indefeasibly paid) of the other Borrowers or by reason of the cessation from any cause whatsoever of the liability of the other Borrowers in respect thereof. (c) (1) any rights to assert against Bank any defense (legal and equitable), set-off, counterclaim, or claim which such Borrower may now or at any time hereafter have against the other Borrowers or any other party liable to Bank; (2) any defense, set-off, counterclaim, or claim, of any kind or nature, arising directly or indirectly from the present or future lack of perfection, sufficiency, validity, or enforceability of the Obligations or any security therefor; (3) any defense such Borrower has to performance hereunder, and any right such Borrower has to be exonerate, provided by Sections 2819, 2822, or 2825 of the California Civil Code, or otherwise, arising by reason of: the impairment or suspension of Bank's rights or remedies against the other Borrowers; the alteration by Bank of the Obligations; any discharge of the other Borrowers' obligations to Bank by operation of law as a result of Bank's intervention or omission; or the acceptance by Bank of anything in partial satisfaction of the Obligations; and (4) the benefit of any statute of limitations affecting such Borrower's liability hereunder or the enforcement thereof, and any act which shall defer or delay the operation of any statute of limitations applicable to the Obligations shall similarly operate to defer or delay the operation of such statute of limitations applicable to such Borrower's liability hereunder. (d) Each Borrower absolutely, unconditionally, knowingly, and expressly waives any defense arising by reason of or deriving from (i) any claim or defense based upon an election of remedies by Bank including any defense based upon an election of remedies by Bank under the provisions of Sections 580a, 580b, 580d, and 726 of the California Code of Civil Procedure or any similar law of California or any other jurisdiction; or (ii) any election by Bank under Section 1111(b) of the Bankruptcy Code to limit the amount of, or any collateral securing, its claim against the Borrowers. Pursuant to California Civil Code Section 2856(b): (i) Each Borrower waives all rights and defenses arising out of an election of remedies by the creditor, even though that election of remedies, such as a nonjudicial foreclosure with respect to security for a guaranteed obligation, has destroyed such Borrower's rights of subrogation and reimbursement against the other Borrowers by the operation of Section 580(d) of the California Code of Civil Procedure or otherwise. (ii) Each Borrower waives all rights and defenses that such Borrower may have because the Obligations are secured by real property. This means, among other things: (1) Bank may collect from such Borrower without first foreclosing on any real or personal property collateral pledged by the other Borrowers; and (2) if Bank forecloses on any real property 61 collateral pledged by the other Borrowers: (A) the amount of the Obligations may be reduced only by the price for which that collateral is sold at the foreclosure sale, even if the collateral is worth more than the sale price; and (B) Bank may collect from such Borrower even if Bank, by foreclosing on the real property collateral, has destroyed any right such Borrower may have to collect from the other Borrowers. This is an unconditional and irrevocable waiver of any rights and defenses each Borrower may have because the Obligations are secured by real property. These rights and defenses include, but are not limited to, any rights or defenses based upon Section 580a, 580b, 580d, or 726 of the California Code of Civil Procedure. (e) If any of the Obligations at any time are secured by a mortgage or deed of trust upon real property, Bank may elect, in its sole discretion, upon a default with respect to the Obligations, to foreclose such mortgage or deed of trust judicially or nonjudicially in any manner permitted by law, before or after enforcing this Agreement and the Loan Documents, without diminishing or affecting the liability of any Borrower hereunder except to the extent the Obligations are repaid with the proceeds of such foreclosure. Each Borrower understands that (a) by virtue of the operation of California's antideficiency law applicable to nonjudicial foreclosures, an election by Bank nonjudicially to foreclose such a mortgage or deed of trust probably would have the effect of impairing or destroying rights of subrogation, reimbursement, contribution, or indemnity of such Borrower against the other Borrowers or other guarantors or sureties, and (b) absent the waiver given by such Borrower, such an election would prevent Bank from enforcing this Agreement and the Loan Documents to which Borrowers are a party against such Borrower. Understanding the foregoing, and understanding that such Borrower is hereby relinquishing a defense to the enforceability of this Agreement and the Loan Documents to which Borrowers are a party, such Borrower hereby waives any right to assert against Bank any defense to the enforcement of this Agreement and the Loan Documents to which Borrowers are a party, whether denominated "estoppel" or otherwise, based on or arising from an election by Bank nonjudicially to foreclose any such mortgage or deed of trust. Each Borrower understands that the effect of the foregoing waiver may be that each Borrower may have liability hereunder for amounts with respect to which such Borrower may be left without rights of subrogation, reimbursement, contribution, or indemnity against the other Borrower or other guarantors or sureties. Each Borrower also agrees that the "fair market value" provisions of Section 580a of the California Code of Civil Procedure shall have no applicability with respect to the determination of such Borrower's liability under this Agreement and the Loan Documents to which Borrowers are a party. (f) Each Borrower hereby absolutely, unconditionally, knowingly, and expressly waives: (i) any right of subrogation such Borrower has or may have as against the other Borrowers with respect to the Obligations; (ii) any right to proceed against the other Borrowers or any other Person, now or hereafter, for contribution, indemnity, reimbursement, or any other suretyship rights and claims, whether direct or indirect, liquidated or contingent, whether arising under express or implied contract or by operation of law, which such Borrower may now have or hereafter have as against the other Borrowers with respect to the Obligations; and (iii) any right to proceed or seek recourse against or with respect to any property or asset of the other Borrowers. (g) WITHOUT LIMITING THE GENERALITY OF ANY OTHER WAIVER OR OTHER PROVISION SET FORTH IN THIS AGREEMENT, EACH BORROWER HEREBY ABSOLUTELY, KNOWINGLY, UNCONDITIONALLY, AND EXPRESSLY WAIVES 62 AND AGREES NOT TO ASSERT ANY AND ALL BENEFITS OR DEFENSES ARISING DIRECTLY OR INDIRECTLY UNDER ANY ONE OR MORE OF CALIFORNIA CIVIL CODE SECTIONS 2799, 2808, 2809, 2810, 2815, 2819, 2820, 2821, 2822, 2825, 2839, 2845, 2848, 2849, AND 2850, CALIFORNIA CODE OF CIVIL PROCEDURE SECTIONS 580a, 580b, 580c, 580d, AND 726, CALIFORNIA UNIFORM COMMERCIAL CODE SECTIONS 3116, 3118, 3119, 3419, AND 3605, AND CHAPTER 2 OF TITLE 14 OF PART 4 OF DIVISION 3 OF THE CALIFORNIA CIVIL CODE. 11.6 Settlement or Releases. Each Borrower consents and agrees that without notice to or by such Borrower, and without affecting or impairing the liability of such Borrower hereunder, Bank may, by action or inaction: (a) compromise, settle, extend the duration or the time for the payment of, or discharge the performance of, or may refuse to or otherwise not enforce this Agreement and the Loan Documents, or any part thereof, with respect to the other Borrowers or any Guarantor; (b) release the other Borrowers or any Guarantor or grant other indulgences to the other Borrowers or any Guarantor in respect thereof; or (c) release or substitute any Guarantor, if any, of the Obligations, or enforce, exchange, release, or waive any security for the Obligations or any other guaranty of the Obligations, or any portion thereof. 11.7 No Election. Bank shall have the right to seek recourse against each Borrower to the fullest extent provided for herein, and no election by Bank to proceed in one form of action or proceeding, or against any party, or on any obligation, shall constitute a waiver of Bank's right to proceed in any other form of action or proceeding or against other parties unless Bank has expressly waived such right in writing. Specifically, but without limiting the generality of the foregoing, no action or proceeding by Bank under this Agreement and the Loan Documents shall serve to diminish the liability of any Borrower under this Agreement and the Loan Documents to which Borrowers are a party except to the extent that Bank finally and unconditionally shall have realized indefeasible payment by such action or proceeding. 11.8 Indefeasible Payment. The Obligations shall not be considered indefeasibly paid unless and until all payments to Bank are no longer subject to any right on the part of any Person, including any Borrower, any Borrower as a debtor in possession, or any trustee (whether appointed pursuant to the Bankruptcy Code, or otherwise) of any Borrower's Assets to invalidate or set aside such payments or to seek to recoup the amount of such payments or any portion thereof, or to declare same to be fraudulent or preferential. Upon such full and final performance and indefeasible payment of the Obligations, Bank shall have no obligation whatsoever to transfer or assign its interest in this Agreement and the Loan Documents to any Borrower. In the event that, for any reason, any portion of such payments to Bank is set aside or restored, whether voluntarily or involuntarily, after the making thereof, then the obligation intended to be satisfied thereby shall be revived and continued in full force and effect as if said payment or payments had not been made, and any Borrower shall be liable for the full amount Bank is required to repay plus any and all costs and 63 expenses (including attorneys' fees and attorneys' fees incurred in proceedings brought under the Bankruptcy Code) paid by Bank in connection therewith. 11.9 Single Loan Account. At the request of Borrowers to facilitate and expedite the administration and accounting processes and procedures of the Loans and Borrowings, Bank have agreed, in lieu of maintaining separate loan accounts on Bank's books in the name of each of the Borrowers, that Bank may maintain a single loan account under the name of all of both Borrowers (the "Loan Account"). All Loans shall be made jointly and severally to Borrowers and shall be charged to the Loan Account, together with all interest and other charges as permitted under and pursuant to this Agreement. The Loan Account shall be credited with all repayments of Obligations received by Bank, on behalf of Borrowers, from either Borrower pursuant to the terms of this Agreement. 11.10 Apportionment of Proceeds of Loans. Each Borrower expressly agrees and acknowledges that Bank shall have no responsibility to inquire into the correctness of the apportionment or allocation of or any disposition by any of Borrowers of (a) the Loans or any Borrowings, or (b) any of the expenses and other items charged to the Loan Account pursuant to this Agreement. The Loans and all such Borrowings and such expenses and other item shall be made for the collective, joint, and several account of Borrowers and shall be charged to the Loan Account. 11.11 Bank Held Harmless. Each Borrower agrees and acknowledges that the administration of this Agreement on a combined basis, as set forth herein, is being done as an accommodation to Borrowers and at their request, and that Bank shall incur no liability to Borrowers as a result thereof. To induce Bank to do so, and in consideration thereof, each Borrower hereby agrees to indemnify and hold Bank harmless from and against any and all liability, expense, loss, damage, claim of damage, or injury, made against Bank by Borrowers or by any other person or entity, arising from or incurred by reason of such administration of the Agreement. 11.12 Borrowers' Integrated Operations. Each Borrower represents and warrants to Bank that the collective administration of the Loans is being undertaken by Bank pursuant to this Agreement because Borrowers are integrated in their operation and administration and require financing on a basis permitting the availability of credit from time to time to Borrowers. Each Borrower will derive benefit, directly and indirectly, from such collective administration and credit availability because the successful operation of each Borrower is enhanced by the continued successful performance of the integrated group. * * * [remainder of this page intentionally left blank] * * * 64 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their respective authorized officers as of the day and year first above written. DECKERS OUTDOOR CORPORATION By /s/ M. Scott Ash ---------------------------------- M. Scott Ash, Chief Financial Officer Address for notices: Deckers Outdoor Corporation 495-A South Fairview Avenue Goleta, California 93117 Attn: Chief Financial Officer Telephone: (805) 967-7611, Ext. 185 Facsimile: (805) 967-7862 UGG HOLDINGS, INC. By /s/ M. Scott Ash ---------------------------------- M. Scott Ash, Chief Financial Officer Address for notices: UGG HOLDINGS, INC. 495-A South Fairview Avenue Goleta, California 93117 Attn: Chief Financial Officer Telephone: (805) 967-7611, Ext. 185 Facsimile: (805) 967-7862 65 COMERICA BANK - CALIFORNIA By /s/ Jason D. Brown ---------------------------------- Jason D. Brown, Vice President Address for notices and Lending Office: Comerica Bank - California 15303 Ventura Boulevard Sherman Oaks, California 91403 Attn: Jason D. Brown Telephone: (818) 379-2926 Facsimile: (818) 379-2902 66 EX-21.1 4 v79832ex21-1.txt EXHIBIT 21.1 EXHIBIT 21.1 SUBSIDIARIES OF THE REGISTRANT Simple Shoes, Inc. (California) Holbrook Limited (Hong Kong) Phillipsburg Limited (Hong Kong) Ugg Holdings, Inc. (California) Deckers Europe B.V. (The Netherlands) EX-23.1 5 v79832ex23-1.txt EXHIBIT 23.1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT The Board of Directors Deckers Outdoor Corporation: We consent to the incorporation by reference in the registration statement (No. 333-82538) on Form S-8 of Deckers Outdoor Corporation of our report dated February 16, 2002, except as to the last paragraph of Note 4 which is as of February 22, 2002, with respect to the consolidated balance sheets of Deckers Outdoor Corporation and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of earnings, stockholders' equity and other comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2001, and the related financial statement schedule, which report appears in the December 31, 2001 annual report on Form 10-K of Deckers Outdoor Corporation. /s/ KPMG LLP Los Angeles, California March 29, 2002 -----END PRIVACY-ENHANCED MESSAGE-----


Delaware (State or other jurisdiction of incorporation or organization)		95-3015862 (I.R.S. Employer Identification No.)

495-A South Fairview Avenue, Goleta, California (Address of principal executive offices)		93117 (Zip Code)


Title of each class		Name of each exchange on which registered

None		None


PART I
	Item 1.Business
	Item 2.Properties
	Item 3.Legal Proceedings
	Item 4.Submission of Matters to a Vote of Security Holders
PART II
	Item 5.Market for Registrant’s Common Equity and Related Stockholder Matters
	Item 6.Selected Financial Data
	Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 7A.Quantitative and Qualitative Disclosures About Market Risk
	Item 8.Financial Statements and Supplementary Data
	Item 9.Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
		Consolidated Balance Sheets
PART III
	Item 10.Directors and Executive Officers of the Registrant
	Item 11.Executive Compensation
	Item 12.Security Ownership of Certain Beneficial Owners and Management
	Item 13.Certain Relationships and Related Transactions
PART IV
	Item 14.Exhibits, Financial Statement Schedules and Reports on Form 8-K
SIGNATURES
EXHIBIT 10.21
EXHIBIT 21.1
EXHIBIT 23.1


		Page

PART I
Item 1.	Business		3
Item 2.	Properties		18
Item 3.	Legal Proceedings		19
Item 4.	Submission of Matters to a Vote of Security Holders		19
PART II
Item 5.	Market for Registrant’s Common Equity and Related Stockholder Matters		20
Item 6.	Selected Financial Data		21
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk		31
Item 8.	Financial Statements and Supplementary Data		31
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		31
PART III
Item 10.	Directors and Executive Officers of the Registrant		53
Item 11.	Executive Compensation		53
Item 12.	Security Ownership of Certain Beneficial Owners and Management		53
Item 13.	Certain Relationships and Related Transactions		53
	PART IV
Item 14.	Exhibits, Financial Statement Schedules and Reports on Form 8-K		54



	2001				2000

	High		Low		High		Low

First Quarter	$	5.13	$	3.38	$	4.13	$	2.50
Second Quarter		4.80		3.41		4.13		2.94
Third Quarter		4.90		3.23		6.50		3.00
Fourth Quarter		4.75		3.41		5.86		4.13



			Years ended December 31

			2001			2000		1999		1998			1997


			(In thousands, except per share data)
Income Statement Data
Net sales			$	91,461			113,738		111,099		103,534			108,135
Cost of sales				52,903			63,540		66,051		67,268			64,049

		Gross profit		38,558			50,198		45,048		36,266			44,086
Selling, general and administrative expenses				34,040			37,568		38,298		39,064			35,474
Litigation Costs				2,180			—		—		—			—
Loss on factory closure				—			—		—		—			500

		Earnings (loss) from operations		2,338			12,630		6,750		(2,798	)		8,112
Other expense (income)				(473	)		295		1,508		1,320			143

		Earnings (loss) before income taxes (benefit)		2,811			12,335		5,242		(4,118	)		7,969
Income taxes (benefit)				1,185			5,320		2,358		(1,211	)		3,445

		Net earnings (loss)	$	1,626			7,015		2,884		(2,907	)		4,524

Net earnings (loss) per common share:
	Basic		$	.18			.77		.33		(.34	)		.50
	Diluted			.17			.74		.32		(.34	)		.50

Weighted-average common shares outstanding:
	Basic			9,247			9,093		8,834		8,632			8,961
	Diluted			9,661			9,476		8,981		8,632			9,012



		At December 31

		2001		2000		1999		1998		1997


		(In thousands)
Balance Sheet Data
Current assets		$	61,358		53,650		49,044		59,309		48,801
Current liabilities			19,193		13,168		10,386		17,174		9,579
	Total assets		85,884		77,712		73,482		84,373		74,693
Long-term debt, less current Installments			159		449		6,276		15,199		7,983
	Total stockholders’ equity		66,532		64,095		56,820		52,000		57,131


Item 7.	*Management’s Discussion and Analysis of Financial Condition and Results of Operations*


	Page

Independent Auditors’ Report		33
Consolidated Balance Sheets as of December 31, 2001 and 2000		34
Consolidated Statements of Earnings for each of the years in the three-year period ended December 31, 2001		35
Consolidated Statements of Stockholders’ Equity and Other Comprehensive Income for each of the years in the three-year period ended December 31, 2001		36
Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2001		37
Notes to Consolidated Financial Statements		38
Consolidated Financial Statement Schedule
Valuation and Qualifying Accounts		52


			2001		2000

Current assets:
	Cash and cash equivalents		$	16,689,000		9,057,000
	Trade accounts receivable, less allowance for doubtful accounts of $2,014,000 and $2,144,000 as of December 31, 2001 and 2000, respectively			20,395,000		23,143,000
	Inventories (note 2)			18,425,000		17,146,000
	Prepaid expenses and other current assets			1,694,000		1,541,000
	Refundable income taxes (note 5)			995,000		119,000
	Deferred tax assets (note 5)			3,160,000		2,644,000

		Total current assets		61,358,000		53,650,000
Property and equipment, at cost, net (note 3)				3,857,000		2,998,000
Intangible assets, less applicable amortization				19,941,000		20,471,000
Other assets, net				728,000		593,000

			$	85,884,000		77,712,000

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Notes payable and current installments of long-term debt (note 4)		$	290,000		1,046,000
	Trade accounts payable			13,915,000		8,020,000
	Reserve for returns			1,235,000		1,080,000
	Accrued sales commissions			1,215,000		451,000
	Accrued payroll			982,000		1,646,000
	Other accrued expenses			1,556,000		925,000

		Total current liabilities		19,193,000		13,168,000

Long-term debt, less current installments (note 4)				159,000		449,000
Commitments and contingencies (note 8)
Stockholders’ equity (note 6):
	Preferred stock, $0.01 par value. Authorized 5,000,000 shares; none issued			—		—
	Common stock, $0.01 par value. Authorized 20,000,000 shares; issued 10,297,309 and outstanding 9,324,357 at December 31, 2001; issued 10,108,929 and outstanding 9,135,977 at December 31, 2000			93,000		91,000
	Additional paid-in capital			25,689,000		25,003,000
	Retained earnings			41,251,000		39,625,000
	Accumulated other comprehensive income (note 9)			123,000		—

				67,156,000		64,719,000
	Less note receivable from stockholder/ former officer			624,000		624,000

		Total stockholders’ equity		66,532,000		64,095,000

			$	85,884,000		77,712,000


										Accumulated		Note receivable
		Common stock				Additional				other		from			Total
						paid-in		Retained		comprehensive		stockholder/			stockholders’		Comprehensive
		Shares		Amount		capital		earnings		income		former officer			equity		income

Balance at December 31, 1998			8,522,679	$	85,000		22,813,000		29,726,000		—		(624,000	)		52,000,000		—
Common stock issued under Teva license agreement (note 7)			428,743		4,000		1,604,000		—		—		—			1,608,000		—
Common stock issued under stock incentive plan			91,352		1,000		284,000		—		—		—			285,000		—
Common stock issued under the employee stock purchase plan			22,231		1,000		42,000		—		—		—			43,000		—
Net earnings			—		—		—		2,884,000		—		—			2,884,000		2,884,000

	Total comprehensive income																	2,884,000

Balance at December 31, 1999			9,065,005		91,000		24,743,000		32,610,000		—		(624,000	)		56,820,000		—
Fair value of options issued under Teva license agreement (note 7)			—		—		78,000		—		—		—			78,000		—
Common stock issued under stock incentive plan			40,671		—		118,000		—		—		—			118,000		—
Common stock issued under the employee stock purchase plan			30,301		—		64,000		—		—		—			64,000		—
Net earnings			—		—		—		7,015,000		—		—			7,015,000		7,015,000

	Total comprehensive income																	7,015,000

Balance at December 31, 2000			9,135,977		91,000		25,003,000		39,625,000		—		(624,000	)		64,095,000		—
Fair value of options issued under Teva license agreement (note 7)			—		—		152,000		—		—		—			152,000		—
Common stock issued under stock incentive plan			162,344		2,000		475,000		—		—		—			477,000		—
Common stock issued under the employee stock purchase plan			26,036		—		59,000		—		—		—			59,000		—
Net earnings			—		—		—		1,626,000		—		—			1,626,000		1,626,000
Unrealized gains on hedging derivatives			—		—		—		—		123,000		—			123,000		123,000

	Total comprehensive income																	1,749,000

Balance at December 31, 2001			9,324,357	$	93,000		25,689,000		41,251,000		123,000		(624,000	)		66,532,000


		2001		2000

Finished goods		$	18,425,000		16,968,000
Work in process			—		48,000
Raw materials			—		130,000

	Total inventories	$	18,425,000		17,146,000


		2001		2000

Machinery and equipment		$	6,913,000		6,697,000
Furniture and fixtures			981,000		1,012,000
Computer information systems			3,000,000		1,061,000
Leasehold improvements			561,000		567,000

			11,455,000		9,337,000
Less accumulated depreciation and amortization			7,598,000		6,339,000

	Net property and equipment	$	3,857,000		2,998,000


	2001		2000

Note payable for purchase of computer equipment, secured by underlying equipment, payable in quarterly installments of $74,200, including interest at a rate of 9.51% through May 2002	$	143,000		410,000
Note payable to the minority shareholder of the Company’s former Heirlooms subsidiary, payable on demand, including interest at a rate of 9.5%		—		644,000
Unsecured note payable in quarterly installments of $41,700, including interest at a rate of 7.93%, due December 2003		306,000		441,000

		449,000		1,495,000
Less current installments		290,000		1,046,000

	$	159,000		449,000


		Federal			State			Total

2001:
	Current	$	1,392,000			394,000			1,786,000
	Deferred		(465,000	)		(136,000	)		(601,000	)

		$	927,000			258,000			1,185,000

2000:
	Current	$	5,492,000			1,419,000			6,911,000
	Deferred		(1,286,000	)		(305,000	)		(1,591,000	)

		$	4,206,000			1,114,000			5,320,000

1999:
	Current	$	1,702,000			(48,000	)		1,654,000
	Deferred		420,000			284,000			704,000

		$	2,122,000			236,000			2,358,000


				Weighted average
	Shares			exercise price

Outstanding at December 31, 1998		1,509,000		$	4.73
Granted		533,100			2.68
Exercised		(57,500	)		1.56
Canceled		(843,000	)		5.08

Outstanding at December 31, 1999		1,141,600			3.68
Granted		215,500			3.28
Exercised		(21,800	)		2.23
Canceled		(56,400	)		3.37

Outstanding at December 31, 2000		1,278,900			3.66
Granted		584,800			3.90
Exercised		(147,500	)		2.24
Canceled		(135,400	)		4.61

Outstanding at December 31, 2001		1,580,800			3.80

Options exercisable at December 31, 2001		854,000		$	4.17


Year ending December 31:
	2002	$	694,000
	2003		677,000

		$	1,371,000


		2001			2000			1999

Sales to external customers:
	Teva	$	61,221,000			79,732,000			80,963,000
	Simple		10,853,000			16,328,000			15,529,000
	Ugg		19,185,000			15,310,000			12,104,000
	Other		202,000			2,368,000			2,503,000

		$	91,461,000			113,738,000			111,099,000

Earnings from operations:
	Teva	$	12,407,000			19,953,000			16,775,000
	Simple		241,000			2,501,000			3,701,000
	Ugg		3,674,000			2,863,000			1,189,000
	Other (primarily unallocated overhead)		(13,984,000	)		(12,687,000	)		(14,915,000	)

		$	2,338,000			12,630,000			6,750,000

Depreciation and amortization:
	Teva	$	1,386,000			818,000			526,000
	Simple		206,000			208,000			213,000
	Ugg		648,000			642,000			635,000
	Other		1,000			12,000			22,000
	Unallocated		1,336,000			1,260,000			1,730,000

		$	3,577,000			2,940,000			3,126,000

Capital expenditures:
	Teva	$	144,000			393,000			3,000
	Simple		10,000			71,000			—
	Ugg		—			63,000			—
	Other		—			1,000			15,000
	Unallocated		2,301,000			1,795,000			929,000

		$	2,455,000			2,323,000			947,000

Total assets from reportable segments:
	Teva	$	24,051,000			25,682,000			29,304,000
	Simple		8,173,000			10,684,000			8,273,000



		2001

		March 31		June 30		September 30			December 31

Net sales		$	34,911,000		21,586,000		14,023,000			20,941,000
Gross profit			15,734,000		9,597,000		4,748,000			8,479,000
Net earnings (loss)			2,487,000		731,000		(2,098,000	)(1)		506,000
Net earnings (loss) per share:
	Basic	$	0.27		0.08		(0.23	)		0.05
	Diluted		0.26		0.08		(0.23	)		0.05


			2001		2000

Deferred tax assets:
	Uniform capitalization adjustment to inventory		$	789,000		455,000
	Inventory obsolescence reserve			—		15,000
	Bad debt and other reserves			1,685,000		1,656,000
	Amortization of intangible assets			580,000		705,000
	Net operating loss carryforwards			—		114,000
	Depreciation of property and equipment			198,000		—
	State taxes			—		247,000

		Total gross deferred tax assets		3,252,000		3,192,000
Less valuation allowance				—		(228,000	)

		Deferred tax assets, net of allowance		3,252,000		2,964,000

Deferred tax liabilities:
	Depreciation of property and equipment			—		39,000
	State taxes			84,000		—
	Other			8,000		281,000

		Total deferred tax liabilities		92,000		320,000

		Net deferred tax assets	$	3,160,000		2,644,000


	(10) Business Segments, Concentration of Business, and Credit Risk and Significant Customers


		2001		2000

Total assets for reportable segments		$	59,428,000		63,869,000
Elimination of intersegment payables			10,000		84,000
Unallocated refundable income taxes and deferred tax assets			3,946,000		2,486,000
Other unallocated corporate assets			22,500,000		11,273,000

	Consolidated total assets	$	85,884,000		77,712,000


(1)	The loss in the quarter reflects litigation costs of $2,180,000 related to the Molly litigation.


		Balance at
		beginning of						Balance at
Description		period		Additions		Deductions		end of period

Year ended December 31, 1999:
	Allowance for doubtful accounts	$	1,204,000		1,820,000		1,211,000		1,813,000
	Reserve for sales discounts		654,000		734,000		1,098,000		290,000
	Reserve for inventory write-downs		2,890,000		1,165,000		3,292,000		763,000
	Allowance for doubtful note receivable		1,500,000		—		1,500,000		—
Year ended December 31, 2000:
	Allowance for doubtful accounts		1,813,000		1,994,000		1,663,000		2,144,000
	Reserve for sales discounts		290,000		1,007,000		589,000		708,000
	Reserve for inventory write-downs		763,000		1,807,000		1,372,000		1,198,000
Year ended December 31, 2001:
	Allowance for doubtful accounts		2,144,000		1,658,000		1,788,000		2,014,000
	Reserve for sales discounts		708,000		946,000		848,000		806,000
	Reserve for inventory write-downs		1,198,000		1,361,000		1,682,000		877,000


Exhibit	2.1	Certificate of Ownership and Merger Merging Deckers Corporation into Deckers Outdoor Corporation. (Exhibit 2.1 to the Registrant’s Registration Statement on Form S-1, File No. 33-67248 and incorporated by reference herein)
	3.1	Amended and Restated Certificate of Incorporation of Deckers Outdoor Corporation. (Exhibit 3.1 to the Registrant’s Registration Statement on Form S-1, File No. 33-67248 and incorporated by reference herein)
	3.2	Restated Bylaws of Deckers Outdoor Corporation. (Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1, File No. 33-67248 and incorporated by reference herein)
	10.1	1993 Employee Stock Incentive Plan. (Exhibit 99 to the Registrant’s Registration Statement on Form S-8, File No. 33-47097 and incorporated by reference herein)
	10.2	Form of Incentive Stock Option Agreement under 1993 Employee Stock Incentive Plan. (Exhibit 10.9 to the Registrant’s Registration Statement on Form S-1, File No. 33-67248 and incorporated by reference herein)
	10.3	Form of Non-Qualified Stock Option Agreement under 1993 Employee Stock Incentive Plan. (Exhibit 10.10 to the Registrant’s Registration Statement on Form S-1, File No. 33-67248 and incorporated by reference herein)
	10.4	Form of Restricted Stock Agreement. (Exhibit 10.11 to the Registrant’s Registration Statement on Form S-1, File No. 33-67248 and incorporated by reference herein)
	10.5	Employment Agreement with Douglas B. Otto. (Exhibit 10.13 to the Registrant’s Registration Statement on Form S-1, File No. 33-67248 and incorporated by reference herein)
	10.6	First Amendment to Employment Agreement with Douglas B. Otto. (Exhibit 10.14 to the Registrant’s Registration Statement on Form S-1, File No. 33-67248 and incorporated by reference herein)
	10.7	Second Amendment to Employment Agreement with Douglas B. Otto. (Exhibit 10.15 to the Registrant’s Registration Statement on Form S-1, File No. 33-67248 and incorporated by reference herein)
	10.8	Third Amendment to Employment Agreement with Douglas B. Otto. (Exhibit 10.30 to the Registrant’s Registration Statement on Form S-1, File No. 33-67248 and incorporated by reference herein)
	10.9	Agreement for Sales of Assets, dated January 26, 1995, between Ken and Nancy Young and Deckers Acquisition Corporation. (Exhibit 10.36 to the Registrant’s Form 10-K for the period ended December 31, 1994 and incorporated by reference herein)
	10.10	Deckers Outdoor Corporation 1995 Employee Stock Purchase Plan. (Exhibit 4.4 to the Registrant’s Registration Statement on Form S-8, File No. 33-96850 and incorporated by reference herein)
	10.11	Amended Compensation Plan for Outside Members of the Board of Directors. (Exhibit 10.42 to the Registrant’s Form 10-Q for the period ended September 30, 1996 and incorporated by reference herein)
	10.12	Extension Agreement to Employment Agreement with Douglas B. Otto. (Exhibit 10.36 to the Registrant’s Form 10-K for the period ended December 31, 1996 and incorporated by reference herein)


			10.13			Limited Recourse Secured Promissory Note between Diana M. Wilson and Deckers Outdoor Corporation, dated April 18, 1997. (Exhibit 10.38 to the Registrant’s Form 10-Q for the period ended March 31, 1997 and incorporated by reference herein)
			10.14			Stock Pledge Agreement between Diana M. Wilson and Deckers Outdoor Corporation, dated April 18, 1997. (Exhibit 10.39 to the Registrant’s Form 10-Q for the period ended March 31, 1997 and incorporated by reference herein)
			10.15			Shareholder Rights Agreement, dated as of November 12, 1998. (Exhibit 10.39 to the Registrant’s Form 10-Q for the period ended September 30, 1998 and incorporated by reference herein)
			10.16			Loan and Security Agreement by and among Congress Financial Corporation (Western) and Deckers Outdoor Corporation, Deckers Outdoor Corporation International, Simple Shoes, Inc., Ugg Holdings, Inc. and Heirlooms, Inc., dated January 21, 1999. (Exhibit 10.40 to the Registrant’s Form 10-K for the period ended December 31, 1998 and incorporated by reference herein)
			10.17			*Teva License Agreement, By and Between Mark Thatcher and Deckers Outdoor Corporation, dated June 7, 1999. (Exhibit 10.41 to the Registrant’s Form 10-Q for the period ended June 30, 1999 and incorporated by reference herein)
			10.18			*Intellectual Property Option Agreement, By and Between Mark Thatcher, an Individual, and Deckers Outdoor Corporation, a Delaware Corporation, dated June 7, 1999. (Exhibit 10.42 to the Registrant’s Form 10-Q for the period ended June 30, 1999 and incorporated by reference herein)
			10.19			First Amendment to Intellectual Property Option Agreement between Deckers Outdoor Corporation and Mark Thatcher, dated January 22, 2001. (Exhibit 10.19 to the Registrant’s Form 10-K for the period ended December 31, 2000 and incorporated by reference herein)
			10.20			Employment Agreement dated February 27, 2001 between Deckers Outdoor Corporation and Peter Benjamin. (Exhibit 10.20 to the Registrant’s Form 10-Q for the period ended June 30, 2001 and incorporated by reference herein)
			10.21			Revolving Credit Agreement dated as of February 21, 2002 among Deckers Outdoor Corporation, UGG Holdings, Inc. and Comerica Bank — California
			21.1			Subsidiaries of Registrant
			23.1			Independent Auditors’ Consent


*	Certain information in this Exhibit was omitted and filed separately with the Securities and Exchange Commission pursuant to a granted confidential treatment request as to the omitted portions of the Exhibit.


/s/ DOUGLAS B. OTTO Douglas B. Otto		Chairman of the Board and Chief Executive Officer

/s/ M. SCOTT ASH M. Scott Ash		Chief Financial Officer (Principal Financial and Accounting Officer)

/s/ GENE E. BURLESON Gene E. Burleson		Director

/s/ JOHN M. GIBBONS John M. Gibbons		Director

/s/ REX A. LICKLIDER Rex A. Licklider		Director