diff --git a/raw/filings/0000719733/2001/0001021408-01-506598/filing.txt b/raw/filings/0000719733/2001/0001021408-01-506598/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..f3fc74c47c5d170f8a8ec643abeb8d7cdd90cd88 --- /dev/null +++ b/raw/filings/0000719733/2001/0001021408-01-506598/filing.txt @@ -0,0 +1,2628 @@ +10-K +1 +d10k.htm +FORM 10-K FOR THE PERIOD ENDED JUNE 30, 2001 +Form 10-K for the period ended June 30, 2001 +TABLE OF CONTENTS LINK +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +Annual Report Pursuant to Section 13 or 15(d) +of +The Securities Exchange Act of 1934 +For the Fiscal Year Ended +Commission File Number +June 30, 2001 +0-11559 +KEY TRONIC CORPORATION +Washington +91-0849125 +(State of Incorporation) +(I.R.S. Employer +Identification No.) +N. 4424 Sullivan Road +Spokane, Washington 99216 +(509) 928-8000 +Securities registered pursuant to Section 12(b) of the Act: None +Securities registered pursuant to Section 12(g) of the Act: Common Stock +The registrant has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months, and has been subject to such filing +requirements during the past 90 days. +Indicate by checkmark if delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy +or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o +The aggregate market value of the voting stock held by non affiliates of the Registrant was $19,619,967 as of June 30, 2001. +The number of shares of Common Stock of the Registrant outstanding as of June 30, 2001 was 9,672,580 shares. +The Exhibit Index is located at page 28. +DOCUMENTS INCORPORATED BY REFERENCE +The following documents are incorporated by reference to the extent specified herein: +Document Description +10-K Part +Proxy Statement dated September 26, 2001 +III +1 +KEY TRONIC CORPORATION +2001 FORM 10-K +TABLE OF CONTENTS +Page +Part I +Item 1. +Business +3 - 6 +Item 2. +Properties +6 +Item 3. +Legal Proceedings +6 - 7 +Item 4. +Submission of Matters to a Vote of Security Holders +7 +Part II +Item 5. +Market for the Registrant's Common Stock and Related Stockholder Matters +7 +Item 6. +Selected Financial Data +7 +Item 7. +Management's Discussion and Analysis of Financial Condition and Results of Operations +8 - 12 +Item 7A. +Quantitative and Qualitative Disclosures about Market Risk +12 +Item 8. +Financial Statements and Supplementary Data +13 - 26 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosures +26 +Part III +Item 10. +Directors and Executive Officers of the Registrant +26 - 27 +Item 11. +Executive Compensation +27 +Item 12. +Security Ownership of Certain Beneficial Owners and Management +27 +Item 13. +Certain Relationships and Related Transactions +27 +Part IV +Item 14. +Exhibits, Financial Statement Schedule, Reports on Form 8-K and Signatures +28 - 31 +2 +FORWARD-LOOKING STATEMENTS +This Annual Report contains forward-looking statements in addition to historical information. Forward-looking statements are subject to certain risks and uncertainties that could cause actual +results to differ materially from those reflected in the forward-looking statements. Risks and uncertainties that might cause such differences include, but are not limited to those outlined in "Management's Discussion and Analysis of Financial +Condition and Results of Operations--Risks and Uncertainties that May Affect Future Results." Readers are cautioned not to place undue reliance on forward-looking statements, which reflect management's opinions only as of the date hereof. The +Company undertakes no obligation to revise or publicly release the results of any revision to forward-looking statements. Readers should carefully review the risk factors described in other documents the Company files from time to time with the +Securities and Exchange Commission, including Quarterly Reports on Form 10-Q. +PART I +Item 1. BUSINESS +Key Tronic Corporation, a Washington corporation organized in 1969, and its subsidiaries (hereinafter collectively called the "Company" or "Key Tronic" unless the context +otherwise requires) are engaged in electronic manufacturing services (EMS) for original equipment manufacturers (OEMs) and manufacturing of keyboards for personal computers, terminals, and workstations. The Company operates on a fiscal year that +ends on the Saturday closest to June 30. The following discussion relates to three fiscal years of the Company. In previous filings EMS was referred to as contract design and manufacturing (CDM). +BACKGROUND +Historically Key Tronic was a manufacturer of electronic keyboards, but during the course of the past two fiscal years, its focus has changed to electronic manufacturing services (EMS). +Presently Key Tronic is known as an independent provider of a mix of EMS services for OEMs. The Company's manufacturing capabilities include circuit board assemblies, tool making, precision molding, proto building, liquid plastic injection molding +and printed circuit board assembly (both through-hole and surface mounting). +Operations are currently conducted in facilities in the United States, China, Ireland and Mexico. This global production capability provides customers with benefits of improved supply chain +management, reduced inventory, lower transportation costs and reduced product fulfillment time. +The EMS industry is comprised of companies that provide a range of manufacturing services for OEMs. The EMS industry has experienced rapid growth over the past several years as more and more +OEMs shift to external manufacturing. Equity Research reports have stated that the EMS market is expected to grow at a rate of 25% over the next three to five years. +KEYBOARD PRODUCTS +During fiscal years 2001, 2000, and 1999, the Company realized revenues of approximately $39.2 million, $70.5 million, and $134.7 million, respectively, from the sale of keyboards representing +approximately 24%, 43%, and 76% of total sales. The keyboard market has continued to trend toward standard keyboard layouts. In order to accommodate the demand for standard products, the Company maintains a purchase-from-stock program. The most +popular standard layouts are built and stocked for immediate availability. These products serve as enhancements to or replacements for the original system-supplied keyboard. +MANUFACTURING +Since inception, the Company has made substantial investments in developing and expanding its now extensive capital equipment base to achieve selective vertical integration in its manufacturing +processes. The Company designs and develops tooling for injection molding machines and manufactures the majority of plastic parts used in the products it manufactures. Additionally, the Company has invested in equipment to produce switch membranes +as a means to reduce cost and improve quality. +The OEM keyboard market has increasingly demanded rapid response time and design adaptability from keyboard manufacturers. New computer products are continually being introduced by computer +manufacturers, with the timing of product introduction often perceived as having distinct marketing advantages. Developing a keyboard for a new application is a custom process, which requires frequent +¯ +3 +contact with the customer while working through changes during design stages. Computer manufacturers place a premium on the ability of the keyboard manufacturer to design and produce keyboards +that meet their technical specifications and aesthetic considerations and to deliver in accordance with production schedules. The processes and skills the Company developed and uses in the keyboard market are transferable to and valued in the EMS +market. This has resulted in the Company gaining new customers and EMS programs. +The Company's automated manufacturing processes enable it to work closely with its customers during design and prototype stages of production for new custom products and to jointly increase +productivity and reduce response time to the market place. Key Tronic uses computer-aided design techniques and unique software to assist in preparation of the tool design layout and tool fabrication, to reduce tooling costs, improve component and +product quality and enhance turnaround time during product development. +The Company uses numerous injection molding machines in producing more than 50,000 different keycaps, enclosures and various plastic parts for the products it manufactures. Designs by Key Tronic +engineers in both tooling and molding have improved standard processing time and thereby increased productivity. During fiscal 1998, Key Tronic introduced stack molding technology to the manufacturing process. Stacked molds allow the Company to +utilize two molds simultaneously thereby producing twice as many parts in nearly the same cycle time used for one part. The molding machines used by the Company employ the latest technology, including the ability to mix plastics and determine the +color of finished components as part of the molding process. This automated, pneumatically-fed process, not only allows precise control of color determination, but also results in lower product costs and improved component quality. The Company also +produces blank keytops for certain models. The print legends are later added using a laser technology to produce entire key configuration layouts in local languages for the European market. +Key Tronic uses a variety of manual to highly-automated assembly processes in its facilities, depending upon product complexity and degree of customization. Automated processes include component +insertion, surface mount technology, flexible robotic assembly, computerized vision system quality inspection, automated switch and keytop installation, and automated functional testing. +The Company purchases materials for its products from a number of different suppliers. Key Tronic believes that it has excellent relationships with its vendors, most of whom have been suppliers +for the Company for many years. +CUSTOMERS AND MARKETING +OEM MARKETS +The Company provides manufacturing services for outsourced OEM products. The Company also manufactures and supplies custom keyboards to leading OEMs in the keyboard market. +Hewlett Packard accounted for approximately 39 percent, 38 percent, and 24 percent of net sales in 2001, 2000, and 1999, respectively. Lexmark accounted for 27 percent of net sales in 2001 and +13 percent in 2000. Microsoft accounted for approximately 5 percent, 9 percent, and 11 percent of net sales in 2001, 2000, and 1999, respectively. Gateway accounted for approximately 1 percent, 8 percent, and 13 percent of net sales in fiscal years +2001, 2000, and 1999, respectively. No other customer accounted for more than 10 percent of net sales during any of the last three years. In 2001, 2000, and 1999, the five largest customers accounted for 81 percent, 72 percent, and 60 percent of +total sales, respectively. +The Company markets its products and services primarily through its direct sales organization aided by distribution sales in the U.S., Canada and Europe. In fiscal 2001, the Company hired a +number of outside sales organizations to help promote its electronic manufacturing services. +All OEM keyboards are accompanied by a manufacturer's three-year warranty that provides for repair or replacement of defective products. Retail products carry a one-year to a limited lifetime +warranty. The limited lifetime warranty is product specific. +¯ +4 +FOREIGN MARKETS +Information concerning geographic areas for the years ended June 30, 2001, July 1, 2000, and July 3, 1999 is summarized in the following table. +(in thousands) +Domestic Exports +U.S. Operations +Mexico Operations +Ireland Operations +Far East Operations +Eliminations +Consolidated +2001 +Net sales: +Unaffiliated +customers +$ +77,842 +$ +76,950 +$ +– +$ +9,617 +$ +1,456 +$ +– +$ +165,865 +Affiliates +– +6,355 +41,829 +12 +22,312 +(70,508 +) +– +Total +$ +77,842 +$ +83,305 +$ +41,829 +$ +9,629 +$ +23,768 +$ +(70,508 +) +$ +165,865 +Income (loss) +before income +taxes +$ +– +$ +(14,714 +) +$ +2,955 +$ +(978 +) +$ +1,865 +$ +142 +$ +(10,730 +) +Total assets +$ +– +$ +68,394 +$ +20,703 +$ +5,879 +$ +8,056 +$ +(28,661 +) +$ +74,371 +2000 +Net sales: +Unaffiliated +customers +$ +53,657 +$ +97,956 +$ +– +$ +11,616 +$ +1,124 +$ +– +$ +164,353 +Affiliates +– +10,571 +22,311 +142 +20,987 +(54,011 +) +– +Total +$ +53,657 +$ +108,527 +$ +22,311 +$ +11,758 +$ +22,111 +$ +(54,011 +) +$ +164,353 +Income (loss) +before income +taxes +$ +– +$ +(6,016 +) +$ +1,318 +$ +(1,786) +) +$ +1,418 +$ +(103 +) +$ +(5,169 +) +Total assets +$ +– +$ +103,271 +$ +7,714 +$ +11,401 +$ +18,854 +$ +(45,425 +) +$ +95,815 +1999 +Net sales: +Unaffiliated +customers +$ +57,192 +$ +102,872 +$ +– +$ +17,650 +$ +590 +$ +– +$ +178,304 +Affiliates +– +9,581 +20,297 +190 +3,493 +(33,561 +) +– +Total +$ +57,192 +$ +112,453 +$ +20,297 +$ +17,840 +$ +4,083 +$ +(33,561 +) +$ +178,304 +Income (loss) +before income +taxes +$ +– +$ +1,989 +$ +1,631 +$ +499 +$ +26 +$ +600 +$ +4,745 +Total assets +$ +– +$ +91,552 +$ +13,585 +$ +15,655 +$ +7,022 +$ +(26,867 +) +$ +100,947 +Transfers to affiliates are made at prices which approximate market. Intercompany margins are eliminated upon consolidation. +In 2001, $88.9 million, or 53.6% percent of the Company's revenues were from foreign sales, primarily sales in Europe, the Far East, Canada, Mexico and South America. Foreign sales in 2000 and +1999 were $65.3 million and $75.4 million, respectively. Foreign sales are made primarily through the Company's direct sales force in the U.S. and Ireland. Key Tronic Shanghai (KTS), the Company's facility in Shanghai, China, began operations in the +third quarter of 1999 and is used to support customers in that area as well as for export. +For additional financial information about foreign operations, see Note 12 to the Consolidated Financial Statements. +BACKLOG +At August 11, 2001, the Company had an order backlog of approximately $81.5 million. This compares with a backlog of approximately $35 million at August 5, 2000. The increase in backlog is +attributable in part to increased customer orders from a new EMS customer for fiscal year 2002. The Company also supports two major OEM customers that have expanded their Just-In-Time (JIT) inventory systems, so that orders are not placed in advance +but are pulled from a stock location maintained by Key Tronic. Order backlog is not necessarily indicative of future sales. Order backlog consists of purchase orders received for products expected to be shipped approximately within the next fiscal +year, although shipment dates are subject to change due to design modifications or other customer requirements. All orders in backlog are expected to be filled within the current fiscal year. +RESEARCH, DEVELOPMENT, AND ENGINEERING +The Company's research, development, and engineering expenses were $2.7 million, $2.8 million, and $4.9 million in 2001, 2000, and 1999, respectively. Research, development and engineering +expenses as a percentage of sales were 1.6 percent, 1.7 percent, and 2.7 percent in 2001, 2000, and 1999, respectively. The slight decrease in fiscal year 2001 is a result of greater recovery of engineering design costs. +¯ +5 +COMPETITION +The Company believes that its principal competitors in the EMS market are: Plexus Corp, SCI Systems, ACT Manufacturing, Celestica, Flextronics International, Jabil Circuits, and Solectron. The +principal methods of competition are price, quality and capability. +The Company believes that its principal competitors in the keyboard market are: Chicony, NMB and Siletek. +TRADEMARKS AND PATENTS +The Company owns several keyboard patents. However, since the Company's focus is now electronic manufacturing services, management believes that these patents will not have a significant impact +on future revenues. The Key Tronic name and logo are federally registered trademarks, and the Company believes they are valuable assets in its business. In fiscal 2001, Key Tronic began operating under the trade name "KeyTronicEMS" to +better represent its primary business concentration. +EMPLOYEES +As of July 28, 2001, the Company had approximately 2,151 employees compared to 2,007 on August 5, 2000. Management considers its employee relations to be excellent. The Company's employees in +Ireland and Reynosa are represented by local unions. The Company has never experienced any material interruption of production due to labor disputes. +The Company's employee benefit program includes a bonus program involving periodic payments to all employees based on quarterly before-tax income. The Company maintains a tax-qualified profit +sharing plan, a 401(k) plan, which provides a matching company contribution on a portion of the employee's contribution, and also provides group health, life, and disability insurance plans. The Company also offers an Executive Stock Option Plan and +an Employee Stock Ownership Plan to certain individuals. +Item 2. PROPERTIES +On December 27, 2000, the Company sold two contiguous parcels of land and its corporate headquarters building in Spokane to Royal Hills Associates L.L.C. (RHA) for approximately $6 million in +cash. In connection with the sale, the Company entered into a 10-year lease agreement with RHA for one floor of the two-story building, which the Company will continue to occupy as its headquarters. The initial monthly rent is $30,875 plus allocated +expenses. Under the terms of the sale agreement, the Company has guaranteed the rent on the second floor of the building for one year following the closing date of December 27, 2000 (see Capital Resources and Liquidity for further discussion). +Proceeds from the sale of these properties was used to pay off the balance of the Company's term loan with General Electrical Capital Corporation (GECC) in the amount of $2,702,000, and to pay down the Company's revolving line of credit (also with +GECC) by $2.4 million. The Company also owns a 165,000 sq. ft. assembly and molding facility in Juarez, Mexico in addition to a 45,000 sq. ft. manufacturing and assembly facility in Las Cruces, New Mexico. The Company leases manufacturing facilities +in the Spokane Industrial Park which total 156,000 sq. ft. and two warehouses in El Paso, Texas, totaling 52,800 sq. ft. One of the leases at the industrial park expired on July 31, 2001, while the other facility lease was renewed until July 31, +2003. In Dundalk, Ireland, the Company leases 24,200 sq. ft. of office and warehouse space. This lease expires on March 1, 2002. The two leases in El Paso were renewed during fiscal year 2001, and both expire on July 31, 2003. In March 2000, the +Company entered into a five-year lease for a 140,000 sq. ft. manufacturing facility in Reynosa, Mexico. In September 1997, the Company signed a five-year operating lease with a local company for property owned by the Company which is located in +Cheney, Washington. The lease terms give the lessee an option to buy the property upon notice at any time during the course of the lease. During the fourth fiscal quarter of 1998, the Company leased space of approximately 36,000 sq. ft. in a +building in Shanghai, China. The Company began an assembly operation in this facility in the third quarter of fiscal year 1999. The Company considers its properties in good condition, well maintained and suitable for operations. The Company +considers the productive capacity of its current facilities sufficient to carry on the Company's business. +Item 3. LEGAL PROCEEDINGS +The Company currently has fifteen lawsuits by computer keyboard users that are in state or federal courts in New York. These suits allege that specific keyboard products manufactured by the +Company were sold with manufacturing, design and warning defects which caused or contributed to their injury. The alleged injuries are not specifically identified but are referred to as repetitive stress injuries (RSI) or cumulative trauma disorders +(CTD). These suits seek compensatory damages and some seek punitive damages. It is more likely than not that compensatory damages, if awarded, will be covered by insurance; however, the likelihood that punitive damages, if awarded, will be covered +by insurance is remote. A total of 123 suits have been dismissed in California, Connecticut, Florida, Illinois, Kansas, Kentucky, Maryland, Massachusetts, Michigan, New Jersey, New York, Pennsylvania and Texas. Given the inherent uncertainty in +litigation, the inherently limited information available with respect to unasserted claims, and the complexity of the circumstances surrounding these matters, management estimates are subject to and will change or be established as facts and +circumstances warrant. +¯ +6 +The Company is also subject to various legal proceedings that arise in the ordinary course of business. In the opinion of management, the outcome of these matters is not expected to have any +material effect on the consolidated financial position or results of operations of the Company. +Also see Note 10 to the June 30, 2001 Consolidated Financial Statements. +Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS +None +PART II +Item 5: MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS +Market Information +Key Tronic Corporation's common stock is traded in the over-the-counter market and is listed on the NASDAQ National Market System under the symbol KTCC. Quarterly high and low sales prices for +Key Tronic common stock for fiscal years 2001 and 2000 were as follows: +2001 +2000 +High +Low +High +Low +First Quarter +5.438 +3.000 +7.250 +4.125 +Second Quarter +5.125 +2.125 +4.750 +3.500 +Third Quarter +3.031 +2.063 +4.688 +3.125 +Fourth Quarter +2.250 +1.438 +3.625 +2.500 +High and low stock prices are based on the daily closing price reported by the NASDAQ National Market System. These quotations represent prices between dealers without adjustment for markups, +markdowns, and commissions, and may not represent actual transactions. +Holders and Dividends +As of June 30, 2001, the Company had 1,400 shareholders of record. The Company's current line of credit agreement contains a covenant that prohibits the declaration or payment of dividends (see +Note 5 to Consolidated Financial Statements). The Company has never paid a cash dividend and does not anticipate payment of dividends on its Common Stock in the foreseeable future. +The following selected consolidated financial data of the Company should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of +Operations" and the other financial information included elsewhere in this Form 10-K. +Item 6: SELECTED FINANCIAL DATA +KEY TRONIC TEN-YEAR FINANCIAL HIGHLIGHTS +(Dollars in millions, except share amounts) +2001 +2000 +1999 +1998 +1997 +1996 +1995 +1994 +1993 +1992 +Net sales +$ +165.9 +$ +164.4 +$ +178.3 +$ +170.1 +$ +184.9 +$ +201.0 +$ +207.5 +$ +159.4 +$ +123.3 +$ +124.0 +Operating income (loss) +(9.5 +) +(3.5 +) +5.2 +1.2 +1.9 +0.2 +9.8 +(8.3 +) +3.7 +(7.7 +) +Net income (loss) +(11.4 +) +(5.3 +) +3.0 +(0.9 +) +0.3 +(1.8 +) +4.4 +(1.1 +) +3.8 +(7.5 +) +Net income (loss) per share +(1.18 +) +(.55 +) +0.32 +(0.09 +) +0.03 +(0.22 +) +0.53 +(0.13 +) +0.49 +(0.97 +) +Depreciation/amortization +5.9 +6.3 +6.9 +9.6 +8.9 +10.0 +8.9 +8.6 +6.3 +6.9 +Total assets +74.4 +95.8 +101.0 +97.0 +100.2 +93.5 +115.1 +101.9 +61.8 +62.2 +Net working capital +22.9 +37.1 +41.8 +34.6 +38.5 +28.0 +37.7 +28.5 +20.0 +17.2 +Long-term debt (net +of current) +9.4 +17.6 +20.6 +22.9 +27.0 +17.3 +28.5 +26.6 +0.8 +0.8 +Shareholders' equity +35.3 +46.6 +51.9 +48.8 +49.8 +49.5 +51.3 +44.5 +43.4 +40.5 +Book value per share +3.65 +4.83 +5.39 +5.06 +5.18 +5.80 +6.06 +5.38 +5.54 +5.21 +Cash dividends per +share +0 +0 +0 +0 +0 +0 +0 +0 +0 +0 +Number of shares +outstanding +at year end (thousands) +9,673 +9,641 +9,631 +9,631 +9,611 +8,534 +8,456 +8,271 +7,837 +7,757 +Number of employees +at year end +2,151 +1,926 +1,951 +2,721 +2,429 +2,824 +2,925 +2,163 +1,204 +1,618 +¯ +7 +Item 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF +FINANCIAL CONDITION AND RESULTS OF OPERATIONS +RESULTS OF OPERATIONS +Fiscal year 2001: Fiscal year 2001 sales increased approximately 1% from the prior year. This slight increase is primarily due to the expansion of the Company's electronic manufacturing services +(EMS) operations; the increase was smaller than the company expected due to decreased orders from one major customer. Unit keyboard sales decreased 43% from the prior year, while the average selling price increased 8.2%. The increase in average +selling price was primarily due to a higher percentage of keyboard sales to distributors. Distribution sales generally have higher margins than sales to OEM customers. The Company was successful in expanding its EMS business from 56% of total +revenue in 2000 to 75% in 2001. The Company continues to emphasize cost control to address price reductions expected by our customers. +If keyboard technology remains the same, price erosion is expected to continue in future years. The Company continues to focus its molding and manufacturing capabilities on increasing production +in the EMS market. At the present time, return on investment in this market tends to be more lucrative than for keyboards. The Company's gross profit percentage decreased 4.2% to 4.6% in fiscal year 2001 compared to fiscal year 2000. This decrease +is primarily due to the decline of orders by one significant customer resulting in lower sales and increased excess operating capacity. There were also lower sales in the distribution keyboard business which traditionally has much higher margins +than the OEM market. +Fiscal year 2000: Fiscal year 2000 sales decreased 8% from the prior year. The decrease was primarily due to a decline in the Company's distribution keyboard sales. Unit keyboard sales decreased +42.4% from the prior year, and the average selling price decreased 13.7%. This impacted the Company's gross profit in 2000 by a decrease of 6.9% to 8.8%. The Company was successful in expanding its EMS business from 21% of total revenue in 1999 to +56% in 2000. The Company continued to emphasize cost control to combat the pressures of ever decreasing unit prices for its keyboards. In 2000, the Company was working with a subcontractor in China for the assembly of keyboards and other input +devices, but ended this contract in 2001. +RISKS AND UNCERTAINTIES THAT COULD AFFECT FUTURE RESULTS +The following risks and uncertainties could affect the Company's actual results and could cause results to differ materially from past results or those contemplated by the Company's +forward-looking statements. When used in this discussion and analysis and elsewhere in this annual report, the words "expects," "believes," "anticipates" and similar expressions are intended to identify forward-looking +statements. Actual future results may differ materially due to uncertainties including risks identified in: Potential Fluctuations In Quarterly Results, Competition, Concentration of Major Customers, Dependence on Key Personnel, Litigation, +Technological Change and New Product Risk, Dilution and Stock Price Volatility. Forward-looking statements are based on management's opinions as of the date of this report. +Potential Fluctuations in Quarterly Results : The Company's quarterly operating results have varied in the past and may vary in the future due to a variety of factors, including changes in +overall demand for computer products, success of customers' programs, timing of new programs, new product introductions or technological advances by the Company, its customers and its competitors, and changes in pricing policies by the Company. For +example, the Company relies on customers' forecasts to plan its business. If those +¯ +8 +forecasts are overly optimistic, the Company's revenues and profits may fall short of expectations. Conversely, if those forecasts are too conservative, the Company could have an unexpected +increase in revenues and profits. +Competition : The EMS business and the keyboard industry are intensely competitive. The Company's major competitors in the EMS business are much larger and may be able to offer +customers lower prices and less risk particularly on large volume programs. Most of the Company's principal competitors in the keyboard industry are headquartered in Asian countries that have a low-cost labor force. Those competitors may be able to +offer customers lower prices on certain high-volume programs. This could result in price reductions, reduced margins and loss of market share, all of which would materially and adversely affect the Company's business, operating results and financial +condition. In addition, competitors can copy the Company's non-proprietary designs after the Company has invested in the development of products for customers, thereby enabling competitors to offer lower prices on such products due to savings in +development costs. +Concentration of Major Customers: At present, the Company's customer base is highly concentrated and could become even more concentrated. Three of the Company's OEM customers +accounted for 39%, 27%, and 5% of net sales during fiscal year 2001. In 2000, these same customers accounted for 38%, 13%, and 9% of net sales. There can be no assurance that the Company's principal customers will continue to purchase products from +the Company at current levels. Moreover, the Company typically does not enter into long-term volume purchase contracts with its customers, and the Company's customers have certain rights to extend or delay the shipment of their orders. The loss of +one or more of the Company's major customers, or the reduction, delay or cancellation of orders from such customers, could materially and adversely affect the Company's business, operating results and financial condition. +Dependence on Key Personnel: The Company's future success depends in large part on the continued service of its key technical, marketing and management personnel and on its +ability to continue to attract and retain qualified employees. The competition for such personnel is intense, and there can be no assurance that the Company will be successful in attracting and retaining such personnel. The loss of key employees +could have a material adverse effect on the Company's business, operating results and financial condition. +Litigation: The Company currently has fifteen lawsuits by computer keyboard users which are in state or federal courts in New York. These suits allege that specific keyboard +products manufactured by the Company were sold with manufacturing, design and warning defects which caused or contributed to injury. The alleged injuries are not specifically identified but are referred to as repetitive stress injuries (RSI) or +cumulative trauma disorders (CTD). These suits seek compensatory damages and some seek punitive damages. It is more likely than not that compensatory damages, if awarded, will be covered by insurance; however, the likelihood that punitive damages, +if awarded, will be covered by insurance is remote. A total of 123 lawsuits have been dismissed in California, Connecticut, Florida, Illinois, Kansas, Kentucky, Maryland, Massachusetts, Michigan, New Jersey, New York, Pennsylvania and Texas. +Technological Change and New Product Risk: The market for the Company's products is characterized by rapidly changing technology, evolving industry standards, frequent new +product introductions and relatively short product life cycles. The introduction of products embodying new technologies or the emergence of new industry standards can render existing products obsolete or unmarketable. The Company's success will +depend upon its ability to enhance its existing products, to develop and introduce, on a timely and cost-effective basis, new products that keep pace with technological developments and emerging industry standards, and to address evolving and +increasingly sophisticated customer requirements. Failure to do so could substantially harm the Company's competitive position. There can be no assurance that the Company will be successful in identifying, developing, manufacturing and marketing +products that respond to technological change, emerging industry standards or evolving customer requirements. +Dilution and Stock Price Volatility: As of June 30, 2001, there were outstanding options for the purchase of approximately 1,966,200 shares of common stock of the +Company (Common Stock), of which options for approximately 1,498,033 shares were vested and exercisable. Holders of the Common Stock will suffer immediate and substantial dilution to the extent outstanding options to purchase the Common Stock are +exercised. The stock price of the Company may be subject to wide fluctuations and possible rapid increases or decreases over a short time period. These fluctuations may be due to factors specific to the Company, such as variations in quarterly +operating results, or changes in analysts' earnings estimates, or to factors relating to the computer industry or securities markets in general, which, in recent years, have experienced significant price fluctuations. These fluctuations often have +been unrelated to the operating performance of the specific companies whose stocks are traded. +NET SALES +Net sales in 2001 were $165.9 million compared to $164.4 million and $178.3 million in 2000 and 1999, respectively. This represents an approximate increase of 1.0% in 2001. The average unit +selling prices of the Company's keyboard products increased by 8.2% in 2001 compared to 13.7% decrease in average unit selling price in 2000. The increase in 2001 is primarily due to the fact that the majority of sales were to distribution customers +where margins per keyboard are higher. EMS sales were 75.3% of total revenue in fiscal 2001 compared to 55.5% and 20.8% in fiscal years 2000 and 1999, respectively. +¯ +9 +COST OF SALES +In 2001, cost of sales was 95.4% of sales compared to 91.2% in 2000 and 84.3% in 1999. The increase in 2001 was due primarily to lower than expected revenues resulting in excess capacity in +operations. The increase in 2000 was due primarily to the decline in distribution keyboard revenues. The Company provides for warranty costs based on historical experience and anticipated product returns. The amounts charged to expense were +$220,000, $372,000, and $1,269,000 in 2001, 2000 and 1999, respectively. Also included in cost of sales is the Company's freight costs for shipping and handling to customers. The Company provides for obsolete and nonsaleable inventories based on +specific identification of inventory against current demand and recent usage. The amounts charged to expense were $435,000, $(359,000), and $1,674,000 in 2001, 2000, and 1999, respectively. +RESEARCH, DEVELOPMENT AND ENGINEERING +The Company's research, development and engineering (RD&E) expenses were $2.7 million, $2.8 million, and $4.9 million, in 2001, 2000, and 1999, respectively. As a percent of sales, these +expenses were 1.6%, 1.7%, and 2.7%, respectively. In 2001, 2000, and 1999, the Company focused most of its RD&E efforts on products for large OEMs. The number of RD&E projects has remained fairly constant over the course of the three years. +The decrease in fiscal year 2001 and 2000 was primarily the result of increased cost recovery for services performed on EMS projects. +SELLING +Selling expenses were $4.7 million, $6.3 million, and $9.3 million, in 2001, 2000, and 1999, respectively. Selling expenses as a percentage of revenues were 2.9%, 3.9%, and 5.2%, respectively. +The decrease in 2001 and 2000 was due to the decline in distribution keyboard sales, which resulted in lower costs for volume incentive rebates and cooperative advertising. +GENERAL AND ADMINISTRATIVE +General and administrative expenses were $9.6 million, $8.7 million and $8.6 million, in 2001, 2000, and 1999, respectively. General and administrative costs as a percentage of sales were 5.8%, +5.3%, and 4.9%, in 2001, 2000, and 1999, respectively. The increase in 2001 was due primarily to an increase in the Company's provision for doubtful accounts receivable of $714,000. General and administrative expenses for 1999 remained about the +same as 1998. The Company recorded $979,000 for its Incentive Compensation Program in 1999 based upon the Company's fiscal year 1999 performance. +INTEREST EXPENSE +The Company had interest expense of $2,125,000, $1,987,000, and $1,887,000 in 2001, 2000, and 1999, respectively. The increase in 2001 and 2000 was due to higher interest rates on the Company's +debt. +OTHER INCOME, NET +The Company had other income of $879,000 in 2001, $278,000 in 2000, and $1,480,000 in 1999. The increase in 2001 is primarily due to an increase in the gain from sales of fixed assets. The +decrease in 2000 was largely due to the gain due to the sale of real estate in Dundalk, Ireland recorded in 1999 (See Capital Resources and Liquidity). +INCOME TAXES +The Company had income tax expense of $643,000, $164,000, and $1,701,000 in 2001, 2000, and 1999, respectively. Income tax expense on foreign operations represented $643,000, $43,000, and +$513,000 of the income tax expense in 2001, 2000, and 1999, respectively. The Company has U.S. tax loss carryforwards of approximately $48.8 million that expire in varying amounts in the years 2006 through 2021. +The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes," (See Note 7 to the June 30, 2001 Consolidated Financial Statements). +Pursuant to SFAS No. 109, the Company has recorded a deferred tax asset. The balance of the deferred tax asset on June 30, 2001 was $4.5 million, which was net of a valuation allowance of $15.8 million. +INTERNATIONAL (MEXICO, EUROPE, ASIA) +The Company's Mexican subsidiary, Key Tronic Juarez, SA de CV, owns an assembly and molding facility in Juarez, Mexico. This subsidiary is primarily used to support the Company's US and European +operations. The Company's Mexican subsidiary, KTC Reynosa, S.A. de C.V., leases manufacturing facilities in Reynosa, Mexico. This subsidiary is used exclusively to manufacture products for an EMS customer. +¯ +10 +Key Tronic Europe, Ltd. (KTEL), the Company's operation in Dundalk, Ireland, was restructured in fiscal years 1997 and 1996 to become a sales and distribution operation. The keyboards previously +manufactured in Dundalk, Ireland to support the European market are now assembled at the Juarez, Mexico and the Shanghai, China facilities. +Through Key Tronic Shanghai (KTS), the Company operates a facility in Shanghai, China, which began operations in 1999 and is used to support customers in that area as well as for +export. +Foreign sales from worldwide operations, including domestic exports, were $88.9 million in 2001 compared to $65.3 million and $75.4 million in 2000 and 1999, respectively. Foreign sales were +53.6% of net sales in 2001 compared to 39.7% and 42.3% in 2000 and 1999, respectively. Sales from KTEL represented 5.8% of consolidated sales to external customers in 2001, compared to 7.1% in 2000 and 9.9% in 1999, respectively. Sales from KTS +represented .9% of total sales in 2001 (See Note 12 to the June 30, 2001 Consolidated Financial Statements). +CAPITAL RESOURCES AND LIQUIDITY +The Company generated cash flows from operating activities of $7.5 million, $3.3 million, and $4.2 million in 2001, 2000, and 1999, respectively. Capital expenditures were $.7 million, $1.4 +million, and $2.3 million in 2001, 2000, and 1999, respectively. The Company's cash position increased by $1.1 million and $1.6 million in fiscal years 2001 and 1999 respectively, compared to a decrease of $0.9 million in 2000. Cash generated from +operating and financing activities allowed the payment of $10.9 million in long-term debt and the purchase of $.7 million in property and equipment in fiscal 2001. The Company had working capital of $22.9 million at June 30, 2001 and $37.1 million +at July 1, 2000. The decrease in working capital was due primarily to a decrease in trade receivables. The Company's trade receivables were $21.7 million at June 30, 2001, a decrease of $12.3 million from 2000. The decrease is primarily due to +decreased sales in the last two quarters of fiscal year 2001. +On December 31, 1996, the Company entered into a secured credit agreement with General Electric Capital Corporation (GECC). The credit facility provided by this agreement originally included a +term loan in the amount of $11 million and a revolving loan for up to $30 million. During the second quarter of fiscal year 1998, the Company entered into an operating lease agreement with GECC, which reduced the borrowing limit on the revolving +loan by $4.2 million. The revolving loan and the term note were secured by the assets of the Company. The term note was paid in full on December 27, 2000 with proceeds from the sale of the Spokane headquarters facility. The agreement contained +financial covenants that related to maximum capital expenditures, minimum debt service coverage, minimum earnings before interest expense, income tax, depreciation, and amortization, and maximum leverage percentages. In addition to these financial +covenants, the credit agreement restricted investments, disposition of assets, and payment of dividends. At June 30, 2001, the Company received a waiver from GECC for non-compliance with certain debt covenants and received a letter of forbearance up +to the refinancing that occurred on August 24, 2001. +On August 24, 2001, the Company entered into a financing agreement with CIT Group/Business Credit, Inc. for a revolving credit facility of up to $25 million and paid off the GECC revolving loan. +The new revolving loan is secured by the assets of the Company. The financing agreement contains financial covenants that relate to maximum capital expenditures, minimum earnings before interest expense, income tax, depreciation, and amortization, +and minimum tangible net worth. The agreement is for a term of three years beginning on August 24, 2001 and ending on August 23, 2004. In addition to the financial covenants, the financing agreement restricts investments, disposition of assets, and +the payment of dividends. +The Company anticipates that capital expenditures of approximately $2.7 million will be required during the next fiscal year. Capital expenditures are expected to be financed through cash flow +from operating activities. +Real estate held for sale is carried at the lower of cost or net realizable value. In September of 1997, the Company entered into a five-year operating lease with a local firm for property owned +by the Company which is located in Cheney, Washington. Monthly lease payments received by the Company are $21,000. The lease terms include an option to buy the property upon notice at any time during the term of the lease. +In June of fiscal year 1999, the Company sold its real estate in Dundalk, Ireland for approximately $2.3 million. Approximately one third of this amount was received in cash at closing. In 2000 +the Company collected an additional $1.0 million of the amount due. Substantially all of the remaining amount was received subsequent to year end. Under the terms of the sale agreement, the Company had rent free possession of the premises until +March 29, 2000. During March of 2000, the Company's Irish operations were moved from the premises to the Finnabair Industrial Park in Dundalk. In fiscal year 1999, the Company realized a gain of $775,000 net of Irish taxes of $251,000 on this +transaction. +The Company believes that funds available under the revolving credit facility and internally generated funds can satisfy cash requirements for a period in excess of 12 months. +¯ +11 +New Accounting Pronouncements +In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." Under +SFAS No. 141, all business combinations should be accounted for using the purchase method of accounting; use of the pooling-of-interests method is prohibited. The provisions of the statement will apply to all business combinations initiated after +June 30, 2002. SFAS No. 142 includes requirements to test goodwill and indefinite lived intangible assets for impairment rather than amortize them. These standards will be adopted in fiscal 2002. The adoption of SFAS No. 141 and No. 142 are not +expected to have a material impact on the Company's financial statements. +SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", was adopted by the Company on July 2, 2000. SFAS No. 133 establishes accounting and reporting standards +for derivative instruments and hedging activities. Under this statement, certain derivatives are recognized at fair market value, and changes in fair market value are recognized as gains or losses. The impact of adoption of SFAS133 was not material +to the Company's financial statements. +In December 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB No. 101"), "Revenue Recognition in Financial Statements", which summarized the SEC's views in +applying generally accepted accounting principles to revenue recognition in financial statements. The Company's adoption of SAB No. 101 on July 2, 2000 did not have a material impact on the Company's operations or financial position. +Item 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The Company is subject to the risk of fluctuating interest rates in the normal course of business. The Company's major market risk relates to its secured revolving credit facility. A portion of +the Company's accounts receivable and inventories are used as collateral for its revolving debt. The interest rates applicable to the Company's revolving loan fluctuate with the JP Morgan Chase Bank prime rate. For the first year of the financing +agreement with CIT, a margin of 0.75% will be applicable as an adder to the prime rate. The agreement specifies four different levels of margin between 0.25% and 1.00% depending on the Company's earnings before interest, taxes, depreciation, and +amortization. Over the past year under the agreement with GECC, the interest rate on the Company's secured debt was based upon either LIBOR or an Index Rate. The LIBOR rate during the year fluctuated between 4.18% and 6.65%. The weighted average +variable interest rates for the Company's secured debt were 9.03% and 7.03% for fiscal years 2001 and 2000, respectively. The weighted average variable interest rates for the revolving debt for fiscal years 2001 and 2000 were 9.48% and 8.37% +respectively. +The Company does not enter into derivative transactions or leveraged swap agreements. +Although the Company does have international operations, the functional currency for all active subsidiaries is the US dollar. The Company imports for its own use raw materials that are used in +its manufacturing operations. Such purchases are denominated in US dollars and are paid for under normal trade terms. +The table below presents principal (or notional) amounts and related weighted average variable rates by fiscal year of maturity. The weighted average variable interest rates for fiscal years +2002 through 2005 are estimated based on implied forward rates in the yield curve as of June 30, 2001. These forward rates have been increased by .75% based on the financing agreement with CIT. +Fiscal Years +Fair Value +(In thousands) +2002 +2003 +2004 +2005 +Total +June 30, 2001 +Interest rate risk: +Secured revolving debt +$8,109 +$8,109 +$8,109 +Average interest rate +4.47% +5.00% +5.27% +5.72% +¯ +12 +Item 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +INDEPENDENT AUDITORS' REPORT +To the Shareholders and Board of Directors of Key Tronic Corporation: +We have audited the accompanying consolidated balance sheets of Key Tronic Corporation and subsidiaries (the Company) as of June 30, 2001 and July 1, 2000, and the related consolidated +statements of operations, shareholders' equity, and cash flows for the years ended June 30, 2001, July 1, 2000, and July 3, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an +opinion on these financial statements 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, such consolidated financial statements present fairly, in all material respects, the financial position of Key Tronic Corporation and subsidiaries at June 30, 2001 and July 1, +2000, and the results of their operations and their cash flows for the years ended June 30, 2001, July 1, 2000, and July 3, 1999, in conformity with accounting principles generally accepted in the United States of America. +/s/ Deloitte & Touche LLP +Deloitte & Touche LLP +Seattle, Washington +August 3, 2001 +(August 24, 2001, as to Note 5) +¯ +13 +CONSOLIDATED BALANCE SHEETS +(In thousands) +June 30, 2001 +July 1, 2000 +ASSETS +Current assets: +Cash and cash equivalents +$ +2,137 +$ +1,013 +Trade receivables, less allowance for doubtful +accounts of $633 and $855 +21,674 +34,008 +Inventories +20,601 +22,720 +Real estate held for sale +1,697 +1,843 +Deferred income tax asset, net +771 +889 +Customer tooling +- +1,748 +Other +5,670 +6,565 +Total current assets +52,550 +68,786 +Property, plant and equipment-at cost +99,228 +103,175 +Less accumulated depreciation +82,559 +81,825 +Total property, plant and equipment +16,669 +21,350 +Other assets: +Deferred income tax asset, net +3,746 +3,627 +Other (net of accumulated amortization of $1,849 and $964) +513 +1,031 +Goodwill (net of accumulated amortization of $895 and $767) +893 +1,021 +$ +74,371 +$ +95,815 +LIABILITIES AND SHAREHOLDERS' EQUITY +Current liabilities: +Current portion of long-term obligations +$ +150 +$ +2,105 +Accounts payable +21,385 +24,315 +Deferred sales proceeds +2,894 +- +Accrued compensation and vacation +2,615 +2,303 +Accrued taxes other than income taxes +973 +1,146 +Interest payable +69 +54 +Other +1,578 +1,735 +Total current liabilities +29,664 +31,658 +Long-term liabilities: +Long-term obligations, less current portion +9,389 +17,555 +Total long-term liabilities +9,389 +17,555 +Commitments and contingencies (Notes 5, 6, and 10) +Shareholders' equity +Common stock, no par value, authorized 25,000 shares; +issued and outstanding 9,673 and 9,641 shares, respectively +38,393 +38,304 +Retained earnings/(deficit) +(3,320 +) +8,053 +Accumulated other comprehensive income +245 +245 +Total shareholders' equity +35,318 +46,602 +$ +74,371 +$ +95,815 +¯ +14 +CONSOLIDATED STATEMENTS OF OPERATIONS +(In thousands, except per share amounts) +June 30, 2001 +Years Ended +July 1, 2000 +July 3, 1999 +Net sales +$ +165,865 +$ +164,353 +$ +178,304 +Cost of sales +158,309 +149,895 +150,284 +Gross profit on sales +7,556 +14,458 +28,020 +Operating expenses: +Research, development and engineering +2,717 +2,846 +4,879 +Selling +4,724 +6,333 +9,341 +General and administrative +9,599 +8,739 +8,648 +Operating income (loss) +(9,484 +) +(3,460 +) +5,152 +Interest expense +2,125 +1,987 +1,887 +Other income, net +(879 +) +(278 +) +(1,480 +) +Income (loss) before income taxes +(10,730 +) +(5,169 +) +4,745 +Income tax provision +643 +164 +1,701 +Net income (loss) +$ +(11,373 +) +$ +(5,333 +) +$ +3,044 +Earnings (loss) per share: +Earnings (loss) per common share +Earnings (loss) per common share – basic +($1.18 +) +($0.55 +) +$0.32 +– diluted +$0.31 +Weighted average shares outstanding +9,668 +9,637 +9,631 +Diluted shares outstanding +9,786 +See notes to consolidated financial statements. +CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME +Accumulated +Other +Common Stock +Retained +Comprehensive +(In thousands) +Shares +Amount +Earnings/(Deficit) +Income +Total +Balances, June 27, 1998 +9,631 +$ +38,273 +$ +10,342 +$ +245 +$ +48,860 +Comprehensive income: +Net income – 1999 +$ +3,044 +$ +3,044 +Balances, July 3, 1999 +9,631 +$ +38,273 +$ +13,386 +$ +245 +$ +51,904 +Comprehensive income: +Net loss – 2000 +$ +(5,333 +) +$ +(5,333 +) +Exercise of stock options +10 +$ +31 +$ +31 +Balances, July 1, 2000 +9,641 +$ +38,304 +$ +8,053 +$ +245 +$ +46,602 +Comprehensive income: +Net loss – 2001 +$ +(11,373 +) +$ +(11,373 +) +Exercise of stock options +32 +$ +89 +$ +89 +Balances, June 30, 2001 +9,673 +$ +38,393 +$ +(3,320 +) +$ +245 +$ +35,318 +See notes to consolidated financial statements. +¯ +15 +CONSOLIDATED STATEMENTS OF CASH FLOWS +Years Ended +(In thousands) +June 30, 2001 +July 1, 2000 +July 3, 1999 +Increase (decrease) in cash and cash equivalents: +Cash flows from operating activities: +Net income (loss) +$ +(11,373 +) +$ +(5,333 +) +$ +3,044 +Adjustments to reconcile net income (loss) to cash +provided (used) by operating activities: +Depreciation and amortization +5,886 +6,330 +6,882 +Provision for obsolete inventory +435 +(359 +) +1,674 +Provision for doubtful receivables +714 +562 +334 +Provision for warranty +220 +372 +1,269 +Provision for litigation +– +– +(900 +) +Gain on disposal of assets +(743 +) +(43 +) +(1,263 +) +Deferred income tax provision +– +121 +836 +Changes in operating assets and liabilities: +Trade receivables +11,620 +(3,286 +) +(8,516 +) +Inventories +1,683 +2,535 +(1,847 +) +Customer tooling +1,258 +701 +2,406 +Other assets +1,259 +(1,182 +) +(1,951 +) +Accounts payable +(2,931 +) +5,595 +3,195 +Accrued compensation and accrued vacation +312 +(966 +) +519 +Deferred sales proceeds +(435 +) +– +– +Other liabilities +(424 +) +(1,791 +) +(1,457 +) +Cash provided by operating activities +7,481 +3,256 +4,225 +Cash flows from investing activities: +Purchase of property and equipment +(720 +) +(1,439 +) +(2,288 +) +Proceeds from sale leaseback of real estate +4,030 +– +– +Proceeds from sale of property and equipment +1,226 +92 +1,043 +Cash used by investing activities +4,536 +(1,347 +) +(1,245 +) +Cash flows from financing activities: +Payment of financing costs +(50 +) +– +– +Proceeds from issuance of common stock +89 +31 +– +Repayment of long-term debt +(3,307 +) +– +– +Borrowing under revolving credit agreement +176,008 +Repayment of revolving credit agreement +(183,633 +) +(2,793 +) +(1,402 +) +Cash used by financing activities +(10,893 +) +(2,762 +) +(1,402 +) +Increase (decrease) in cash and cash equivalents +1,124 +(853 +) +1,578 +Cash and cash equivalents, beginning of year +1,013 +1,866 +288 +Cash and cash equivalents, end of year +$ +2,137 +$ +1,013 +$ +1,866 +See notes to consolidated financial statements. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. SIGNIFICANT ACCOUNTING POLICIES +Business +Key Tronic Corporation and subsidiaries (the Company) is engaged in electronic manufacturing services (EMS) for original equipment manufacturers (OEMs), and also manufactures keyboards and +other input devices. +Principles of Consolidation +The consolidated financial statements include the Company and its wholly owned subsidiaries in Ireland, Mexico, and China. Intercompany balances and transactions have been eliminated in +consolidation. +¯ +16 +Use of Estimates +The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that +affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates +include the allowance for doubtful receivables, the provision for obsolete and non-saleable inventories, the valuation allowances on deferred tax assets, and the provision for warranty costs. Actual results could differ from those +estimates. +Cash Equivalents +The Company considers investments with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost which approximates fair value. +Inventories +Inventories are stated at the lower of cost or market. Cost is determined principally using the first-in, first-out (FIFO) method. The provision to adjust inventory to market value for obsolete +and non-saleable inventories was approximately $2,712,000 and $2,349,000 at June 30, 2001 and July 1, 2000, respectively. The Company provides for obsolete and non-saleable inventories based on specific identification of inventory against current +demand and recent usage. +Customer Tooling +Customer tooling is the Company's prepaid tooling design and construction costs for customer specified new production tools and molds. Each new project's costs are recorded and tracked against +expected costs. These actual costs are invoiced to the Company's customers depending on the terms agreed upon during the quoting process prior to initiation of each new project. +Property, Plant and Equipment +Property, plant and equipment are carried at cost and depreciated using straight-line methods over the expected useful lives. Constructed molds and dies are expensed as incurred if there is no +future utility beyond one year. Capitalized molds and dies are depreciated over the expected useful lives of one to three years. +Valuation of Long-lived Assets +The Company, using its best estimates based on reasonable and supportable assumptions and projections, reviews assets for impairment whenever events or changes in circumstances have indicated +that the carrying amount of its assets might not be recoverable. Impaired assets are reported at the lower of cost or fair value. No assets were written down during the fiscal year ended June 30, 2001. +Goodwill +Goodwill resulted from the acquisition of substantially all of the assets and liabilities of Honeywell, Inc.'s Keyboard Division on July 30, 1993. Goodwill is amortized on a straight-line basis +over a period of 15 years (See New Accounting Pronouncements). +Long-term Liabilities +Short-term obligations that are expected to be refinanced on a long-term basis have been presented as long-term liabilities, see Note 5 for further discussion. +Accrued Warranty +An accrual is made for expected warranty costs, with the related expense recognized in cost of goods sold. Management reviews the adequacy of this accrual quarterly based on historical analysis +and anticipated product returns. Accrued warranty costs at June 30, 2001 and July 1, 2000, were $327,000 and $454,000, respectively. +Net Sales +Sales are generally recognized when products are shipped. Provisions for estimated sales returns are not significant. The Company provides for doubtful accounts receivable primarily based on +specific identification. +¯ +17 +Cost Of Sales +Cost of sales includes related shipping and handling costs. +Research, Development and Engineering +Research, development and engineering expenses include unreimbursed costs of electronic manufacturing services (EMS) as well as design and engineering costs associated with the production of +custom keyboards. Such costs are charged to expense as incurred. +Income Taxes +The Company accounts for income taxes in accordance with provisions of Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." Under the asset and +liability method prescribed by SFAS No. 109, deferred income taxes are provided for temporary differences between the financial reporting and tax bases of assets and liabilities. Deferred taxes are measured using provisions of currently enacted tax +laws. Tax credits are accounted for as a reduction of income taxes in the year the credit originates. +Per Share Data +Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share +is computed by dividing income available to common stockholders by the weighted average number of common and common equivalent shares outstanding during the period using the treasury stock method. The computation assumes the proceeds from the +exercise of stock options were used to repurchase common shares at the average market price during the period. The computation of diluted earnings per share does not assume conversion, exercise, or contingent issuance of common stock equivalent +shares that would have an antidilutive effect on earnings per share. +Foreign Currency Translation Adjustment +The functional currency of the Company's subsidiaries in Ireland, Mexico and China is the U.S. dollar. Realized foreign currency transaction gains and losses are included in general and +administrative expenses. Assets and liabilities of the Company's subsidiary in Ireland had been translated to U.S. dollars at year-end exchange rates. Revenues and expenses had been translated at average exchange rates. Translation gains and losses +had been included in a separate component of shareholders' equity. The foreign currency translation adjustment of $245,000 for the year ended June 29, 1996, which was included in the Consolidated Statements of Shareholders' Equity, was a result of +changing the functional currency from the Punt to U.S. Dollars and was included in other comprehensive income. +Fair Value of Financial Instruments +The carrying values reflected in the balance sheets at June 30, 2001 and July 1, 2000, reasonably approximate the fair value of cash and cash equivalents. Based on the borrowing rates currently +available to the Company for loans with similar terms and average maturities, the fair value of long-term debt is estimated to be $8.1 million and $19.0 million, respectively, as of June 30, 2001 and July 1, 2000, which approximates the carrying +values of $8,109,000 as of June 30, 2001 and $19,041,557 as of July 1, 2000. +Stock-based Compensation +The Company accounts for its stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board No. 25, "Accounting for Stock Issued to +Employees", and SFAS No. 123 "Accounting for Stock-Based Compensation". Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models. These models require subjective +assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average +assumptions: expected life, 73 months in 2001, 73 months in 2000, and 72 months in 1999, respectively; stock volatility, 64.32% in 2001, 64.34% in 2000, and 57.2% in 1999, respectively; risk free interest rates, 6.16% in 2001, 6.16% in 2000, and +6.03% in 1999, respectively and no dividends during the expected term. The Company's calculations are based on a multiple option valuation approach and forfeitures are recognized as they occur. If the computed fair values of the 2001, 2000, and 1999 +awards had been amortized to expense over the vesting period of the awards, pro forma net income (loss) would have been $(11,734,050) $(1.21) loss per share) in 2001, ($5,747,000) ($.60 loss per share) in 2000, and $2,122,000 ($.22 income per share) +in 1999. The weighted average fair values of options granted during fiscal years 2001, 2000, and 1999 were $4.26, $4.38, and $2.88 per share, respectively. +¯ +18 +New Accounting Pronouncements +In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." Under +SFAS No. 141, all business combinations should be accounted for using the purchase method of accounting; use of the pooling-of-interests method is prohibited. The provisions of the statement will apply to all business combinations initiated after +June 30, 2001. SFAS No. 142 includes requirements to test goodwill and indefinite lived intangible assets for impairment rather than amortize them. These standards will be adopted in fiscal 2002. The adoption of SFAS No. 141 and No. 142 are not +expected to have a material impact on the Company's financial statements. +SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" as amended, was adopted by the Company on July 2, 2000. SFAS No. 133 and the related amendments establishes +accounting and reporting standards for derivative instruments and hedging activities. Under this statement, certain derivatives are recognized at fair market value, and changes in fair market value are recognized as gains or losses. The impact of +adoption was not material to the Company's financial statements. +In December 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB No. 101"), "Revenue Recognition in Financial Statements", which summarized the SEC's views in +applying generally accepted accounting principles to revenue recognition in financial statements. The Company's adoption of SAB No. 101 on July 2, 2000 did not have a material impact on the Company's operations or financial position. +Reclassifications +Certain reclassifications of prior year balances have been made for consistent presentation with the current year. +Fiscal Year +The Company operates on a 52/53 week fiscal year. Fiscal years end on the Saturday nearest June 30. As such, fiscal years 2001, 2000, and 1999 ended on June 30, 2001, July 1, 2000, and July 3, +1999, respectively. Fiscal year 2002 will end on June 29, 2002. +2. INVENTORIES +Components of inventories were as follows: +June 30, 2001 +July 1, 2000 +(in thousands) +Finished goods +$ +8,589 +$ +8,378 +Work-in-process +2,088 +2,512 +Raw materials +12,636 +14,179 +Reserve for obsolescence +(2,712 +) +(2,349 +) +$ +20,601 +$ +22,720 +3. PROPERTY, PLANT AND EQUIPMENT +Life +June 30, 2001 +July 1, 2000 +(in years) +(in thousands) +Land +$ +2,052 +$ +2,486 +Buildings and improvements +3 to 30 +16,693 +16,944 +Equipment +1 to 10 +67,142 +70,473 +Furniture and fixtures +3 to 5 +13,341 +13,272 +$ +99,228 +$ +103,175 +4. RELATED PARTY TRANSACTIONS +The Company has life insurance policies on the life of its founder with net death benefits totaling approximately $3,000,000. Of these, policies with death benefits totaling $750,000 have been +designated to fund obligations of the Company to the founder's spouse in the event of his death and, accordingly, such obligations are not recorded in the financial statements. Net cash values of such policies are recorded in the amount of $40,000 +and $339,000 in 2001 and 2000, respectively, and are included in other noncurrent assets. +5. LONG-TERM OBLIGATIONS +The Company maintained a secured credit agreement with General Electric Capital Corporation (GECC). The credit facility provided by this agreement, originally contained a term note of $11 +million and a revolving loan for up to $30 million. During the second quarter of fiscal year 1998, the Company entered into an operating lease agreement with GECC, which reduced the borrowing limit on +¯ +19 +the revolving loan by $4.2 million. The revolving loan and the term note were secured by the assets of the Company. The term note was paid in full on December 27, 2000 with proceeds from the +sale of the Spokane headquarters facility. The revolving loan with GECC bore interest based on the London Interbank Offered Rate (LIBOR). The rate fluctuated between 4.1675% and 6.6500% during fiscal year 2001. The applicable interest rates at June +30, 2001 and July 1, 2000 were 9.25% and 8.43%, respectively. The agreement contained financial covenants that related to maximum capital expenditures, minimum debt service coverage, minimum earnings before interest expense, income tax, +depreciation, and amortization, and maximum leverage percentages. In addition to these financial covenants, the credit agreement restricted investments, disposition of assets, and payment of dividends. At June 30, 2001, the Company received a waiver +from GECC for non-compliance with certain debt covenants and received a letter of forbearance up to the refinancing that occurred on August 24, 2001. +On August 24, 2001, the Company obtained a new revolving credit facility with CIT Group/Business Credit, Inc. for up to $25 million and paid off the GECC revolving loan. The new revolving loan +is secured by the assets of the Company. For the first year of the financing agreement with CIT, a margin of 0.75% will be applicable as an adder to the prime rate. The agreement specifies four different levels of margin between 0.25% and 1.00% +depending on the Company's earnings before interest, taxes, depreciation, and amortization. The agreement contains financial covenants that relate to maximum capital expenditures, minimum earnings before interest expense, income tax, depreciation, +and amortization, and minimum tangible net worth. The agreement is for a term of three years beginning on August 24, 2001 and ending on August 23, 2004. In addition to the financial covenants, the credit agreement restricts investments, disposition +of assets, and the payment of dividends. +Long-term obligations consist of: +June 30, 2001 +July 1, 2000 +(in thousands) +Note payable +$ +0 +$ +3,307 +Revolving loan +8,109 +15,735 +Deferred sales proceeds +701 +— +Deferred compensation obligation +729 +618 +Total long-term obligations +9,539 +19,660 +Less current portion +(150 +) +(2,105 +) +$ +9,389 +$ +17,555 +The Company accounts for its post-retirement benefits in accordance with the provisions SFAS No. 106 "Employers' Accounting for Post-retirement Benefits Other than Pensions". Under +SFAS No. 106, the Company has recorded a liability for certain compensation related agreements for two former employees. The liability was estimated based upon the present value of future cash payments as specified in the agreements. This cost of +$296,000 in 2001, $175,000 in 2000, and $181,000 in 1999 was charged against general and administrative expenses. Principal maturities of long-term obligations at June 30, 2001 are: +Fiscal Years Ending +(in thousands) +2002 +$ +150 +2003 +150 +2004 +150 +2005 +8,259 +2006 +129 +Future Years +701 +Total +$ +9,539 +6. LEASES +The Company has operating leases for certain equipment and production facilities which expire over periods from one to five years. Future minimum payments under non-cancelable operating leases +with initial or remaining terms of one year or more at June 30, 2001, are summarized as follows: +Fiscal Years Ending +(in thousands) +2002 +4,534 +2003 +3,238 +2004 +2,412 +2005 +1,407 +2006 +758 +Future +1,996 +Total minimum lease payments +14,345 +¯ +20 +Rental expenses under operating leases were $4,358,000, $2,908,000, and $2,313,000 in 2001, 2000, and 1999, respectively. +7. INCOME TAXES +Income taxes consist of the following: +2001 +2000 +1999 +Current income taxes: +Federal +$ +— +$ +— +$ +(94 +) +Foreign +643 +43 +513 +State +— +— +40 +643 +43 +459 +Deferred income taxes: +Federal +(4,598 +) +(2,085 +) +879 +Foreign +— +— +— +State +(34 +) +64 +(43 +) +(4,632 +) +(2,021 +) +836 +Change in valuation allowance +4,632 +2,142 +406 +Total income taxes +$ +643 +$ +164 +$ +1,701 +The Company's effective tax rate differs from the federal tax rate as follows: +Year ended +June 30, 2001 +July 1, 2000 +July 3, 1999 +(in thousands) +Federal income tax provision (benefit) +at statutory rates +$ +(3,648 +) +$ +(1,757 +) +$ +1,613 +Effect of foreign income (loss) +at statutory rates +(350 +) +160 +(815 +) +Permanent differences: +Life insurance premiums +43 +37 +30 +Other +(677 +) +(461 +) +(46 +) +Foreign tax provision (benefit) at +foreign statutory rate +643 +43 +513 +Change in valuation allowance +4,632 +2,142 +406 +Adjustment for effect of beneficial tax rate +on foreign manufacturing (income) loss +— +— +— +Income tax provision +$ +643 +$ +164 +$ +1,701 +In fiscal year 2001, foreign income decreased the Company's effective income tax rate, because such income is taxed at a lower rate than U.S. income. In fiscal year 2000, foreign losses +increased the Company's effective income tax rate, because such losses are not deductible for U.S. tax purposes. In fiscal year 1999, foreign income decreased the Company's effective income tax rate. The domestic and foreign components of income +(loss) before income taxes were: +Year ended +June 30, 2001 +July 1, 2000 +July 3, 1999 +(in thousands) +Domestic +$ +(11,758 +) +$ +(4,698 +) +$ +3,551 +Foreign +$ +1,029 +$ +(471 +) +$ +1,194 +Income (loss) before income taxes +$ +(10,729 +) +$ +(5,169 +) +$ +4,745 +¯ +21 +Deferred income taxes result from temporary differences in the timing of recognition of revenue and expenses. Deferred income tax assets and liabilities consist of the following at: +June 30, 2001 +July 1, 2000 +(in thousands) +Allowance for doubtful accounts +$ +184 +$ +270 +Inventory +1,053 +1,296 +Vacation accrual +330 +337 +Self insurance accrual +60 +104 +Warranty accrual +111 +154 +State deferred asset +220 +186 +Other +120 +357 +Current deferred income tax assets +2,078 +2,704 +Current portion of valuation allowance +(1,308 +) +(1,815 +) +Current deferred income tax assets net of valuation allowance +$ +770 +$ +889 +Deferred compensation +$ +248 +$ +210 +Depreciation and amortization +712 +603 +Net operating loss carryforwards +16,588 +11,713 +Tax credit carryforwards +680 +680 +Other +— +(236 +) +Noncurrent deferred income tax assets +18,228 +12,970 +Valuation allowance net of current portion +(14,482 +) +(9,343 +) +Noncurrent deferred income tax assets net of valuation allowance +$ +3,746 +$ +3,627 +Total deferred income tax assets +$ +4,516 +$ +4,516 +At June 30, 2001, the Company had tax loss carryforwards of approximately $48.8 million, which expire in varying amounts in the years 2006 through 2021. Additionally, for federal income tax +purposes, the Company has approximately $705,000 of general business credit carryforwards which expire in varying amounts in the years 2004 through 2010. Approximately $257,000 of the general business credit carryforwards have an indefinite +carryforward period. Foreign income tax expense is calculated at the statutory rate of the foreign taxing jurisdiction. +Management has considered the relative impact of positive and negative evidence, including previous and forecasted revenues and profits/losses, existing contracts and sales backlogs, and other +evidence, and believes that it is more likely than not that the Company will generate sufficient taxable income to allow the realization of the net deferred tax assets within the near future. +8. EARNINGS PER SHARE +Basic EPS is computed by dividing income available to common shareholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted +EPS is computed by dividing income available to common shareholders by the weighted-average number of common shares and common share equivalents outstanding during the period. Key Tronic uses the treasury stock method in calculating the dilutive +effect of common stock equivalents. +There are no adjustments to the income available to common shareholders for the years ended June 30, 2001, July 1, 2000, July 3, 1999. The following table presents the Company's calculations of +weighted average shares (number of shares): +For The Years Ended: +Weighted Avg. Shares +Adjustments For +Potential Common Shares +Total +June 30, 2001 +9,667,785 +Antidilutive +9,667,785 +July 1, 2000 +9,636,506 +Antidilutive +9,636,506 +July 3, 1999 +9,630,830 +155,086 +9,785,916 +The adjustment for potential common shares of 103,688 and 276,280 as of June 30, 2001 and July 1, 2000 was not included in the calculation of weighted average shares outstanding for such date as +the effect was considered to be antidilutive. The number of outstanding options with an exercise price greater than average market price for fiscal years ended June 30, 2001, July 1, 2000, and July 3, 1999 were 1,966,200, 1,425,760, and 1,054,376, +respectively. +9. SHAREHOLDERS' EQUITY +The Company has executive stock option plans for certain key employees. Options under these plans vest over one to five years and become exercisable as they vest. Options under the plans become +exercisable in full immediately prior to the occurrence of a "Change in Control" as defined in the plan documents. As of June 30, 2001, 2,795,000 shares have been reserved for issuance and 1,806,200 options were outstanding of which +1,498,033 shares were exercisable. These options expire in ten years from the date of grant. Compensation expense for options will be recorded if the exercise price of the option is less than the closing market price of the stock on the date of +grant. There was no compensation expense incurred in conjunction with options in 2001, 2000, or 1999 as all options were granted at fair market value. +¯ +22 +The Company also has a stock option plan for "Nonemployee Directors." Options under this plan vest over a three year period and are exercisable as they vest. As of June 30, 2001, +300,000 shares have been reserved for issuance and 160,000 options were outstanding of which 93,750 shares were exercisable. These options expire ten years from the date of grant. +Following is a summary of employee plan activity: +Price Range +Number +Of Options +Weighted Average +Exercise Price +Outstanding June 27, 1998 +$ +2.75 to $16.25 +1,612,693 +$ +6.31 +Granted during 1999 +$ +2.75 to $ 5.56 +212,500 +$ +2.88 +Expired or canceled +$ +2.75 to $16.25 +(134,177 +) +$ +7.39 +Outstanding, July 3, 1999 +$ +2.75 to $16.25 +1,691,016 +$ +5.79 +Granted during 2000 +$ +2.81 to $ 6.50 +583,500 +$ +3.70 +Expired or canceled +$ +2.75 to $16.25 +(217,876 +) +$ +8.00 +Options exercised +$ +2.75 to $ 3.88 +(10,500 +) +$ +3.02 +Outstanding, July 1, 2000 +$ +2.75 to $16.25 +2,046,140 +$ +4.98 +Granted during 2001 +$ +1.54 to $ 5.03 +63,500 +$ +4.26 +Expired or canceled +$ +2.75 to $16.25 +(112,190 +) +$ +4.98 +Options exercised +$ +2.75 to $ 3.31 +(31,250 +) +$ +2.86 +Outstanding, June 30, 2001 +$ +1.54 to $16.25 +1,966,200 +$ +4.99 +Additional information regarding options outstanding as of June 30, 2001, is as follows: +Options +Outstanding +Options +Exercisable +Weighted Avg. +Remaining +Weighted +Weighted +Range of +Number +Contractual +Avg. Exercise +Number +Avg. Exercise +Exercise Prices +Outstanding +Life (yrs.) +Price +Exercisable +Price +$ 1.54 +5,000 +9.8 +$ 1.54 +– +$ – +$2.32 - $ 3.48 +838,500 +7.7 +$ 2.79 +585,833 +$ 2.78 +$3.49 - $ 5.24 +463,500 +5.4 +$ 4.74 +391,250 +$ 4.79 +$5.25 - $ 7.87 +396,029 +6.0 +$ 5.99 +356,529 +$ 5.93 +$7.88 - $16.25 +263,171 +3.7 +$10.99 +263,171 +$10.99 +$1.54 - $16.25 +1,966,200 +6.3 +$ 4.99 +1,591,783 +$ 5.33 +Of the 1,966,200 options outstanding as of June 30, 2001, 1,591,783 were exercisable, 2,046,140 options outstanding as of July 1, 2000, 1,375,890 were exercisable, and of the 1,691,016 options +outstanding as of July 3, 1999 1,090,766 were exercisable. +The Company's Variable Investment Plan is available to employees who have attained age 21. The plan has an Employer's Discretionary Contribution Trust, invested in the Company's stock, and an +Employee Contribution Trust consisting of several investment alternatives. The Company contributes an amount equal to 100% of the employee's contribution on the first 2% of the employee's compensation and an additional 50% of the employee's +contribution on the following 2% of the employee's compensation. On April 1, 2001, the Company began matching 25% on the next 2% of contributions. Company contributions to the Trust were $334,863, $321,724 and $397,538 in 2001, 2000 and 1999, +respectively. The Company has an Employee Stock Ownership Plan. No contributions were made to the plan in 2001, 2000 or 1999. +In fiscal year 2000, the Company's Board of Directors approved an additional employee stock option plan which increased the number of shares of common stock available for issuance to employees +by 425,000 shares. +10. COMMITMENTS AND CONTINGENCIES +Litigation +The Company currently has fifteen lawsuits by computer keyboard users, which are in state or federal courts in New York. These suits allege that specific keyboard products manufactured by the +Company were sold with manufacturing, design and warning defects, which caused or contributed to their injury. The alleged injuries are not specifically identified but are referred to as +repetitive stress injuries (RSI) or cumulative trauma disorders (CTD). These suits seek compensatory damages and some seek punitive damages. It is more likely than not that compensatory damages, if awarded, will be covered by insurance; however, the +likelihood that punitive damages, if awarded, will be covered by insurance is remote. A total of 123 suits have been dismissed in California, Connecticut, Florida, Illinois, Kansas, Kentucky, Maryland, Massachusetts, Michigan, New Jersey, New York, +Pennsylvania and Texas. One of the 123 dismissed suits is on appeal in New York. No provision has been made to cover any future costs. Management's position will change if warranted by facts and circumstances. +¯ +23 +Gi ven the inherent uncertainty in litigation, the inherently limited information available with respect to unasserted claims, and the +complexity of the circumstances surrounding these matters, management estimates are subject to and will change or be established as facts and circumstances warrant. The Company is also subject to various legal proceedings that arise in the ordinary +course of business. In the opinion of management, the outcome of these matters is not expected to have any material effect on the consolidated financial position or results of operations of the Company. +Capital Expenditures +The amount of firm commitments to contractors and suppliers for capital expenditures was approximately $456,000 at June 30, 2001. +11. OTHER INCOME, NET +Other income, net consists of: +June 30, 2001 +Year Ended +July 1, 2000 +July 3, 1999 +(in thousands) +Gain on sale of real estate - Ireland +$ +– +$ +– +$ +775 +Other +879 +278 +705 +Total +$ +879 +$ +278 +$ +1,480 +The Company's subsidiary in Dundalk, Ireland sold its building in Dundalk at the end of fiscal year 1999 for approximately $2.3 million and received approximately $1 million at closing. In May +of 2000, the Company received $1.0 million payment on this sale. Approximately $300,000 remained in an escrow account in Ireland pending final closing adjustments. Substantially all the money in the escrow account was paid subsequent to year end +June 30, 2001. +12. ENTERPRISE-WIDE DISCLOSURES +Management organizes its business around EMS and keyboards based on geographic area. These businesses have been aggregated as each segment has similar economic characteristics, and the nature of +the segments, its production processes, customers and distribution methods are similar. +Of the revenues for the years ended June 30, 2001, July 1, 2000 and July 3, 1999, EMS sales were $126.3 million, $91.2 million, and $37.1 million, respectively. Keyboard sales for the years +ended June 30, 2001, July 1, 2000 and July 3, 1999 were $39.2 million, $70.5 million, and $134.7 million, respectively. The remainder of revenues for all years presented were from sales of miscellaneous other products and services. +Information concerning geographic areas for the years ended June 30, 2001, July 1, 2000 and July 3, 1999 is summarized in the following table. Revenues provided below are based on the shipping +destination. +(in thousands) +Domestic +International +Total +2001 +Net sales +$ +76,950 +$ +88,915 +$ +165,865 +Long-lived assets +$ +15,629 +$ +1,040 +$ +16,669 +2000 +Net sales +$ +99,077 +$ +65,276 +$ +164,353 +Long-lived assets +$ +20,066 +$ +1,284 +$ +21,350 +1999 +Net sales +$ +102,872 +$ +75,432 +$ +178,304 +Long-lived assets +$ +23,433 +$ +1,089 +$ +$24,522 +¯ +24 +For the year ended June 30, 2001, 25.7% of the Company's domestic exports were sold to customers in Europe, 42.8% were sold to customers in the Far East, 29.7% were sold to customers in Mexico, +and the remaining 2% were spread among customers in South America and Canada. +For the year ended July 1, 2000, 43% of the Company's domestic exports were sold to customers in Europe, 36% were sold to customers in the Far East, and the remaining 21% were spread among +customers in Mexico, South America, and Canada. For the year ended July 3, 1999, 58% of the Company's domestic exports were sold to customers in Europe, 30% were sold to customers in the Far East, and the remaining 12% were spread among customers in +Mexico, South America and Canada. +Significant Customers +One customer accounted for approximately 39%, 38% and 24% of net sales for the years ended June 30, 2001, July 1, 2000 and July 3, 1999, respectively. This customer accounted for approximately +5% and 45% of trade receivables at June 30, 2001, and July 1, 2000, respectively. Another customer accounted for approximately 27% of net sales in fiscal year 2001 and 13% in fiscal year 2000. This customer accounted for 15% and 9% of trade +receivables at June 30, 2001 and July 1, 2000. Another customer accounted for 5%, 9% and 11% of net sales in 2001, 2000, and 1999, respectively. A fourth customer accounted for 1%, 8% and 11% of sales for fiscal years 2001, 2000, and 1999, +respectively. No other customers accounted for more than 10% of net sales for years ended June 30, 2001, July 1, 2000 and July 3, 1999. +13. SUPPLEMENTAL CASH FLOW AND NON-CASH INFORMATION +Year Ended +June 30, 2001 +July 1, 2000 +July 3, 1999 +(in thousands) +Interest payments +$ +2,110 +$ +1,960 +$ +1,892 +Income tax payments +$ +640 +$ +395 +$ +412 +Note received for sale of Ireland property (see Note 11) +$ +0 +$ +– +$ +1,479 +14. RESTRUCTURING CHARGES +As of July 1, 2000, the Company had no remaining reserve for restructuring charges in Ireland. In fiscal year 2000, the Company repaid $177,000 to the Irish Development Authority (IDA) for the +repayment of grants, and the remaining amount of $45,000 was paid for severance. The Company currently plans to maintain the Irish plant as its sales, marketing, and distribution facility to service the European community. +Reserve for Restructuring Obligations +2001 +2000 +Balance at beginning of year +$ +– +$ +222,000 +Amounts paid +$ +– +$ +222,000 +Balance at end of year +$ +– +$ +– +15. QUARTERLY FINANCIAL DATA +(Unaudited) +Year Ended June 30, 2001 +First +Second +Third +Fourth +Quarter +Quarter +Quarter +Quarter +(in thousands, except per share amounts) +Net sales +$ +51,214 +$ +52,586 +$ +32,228 +$ +29,838 +Gross profit +$ +5,304 +$ +4,486 +$ +(2,069 +) +$ +(164 +) +Income (loss) before income taxes +$ +312 +$ +181 +$ +(6,562 +) +$ +(4,661 +) +Net income (loss) +$ +206 +$ +3 +$ +(6,735 +) +$ +(4,847 +) +Earnings (loss) per common share basic and diluted +$ +.02 +$ +.00 +$ +(.70 +) +$ +(.50 +) +Weighted average shares outstanding +9,655 +9,671 +9,673 +9,673 +Diluted shares outstanding +9,948 +9,917 +N/A +N/A +¯ +25 +Year Ended July 1, 2000 +First +Second +Third +Fourth +Quarter +Quarter +Quarter +Quarter +Net sales +$ +41,775 +$ +41,285 +$ +34,342 +$ +46,951 +Gross profit +$ +5,968 +$ +3,339 +$ +563 +$ +4,588 +Income (loss) before income taxes +$ +285 +$ +(1,819 +) +$ +(3,754 +) +$ +119 +Net income (loss) +$ +210 +$ +(1,833 +) +$ +(3,729 +) +$ +19 +Earnings (loss) per common share basic and diluted +$ +.02 +$ +(.19 +) +$ +(.39 +) +$ +0 +Weighted average shares outstanding +9,633 +9,635 +9,637 +9,641 +Diluted shares outstanding +9,935 +N/A +N/A +9,667 +Item 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES +None +PART III +Item 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT +DALE F. PILZ – Director +Mr. Pilz, age 75, has been a director of the Company since April 1992. On March 1, 2000, Mr. Pilz was elected Chairman of the Board. Mr. Pilz was Chief Executive Officer of Flowind Corporation +from 1986 to 1990. He served as President of Omninet Corporation from 1985 to 1986. Prior to that, Mr. Pilz was Chief Executive Officer and President of GTE Sprint Communications from 1983 to 1985 and also served as Chief Executive Officer and +President of GTE Spacenet Corporation from 1983 to 1985. +WENDELL J. SATRE – Director +Mr. Satre, age 83, has been a director of the Company since 1988 and served as Chairman of the Board of Directors from July 1991 through August 1995. Mr. Satre also served as a director from +1983 through 1986 and served as Acting President of the Company from August 1991 through February 1992. Mr. Satre is the retired Chairman of the Board and Chief Executive Officer of the Washington Water Power Company, a public utility headquartered +in Spokane, Washington. Mr. Satre also serves on the Board of Directors of Output Technology Corporation and The Coeur d'Alenes Company. +YACOV A. SHAMASH – Director +Dr. Shamash, age 51, has been a director of the Company since 1989. He has been the Dean of Engineering and Applied Sciences at the State University of New York campus at Stony Brook since 1992. +Professor Shamash developed and directed the NSF Industry/University Cooperative Research Center for the Design of Analog/Digital Integrated Circuits from 1989 to 1992 and also served as Chairman of the Electrical and Computer Engineering Department +at Washington State University from 1985 until 1992. +CLARENCE W. SPANGLE – Director +Mr. Spangle, age 76, has been a director of the Company since July 1992. A former Chairman of Memorex and President of Honeywell Information Systems, Mr. Spangle has been an independent +management consultant since 1985. Mr. Spangle also serves on the Board of Directors of Apertus Technologies, Inc. +WILLIAM E. TERRY – Director +Mr. Terry, age 68, has been a director of the Company since August 1992. Mr. Terry retired from Hewlett-Packard in December 1993 where he served in a number of executive positions during the +past 36 years. He is a member of the Advisory Committee of the Santa Clara University Engineering School and, in 1983, was elected to the university's Board of Regents. Mr. Terry also serves on the Board of Directors of Altera Corporation. +¯ +26 +PATRICK SWEENEY – Director +Mr. Sweeney, age 66, has been a director of the Company since July 2000. Mr. Sweeney was President and CEO of Hadco Corporation from 1991 through 1995 and formerly served as Hadco's Vice +President/Chief Financial Officer and Vice President of Operations. Prior to that, Mr. Sweeney was the Vice President of International Manufacturing at Wang - USA from 1981 through 1986 and also served as Managing Director of Ireland for Wang and as +Plant Manager of its Galway and Clonmel divisions. Mr. Sweeney also serves on the Board of Directors of Aimware, Asic Alliance, Info.Mosaic, Manufacturers' Services Ltd. Advisory Board, Pentus, Photo Machining Inc., Piercom, and Raidtec. +JACK W. OEHLKE – Director, President and Chief Executive Officer +Mr. Oehlke, age 55, has been President and Chief Executive officer of the Company since June 1997. From October 1995, he served as Chief Operating Officer. Previously, he served as Senior Vice +President of Operations from January 1995 to October 1995 and Vice President of Manufacturing Operations of the Company from December 1993 to January 1995. Mr. Oehlke served as Director of Operations, Director of Quality and in various management +positions within manufacturing, engineering and quality functions of the Microswitch Division of Honeywell, Inc. from 1968 to 1993. +RONALD F. KLAWITTER – Executive Vice President of Administration and Chief Financial Officer +Mr. Klawitter, age 49, has been Executive Vice President of Administration, CFO, and Treasurer since July 1997. Previously was Vice President of Finance, Secretary and Treasurer of the Company +since October 1995. He was Acting Secretary from November 1994 to October 1995 and Vice President of Finance and Treasurer from 1992 to October 1995. From 1987 to 1992, Mr. Klawitter was Vice President, Finance at Baker Hughes Tubular Service, a +subsidiary of Baker Hughes, Inc. +CRAIG D. GATES – Executive Vice President of Marketing, Engineering, and Sales +Mr. Gates, age 42, has been Executive Vice President of Marketing, Engineering and Sales since July 1997. Previously he was Vice President and General Manager of New Business Development from +October 1995 to July 1997. He joined the Company as Vice President of Engineering in October of 1994. Mr. Gates has a Bachelor of Science Degree in Mechanical Engineering and a Masters in Business Administration from the University of Illinois, +Urbana. From 1982 he held various engineering and management positions within the Microswitch Division of Honeywell, Inc., in Freeport, Illinois, and from 1991 to October 1994 he served as Director of Operations, Electronics for +Microswitch. +EFREN R. PEREZ – Vice President of S.W. Operations +Mr. Perez, age 61, has served as Vice President of S.W. Operations since July 1997. Previously he was the Managing Director of S.W. Operations from July 1996 to July 1997 and Director of S.W. +Operations from July 1995 to June 1996. Following the Company's acquisition of the Honeywell, Inc. Keyboard Division, Mr. Perez served as Plant Manager in Juarez from July 1993 to July 1995. He served as Plant Manager in Juarez for the Keyboard +Division of Honeywell, Inc. from February 1989 to July 1993. Mr. Perez is a graduate of the University of Mexico with a B.S. in Physics. +MICHAEL D. CHARD – Vice President of Materials +Mr. Chard, age 43, has been Vice President of Materials of the Company since July 28, 2000. From February 1999 to July 28, 2000, he held various management positions with the Company in +planning, quality assurance, and materials. From January 1997 to January 1999, he was Vice President of Product Delivery at Wang Global and its predecessor Olivetti North America. From 1983 to 1996, he held various management positions in finance, +marketing, and operations at ISC Systems, the predecessor to Olivetti North America. He holds a BA Degree in Business and Accounting from Washington State University and is a Certified Public Accountant. +Compliance with Section 16(a) of the Exchange Act: +Incorporated by reference to Key Tronic Corporation's 2001 Proxy Statement to Shareholders. +Items 11, 12 and 13: EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT; AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. +Information appearing under the captions "Executive Compensation", "Beneficial Ownership of Securities", "Certain Relationships and Transactions" and +"Compensation Committee Interlocks and Insider Participation" in the Company's 2001 Proxy Statement is incorporated herein by this reference. +¯ +27 +PART IV +Item 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K +(A) FINANCIAL STATEMENTS AND SCHEDULE +Page in +Form 10-K +FINANCIAL STATEMENTS +Independent Auditors' Report +13 +Consolidated Balance Sheets, as of June 30, 2001 and July 1, 2000 +14 +Consolidated Statements of Operations for +the years ended June 30, 2001, July 1, 2000 and July 3, 1999 +15 +Consolidated Statements of Shareholders' Equity +for the years ended June 30, 2001, July 1, 2000 and July 3, 1999 +15 +Consolidated Statements of Cash Flows for the +years ended June 30, 2001, July 1, 2000 and July 3, 1999 +16 +Notes to Consolidated Financial Statements +16-26 +SCHEDULE +II. Consolidated Valuation and Qualifying Accounts +30 +Other schedules are omitted because of the absence of conditions under which they are required, or because required information is given in the financial statements or notes thereto. +REPORTS ON FORM 8-K +None +(C) EXHIBITS +The Company will, upon request and upon payment of a reasonable fee not to exceed the rate at which such copies are available from the Securities and Exchange Commission, furnish copies of any +of the following exhibits to its security holders. +Exhibit No. +(3) +(a) +Articles of Incorporation +(i) +(b) +By-Laws, as amended +(iii) +(4) +Certain long-term debt is described in Note 5 to the Consolidated Financial Statements of the Company. The Company agrees +to furnish to the Commission, upon request, copies of any instruments defining rights of holders of long-term debt described in Note 5. +N/A +(10) +Material Contracts +(a) +The Key Tronic Corporation Variable Investment Plan. +(iii) +(b) +Key Employee Stock Option Plan, as amended. +(i) +(c) +Executive Stock Option Plan. +(iii) +(d) +Stock Bonus Plan (PAYSOP). +(iii) +(e) +Directors and Officers Liability and Company Reimbursement Policies. +(i) +(f) +Leases with Spokane Industrial Park, Inc. +(i) +¯ +28 +(g) +Amended and Restated Employment Agreement with Lewis G. Zirkle. +(iii) +(h) +Agreement Regarding Split Dollar Life Insurance Policies, as amended. +(iv) +(i) +Executive SAR Stock Option Plan of Key Tronic Corporation +(v) +(j) +Key Tronic Corporation 1990 Stock Option Plan for Non-Employee Directors +(v) +(k) +Employee Stock Ownership Plan +(vi) +(l) +Registration Rights Agreement with Hiller Key Tronic Partners +(vii) +(m) +Officer Severance Agreements +(vii) +(n) +Purchase agreement with Honeywell, Inc. +(viii) +(o) +Officer Employment Agreement +(ix) +(p) +Executive Stock Option Plan +(x) +(q) +Secured Financing Agreement With The CIT Business Group, Inc. +(xi) +(r) +Secured Financing Agreement With General Electric Capital Corporation +(xii) +(s) +Executive Stock Option Plan 2000 +(xiii) +(t) +Employment Contract +(xiv) +(13) +2001 Annual Report to Shareholders (to the extent set forth in Parts I, II, and IV (a) of this report). +(i) +Previous filing on Form S-1 is incorporated by reference, exhibit number indicated +(ii) +Incorporated by reference to report on Form 10-K for the year ended 06/30/87 +(iii) +Incorporated by reference to report on Form 10-K for the year ended 06/30/86 +(iv) +Incorporated by reference to report on Form 10-K for the year ended 06/30/85 +(v) +Incorporated by reference, Key Tronic Corporation 1990 Proxy Statement, pages C-1 - D3 +(vi) +Incorporated by reference to report on Form 10-K for the year ended 06/30/91 +(vii) +Incorporated by reference to report on Form 10-K for the year ended 07/04/92 +(viii) +Incorporated by reference to report on Form 8-K filed August 12, 1993. +(ix) +Incorporated by reference, Key Tronic Corporation 1996 Proxy Statement, pages 10-11 +(x) +Incorporated by reference, Key Tronic Corporation 1995 Proxy Statement, pages 19-22 +(xi) +Incorporated by reference to report on Form 8-K filed October 24, 1994. +(xii) +Incorporated by reference to report on Form 8-K filed January 14, 1997. +(xiii) +Incorporated by reference to report on Form 10-Q for the quarter ended 12/30/00. +(xiv) +Incorporated by reference, Key Tronic Corporation 2000 proxy statement, pages 11-12 +(21) +Subsidiaries of Registrant +(23) +Independent Auditors' Consent and Report on Financial Statement Schedule +¯ +29 +PART IV +SCHEDULE II +KEY TRONIC CORPORATION AND SUBSIDIARIES +CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS +FISCAL YEARS ENDED JUNE 30, 2001, JULY 1, 2000 AND +JULY 3, 1999 +2001 +2000 +1999 +Allowance for Obsolete Inventory +Balance at beginning of year +$ +2,348,840 +$ +3,065,901 +$ +2,739,390 +Provision charged to income +435,000 +(358,922 +) +1,673,574 +Dispositions +(72,043 +) +(358,139 +) +(1,347,063 +) +Balance at end of year +$ +2,711,797 +$ +2,348,840 +$ +3,065,901 +Allowance for Doubtful Accounts +Balance at beginning of year +$ +855,334 +$ +542,430 +$ +885,042 +Provision charged to income +714,000 +562,000 +333,873 +Write-offs and reinstatements +(936,334 +) +(249,096 +) +(676,485 +) +Balance at end of year +$ +633,000 +$ +855,334 +$ +542,430 +Reserve for Litigation +Balance at beginning of year +$ +– +$ +– +$ +900,000 +Cost incurred-net of recoveries +– +$ +– +(900,000 +) +Balance at end of year +$ +– +$ +– +– +Accrued Warranty Costs +Balance at beginning of year +$ +453,759 +$ +723,884 +$ +664,379 +Provision charged to income +220,000 +371,861 +1,269,096 +Costs incurred +(347,214 +) +(641,986 +) +(1,209,591 +) +Balance at end of year +$ +326,545 +$ +453,759 +$ +723,884 +¯ +30 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the +registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: +September 7, 2001 +KEY TRONIC CORPORATION +By: +/s/ Jack W. Oehlke +Jack W. Oehlke, Director, President, +and 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: +/s/ Jack W. Oehlke Jack W. Oehlke +(Director, President and +Chief Executive Officer) +September 7, 2001 Date +/s/ Ronald F. Klawitter Ronald F. Klawitter +(Principal Financial Officer) +September 7, 2001 Date +/s/ Dale F. Pilz Dale F. Pilz +(Director) +September 7, 2001 Date +/s/ Wendell J. Satre Wendell J. Satre +(Director) +September 7, 2001 Date +/s/ Yacov A. Shamash Yacov A. Shamash +(Director) +September 7, 2001 Date +/s/ Clarence W. Spangle Clarence W. Spangle +(Director) +September 7, 2001 Date +/s/ Patrick Sweeney Patrick Sweeney +(Director) +September 7, 2001 Date +/s/ William E. Terry William E. Terry +(Director) +September 7, 2001 Date +¯ +31 \ No newline at end of file diff --git a/raw/filings/0000719733/2001/0001021408-01-506598/filing_metadata.csv b/raw/filings/0000719733/2001/0001021408-01-506598/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..cbbfde0dd06a38d9822018eba37d2036c3461e77 --- /dev/null +++ b/raw/filings/0000719733/2001/0001021408-01-506598/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000719733,KTCC,KEY TRONIC CORP,10-K,2001-09-12,2001-06-30,2001-09-12T04:00:00.000Z,0001021408-01-506598,d10k.htm,"FORM 10-K FOR THE PERIOD ENDED JUNE 30, 2001",586433,0,0,https://www.sec.gov/Archives/edgar/data/719733/000102140801506598/d10k.htm,https://www.sec.gov/Archives/edgar/data/719733/000102140801506598/,2001,2001,1 diff --git a/raw/filings/0000719733/2001/0001021408-01-506598/item1.txt b/raw/filings/0000719733/2001/0001021408-01-506598/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..ca932880add571eac492715d425f6d48a98c2d09 --- /dev/null +++ b/raw/filings/0000719733/2001/0001021408-01-506598/item1.txt @@ -0,0 +1,326 @@ +Item 1. BUSINESS +Key Tronic Corporation, a Washington corporation organized in 1969, and its subsidiaries (hereinafter collectively called the "Company" or "Key Tronic" unless the context +otherwise requires) are engaged in electronic manufacturing services (EMS) for original equipment manufacturers (OEMs) and manufacturing of keyboards for personal computers, terminals, and workstations. The Company operates on a fiscal year that +ends on the Saturday closest to June 30. The following discussion relates to three fiscal years of the Company. In previous filings EMS was referred to as contract design and manufacturing (CDM). +BACKGROUND +Historically Key Tronic was a manufacturer of electronic keyboards, but during the course of the past two fiscal years, its focus has changed to electronic manufacturing services (EMS). +Presently Key Tronic is known as an independent provider of a mix of EMS services for OEMs. The Company's manufacturing capabilities include circuit board assemblies, tool making, precision molding, proto building, liquid plastic injection molding +and printed circuit board assembly (both through-hole and surface mounting). +Operations are currently conducted in facilities in the United States, China, Ireland and Mexico. This global production capability provides customers with benefits of improved supply chain +management, reduced inventory, lower transportation costs and reduced product fulfillment time. +The EMS industry is comprised of companies that provide a range of manufacturing services for OEMs. The EMS industry has experienced rapid growth over the past several years as more and more +OEMs shift to external manufacturing. Equity Research reports have stated that the EMS market is expected to grow at a rate of 25% over the next three to five years. +KEYBOARD PRODUCTS +During fiscal years 2001, 2000, and 1999, the Company realized revenues of approximately $39.2 million, $70.5 million, and $134.7 million, respectively, from the sale of keyboards representing +approximately 24%, 43%, and 76% of total sales. The keyboard market has continued to trend toward standard keyboard layouts. In order to accommodate the demand for standard products, the Company maintains a purchase-from-stock program. The most +popular standard layouts are built and stocked for immediate availability. These products serve as enhancements to or replacements for the original system-supplied keyboard. +MANUFACTURING +Since inception, the Company has made substantial investments in developing and expanding its now extensive capital equipment base to achieve selective vertical integration in its manufacturing +processes. The Company designs and develops tooling for injection molding machines and manufactures the majority of plastic parts used in the products it manufactures. Additionally, the Company has invested in equipment to produce switch membranes +as a means to reduce cost and improve quality. +The OEM keyboard market has increasingly demanded rapid response time and design adaptability from keyboard manufacturers. New computer products are continually being introduced by computer +manufacturers, with the timing of product introduction often perceived as having distinct marketing advantages. Developing a keyboard for a new application is a custom process, which requires frequent +¯ +3 +contact with the customer while working through changes during design stages. Computer manufacturers place a premium on the ability of the keyboard manufacturer to design and produce keyboards +that meet their technical specifications and aesthetic considerations and to deliver in accordance with production schedules. The processes and skills the Company developed and uses in the keyboard market are transferable to and valued in the EMS +market. This has resulted in the Company gaining new customers and EMS programs. +The Company's automated manufacturing processes enable it to work closely with its customers during design and prototype stages of production for new custom products and to jointly increase +productivity and reduce response time to the market place. Key Tronic uses computer-aided design techniques and unique software to assist in preparation of the tool design layout and tool fabrication, to reduce tooling costs, improve component and +product quality and enhance turnaround time during product development. +The Company uses numerous injection molding machines in producing more than 50,000 different keycaps, enclosures and various plastic parts for the products it manufactures. Designs by Key Tronic +engineers in both tooling and molding have improved standard processing time and thereby increased productivity. During fiscal 1998, Key Tronic introduced stack molding technology to the manufacturing process. Stacked molds allow the Company to +utilize two molds simultaneously thereby producing twice as many parts in nearly the same cycle time used for one part. The molding machines used by the Company employ the latest technology, including the ability to mix plastics and determine the +color of finished components as part of the molding process. This automated, pneumatically-fed process, not only allows precise control of color determination, but also results in lower product costs and improved component quality. The Company also +produces blank keytops for certain models. The print legends are later added using a laser technology to produce entire key configuration layouts in local languages for the European market. +Key Tronic uses a variety of manual to highly-automated assembly processes in its facilities, depending upon product complexity and degree of customization. Automated processes include component +insertion, surface mount technology, flexible robotic assembly, computerized vision system quality inspection, automated switch and keytop installation, and automated functional testing. +The Company purchases materials for its products from a number of different suppliers. Key Tronic believes that it has excellent relationships with its vendors, most of whom have been suppliers +for the Company for many years. +CUSTOMERS AND MARKETING +OEM MARKETS +The Company provides manufacturing services for outsourced OEM products. The Company also manufactures and supplies custom keyboards to leading OEMs in the keyboard market. +Hewlett Packard accounted for approximately 39 percent, 38 percent, and 24 percent of net sales in 2001, 2000, and 1999, respectively. Lexmark accounted for 27 percent of net sales in 2001 and +13 percent in 2000. Microsoft accounted for approximately 5 percent, 9 percent, and 11 percent of net sales in 2001, 2000, and 1999, respectively. Gateway accounted for approximately 1 percent, 8 percent, and 13 percent of net sales in fiscal years +2001, 2000, and 1999, respectively. No other customer accounted for more than 10 percent of net sales during any of the last three years. In 2001, 2000, and 1999, the five largest customers accounted for 81 percent, 72 percent, and 60 percent of +total sales, respectively. +The Company markets its products and services primarily through its direct sales organization aided by distribution sales in the U.S., Canada and Europe. In fiscal 2001, the Company hired a +number of outside sales organizations to help promote its electronic manufacturing services. +All OEM keyboards are accompanied by a manufacturer's three-year warranty that provides for repair or replacement of defective products. Retail products carry a one-year to a limited lifetime +warranty. The limited lifetime warranty is product specific. +¯ +4 +FOREIGN MARKETS +Information concerning geographic areas for the years ended June 30, 2001, July 1, 2000, and July 3, 1999 is summarized in the following table. +(in thousands) +Domestic Exports +U.S. Operations +Mexico Operations +Ireland Operations +Far East Operations +Eliminations +Consolidated +2001 +Net sales: +Unaffiliated +customers +$ +77,842 +$ +76,950 +$ +– +$ +9,617 +$ +1,456 +$ +– +$ +165,865 +Affiliates +– +6,355 +41,829 +12 +22,312 +(70,508 +) +– +Total +$ +77,842 +$ +83,305 +$ +41,829 +$ +9,629 +$ +23,768 +$ +(70,508 +) +$ +165,865 +Income (loss) +before income +taxes +$ +– +$ +(14,714 +) +$ +2,955 +$ +(978 +) +$ +1,865 +$ +142 +$ +(10,730 +) +Total assets +$ +– +$ +68,394 +$ +20,703 +$ +5,879 +$ +8,056 +$ +(28,661 +) +$ +74,371 +2000 +Net sales: +Unaffiliated +customers +$ +53,657 +$ +97,956 +$ +– +$ +11,616 +$ +1,124 +$ +– +$ +164,353 +Affiliates +– +10,571 +22,311 +142 +20,987 +(54,011 +) +– +Total +$ +53,657 +$ +108,527 +$ +22,311 +$ +11,758 +$ +22,111 +$ +(54,011 +) +$ +164,353 +Income (loss) +before income +taxes +$ +– +$ +(6,016 +) +$ +1,318 +$ +(1,786) +) +$ +1,418 +$ +(103 +) +$ +(5,169 +) +Total assets +$ +– +$ +103,271 +$ +7,714 +$ +11,401 +$ +18,854 +$ +(45,425 +) +$ +95,815 +1999 +Net sales: +Unaffiliated +customers +$ +57,192 +$ +102,872 +$ +– +$ +17,650 +$ +590 +$ +– +$ +178,304 +Affiliates +– +9,581 +20,297 +190 +3,493 +(33,561 +) +– +Total +$ +57,192 +$ +112,453 +$ +20,297 +$ +17,840 +$ +4,083 +$ +(33,561 +) +$ +178,304 +Income (loss) +before income +taxes +$ +– +$ +1,989 +$ +1,631 +$ +499 +$ +26 +$ +600 +$ +4,745 +Total assets +$ +– +$ +91,552 +$ +13,585 +$ +15,655 +$ +7,022 +$ +(26,867 +) +$ +100,947 +Transfers to affiliates are made at prices which approximate market. Intercompany margins are eliminated upon consolidation. +In 2001, $88.9 million, or 53.6% percent of the Company's revenues were from foreign sales, primarily sales in Europe, the Far East, Canada, Mexico and South America. Foreign sales in 2000 and +1999 were $65.3 million and $75.4 million, respectively. Foreign sales are made primarily through the Company's direct sales force in the U.S. and Ireland. Key Tronic Shanghai (KTS), the Company's facility in Shanghai, China, began operations in the +third quarter of 1999 and is used to support customers in that area as well as for export. +For additional financial information about foreign operations, see Note 12 to the Consolidated Financial Statements. +BACKLOG +At August 11, 2001, the Company had an order backlog of approximately $81.5 million. This compares with a backlog of approximately $35 million at August 5, 2000. The increase in backlog is +attributable in part to increased customer orders from a new EMS customer for fiscal year 2002. The Company also supports two major OEM customers that have expanded their Just-In-Time (JIT) inventory systems, so that orders are not placed in advance +but are pulled from a stock location maintained by Key Tronic. Order backlog is not necessarily indicative of future sales. Order backlog consists of purchase orders received for products expected to be shipped approximately within the next fiscal +year, although shipment dates are subject to change due to design modifications or other customer requirements. All orders in backlog are expected to be filled within the current fiscal year. +RESEARCH, DEVELOPMENT, AND ENGINEERING +The Company's research, development, and engineering expenses were $2.7 million, $2.8 million, and $4.9 million in 2001, 2000, and 1999, respectively. Research, development and engineering +expenses as a percentage of sales were 1.6 percent, 1.7 percent, and 2.7 percent in 2001, 2000, and 1999, respectively. The slight decrease in fiscal year 2001 is a result of greater recovery of engineering design costs. +¯ +5 +COMPETITION +The Company believes that its principal competitors in the EMS market are: Plexus Corp, SCI Systems, ACT Manufacturing, Celestica, Flextronics International, Jabil Circuits, and Solectron. The +principal methods of competition are price, quality and capability. +The Company believes that its principal competitors in the keyboard market are: Chicony, NMB and Siletek. +TRADEMARKS AND PATENTS +The Company owns several keyboard patents. However, since the Company's focus is now electronic manufacturing services, management believes that these patents will not have a significant impact +on future revenues. The Key Tronic name and logo are federally registered trademarks, and the Company believes they are valuable assets in its business. In fiscal 2001, Key Tronic began operating under the trade name "KeyTronicEMS" to +better represent its primary business concentration. +EMPLOYEES +As of July 28, 2001, the Company had approximately 2,151 employees compared to 2,007 on August 5, 2000. Management considers its employee relations to be excellent. The Company's employees in +Ireland and Reynosa are represented by local unions. The Company has never experienced any material interruption of production due to labor disputes. +The Company's employee benefit program includes a bonus program involving periodic payments to all employees based on quarterly before-tax income. The Company maintains a tax-qualified profit +sharing plan, a 401(k) plan, which provides a matching company contribution on a portion of the employee's contribution, and also provides group health, life, and disability insurance plans. The Company also offers an Executive Stock Option Plan and +an Employee Stock Ownership Plan to certain individuals. \ No newline at end of file diff --git a/raw/filings/0000719733/2001/0001021408-01-506598/item13.txt b/raw/filings/0000719733/2001/0001021408-01-506598/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..9381a55a197d9757b10b0c1054a19c69cf69b52c --- /dev/null +++ b/raw/filings/0000719733/2001/0001021408-01-506598/item13.txt @@ -0,0 +1,3 @@ +Item 13. +Certain Relationships and Related Transactions +27 \ No newline at end of file diff --git a/raw/filings/0000719733/2001/0001021408-01-506598/item9a.txt b/raw/filings/0000719733/2001/0001021408-01-506598/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000719733/2001/0001021408-01-506598/rp_note.txt b/raw/filings/0000719733/2001/0001021408-01-506598/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..5fae0dcc201e78a93b8819c38d5ddf52b427e50f --- /dev/null +++ b/raw/filings/0000719733/2001/0001021408-01-506598/rp_note.txt @@ -0,0 +1,4 @@ +4. RELATED PARTY TRANSACTIONS +The Company has life insurance policies on the life of its founder with net death benefits totaling approximately $3,000,000. Of these, policies with death benefits totaling $750,000 have been +designated to fund obligations of the Company to the founder's spouse in the event of his death and, accordingly, such obligations are not recorded in the financial statements. Net cash values of such policies are recorded in the amount of $40,000 +and $339,000 in 2001 and 2000, respectively, and are included in other noncurrent assets. \ No newline at end of file diff --git a/raw/filings/0000719733/2001/0001021408-01-506598/rpt_disclosure.txt b/raw/filings/0000719733/2001/0001021408-01-506598/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000719733/2002/0001032210-02-001358/filing.txt b/raw/filings/0000719733/2002/0001032210-02-001358/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..526a0aadc7550ba66a77a16b9ba1a7b4a5c5c568 --- /dev/null +++ b/raw/filings/0000719733/2002/0001032210-02-001358/filing.txt @@ -0,0 +1,2771 @@ +10-K +1 +d10k.htm +FORM 10-K FOR FISCAL YEAR ENDED JUNE 29, 2002 +Prepared by R.R. Donnelley Financial -- Form 10-K For Fiscal Year Ended June 29, 2002 +Table of Contents +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF +THE SECURITIES EXCHANGE ACT OF 1934 +For the Fiscal Year Ended June 29, 2002 +Commission File Number 0-11559 +KEY TRONIC CORPORATION +Washington +91-0849125 +(State of Incorporation) +(I.R.S. Employer +Identification +No.) +N. 4424 Sullivan Road +Spokane, Washington 99216 +(509) 928-8000 +Securities registered pursuant to Section 12(b) of the Act: +None +Securities registered pursuant to Section 12(g) of the Act: +Common Stock +The registrant has filed all reports required +to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months, and has been subject to such filing requirements during the past 90 days. +Indicate by checkmark if delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s +knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. +The aggregate market value of the voting stock held by non-affiliates of the Registrant was $9,564,388 as of June 29, 2002. +The number of shares of Common Stock of the Registrant outstanding as of June 29, 2002 was 9,672,580 shares. +The Exhibit Index is located at pages 31-32. +DOCUMENTS INCORPORATED BY REFERENCE +The following documents are incorporated by reference +to the extent specified herein: +Document Description +10-K Part +Proxy Statement dated September 26, 2001 +III +Table of Contents +KEY TRONIC CORPORATION +2002 FORM 10-K +TABLE OF CONTENTS +Page +Part I +Item 1. +Business +3-5 +Item 2. +Properties +6 +Item 3. +Legal Proceedings +6 +Item 4. +Submission of Matters to a Vote of Security Holders +6 +Part II +Item 5. +Market for the Registrant’s Common Stock and Related Stockholder Matters +7 +Item 6. +Selected Financial Data +7 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +8-13 +Item 7A. +Quantitative and Qualitative Disclosures about Market Risk +13-14 +Item 8. +Financial Statements and Supplementary Data +15-28 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosures +28 +Part III +Item 10. +Directors and Executive Officers of the Registrant +29-30 +Item 11. +Executive Compensation +30 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +30 +Item 13. +Certain Relationships and Related Transactions +31 +Part IV +Item 14. +Exhibits, Financial Statement Schedule, Reports on Form 8-K and Signatures +31-37 +Table of Contents +FORWARD-LOOKING STATEMENTS +This Annual Report contains forward-looking statements in addition to historical information. Forward-looking statements are subject to certain risks and uncertainties that +could cause actual results to differ materially from those reflected in the forward-looking statements. Risks and uncertainties that might cause such differences include, but are not limited to those outlined in “Management’s Discussion +and Analysis of Financial Condition and Results of Operations—Risks and Uncertainties that May Affect Future Results.” Readers are cautioned not to place undue reliance on forward-looking statements, which reflect management’s +opinions only as of the date hereof. The Company undertakes no obligation to revise or publicly release the results of any revision to forward-looking statements. Readers should carefully review the risk factors described in other documents the +Company files from time to time with the Securities and Exchange Commission, including Quarterly Reports on Form 10-Q. +PART I +Item 1. +Business +Key Tronic Corporation (dba KeyTronicEMS), a Washington corporation +organized in 1969, and its subsidiaries (hereinafter collectively called the “Company” or “Key Tronic” unless the context otherwise requires) are principally engaged in electronic manufacturing services (EMS) for original +equipment manufacturers (OEMs). The Company also manufactures keyboards for personal computers, terminals, and workstations primarily in standard layouts that can be sold directly from stock. +BACKGROUND +Historically, Key Tronic was a +manufacturer of only electronic keyboards, but about four years ago, after assessing its strengths and capabilities, the Company’s focus was shifted to electronic manufacturing services (EMS). Presently, Key Tronic is known as an independent +provider of a mix of EMS services for OEMs. The Company’s manufacturing capabilities include tool making, precision molding, prototype design, liquid plastic injection molding, printed circuit board assembly (both through-hole and surface- +mount), and full box build. +Operations are currently conducted in facilities in the United States, China, Ireland +and Mexico. This global production capability provides customers with benefits of improved supply-chain management, reduced inventory, lower transportation costs and reduced product fulfillment time. +The EMS industry is comprised of companies that provide a range of manufacturing services for OEMs. The EMS industry has experienced rapid +growth over the past several years as more and more OEMs shift to external manufacturing, and it is expected to continue in this growth pattern for several years. +CUSTOMERS AND MARKETING +OEM MARKETS +The Company provides manufacturing services for outsourced OEM products. Key Tronic is capable of providing a mix of EMS services +including product design, tool making, precision molding, prototype design, liquid plastic injection molding, printed circuit board assembly, full box build, and screened silver flexible circuit membranes. The percentage of revenues from EMS +services for the fiscal years ended June 29, 2002, June 30, 2001, and July 1, 2000 were 89.4%, 76.2%, and 55.5%, respectively. Sales of such products are generally not seasonal in nature. +Hewlett Packard accounted for approximately 10%, 39%, and 38% of the Company’s consolidated revenues in fiscal years 2002, 2001, and 2000, respectively. Lexmark +accounted for 13%, 27%, and 13% of consolidated revenues in fiscal years 2002, 2001, and 2000, respectively. During fiscal year 2002, the Company performed product design, plastic injection molding, and manufacturing for Clorox Products +Manufacturing Company, a new customer who accounted for 39% of consolidated revenue. No other customers accounted for 10% or more of consolidated revenues in the three fiscal years presented. In the fiscal years ended June 29, 2002, June 30, 2001, +and July 1, 2000, the five largest customers accounted for 76%, 81%, and 72% of total sales, respectively. +Although keyboard manufacturing is still included in the Company’s product offerings, annual sales continue to decline. During the fiscal years ended June 29, 2002, June 30, 2001, and July 1, 2000, the Company realized revenues +of approximately $18.3 million, $38.6 million, and $70.5 million, respectively, from the sale of keyboards representing approximately 10.4%, 23.3%, and 42.9% of consolidated revenues. The keyboard market has continued to trend toward standard +keyboard layouts. In order to accommodate the demand for standard products, the Company maintains a purchase-from-stock program. The most popular standard layouts are built and stocked for immediate availability. These products serve as enhancements +to or replacements for the original system-supplied +3 +Table of Contents +keyboards. Keyboard sales can increase somewhat during the last half of each calendar year in conjunction with the holiday season, but generally +sales of these products are not seasonal in nature. +The Company markets its products and services primarily +through its direct sales organization aided by strategically located field sales people and distributors. Although the Company established relationships with several independent sales organizations to assist in marketing the Company’s EMS +product lines in the U.S., commissions earned and paid during fiscal year 2002 were insignificant. +MANUFACTURING +Since inception, the Company has made substantial investments in developing and expanding its now extensive capital equipment +base to achieve selective vertical integration in its manufacturing processes. The Company designs and develops tooling for injection molding machines and manufactures the majority of plastic parts used in the products it manufactures. Additionally, +the Company has invested in equipment to produce screened silver flexible circuit membranes. +The Company’s +automated manufacturing processes enable it to work closely with its customers during design and prototype stages of production for new custom products and to jointly increase productivity and reduce response time to the marketplace. Key Tronic uses +computer-aided design techniques and unique software to assist in preparation of the tool design layout and tool fabrications, to reduce tooling costs, improve component and product quality and enhance turnaround time during product development. +Key Tronic uses a variety of manual and highly automated assembly processes in its facilities, depending upon +product complexity and degree of customization. Automated processes include component insertion, surface-mount technology, flexible robotic assembly, computerized vision system quality inspection, automated switch and keytop installation, and +automated functional testing. +The Company purchases materials and components for its products from a number of +different suppliers both domestic and international. Key Tronic develops close working relationships with its suppliers, many of whom have been supplying products to the Company for several years. +FOREIGN MARKETS +Information concerning geographic areas for the years ended June 29, 2002, June 30, 2001, and July 1, 2000 is summarized in the following table. +Domestic Exports +U.S. Operations +Mexico Operations +Ireland Operations +Far East Operations +Eliminations +Consolidated +(in thousands) +2002 +Net sales: +Unaffiliated Customers +$ +26,888 +$ +143,324 +$ +— +$ +5,291 +$ +88 +$ +— +$ +175,591 +Affiliates +3,187 +40,438 +(60 +) +19,037 +62,602 +— +Total +$ +26,888 +$ +146,511 +$ +40,438 +$ +5,231 +$ +19,125 +$ +(62,602 +) +$ +175,591 +Income (loss) before income Taxes +$ +— +$ +(22,242 +) +$ +2,023 +$ +(885 +) +$ +948 +$ +210 +$ +(19,946 +) +Total assets +$ +— +$ +38,940 +$ +14,658 +$ +3,161 +$ +9,511 +$ +(8,831 +) +$ +57,439 +2001 +Net sales: +Unaffiliated customers +$ +77,842 +$ +76,950 +$ +— +$ +9,617 +$ +1,456 +$ +— +$ +165,865 +Affiliates +— +6,355 +41,829 +12 +22,312 +(70,508 +) +— +Total +$ +77,842 +$ +83,305 +$ +41,829 +$ +9,629 +$ +23,768 +$ +(70,508 +) +$ +165,865 +Income (loss) before income Taxes +$ +— +$ +(14,714 +) +$ +2,955 +$ +(978 +) +$ +1,865 +$ +142 +$ +(10,730 +) +Total assets +$ +— +$ +68,394 +$ +20,703 +$ +5,879 +$ +8,056 +$ +(28,661 +) +$ +74,371 +4 +Table of Contents +2000 +Net sales: +Unaffiliated customers +$ +53,657 +$ +97,956 +$ +— +$ +11,616 +$ +1,124 +$ +— +$ +164,353 +Affiliates +— +10,571 +22,311 +142 +20,987 +(54,011 +) +— +Total +$ +53,657 +$ +108,527 +$ +22,311 +$ +11,758 +$ +22,111 +$ +(54,011 +) +$ +164,353 +Income (loss) before income taxes +$ +— +$ +(6,016 +) +$ +1,318 +$ +(1,786 +) +$ +1,418 +$ +(103 +) +$ +(5,169 +) +Total assets +$ +— +$ +103,271 +$ +7,714 +$ +11,401 +$ +18,854 +$ +(45,425 +) +$ +95,815 +In fiscal year 2002, $32.3 million, or 18.4% of the Company’s +revenues were from foreign sales, primarily sales in Europe, the Far East, and Mexico. Foreign sales in fiscal years 2001 and 2000 were $88.9 million and $65.3 million, respectively. Foreign sales are made primarily through the Company’s direct +sales force in the U.S. and Ireland. Key Tronic Shanghai (KTS), the Company’s facility in Shanghai, China, is used to support customer requirements within the local area as well as for export. +For additional financial information about foreign operations, see Note 12 to the Consolidated Financial Statements. +BACKLOG +At August 3, 2002, the Company had an order backlog of approximately $24.6 million. This compares with a backlog of approximately $81.5 million at August 11, 2001. The decrease in backlog is primarily attributable to a different +order placement process by a major EMS customer in the current fiscal year. As of August 11, 2001, this customer had placed a blanket purchase order with the Company that covered its forecasted annual requirement of product. A few months after this +date, the customer chose instead to cancel the blanket purchase order and replace it with more accurate purchase orders on a monthly basis. Order backlog is not necessarily indicative of future sales. Order backlog consists of purchase orders +received for products expected to be shipped approximately within the next fiscal year, although shipment dates are subject to change due to design modifications or other customer requirements. +RESEARCH, DEVELOPMENT, AND ENGINEERING +The +Company’s research, development, and engineering expenses (RD&E) were $2.6 million, $2.7 million, and $2.8 million in fiscal years 2002, 2001, and 2000, respectively. Research, development and engineering expenses as a percentage of sales +were 1.5%, 1.6%, and 1.7% in fiscal years 2002, 2001, and 2000, respectively. RD&E expenses have remained relatively consistent. +COMPETITION +The Company believes that its principal competitors in the EMS market are: +Plexus Corp, SCI Systems, ACT Manufacturing, Celestica, Flextronics International, Jabil Circuits, and Solectron. The principal methods of competition are price, quality, and the range of services offered. +TRADEMARKS AND PATENTS +The Company owns several keyboard patents; however, since the Company’s focus is now electronic manufacturing services, management believes that these patents will not have a significant impact on future revenues. The Key Tronic +name and logo are federally registered trademarks, and the Company believes they are valuable assets in its business. In fiscal year 2001, Key Tronic began operating under the trade name “KeyTronicEMS” to better represent its primary +business concentration. +EMPLOYEES +As of July 25, 2002, the Company had approximately 1,953 employees compared to 2,151 on July 28, 2001. The Company’s employees in Ireland and Reynosa are represented by local unions. The Company +has never experienced any material interruption of production due to labor disputes. +The Company’s employee +benefit program includes a bonus program involving periodic payments to all employees based on quarterly before-tax income. The Company maintains a tax-qualified profit sharing plan, a 401(k) plan, which provides a matching company contribution on a +portion of the employee’s contribution, and also provides group health, life, and disability insurance plans. The Company also offers an Executive Stock Option Plan and an Employee Stock Ownership Plan to certain individuals. +5 +Table of Contents +Item 2. Properties +On December 27, 2000, +the Company sold two contiguous parcels of land and its corporate headquarters building in Spokane to Royal Hills Associates L.L.C. (RHA) for approximately $6 million in cash. In connection with the sale, the Company entered into a 10-year lease +agreement with RHA for one floor of the two-story building, which the Company will continue to occupy as its headquarters. Under the terms of the sale agreement, the Company had guaranteed the rent on the second floor of the building for one year +following the closing date of December 27, 2000. In January 2002, the Company’s monthly rent payment decreased from $62,125 to $30,875 plus allocated expenses. The Company also owns a 165,000 sq. ft. assembly and molding facility in Juarez, +Mexico in addition to a 45,000 sq. ft. manufacturing and assembly facility in Las Cruces, New Mexico. At the end of November 2001, the Company leased an additional 49,411 sq. ft. in Juarez, Mexico to be used primarily as warehouse space with some +light manufacturing. The Company leases a manufacturing facility in the Spokane Industrial Park with a total of 96,000 sq. ft. and two warehouses in El Paso, Texas, totaling 52,800 sq. ft. In Dundalk, Ireland, the Company leases 24,200 sq. ft. of +office and warehouse space. The two leases in El Paso were renewed during fiscal year 2001, and both expire on July 31, 2003. On September 1, 2001, the Company signed a 12-month lease agreement for an additional 32,000 sq. ft. of warehouse space in +El Paso, Texas. This lease was renewed on a month-to-month basis. In March 2000, the Company entered into a five-year lease for a 140,000 sq. ft. manufacturing facility in Reynosa, Mexico. In September 1997, the Company signed a five-year operating +lease with a local company for property owned by the Company, which is located in Cheney, Washington. The lease terms included an option to buy the property upon notice at any time during the course of the lease. On February 21, 2002, the Company +sold the real estate, which was held for sale and carried at the lower of cost or net realized value, for $1,705,628 and recorded a gain of $84,000. During the fourth fiscal quarter of 1998, the Company leased space of approximately 36,000 sq. ft. +in a building in Shanghai, China. The Company began an assembly operation in this facility in the third quarter of fiscal year 1999. The Company considers its properties in good condition, well maintained and suitable for operations. The Company +considers the productive capacity of its current facilities sufficient to carry on the Company’s business. +Item +3. +Legal Proceedings +On December 20, 2001, a jury in Seattle federal court +rendered a verdict in the case of F&G Scrolling Mouse, LLC, Fernando Falcon and Federico Gilligan v. Microsoft Corporation, Honeywell, Inc., and Key Tronic Corporation, United States District Court for the Western District of +Washington, Case No. C99-995C finding that Key Tronic misappropriated trade secrets and breached a confidentiality agreement with Plaintiffs Fernando Falcon, Federico Gilligan and their company, F&G Scrolling Mouse LLC. Plaintiffs alleged +that Key Tronic misappropriated plaintiffs’ trade secrets and breached a confidentiality agreement by disclosing to Microsoft, in violation of that agreement, information provided by Plaintiffs to Key Tronic pursuant to the confidentiality +agreement. Plaintiffs alleged that they were damaged as a result of Microsoft’s subsequent use of Plaintiffs’ trade secrets in the development of Microsoft’s IntelliMouse product. Honeywell was dismissed without prejudice from this +action on December 2, 1999, and Plaintiffs settled with Microsoft and dismissed that defendant with prejudice on March 30, 2000. +Although the jury found that the misappropriation was not willful, it awarded damages in the amount of $16.5 million. The judgment was subsequently increased to approximately $19.2 million through an award of pre-judgment interest. +The trial court denied Key Tronic’s motion for judgment as a matter of law and motion for new trial. Key Tronic filed notice of appeal to the U.S. Court of Appeals for the Ninth Circuit on May 16, 2002. On June 6, 2002, the bankruptcy court +granted a stay of execution on the judgment pending the outcome of the appeal to the Ninth Circuit. Under the terms of the stay of execution of judgment, the court approved a supersedeas bond on the terms requested by Key Tronic in the amount of +$1.75 million, with quarterly additions of 50% of the company’s operating income, as security for the $19.2 million judgment. Key Tronic intends to vigorously pursue its appeal in this matter. An unfavorable outcome in this matter could likely +impair the Company’s ability to continue as a going concern and have a material adverse impact on the Company’s cash flows. +The Company is also subject to various legal proceedings and claims that arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, the outcome of these matters is not +expected to have any material adverse impact on the consolidated financial position, results of operations or cash flows of the Company. +Also see Note 10 to the June 29, 2002 Consolidated Financial Statements. +Item +4. +Submission of Matters to a Vote of Security Holders +None +6 +Table of Contents +PART II +Item 5: +Market for Registrant’s Common Stock and Related Shareholder Matters +Market Information +Key Tronic Corporation’s common stock is traded in the +over-the-counter market and is listed on the NASDAQ National Market System under the symbol KTCC. Quarterly high and low closing sales prices for Key Tronic common stock for fiscal years 2002 and 2001 were as follows: +2002 +2001 +High +Low +High +Low +First Quarter +2.650 +1.420 +5.438 +3.000 +Second Quarter +2.900 +1.200 +5.125 +2.125 +Third Quarter +1.570 +0.950 +3.031 +2.063 +Fourth Quarter +2.060 +0.680 +2.250 +1.438 +High and low stock prices are based on the daily closing price +reported by the NASDAQ National Market System. These quotations represent prices between dealers without adjustment for markups, markdowns, and commissions, and may not represent actual transactions. +Holders and Dividends +As of June 29, 2002, the Company had 1,410 shareholders of record. The Company’s current line of credit agreement contains a covenant that prohibits the declaration or payment of dividends (see +Note 5 to Consolidated Financial Statements). The Company has never paid a cash dividend and does not anticipate payment of dividends on its Common Stock in the foreseeable future. +The following selected consolidated financial data of the Company should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition +and Results of Operations” and the other financial information included elsewhere in this Form 10-K. +Item +6: +Selected Financial Data +KEY TRONIC TEN-YEAR FINANCIAL HIGHLIGHTS +2002 +2001 +2000 +1999 +1998 +1997 +1996 +1995 +1994 +1993 +(Dollars in millions, except share amounts) +Net sales +$ +175.6 +$ +165.9 +$ +164.4 +$ +178.3 +$ +170.1 +$ +184.9 +$ +201.0 +$ +207.5 +$ +159.4 +$ +123.3 +Operating income (loss) +1.2 +(9.5 +) +(3.5 +) +5.2 +1.2 +1.9 +0.2 +9.8 +(8.3 +) +3.7 +Net income (loss) +(25.4 +) +(11.4 +) +(5.3 +) +3.0 +(0.9 +) +0.3 +(1.8 +) +4.4 +(1.1 +) +3.8 +Net income (loss) per share +(2.62 +) +(1.18 +) +(.55 +) +0.32 +(0.09 +) +0.03 +(0.22 +) +0.53 +(0.13 +) +0.49 +Depreciation/amortization +4.4 +5.9 +6.3 +6.9 +9.6 +8.9 +10.0 +8.9 +8.6 +6.3 +Total assets +57.4 +74.4 +95.8 +101.0 +97.0 +100.2 +93.5 +115.1 +101.9 +61.8 +Net working capital +22.5 +22.9 +37.1 +41.8 +34.6 +38.5 +28.0 +37.7 +28.5 +20.0 +Long-term liabilities +26.8 +9.4 +17.6 +20.6 +22.9 +27.0 +17.3 +28.5 +26.6 +0.8 +Shareholders’ equity +9.7 +35.3 +46.6 +51.9 +48.8 +49.8 +49.5 +51.3 +44.5 +43.4 +Book value per share +1.00 +3.65 +4.83 +5.39 +5.06 +5.18 +5.80 +6.06 +5.38 +5.54 +Cash dividends per share +0 +0 +0 +0 +0 +0 +0 +0 +0 +0 +Number of shares outstanding at year end (thousands) +9,673 +9,673 +9,641 +9,631 +9,631 +9,611 +8,534 +8,456 +8,271 +7,837 +Number of employees at year end +1,995 +2,151 +1,926 +1,951 +2,721 +2,429 +2,824 +2,925 +2,163 +1,204 +7 +Table of Contents +Item 7: +Management’s Discussion and Analysis of Financial Condition and Results of Operations +RESULTS OF OPERATIONS +Fiscal year 2002: Fiscal year 2002 sales +increased approximately 6% from fiscal year 2001. This increase is due primarily to sales of new EMS products offset by declines in keyboard sales. Revenue from keyboard sales decreased $20.3 million or 52.6% from fiscal 2001 while revenue from EMS +sales increased $30.7 million or 24.3%. Even though keyboard sales continue to decline, the margins on these sales usually exceed those that can be realized on EMS sales, so the Company will continue to service this industry until such time that it +is no longer feasible or profitable to do so. The Company’s gross profit percentage on sales for fiscal year 2002 was 8.5%, which is an increase of 3.9% from fiscal year 2001. This increase is primarily the result of a new product line in full +production during fiscal year 2002 that utilized excess operating capacity. The Company continues to emphasize expansion of EMS products and services. +Fiscal year 2001: Fiscal year 2001 sales increased approximately 1% from the prior year. This slight increase is primarily due to the expansion of the Company’s electronic +manufacturing services (EMS) operations; the increase was smaller than the company expected due to decreased orders from one major customer. Unit keyboard sales decreased 43% from the prior year, while the average selling price increased 8.2%. The +increase in average selling price was primarily due to a higher percentage of keyboard sales to distributors. Distribution sales generally have higher margins than sales to OEM customers. The Company was successful in expanding its EMS business from +56% of total revenue in 2000 to 76% in 2001. The Company continues to emphasize cost control to address price reductions expected by our customers. +If keyboard technology remains the same, price erosion is expected to continue in future years. The Company continues to focus its molding and manufacturing capabilities on increasing production in the +EMS market. The Company’s gross profit percentage decreased 4.2% to 4.6% in fiscal year 2001 compared to fiscal year 2000. This decrease is primarily due to the decline of orders by one significant customer resulting in lower sales and +increased excess operating capacity. There were also lower sales in the distribution keyboard business, which traditionally has much higher margins than the OEM market. +CRITICAL ACCOUNTING POLICIES +Inactive, Obsolete and +Surplus Inventory Reserve: The Company reserves for inventories that it deems inactive, obsolete or surplus. This reserve is calculated based upon the demand for the products that the Company produces. Demand is determined +by expected sales or customer forecasts. If expected sales do not materialize, then the Company would have inventory in excess of their reserves and would have to charge the excess against future earnings. In the case where the Company has purchased +material based upon a customer’s forecast, the Company is usually covered by lead-time assurance agreements with each customer. These contracts state that the financial liability for material purchased within lead-time and based upon the +customer’s forecasts, lies with the customer. If the Company purchases material outside the lead-time assurance agreement and the customer’s forecasts do not materialize, the Company would have the financial liability and would have to +charge the excess against future earnings. +Bad Debt Accrual: The Company values its +accounts receivable net of an allowance for doubtful accounts. This allowance is based on estimates of the portion of accounts receivable that may not be collected in the future, and the amount of this allowance is disclosed in the Company’s +Consolidated Balance Sheet. The estimates used are based primarily on specific identification of potentially uncollectible accounts. Such accounts are identified using publicly available information in conjunction with evaluations of current payment +activity. However, if any of the Company’s customers were to develop unexpected and immediate financial problems that would prevent payment of open invoices, the Company could incur additional and possibly material expenses that would +negatively impact earnings. +Accrued Warranty: An accrual is made for expected +warranty costs, with the related expense recognized in cost of good sold. Management reviews the adequacy of this accrual quarterly based on historical analysis and anticipated product returns. Over the course of the past three years, the +Company’s warranty expense has decreased. As the Company has made the transition from manufacturing keyboards only to EMS, its exposure to warranty issues has declined significantly. The Company’s warranty period for keyboards is generally +three times longer than that for EMS products. Also the Company does not warranty design defects for EMS customers. The declines in warranty expense and the related accrual account are directly related to the change in the composition of the +Company’s revenue from keyboards to EMS. +RISKS AND UNCERTAINTIES THAT COULD AFFECT FUTURE RESULTS +The following risks and uncertainties could affect the Company’s actual results and could cause results to differ materially from +past results or those contemplated by the Company’s forward-looking statements. When used in this discussion and analysis and elsewhere in this annual report, the words “expects,” “believes,” “anticipates” and +similar expressions are intended to identify forward-looking +8 +Table of Contents +statements. Actual future results may differ materially due to uncertainties including risks identified in: Potential Fluctuations In Quarterly +Results, Litigation, Competition, Concentration of Major Customers, Dependence on Key Personnel, Technological Change and New Product Risk, and Dilution and Stock Price Volatility. Forward-looking statements are based on management’s opinions +as of the date of this report. +Potential Fluctuations in Quarterly Results: The +Company’s quarterly operating results have varied in the past and may vary in the future due to a variety of factors, including changes in overall demand for computer products, success of customers’ programs, timing of new programs, new +product introductions or technological advances by the Company, its customers and its competitors, and changes in pricing policies by the Company. For example, the Company relies on customers’ forecasts to plan its business. If those forecasts +are overly optimistic, the Company’s revenues and profits may fall short of expectations. Conversely, if those forecasts are too conservative, the Company could have an unexpected increase in revenues and profits. +Litigation: On December 20, 2001, a jury in Seattle federal court rendered a verdict in the case of +F&G Scrolling Mouse, LLC, Fernando Falcon and Federico Gilligan v. Microsoft Corporation, Honeywell, Inc., and Key Tronic Corporation, United States District Court for the Western District of Washington, Case No. C99-995C finding that +Key Tronic misappropriated trade secrets and breached a confidentiality agreement with Plaintiffs Fernando Falcon, Federico Gilligan and their company, F&G Scrolling Mouse LLC. Plaintiffs alleged that Key Tronic misappropriated plaintiffs’ +trade secrets and breached a confidentiality agreement by disclosing to Microsoft, in violation of that agreement, information provided by Plaintiffs to Key Tronic pursuant to the confidentiality agreement. Plaintiffs alleged that they were damaged +as a result of Microsoft’s subsequent use of Plaintiffs’ trade secrets in the development of Microsoft’s IntelliMouse product. Honeywell was dismissed without prejudice from this action on December 2, 1999, and Plaintiffs settled with +Microsoft and dismissed that defendant with prejudice on March 30, 2000. +Although the jury found that the +misappropriation was not willful, it awarded damages in the amount of $16.5 million. The judgment was subsequently increased to approximately $19.2 million through an award of pre-judgment interest. The trial court denied Key Tronic’s motion +for judgment as a matter of law and motion for new trial. Key Tronic filed notice of appeal to the U.S. Court of Appeals for the Ninth Circuit on May 16, 2002. On June 6, 2002, the federal district court granted a stay of execution of judgment +pending the outcome of the appeal to the Ninth Circuit. Under the terms of the stay of execution of judgment, the court approved a supersedeas bond on the terms requested by Key Tronic in the amount of $1.75 million, with quarterly additions of 50% +of the company’s operating income, as security for the $19.2 million judgment. Key Tronic intends to vigorously pursue its appeal in this matter. An unfavorable outcome in this matter could likely impair the Company’s ability to continue +as a going concern and have a material adverse impact on the Company’s cash flows. +Competition: The EMS business is intensely competitive. The Company’s major competitors in the EMS business are much larger and may be able to offer customers lower prices and less risk particularly +on large volume programs. This could result in price reductions, reduced margins and loss of market share, all of which would materially and adversely affect the Company’s business, operating results and financial condition. In addition, +competitors can copy the Company’s non-proprietary designs after the Company has invested in the development of products for customers, thereby enabling competitors to offer lower prices on such products due to savings in development costs. +Concentration of Major Customers: At present, the Company’s customer base is +highly concentrated and could become even more concentrated. Three of the Company’s OEM customers accounted for 10%, 13%, and 10% of net sales during fiscal year 2002. In 2001, these same customers accounted for 39%, 27%, and 5% of net sales. A +newly acquired EMS customer accounted for 39% of net sales in fiscal year 2002. There can be no assurance that the Company’s principal customers will continue to purchase products from the Company at current levels. Moreover, the Company +typically does not enter into long-term volume purchase contracts with its customers, and the Company’s customers have certain rights to extend or delay the shipment of their orders. The loss of one or more of the Company’s major +customers, or the reduction, delay or cancellation of orders from such customers, could materially and adversely affect the Company’s business, operating results and financial condition. +Dependence on Key Personnel: The Company’s future success depends in large part on the continued +service of its key technical, marketing and management personnel and on its ability to continue to attract and retain qualified employees. The competition for such personnel is intense, and there can be no assurance that the Company will be +successful in attracting and retaining such personnel. The loss of key employees could have a material adverse effect on the Company’s business, operating results and financial condition. +Technological Change and New Product Risk: The market for the Company’s products is characterized by +rapidly changing technology, evolving industry standards, frequent new product introductions and relatively short product life cycles. The introduction of products embodying new technologies or the emergence of new industry standards can render +existing products obsolete or unmarketable. The Company’s success will depend upon its ability to enhance its existing products, to develop and introduce, on a timely and cost-effective basis, new products that keep pace with technological +developments and emerging industry standards, and to address evolving and increasingly sophisticated customer requirements. Failure to do so could substantially harm the Company’s +9 +Table of Contents +competitive position. There can be no assurance that the Company will be successful in identifying, developing, manufacturing and marketing +products that respond to technological change, emerging industry standards or evolving customer requirements. +Dilution and Stock Price Volatility: As of June 29, 2002, there were outstanding options for the purchase of approximately 2,081,304 shares of common stock of the Company (Common Stock), of +which options for approximately 1,793,887 shares were vested and exercisable. Holders of the Common Stock will suffer immediate and substantial dilution to the extent outstanding options to purchase the Common Stock are exercised. The stock price of +the Company may be subject to wide fluctuations and possible rapid increases or decreases over a short time period. These fluctuations may be due to factors specific to the Company, such as variations in quarterly operating results, or changes in +analysts’ earnings estimates, or to factors relating to the computer manufacturing industry or securities markets in general, which, in recent years, have experienced significant price fluctuations. These fluctuations often have been unrelated +to the operating performance of the specific companies whose stocks are traded. +NET SALES +Net sales in fiscal year 2002 were $175.6 million compared to $165.9 million and $164.4 million in fiscal years 2001 and 2000, +respectively. This represents an approximate increase of 6% in fiscal year 2002. This increase is due primarily to sales of new EMS products offset by decreases in keyboard sales. Sales to Clorox, a newly acquired EMS customer in fiscal year 2002, +contributed significantly to the increase in EMS revenues. However, there can be no assurance that continuing orders from Clorox will exceed or even meet the current fiscal year’s level. EMS sales were 89.4% of total revenue in fiscal 2002 +compared to 76.2% and 55.5% in fiscal years 2001 and 2000, respectively. Keyboard sales were 10.4% of sales in fiscal 2002 compared to 23.3% and 42.9% of total sales in fiscal years 2001 and 2000, respectively. The decline in keyboard revenue is +mainly due to decreased sales to OEM customers. OEM keyboard margins are extremely low so the Company has not pursued that business as aggressively. Although revenues from keyboard sales continue to decline, margins on the remaining keyboard +business tend to exceed those that can be realized from EMS products. Therefore, the Company will continue to service this industry as long as it remains feasible and profitable to do so. +COST OF SALES +In fiscal year 2002, cost of +sales was 91.5% of revenues compared to 95.4% in fiscal year 2001 and 91.2% in fiscal year 2000. The decrease in 2002 was due primarily to a newly acquired EMS program that helped utilize excess capacity in one of the Company’s production +facilities. The increase in fiscal year 2001 compared to fiscal year 2000 was due primarily to lower than expected revenues. The Company provides for warranty costs based on historical experience and anticipated product returns. The amounts charged +to expense were $215,000, $220,000, and $372,000 in fiscal years 2002, 2001, and 2000, respectively. The decline in warranty expense is attributable primarily to the decline in keyboard sales. The Company’s warranty period for keyboards is +generally three times longer than that for EMS products. Also the Company does not warranty design defects for EMS customers. Cost of sales also includes shipping and handling costs of $2.4 million in fiscal year 2002 compared to $2.0 million in +fiscal year 2001, and $2.4 million in fiscal year 2000. The Company’s freight costs for inbound shipments of production materials fluctuates from year to year depending on negotiated freight rates and the necessity for expedited shipping +methods. The Company provides for obsolete and non-saleable inventories based on specific identification of inventory against current demand and recent usage. The amounts charged to expense were $2.2 million, $.4 million, and $(.4 million) in fiscal +years 2002, 2001, and 2000, respectively. The large increase in this expense for fiscal year 2002 is the result of fully reserving the remaining inventory on hand for a particular keyboard product line that is unlikely to be sold based on current +demand and usage. +RESEARCH, DEVELOPMENT AND ENGINEERING +The Company’s research, development and engineering (RD&E) expenses were $2.6 million, $2.7 million, and $2.8 million, in fiscal years 2002, 2001, and 2000, +respectively. As a percentage of sales, these expenses were 1.5%, 1.6%, and 1.7%, respectively. In fiscal years 2002, 2001, and 2000, the Company focused most of its RD&E efforts on EMS programs. The number of RD&E projects has remained +fairly constant over the course of the three years. The slight decrease in fiscal year 2002 compared to fiscal year 2001 is due primarily to decreased demand for these services in the second half of the fiscal year. The decrease between fiscal years +2001 and 2000 was due primarily to the Company reallocating resources to fee for services. +SELLING +Selling expenses were $2.8 million, $4.7 million, and $6.3 million in fiscal years 2002, 2001, and 2000, respectively. Selling expenses as +a percentage of revenues were 1.6%, 2.9%, and 3.9%, respectively. The decreases in fiscal years 2002 and 2001 were due primarily to significant declines in keyboard sales. Sales of keyboards through distribution require greater promotional and +marketing programs than sales of EMS products. In addition, the Company did not employ outside sales representatives for its keyboard products in fiscal year 2002, so commission expense was significantly decreased. +10 +Table of Contents +GENERAL AND ADMINISTRATIVE +General and administrative expenses were $8.4 million, $9.6 million and $8.7 million in fiscal years 2002, 2001, and 2000, respectively. As a percentage of sales, these +expenses were 4.8% in fiscal year 2002, 5.8% in fiscal year 2001, and 5.3% in fiscal year 2000. The decrease in fiscal year 2002 was primarily due to three factors; a significant decrease in the provision for doubtful accounts, a decrease in +required professional services charged to G&A, and decreased compensation and fringe benefits as a result of attrition and a 10% reduction in salaries for more highly compensated employees. The increase between fiscal years 2000 and 2001 was due +primarily to an increase in the Company’s provision for doubtful accounts receivable. +INTEREST EXPENSE +The Company had interest expenses of $1.3 million, $2.1 million, and $2.0 million in fiscal years 2002, 2001, and 2000, +respectively. The decrease in fiscal year 2002 was due to a decreased balance for the Company’s revolving line of credit and lower interest rates. During fiscal year 2002, the Company offered discount terms to one of its larger EMS customers, +which contributed to increased availability of cash. This cash, in turn, was used to pay down the Company’s revolving loan. +LITIGATION +The Company reported expenses of $20,214,000 associated with the litigation +judgment awarded to F&G Scrolling Mouse LLC by the United States District Court for the Western District of Washington, Case No. C99-995C. The $20.2 million includes estimated legal fees of $1.0 million. This judgment is discussed in detail in +Footnote 10, “Commitments and Contingencies”, following the financial statements. +OTHER INCOME, NET +The Company had net other income of $358,000, $879,000, and $278,000 in fiscal years 2002, 2001, and 2000, respectively. The +net other income for fiscal year 2002 is primarily the result of recognizing gains on the sale of two of the Company’s buildings. In February of 2002, the Company sold its real estate located in Cheney, Washington, recognizing a gain of $84,000 +(Note 3). In December of 2000, the Company sold its headquarters building in Spokane, Washington, under a sale lease-back transaction. The Company did not recognize the gain on the sale of the headquarters building during the time period that it had +guaranteed the rent on the second floor of the building. At the end of December 2001, the one-year of guaranteed rent payments was fulfilled, and the Company recognized a gain of $479,000 (Note 3) from the sale of this building. The difference +between these gains and the reported amount of $358,000 is due to miscellaneous non-operating charges taken by the Company. The increase in 2001 was primarily due to gains from the sale of fixed assets. +INCOME TAXES +The +Company had income tax expense of $5.4 million in fiscal year 2002 compared to $643,000 in fiscal year 2001, and $164,000 in fiscal 2000. The increase for fiscal year 2002 is due primarily to expensing the Company’s deferred tax assets in +entirety after the litigation judgment was awarded to F&G Scrolling Mouse. These assets totaled $4.5 million. Prior to the award of this judgment, Key Tronic had almost $45.9 million in tax loss carry-forwards. Financial Accounting Standard No. +109 requires that management assess the sources of future taxable income, which may be available to recognize the deductible differences that comprise deferred tax assets. A valuation allowance against deferred tax assets is required if it is more +likely than not that some or all of the deferred tax assets will not be realized. Because the litigation judgment could be considered evidence of the Company’s possible inability to utilize the balance of the deferred tax assets, the valuation +allowance was increased to the full value. The Company’s tax loss carry-forwards begin expiring in 2006. The remaining $900,000 of the Company’s income tax provision was due to income taxes on the earnings of foreign operations. The income +tax expense in fiscal years 2001 and 2000 was due to income taxes on the earnings of foreign operations. +The +Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”, (See Note 7 to the June 29, 2002 Consolidated Financial Statements). +INTERNATIONAL (MEXICO, EUROPE, ASIA) +One of the +Company’s Mexican subsidiaries, Key Tronic Juarez SA de CV, owns an assembly and molding facility in Juarez, Mexico. This subsidiary is primarily used to support the Company’s U.S. operations. The Company’s Mexican subsidiary, Key +Tronic Reynosa +11 +Table of Contents +SA de CV, leases manufacturing facilities in Reynosa, Mexico. This subsidiary is used exclusively to manufacture products for one EMS customer. +Key Tronic Europe, Ltd. (KTEL), the Company’s operation in Dundalk, Ireland, is primarily used to solicit +sales and support customers within Europe. The keyboards previously manufactured in Dundalk, Ireland to support the European market are now assembled at the Shanghai, China facility. +Key Tronic Computer Peripheral Co., Ltd., located in Shanghai, China, began operations in 1999. Its primary function is manufacturing electronic keyboards for export; +however, it is also capable of providing EMS services for local customers. +Foreign sales from worldwide +operations, including domestic exports, were $32.3 million in fiscal 2002 compared to $88.9 million and $65.3 million in fiscal years 2001 and 2000, respectively. Foreign sales were 18.4% of net sales in fiscal 2002 compared to 53.6% and 39.7% in +fiscal years 2001 and 2000, respectively. Sales from Key Tronic Europe, Ltd. represented approximately 3.0% of consolidated sales to external customers in fiscal year 2002 compared to 5.8% in fiscal 2001 and 7.1% in fiscal 2000, respectively. The +decrease in foreign sales for fiscal year 2002 is primarily the result of declining sales to the foreign subsidiaries of one EMS customer and the continuing decline of keyboard sales from the Company’s subsidiary in Ireland. Although the +Company hopes to expand its EMS business to include the European market, sales within Europe currently are primarily for electronic keyboards. Sales from Key Tronic Computer Peripheral Co., Ltd. to local customers represented only $88,000 in fiscal +year 2002. In fiscal years 2001 and 2000, sales to local customers were $1.5 million and $1.1 million, respectively. The decrease in sales to local Chinese customers is also the result of lower purchases from the same EMS customer as previously +discussed. +CAPITAL RESOURCES AND LIQUIDITY +The Company generated cash flows from operating activities of $.9 million, $7.5 million, and $3.3 million in fiscal years 2002, 2001, and 2000, respectively. The +significant decrease in fiscal year 2002 was due primarily to the reduction of accounts payable. The significant increase in fiscal year 2001 was due primarily to proceeds from the sale of real estate, property, and equipment. Capital expenditures +were $1.1 million, $.7 million, and $1.4 million in fiscal years 2002, 2001, and 2000, respectively. The Company’s cash position decreased by $.7 million from fiscal year 2001 to fiscal year 2002. Cash generated from operating and financing +activities allowed the net payment of $1.6 million in long-term debt and the purchase of $1.1 million in property and equipment in fiscal 2002. The Company had working capital of $22.5 million at June 29, 2002 and $22.9 million at June 30, 2001. +This level of consistency was due primarily to lower levels of accounts receivable and inventory from fiscal year 2001 to 2002 offset by reduced accounts payable from fiscal year 2001 to 2002. +On August 22, 2001, the Company entered into a financing agreement with CIT Group/Business Credit, Inc. for a revolving credit facility of up to $25 million and paid +off the GECC revolving loan. The new revolving loan is secured by the assets of the Company. The financing agreement contains financial covenants that relate to maximum capital expenditures, minimum earnings before interest expense, income tax, +depreciation, and amortization, and minimum tangible net worth. The agreement is for a term of three years beginning on August 24, 2001 (the closing date of the agreement) and ending on August 23, 2004. In addition to the financial covenants, +the financing agreement restricts investments, disposition of assets, and the payment of dividends. +As a result +of the litigation judgment described in Note 10 to the financial statements, CIT notified the Company that it was in default of certain financial covenants contained in the revolving loan agreement, and that all subsequent loans or advances under +the credit facility would be at the lender’s sole discretion. Under these terms, the Company’s revolving debt would have had to be classified as short-term. On June 6, 2002, the federal district court granted a stay of execution of +judgment to the Company pending the outcome of the appeal to the Ninth Circuit, which was filed on May 16, 2002. As a result, on July 15, 2002, CIT issued an amendment to the loan agreement containing a clause that granted a waiver of the defaults. +This amendment is contingent upon the continued stay of execution of judgment and the maintenance of the remaining covenants. Therefore, the revolving debt is classified as long-term, because an outcome of the appeal is not probable prior to the end +of the Company’s next fiscal year. +The Company anticipates that capital expenditures of approximately $2.4 +million will be required during the next fiscal year. Capital expenditures are expected to be financed through cash flow from operating activities. +The Company believes that funds available under the revolving credit facility and internally generated funds can satisfy cash requirements for a period in excess of 12 months provided that the current +stay of execution remains in place for a period in excess of 12 months. +New Accounting Pronouncements +On July 1, 2001, the Company adopted Financial Accounting Standards Board (FASB) No. 141, “Business +Combinations.” This statement addresses financial accounting and reporting for business combinations and supersedes APB opinion No. 16, “Business +12 +Table of Contents +Combinations”, and FASB statement No. 38, “Accounting for Preacquisition Contingencies of Purchased Enterprises”. Under SFAS No. +141, all business combinations will be accounted for using the purchase method of accounting; use of the pooling of interest method is prohibited. The impact of adoption was not material to the Company’s financial statements. +In July 2001, the Financial Accounting Standards Board (FASB) issued No. 142, “Goodwill and Other Intangible Assets.” +SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Under the statement, the Company will address intangible assets that are acquired individually or with a group of other assets upon their +acquisition and initially recorded in the financial statements. The Company adopted SFAS No. 142 on June 30, 2002. The adoption of SFAS No. 142 is not expected to have a material impact on the Company’s financial statements. +In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143, “Accounting for Asset Retirement +Obligations.” SFAS No. 143 addresses accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Under SFAS No. 143, the Company will report all legal +obligations associated with the retirement of long-lived assets that result from acquisition, construction, development, and the normal operation of long-lived assets. The Company adopted SFAS No. 143 on June 30, 2002. The impact of adoption is not +expected to have a material impact on the Company’s financial statements. +In August 2001, the FASB issued +SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 addresses accounts and reporting for the impairment or disposal of long-lived assets. This statement supersedes FASB No. 121 and Opinion No. 30. +SFAS No. 144 retains the fundamental provision of SFAS No. 121. It sets new criteria for asset classifications and establishes a broader scope of qualifying discounted operations. The Company adopted SFAS No. 144 on June 30, 2002. The impact of +adoption is not expected to be a material impact on the Company’s financial statements. +In April, 2002, the +Financial Accounting Standards Board issued SFAS No. 145. The purpose of this statement is to rescind previously issued SFAS Nos. 4, 44, and 64, and to amend SFAS No. 13. Statement Nos. 4 and 64 relate to reporting gains and losses from +extinguishment of debt. Statement No. 44 concerned accounting of intangible assets of motor carriers, and Statement No. 13, “Accounting for Leases” was amended to eliminate an inconsistency between the required accounting for +sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The provisions related to Statement 13 are effective for transactions occurring after +May 15, 2002, and the remaining provisions of the statement are effective for fiscal years beginning after May 15, 2002. The Company adopted this new statement after issuance in April 2002; however, there were no lease transactions during the period +between May 15, 2002 and June 29, 2002 that would be covered under the provisions of the statement. This new statement, in its entirety, will be in effect for the Company’s fiscal year beginning June 30, 2002. Adoption of this statement is not +expected to have a material impact on the Company’s financial results. +Statement of Financial Accounting +Standards No. 146, “Accounting for Costs Associated With Exit or Disposal Activities”, was issued in June 2002. This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies +Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)”. The provisions of this statement +are effective for exit or disposal activities that are initiated after December 31, 2002. The Company adopted SFAS No. 146 on June 30, 2002 for exit or disposal activities initiated after December 31, 2002. Adoption of this statement is not expected +to have a material impact on the Company’s financial results. +Item 7A: +Quantitative and Qualitative Disclosures About Market Risk +The Company is +subject to the risk of fluctuating interest rates in the normal course of business. The Company’s major market risk relates to its secured revolving credit facility. A portion of the Company’s accounts receivable and inventories are used +as collateral for its revolving debt. The interest rates applicable to the Company’s revolving loan fluctuate with the JP Morgan Chase Bank prime rate. For the first year of the financing agreement with CIT, a margin of 0.75% was applicable as +an adder to the prime rate. The agreement specifies four different levels of margin between 0.25% and 1.00% depending on the Company’s earnings before interest, taxes, depreciation, and amortization. As of June 29, 2002, the Company was paying +a rate of 5.5% on its revolving debt. +The Company does not enter into derivative transactions or leveraged swap +agreements. +Although the Company does have international operations, the functional currency for all active +subsidiaries is the U.S. dollar. The Company imports for its own use raw materials that are used in its manufacturing operations. Such purchases are predominately denominated in U.S. dollars and are paid for under normal trade terms. +The table below presents principal (or notional) amounts and related weighted average variable rates by fiscal year of +maturity. The weighted average variable interest rates for fiscal years 2003 and 2004 are estimated based on implied forward rates in the yield curve as of June 29, 2002. These forward rates have been increased by .75% based on the financing +agreement with CIT. The Company’s +13 +Table of Contents +revolving debt could increase or decrease depending upon cash needs over the period of time that the financing agreement remains in place with +CIT. The JP Morgan Chase Bank prime rate will fluctuate with the market and could go up or down depending on market conditions. The Company’s applicable margin is estimated to remain at .75% based on expected performance over the course of the +next two fiscal years. +Fiscal Years +Total +Fair Value June 29, 2002 +2003 +2004 +(In thousands) +Interest rate risk: +Secured revolving debt +$ +6,475 +$ +6,475 +$ +6,475 +Average interest rate +5.50 +% +5.50 +% +14 +Table of Contents +Item 8: +Financial Statements and Supplementary Data +INDEPENDENT AUDITORS’ REPORT +To the Shareholders and Board of Directors of Key Tronic Corporation: +We have audited the accompanying consolidated balance sheets of Key Tronic Corporation and subsidiaries (the Company) as of +June 29, 2002 and June 30, 2001, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the years ended June 29, 2002, June 30, 2001, and July 1, 2000. These financial statements are the responsibility +of the Company’s management. Our responsibility is to express an opinion on these financial statements 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, such consolidated financial statements present fairly, in all material respects, the financial position of Key Tronic Corporation and subsidiaries at June +29, 2002 and June 30, 2001, and the results of their operations and their cash flows for the years ended June 29, 2002, June 30, 2001, and July 1, 2000, in conformity with accounting principles generally accepted in the United States of America. +/s/ D ELOITTE & T OUCHE LLP +Deloitte & Touche LLP +Seattle, Washington +August 16, 2002 +15 +Table of Contents +CONSOLIDATED BALANCE SHEETS +June 29, 2002 +June 30, 2001 +(In thousands) +ASSETS +Current assets: +Cash and cash equivalents +$ +1,485 +$ +2,137 +Trade receivables, less allowance for doubtful accounts of $444 and $633 +20,978 +21,674 +Inventories +18,395 +20,601 +Real estate held for sale +— +1,697 +Deferred income tax asset, net +— +771 +Other +2,588 +5,670 +Total current assets +43,446 +52,550 +Property, plant and equipment +85,286 +99,228 +Less accumulated depreciation +73,054 +82,559 +Total property, plant and equipment +12,232 +16,669 +Other assets: +Deferred income tax asset, net +— +3,746 +Other (net of accumulated amortization of $240 and $870) +996 +513 +Goodwill (net of accumulated amortization of $1,035 and $907) +765 +893 +$ +57,439 +$ +74,371 +LIABILITIES AND SHAREHOLDERS’ EQUITY +Current liabilities: +Current portion of long-term obligations +$ +228 +$ +150 +Accounts payable +14,409 +21,385 +Deferred sales proceeds +— +2,894 +Accrued compensation and vacation +2,803 +2,615 +Other +3,465 +2,620 +Total current liabilities +20,905 +29,664 +Long-term liabilities: +Litigation judgment +19,186 +— +Revolver +6,475 +8,110 +Other long-term obligations +1,162 +1,279 +Total long-term liabilities +26,823 +9,389 +Commitments and contingencies (Notes 5, 6, and 10) +Shareholders’ equity +Common stock, no par value, authorized 25,000 shares; issued and outstanding 9,673 and 9,673 shares, +respectively +38,393 +38,393 +Retained earnings/(deficit) +(28,682 +) +(3,320 +) +Accumulated other comprehensive income +— +245 +Total shareholders’ equity +9,711 +35,318 +$ +57,439 +$ +74,371 +16 +Table of Contents +CONSOLIDATED STATEMENTS OF OPERATIONS +Years Ended +June 29, 2002 +June 30, 2001 +July 1, 2000 +(In thousands, except per share amounts) +Net sales +$ +175,591 +$ +165,865 +$ +164,353 +Cost of sales +160,606 +158,309 +149,895 +Gross profit on sales +14,985 +7,556 +14,458 +Operating expenses: +Research, development and engineering +2,554 +2,717 +2,846 +Selling +2,793 +4,724 +6,333 +General and administrative +8,414 +9,599 +8,739 +Operating income (loss) +1,224 +(9,484 +) +(3,460 +) +Interest expense +1,314 +2,125 +1,987 +Litigation judgment expense +20,214 +— +— +Other income, net +(358 +) +(879 +) +(278 +) +Loss before income taxes +(19,946 +) +(10,730 +) +(5,169 +) +Income tax provision +5,416 +643 +164 +Net loss +$ +(25,362 +) +$ +(11,373 +) +$ +(5,333 +) +Loss per share: +Loss per common share—basic and diluted +$ +(2.62 +) +$ +(1.18 +) +$ +(0.55 +) +Weighted average shares outstanding +9,673 +9,668 +9,637 +See notes to consolidated financial statements. +CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME +Common Stock +Retained +Earnings/(Deficit) +Accumulated Other Comprehensive +Income +Total +Shares +Amount +(In thousands) +Balances, July 3, 1999 +9,631 +$ +38,273 +$ +13,386 +$ +245 +$ +51,904 +Comprehensive income: +Net loss—2000 +$ +(5,333 +) +$ +(5,333 +) +Exercise of stock options +10 +$ +31 +$ +31 +Balances, July 1, 2000 +9,641 +$ +38,304 +$ +8,053 +$ +245 +$ +46,602 +Comprehensive income: +Net loss—2001 +$ +(11,373 +) +$ +(11,373 +) +Exercise of stock options +32 +$ +89 +$ +89 +Balances, June 30, 2001 +9,673 +$ +38,393 +$ +(3,320 +) +$ +245 +$ +35,318 +Comprehensive income: +Net loss—2002 +$ +(25,362 +) +$ +(25,362 +) +Other comprehensive income: +Foreign currency translation +$ +(245 +) +$ +(245 +) +Total comprehensive income +$ +(25,607 +) +Balances, June 29, 2002 +9,673 +$ +38,393 +$ +(28,682 +) +$ +— +$ +9,711 +See notes to consolidated financial statements. +17 +Table of Contents +CONSOLIDATED STATEMENTS OF CASH FLOWS +Years Ended +June 29, 2002 +June 30, 2001 +July 1, 2000 +(In thousands) +Increase (decrease) in cash and cash equivalents: +Cash flows from operating activities: +Net loss +$ +(25,362 +) +$ +(11,373 +) +$ +(5,333 +) +Adjustments to reconcile net income (loss) to cash provided (used) by operating activities: +Depreciation and amortization +4,397 +5,886 +6,330 +Provision for obsolete inventory +2,225 +435 +(359 +) +Provision for doubtful receivables +175 +714 +562 +Provision for warranty +215 +220 +372 +Litigation judgment +19,479 +— +— +Gain on sale of assets +(559 +) +(743 +) +(43 +) +Deferred income tax provision +12,866 +4,632 +2,142 +Foreign currency translation +(245 +) +— +— +Changes in operating assets and liabilities: +Trade receivables +521 +11,620 +(3,286 +) +Inventories +(19 +) +1,683 +2,535 +Other assets +2,376 +2,517 +(481 +) +Accounts payable +(6,976 +) +(2,931 +) +5,595 +Accrued compensation and vacation +188 +312 +(966 +) +Changes in deferred tax assets +(8,350 +) +(4,632 +) +(2,021 +) +Deferred sales proceeds +(349 +) +(435 +) +— +Other liabilities +337 +(424 +) +(1,791 +) +Cash provided by operating activities +919 +7,481 +3,256 +Cash flows from investing activities: +Purchase of property and equipment +(1,142 +) +(720 +) +(1,439 +) +Proceeds from sale-leaseback of real estate +— +4,030 +— +Proceeds from sale of property and equipment and assets held for sale +1,711 +1,226 +92 +Cash provided by investing activities +569 +4,536 +(1,347 +) +Cash flows from financing activities: +Payment of financing costs +(504 +) +(50 +) +— +Proceeds from issuance of common stock +— +89 +31 +Repayment of long-term debt +— +(3,307 +) +— +Borrowing under revolving credit agreement +177,432 +176,008 +Repayment of revolving credit agreement +(179,068 +) +(183,633 +) +(2,793 +) +Cash used by financing activities +(2,140 +) +(10,893 +) +(2,762 +) +Increase (decrease) in cash and cash equivalents +(652 +) +1,124 +(853 +) +Cash and cash equivalents, beginning of year +2,137 +1,013 +1,866 +Cash and cash equivalents, end of year +$ +1,485 +$ +2,137 +$ +1,013 +See notes to consolidated financial statements. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. SIGNIFICANT ACCOUNTING POLICIES +Business +Key Tronic Corporation and subsidiaries (the Company) is engaged in electronic manufacturing services (EMS) +for original equipment manufacturers (OEMs), and also manufactures keyboards and other input devices. +Principles of Consolidation +The consolidated financial statements include the Company and +its wholly owned subsidiaries in Ireland, Mexico, and China. Intercompany balances and transactions have been eliminated in consolidation. One of the Company’s subsidiaries, KT FSC was +18 +Table of Contents +legally dissolved on September 5, 2001. There was no material impact to the Company’s financial +statements, since this subsidiary had been inactive for several years. +Use of Estimates +The preparation of financial statements in conformity with accounting principles generally accepted in the United States of +America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues +and expenses during the reporting period. Significant estimates include the allowance for doubtful receivables, the provision for obsolete and non-saleable inventories, the valuation allowances on deferred tax assets, and the provision for warranty +costs. Actual results could differ from those estimates. +Cash Equivalents +The Company considers investments with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried +at cost, which approximates fair value. The Company considers investments with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost, which approximates fair value. As of June 29, 2002 and June 30, +2001, the Company’s cash balances included $279,827 and $299,217, respectively, in restricted cash. Such amounts are considered restricted, because the Company cannot use the funds for any purpose other than to decrease the Company’s +revolving debt. +Inventories +Inventories are stated at the lower of cost or market. Cost is determined principally using the first-in, first-out (FIFO) method. The reserve to adjust inventory to market +value for obsolete and non-saleable inventories was approximately $4,765,000 and $2,712,000 at June 29, 2002 and June 30, 2001, respectively. The Company provides for obsolete and non-saleable inventories based on specific identification of +inventory against current demand and recent usage. +Property, Plant and Equipment +Property, plant and equipment are carried at cost and depreciated using straight-line methods over the expected useful lives. Constructed +molds and dies are expensed as incurred if there is no future utility beyond one year. Capitalized molds and dies are depreciated over the expected useful lives of one to three years. +Valuation of Long-lived Assets +The Company, using its best estimates based on reasonable and supportable assumptions and projections, reviews assets for impairment whenever events or changes in circumstances have indicated that the carrying amount of its assets +might not be recoverable. Impaired assets are reported at the lower of cost or fair value. No assets were written down during the fiscal years ended June 29, 2002, June 30, 2001, and July 1, 2000, respectively. +Goodwill +Goodwill resulted from the acquisition of substantially all of the assets and liabilities of Honeywell, Inc.’s Keyboard Division on July 30, 1993. Goodwill is amortized on a straight-line basis over a period of 15 years (See New +Accounting Pronouncements on page 21 regarding future accounting of goodwill). +Accrued Warranty +An accrual is made for expected warranty costs, with the related expense recognized in cost of goods sold. +Management reviews the adequacy of this accrual quarterly based on historical analyses and anticipated product returns. Accrued warranty costs at June 29, 2002 and June 30, 2001, were $294,000 and $327,000, respectively. +Net Sales +Sales are generally recognized when products are shipped, because that is when the customer takes ownership of the goods and assumes risk of loss. Provisions for estimated sales returns are not significant. The Company provides for +doubtful accounts receivable primarily based on specific identification. +19 +Table of Contents +Cost Of Sales +Cost of sales includes related shipping and handling costs. +Research, Development and Engineering +Research, development and engineering +expenses include unreimbursed costs of electronic manufacturing services (EMS) as well as design and engineering costs associated with the production of EMS programs. Such costs are charged to expense as incurred. +Income Taxes +The Company accounts for income taxes in accordance with provisions of Statement of Financial Accounting Standards (SFAS) No. 109, “Accounting for Income Taxes.” Under the asset and liability method prescribed by +SFAS No. 109, deferred income taxes are provided for temporary differences between the financial reporting and tax bases of assets and liabilities. Deferred taxes are measured using provisions of currently enacted tax laws. Tax credits are accounted +for as a reduction of income taxes in the year the credit originates. +Per Share Data +Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of +common shares outstanding during the period. Diluted earnings per share is computed by dividing income available to common stockholders by the weighted average number of common and common equivalent shares outstanding during the period using the +treasury stock method. The computation assumes the proceeds from the exercise of stock options were used to repurchase common shares at the average market price during the period. The computation of diluted earnings per share does not assume +conversion, exercise, or contingent issuance of common stock equivalent shares that would have an antidilutive effect on earnings per share. +Foreign Currency Translation Adjustment +The functional +currency of the Company’s subsidiaries in Ireland, Mexico and China is the U.S. dollar. Realized foreign currency transaction gains and losses are included in general and administrative expenses. Assets and liabilities of the Company’s +subsidiary in Ireland had been translated to U.S. dollars at year-end exchange rates. Revenues and expenses had been translated at average exchange rates. Translation gains and losses had been included in a separate component of shareholders’ +equity. The foreign currency translation adjustment of $245,000 as of June 30, 2001, which was included in other comprehensive income, was written off in fiscal year 2002 as a result of the disposal of the majority of the assets in the subsidiary in +Ireland. +Fair Value of Financial Instruments +The carrying values reflected in the balance sheets at June 29, 2002 and June 30, 2001, reasonably approximate the fair value of cash and cash equivalents. Based on the +borrowing rates currently available to the Company for loans with similar terms and average maturities, the fair value of long-term debt is estimated to be $6.5 million and $8.1 million, respectively, as of June 29, 2002 and June 30, 2001, which +approximates the carrying values of $6,475,000 as of June 29, 2002 and $8,109,000 as of June 30, 2001. +Stock-based Compensation +The Company accounts for its stock-based awards to employees +using the intrinsic value method in accordance with Accounting Principles Board No. 25 “Accounting for Stock Issued to Employees” and SFAS No. 123 “Accounting for Stock-Based Compensation”. Under SFAS No. 123, the fair value of +stock-based awards to employees is calculated through the use of option pricing models. These models require subjective assumptions, including future stock price volatility and expected time to exercise. The Company’s calculations were made +using the Black-Scholes option pricing model with the following weighted average assumptions: expected life, 77 months in 2002, 73 months in 2001, and 73 months in 2000, respectively; stock volatility, 83.69% in 2002, 64.32% in 2001, and 64.34% in +2000, respectively; risk free interest rates, 3.89% in 2002, 6.16% in 2001, and 6.16% in 2000, respectively, and no dividends during the expected term. The Company’s calculations are based on a multiple option valuation approach with estimated +forfeitures of 3% annually. If the computed fair values of the fiscal years 2002, 2001, and 2000 awards had been amortized to expense over the vesting period of the awards, the pro forma net losses and proforma net losses per share would have been +$25,774,479 or $2.66 per share in fiscal year 2002, $11,734,050 or $1.21 per share in fiscal year 2001, and $5,747,000 or $.60 per share in fiscal year 2000. The weighted average fair values of options granted during fiscal years 2002, 2001, and +2000 were $2.07, $4.26, and $4.38 per share, respectively. +20 +Table of Contents +New Accounting Pronouncements +On July 1, 2001, the Company adopted Financial Accounting Standards Board (FASB) No. 141, “Business Combinations.” This +statement addresses financial accounting and reporting for business combinations and supersedes APB opinion No. 16, “Business Combinations”, and FASB statement No. 38, “Accounting for Preacquisition Contingencies of Purchased +Enterprises”. Under SFAS No. 141, all business combinations will be accounted for using the purchase method of accounting; use of the pooling of interest method is prohibited. The impact of adoption was not material to the Company’s +financial statements. +In July 2001, the Financial Accounting Standards Board (FASB) issued No. 142, +“Goodwill and Other Intangible Assets.” SFAS No. 142 changes the accounting for goodwill from an amortization method to an impairment-only approach. Under the statement, the Company will address intangible assets that are acquired +individually or with a group of other assets upon their acquisition and initially recorded in the financial statements. The Company adopted SFAS No. 142 on June 30, 2002. The adoption of SFAS No. 142 is not expected to have a material impact on the +Company’s financial statements. +In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS +No. 143, “Accounting for Asset Retirement Obligations.” SFAS No. 143 addresses accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Under SFAS No. +143, the Company will report all legal obligations associated with the retirement of long-lived assets that result from acquisition, construction, development, and the normal operation of long-lived assets. The Company adopted SFAS No. 143 on June +30, 2002. The impact of adoption is not expected to have a material impact on the Company’s financial statements. +In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 addresses accounts and reporting for the impairment or disposal of long-lived assets. This +statement supersedes FASB No. 121 and Opinion No. 30. SFAS No. 144 retains the fundamental provision of SFAS No. 121. It sets new criteria for asset classifications and establishes a broader scope of qualifying discounted operations. The Company +adopted SFAS No. 144 on June 30, 2002. The impact of adoption is not expected to be a material impact on the Company’s financial statements. +In April, 2002, the Financial Accounting Standards Board issued SFAS No. 145. The purpose of this statement is to rescind previously issued SFAS Nos. 4, 44, and 64, and to amend SFAS No. 13. Statement +Nos. 4 and 64 relate to reporting gains and losses from extinguishment of debt. Statement No. 44 concerned accounting of intangible assets of motor carriers, and Statement No. 13, “Accounting for Leases” was amended to eliminate an +inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The provisions related to Statement +13 are effective for transactions occurring after May 15, 2002, and the remaining provisions of the statement are effective for fiscal years beginning after May 15, 2002. The Company adopted this new statement after issuance in April 2002; however, +there were no lease transactions during the period between May 15, 2002 and June 29, 2002 that would be covered under the provisions of the statement. This new statement, in its entirety, will be in effect for the Company’s fiscal year +beginning June 30, 2002. Adoption of this statement is not expected to have a material impact on the Company’s financial results. +Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated With Exit or Disposal Activities”, was issued in June 2002. This statement addresses financial accounting and reporting for +costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs +Incurred in a Restructuring)”. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002. The Company adopted SFAS No. 146 on June 30, 2002 for exit or disposal activities +initiated after December 31, 2002. Adoption of this statement is not expected to have a material impact on the Company’s financial results. +Reclassifications +Certain reclassifications of prior year +balances have been made for consistent presentation with the current year. +Fiscal Year +The Company operates on a 52/53 week fiscal year. Fiscal years end on the Saturday nearest June 30. As such, fiscal years 2002, +2001, and 2000 ended on June 29, 2002, June 30, 2001, and July 1, 2000, respectively. Fiscal year 2003 will end on June 28, 2003. +21 +Table of Contents +2. INVENTORIES +Components of inventories were as follows: +June 29, 2002 +June 30, 2001 +(in thousands) +Finished goods +$ +8,323 +$ +8,589 +Work-in-process +2,002 +2,088 +Raw materials +12,835 +12,636 +Reserve for obsolescence +(4,765 +) +(2,712 +) +$ +18,395 +$ +20,601 +3. PROPERTY, PLANT AND EQUIPMENT +Life +June 29, 2002 +June 30, 2001 +(in years) +(in thousands) +Land +— +$ +1,730 +$ +2,052 +Buildings and improvements +3 to 30 +11,021 +16,693 +Equipment +1 to 10 +66,363 +67,142 +Furniture and fixtures +3 to 5 +6,172 +13,341 +$ +85,286 +$ +99,228 +In December of 2000, the Company sold its headquarters building, +located in Spokane, Washington, associated land (Parcel 1), and adjacent property (Parcel 2). In conjunction with the sale, the Company entered into a ten year lease agreement for a portion of the building, located on Parcel 1, and guaranteed one +year of rent on the vacant portion. The company allocated the proceeds from the sale between the building, Parcel 1, and Parcel 2, in the amount of $3.2 million, $801,000, and $1.1 million, respectively. The associated net book value of the assets +sold were $1.8 million, $322,000, and $434,000 respectively. The Company immediately recognized the gain on the sale of Parcel 2, in the amount of $648,000, and deferred the proceeds associated with Parcel 1 and the building for one and ten years, +respectively. On December 27, 2001, upon culmination of the Company’s guaranteed rent obligation, the Company recognized the proceeds allocated to the building, net of the guaranteed rent payments of $745,500, and recognized a gain in the +amount of $479,000 on Parcel 1, which was included within other income. The remaining gain, allocated to the building was deferred under other long-term obligations and will be amortized to other income over the remaining lease term. +In February of 2002, the Company sold its Cheney, Washington, facility, which had previously been recorded as real estate held +for sale, for $1.7 million, resulting in a gain of $84,000, recorded within other income +4. RELATED PARTY +TRANSACTIONS +The Company has life insurance policies on the life of its founder with net death benefits +totaling approximately $3,000,000. Of these, policies with death benefits totaling $750,000 have been designated to fund obligations of the Company to the founder’s spouse in the event of his death and, accordingly, such obligations are not +recorded in the financial statements. Net cash values of such policies are recorded in the amount of $91,000 and $40,000 in fiscal 2002 and fiscal 2001, respectively, and are included in other noncurrent assets. +5. LONG-TERM OBLIGATIONS +On August 22, 2001, the Company obtained a new revolving credit facility with CIT Group/Business Credit, Inc. for up to $25 million and paid off the GECC revolving loan. The new +revolving loan is secured by the assets of the Company. For the first year of the financing agreement with CIT, a margin of 0.75% will be applicable as an adder to the prime rate. The full rate of interest as of June 29, 2002 was 5.5%. The agreement +specifies four different levels of margin between 0.25% and 1.00% depending on the Company’s earnings before interest, taxes, depreciation, and amortization. On August 23, 2001, just prior to closing the financing agreement with CIT, the +Company was paying 9.0% interest, which included a 2.5% premium above the prime rate as of that date. The CIT agreement contains financial covenants that relate to maximum capital expenditures, minimum earnings before interest expense, income tax, +depreciation, and amortization, and minimum tangible net worth. The agreement is for a term of three years beginning on August 24, 2001 (the closing date of the agreement) and ending on August 23, 2004. In addition to the financial covenants, the +credit agreement restricts investments, disposition of assets, and the payment of dividends. As of June 29, 2002, the Company was not in compliance with its debt covenants and had been notified by CIT of the default. However, on July 15, 2002, CIT +and the Company signed an amendment to the revolving credit agreement that is contingent upon the continuance of the stay of execution of judgment granted to the Company by the court on June 6, 2002 (Note 10). Because the amendment resulted in a +waiver of the Company’s default, and a resolution of the appeal is not probable prior to the end of the Company’s next fiscal year, the revolving debt was classified as long-term. +22 +Table of Contents +6. LEASES +The Company has operating leases for certain equipment and production facilities, which expire over periods from one to five years. Future minimum payments under +non-cancelable operating leases with initial or remaining terms of one year or more at June 29, 2002, are summarized as follows: +Fiscal Years Ending +(in thousands) +2003 +4,362 +2004 +2,878 +2005 +1,544 +2006 +898 +2007 +518 +Future +1,543 +Total minimum lease payments +11,743 +Rental expenses under operating leases were $4,548,000, $4,358,000, +and $2,908,000 in 2002, 2001, and 2000, respectively. +7. INCOME TAXES +Income taxes consist of the following: +2002 +2001 +2000 +Current income taxes: +Federal +$ +— +$ +— +$ +— +Foreign +900 +643 +43 +State +— +— +— +900 +643 +43 +Deferred income taxes: +Federal +(7,627 +) +(4,598 +) +(2,085 +) +Foreign +— +— +— +State +(723 +) +(34 +) +64 +(8,350 +) +(4,632 +) +(2,021 +) +Change in valuation allowance +12,866 +4,632 +2,142 +Total income taxes +$ +5,416 +$ +643 +$ +164 +The Company’s effective tax rate differs from the federal tax +rate as follows: +Year Ended +June 29, 2002 +June 30, 2001 +July 1, 2000 +(in thousands) +Federal income tax benefit at statutory rates +$ +(6,782 +) +$ +(3,648 +) +$ +(1,757 +) +Effect of foreign income (loss) at statutory rates +(93 +) +(350 +) +160 +State taxes (net of Federal effect) +(723 +) +— +— +Permanent differences: +Life insurance premiums +50 +43 +37 +Other +(802 +) +(677 +) +(461 +) +Foreign tax provision at foreign statutory rate +900 +643 +43 +Change in valuation allowance +12,866 +4,632 +2,142 +Income tax provision +$ +5,416 +$ +643 +$ +164 +23 +Table of Contents +In fiscal years 2002 and 2001 foreign income decreased the Company’s +effective income tax rate, because such income is taxed at a lower rate than U.S. income. In fiscal year 2000, foreign losses increased the Company’s effective income tax rate, because such losses are not deductible for U.S. tax purposes. The +domestic and foreign components of income (loss) before income taxes were: +Year Ended +June 29, 2002 +June 30, 2001 +July 1, 2000 +(in thousands) +Domestic +$ +(20,219 +) +$ +(11,758 +) +$ +(4,698 +) +Foreign +273 +1,029 +(471 +) +Loss before income taxes +$ +(19,946 +) +$ +(10,729 +) +$ +(5,169 +) +Deferred income taxes result from temporary differences in the +timing of recognition of revenue and expenses. Deferred income tax assets and liabilities consist of the following at: +June 29, 2002 +June 30, 2001 +(in thousands) +Allowance for doubtful accounts +$ +122 +$ +184 +Inventory +2,537 +1,053 +Vacation accrual +360 +330 +Self insurance accrual +58 +60 +Warranty accrual +100 +111 +State deferred asset +943 +220 +Litigation judgment (current portion) +99 +— +Other +— +120 +Current deferred income tax assets +4,219 +2,078 +Current portion of valuation allowance +(4,219 +) +(1,308 +) +Current deferred income tax assets, net of valuation allowance +— +770 +Deferred compensation +$ +237 +$ +248 +Depreciation and amortization +1,718 +712 +Litigation judgment (non-current portion) +6,523 +— +Net operating loss carryforwards +15,260 +16,588 +Tax credit carryforwards +680 +680 +Charitable contribution carryforwards +19 +— +Noncurrent deferred income tax assets +24,437 +18,228 +Valuation allowance, net of current portion +(24,437 +) +(14,482 +) +Noncurrent deferred income tax assets, net of valuation allowance +$ +— +$ +3,746 +Total deferred income tax assets +$ +— +$ +4,516 +Financial Accounting Standard No. 109 requires that management +assess the sources of future taxable income, which may be available to recognize the deductible differences that comprise deferred tax assets. A valuation allowance against deferred tax assets is required if it is more likely than not that some or +all of the deferred tax assets will not be realized. Because the litigation judgment (See Note 10) could negatively impact the Company’s future earnings, the valuation allowance was increased to the full value of the deferred tax assets. +At June 29, 2002, the Company had tax loss carryforwards of approximately $44.9 million, +which expire in varying amounts in the years 2006 through 2022. Additionally, for federal income tax purposes, the Company has approximately $735,000 of general business credit carryforwards, which expire in varying amounts in the years 2004 through +2010. Approximately $257,000 of the general business credit carryforwards have an indefinite carryforward period. Foreign income tax expense is calculated at the statutory rate of the foreign taxing jurisdiction. +8. EARNINGS PER SHARE +Basic EPS is computed by dividing income available to common shareholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is +computed by dividing income available to common shareholders by the weighted-average number of common shares and common share equivalents outstanding during the period. Key Tronic uses the treasury stock method in calculating the dilutive effect of +common stock equivalents. +24 +Table of Contents +There are no adjustments to the income available to common shareholders or the +weighted average shares outstanding for the years ended June 29, 2002, June 30, 2001, and July 1, 2000. The adjustment for potential common shares of 508, 103,688 and 276,280 as of June 29, 2002, June 30, 2001 and July 1, 2000 was not included in +the calculation of weighted average shares outstanding for such dates as the effects were considered to be antidilutive. The number of outstanding options with an exercise price greater than average market price for fiscal years ended June 29, 2002, +June 30, 2001, and July 1, 2000 were 2,081,304, 1,966,200, and 1,425,760, respectively. +9. SHAREHOLDERS’ +EQUITY +The Company has executive stock option plans for certain key employees. Options under these plans vest +over one to five years and become exercisable as they vest. Options under the plans become exercisable in full immediately prior to the occurrence of a “Change in Control” as defined in the plan documents. As of June 29, 2002, 2,795,000 +shares have been reserved for issuance and 1,881,304 options were outstanding of which 1,659,304 shares were exercisable. These options expire in ten years from the date of grant. Compensation expense for options will be recorded if the exercise +price of the option is less than the closing market price of the stock on the date of grant. There was no compensation expense incurred in conjunction with options in fiscal years 2002, 2001, or 2000, respectively, as all options were granted at +fair market value. +The Company also has a stock option plan for “Nonemployee Directors.” Options under +this plan vest over a three-year period and are exercisable as they vest. As of June 29, 2002, 300,000 shares have been reserved for issuance and 200,000 options were outstanding of which 134,583 shares were exercisable. These options expire ten +years from the date of grant. +Following is a summary of plan activity: +Number +Weighted Average +Price Range +Of Options +Exercise Price +Outstanding, July 3, 1999 +$2.75 to $16.25 +1,691,016 +$5.79 +Granted during 2000 +$2.81 to $ 6.50 +583,500 +$3.70 +Expired or canceled +$2.75 to $16.25 +(217,876 +) +$8.00 +Options exercised +$2.75 to $ 3.88 +(10,500 +) +$3.02 +Outstanding, July 1, 2000 +$2.75 to $16.25 +2,046,140 +$4.98 +Granted during 2001 +$1.54 to $ 5.03 +63,500 +$4.26 +Expired or canceled +$2.75 to $16.25 +(112,190 +) +$4.98 +Options exercised +$2.75 to $ 3.31 +(31,250 +) +$2.86 +Outstanding, June 30, 2001 +$1.54 to $16.25 +1,966,200 +$4.99 +Granted during 2002 +$2.00 to $ 2.11 +130,000 +$2.07 +Expired or canceled +$2.75 to $ 7.25 +(14,896 +) +$4.12 +Outstanding, June 29, 2002 +$1.54 to $16.25 +2,081,304 +$4.81 +Additional information regarding options outstanding as of June 29, +2002, is as follows: +Options Outstanding +Options Exercisable +Weighted Avg. +Remaining +Weighted +Weighted +Range of +Number +Contractual +Avg. Exercise +Number +Avg. Exercise +Exercise Prices +Outstanding +Life (yrs.) +Price +Exercisable +Price +$1.54—$ 2.31 +135,000 +9.8 +$ 2.05 +1,667 +$ 1.54 +$2.32—$ 3.48 +829,500 +7.7 +$ 2.79 +702,333 +$ 2.78 +$3.49—$15.24 +462,000 +5.4 +$ 4.74 +435,083 +$ 4.75 +$5.25—$ 7.87 +391,633 +6.0 +$ 5.98 +391,633 +$ 5.98 +$7.88—$16.25 +263,171 +3.7 +$10.99 +263,171 +$10.99 +$1.54—$16.25 +2,081,304 +6.3 +$ 4.81 +1,793,887 +$ 5.16 +The Company’s Variable Investment +Plan is available to employees who have attained age 21. The plan has an Employer’s Discretionary Contribution Trust, invested in the Company’s stock, and an Employee Contribution Trust consisting of several investment alternatives. The +Company contributes an amount equal to 100% of the employee’s contribution on the first 2% of the employee’s compensation and an additional 50% of the employee’s contribution on the following 2% of the employee’s compensation. On +April 1, 2001, the Company began matching 25% on the next 2% of contributions. Company contributions to the Trust were +25 +Table of Contents +$362,458, $334,863 and $321,724 in fiscal years 2002, 2001 and 2000, respectively. The Company has an +Employee Stock Ownership Plan. No contributions were made to the plan in fiscal years 2002, 2001 or 2000. +10. COMMITMENTS AND CONTINGENCIES +Litigation +On December 20, 2001, a jury in Seattle federal court rendered a verdict in the case of F&G Scrolling Mouse, LLC, +Fernando Falcon and Federico Gilligan v. Microsoft Corporation, Honeywell, Inc., and Key Tronic Corporation, United States District Court for the Western District of Washington, Case No. C99-995C finding that Key Tronic misappropriated trade +secrets and breached a confidentiality agreement with Plaintiffs Fernando Falcon, Federico Gilligan and their company, F&G Scrolling Mouse LLC. Plaintiffs alleged that Key Tronic misappropriated plaintiffs’ trade secrets and breached a +confidentiality agreement by disclosing to Microsoft, in violation of that agreement, information provided by Plaintiffs to Key Tronic pursuant to the confidentiality agreement. Plaintiffs alleged that they were damaged as a result of +Microsoft’s subsequent use of Plaintiffs’ trade secrets in the development of Microsoft’s IntelliMouse product. Honeywell was dismissed without prejudice from this action on December 2, 1999, and Plaintiffs settled with Microsoft and +dismissed that defendant with prejudice on March 30, 2000. +Although the jury found that the misappropriation was +not willful, it awarded damages in the amount of $16.5 million. The judgment was subsequently increased to approximately $19.2 million through an award of pre-judgment interest. The trial court denied Key Tronic’s motion for judgment as a +matter of law and motion for new trial. Key Tronic filed notice of appeal to the U.S. Court of Appeals for the Ninth Circuit on May 16, 2002. On June 6, 2002, the federal district court granted a stay of execution of judgment pending the outcome of +the appeal to the Ninth Circuit. Under the terms of the stay of execution of judgment, the court approved a supersedeas bond on the terms requested by Key Tronic in the amount of $1.75 million, with quarterly additions of 50% of the company’s +operating income, as security for the $19.2 million judgment. The supersedeas bond is secured by the Company’s line of credit. The Company recorded $19.5 million including anticipated legal costs of which $.3 million is short-term. Key Tronic +intends to vigorously pursue its appeal in this matter. An unfavorable outcome in this matter could likely impair the Company’s ability to continue as a going concern and have a material adverse impact on the Company’s cash flows. +Capital Expenditures +The amount of firm commitments to contractors and suppliers for capital expenditures was approximately $453,000 at June 29, 2002. +11. DEFERRED COMPENSATION +The Company accounts for its post-retirement benefits in accordance with the provisions SFAS No. 106 “Employers’ Accounting for Post-retirement Benefits Other than Pensions”. Under SFAS +No. 106, the Company has recorded a liability for certain compensation related agreements for two former employees. The liability, estimated to be $.7 million and included in long-term liabilities, was based upon the present value of future cash +payments as specified in the agreements. This cost of $175,000 in 2002, $296,000 in 2001, and $175,000 in 2000 was charged against general and administrative expenses. Principal maturities of long-term obligations at June 29, 2002 are: +Fiscal Years Ending +(in thousands) +2003 +$ +228 +2004 +228 +2005 +228 +2006 +228 +2007 +205 +Future Years +273 +Total +$ +1,390 +12. ENTERPRISE-WIDE DISCLOSURES +Management organizes its business around EMS and keyboards based on geographic area. These businesses have been aggregated as each segment +has similar economic characteristics, and the nature of the segments, its production processes, customers and distribution methods are similar. +Of the revenues for the years ended June 29, 2002, June 30, 2001 and July 1, 2000, EMS sales were $157.0 million, $126.3 million, and $91.2 million, respectively. Keyboard sales for the years ended +June 29, 2002, June 30, 2001 and July 1, 2000 were $18.3 million, +26 +Table of Contents +$38.6 million, and $70.5 million, respectively. The remainder of revenues for all years presented were +from sales of miscellaneous other products and services. +Information concerning geographic areas for the years +ended June 29, 2002, June 30, 2001 and July 1, 2000 is summarized in the following table. Revenues provided below are based on the shipping destination. +Domestic +International +Total +(in thousands) +2002 +Net sales +$ +143,324 +$ +32,267 +$ +175,591 +Long-lived assets +$ +11,429 +$ +803 +$ +12,232 +2001 +Net sales +$ +76,950 +$ +88,915 +$ +165,865 +Long-lived assets +$ +15,629 +$ +1,040 +$ +16,669 +2000 +Net sales +$ +99,077 +$ +65,276 +$ +164,353 +Long-lived assets +$ +20,066 +$ +1,284 +$ +21,350 +For the year ended June 29, 2002, 45.4% of the Company’s +domestic exports were sold to customers in Mexico, 44.3% were sold to customers in the Far East, 6.6% were sold to customers in Europe, and the remaining 3.7% were spread among customers in Canada and South America. +For the year ended June 30, 2001, 25.7% of the Company’s domestic exports were sold to customers in Europe, 42.8% were sold to +customers in the Far East, 29.7% were sold to customers in Mexico, and the remaining 2% were spread among customers in South America and Canada. +Significant Customers +At present, the Company’s +customer base is highly concentrated and could become even more concentrated. Three of the Company’s OEM customers accounted for 10%, 13%, and 10% of net sales during fiscal year 2002. In 2001, these same customers accounted for 39%, 27%, and +5% of net sales. A newly acquired EMS customer accounted for 39% of net sales in fiscal year 2002. There can be no assurance that the Company’s principal customers will continue to purchase products from the Company at current levels. Moreover, +the Company typically does not enter into long-term volume purchase contracts with its customers, and the Company’s customers have certain rights to extend or delay the shipment of their orders. The loss of one or more of the Company’s +major customers, or the reduction, delay or cancellation of orders from such customers, could materially and adversely affect the Company’s business, operating results and financial condition. +13. SUPPLEMENTAL CASH FLOW AND NON-CASH INFORMATION +Year Ended +June 29, 2002 +June 30, 2001 +July 1, 2000 +(in thousands) +Interest payments +$ +1,340 +$ +2,110 +$ +1,960 +Income tax payments +$ +1,208 +$ +640 +$ +395 +Non-Cash Information: +In December of 2001, the remaining current portion of the deferred sales proceeds, or $2,583,730, was recognized, and the Company removed +the value of the building from the Company’s fixed assets and recorded the associated gain (Note 3). The long-term portion of the deferred sales proceeds will be amortized over the remaining nine-year life of the lease for the first floor of +the building. +27 +Table of Contents +14. QUARTERLY FINANCIAL DATA +Year Ended June 29, 2002 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +(Unaudited) +Net sales +$ +34,627 +$ +50,516 +$ +46,515 +$ +43,933 +Gross profit +$ +2,132 +$ +4,877 +$ +4,300 +$ +3,676 +Income (loss) before income taxes +$ +(1,205 +) +$ +(16,140 +) +$ +481 +$ +(3,082 +) +Net income (loss) +$ +(982 +) +$ +(21,595 +) +$ +399 +$ +(3,184 +) +Earnings (loss) per common share basic and diluted +$ +(.10 +) +$ +(2.23 +) +$ +.04 +$ +(.33 +) +Weighted average shares outstanding +9,673 +9,673 +9,673 +9,673 +Diluted shares outstanding +N/A +N/A +9,673 +N/A +Year Ended June 30, 2001 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +Net sales +$ +51,214 +$ +52,586 +$ +32,228 +$ +29,838 +Gross profit +$ +5,304 +$ +4,486 +$ +(2,069 +) +$ +(164 +) +Income (loss) before income taxes +$ +312 +$ +181 +$ +(6,562 +) +$ +(4,661 +) +Net income (loss) +$ +206 +$ +3 +$ +(6,735 +) +$ +(4,847 +) +Earnings (loss) per common share basic and diluted +$ +.02 +$ +.00 +$ +(.70 +) +$ +(.50 +) +Weighted average shares outstanding +9,655 +9,671 +9,673 +9,673 +Diluted shares outstanding +9,948 +9,917 +N/A +N/A +Item 9: +Changes in and Disagreements With Accountants on Accounting and Financial Disclosures +None +28 +Table of Contents +PART III +Item 10: Directors and Executive Officers of the Registrant +DALE F. PILZ —Director +Mr. Pilz, age 76, has been a director of the Company +since April 1992. On March 1, 2000, Mr. Pilz was elected Chairman of the Board. Mr. Pilz was Chief Executive Officer of Flowind Corporation from 1986 to 1990. He served as President of Omninet Corporation from 1985 to 1986. Prior to that, Mr. Pilz +was Chief Executive Officer and President of GTE Sprint Communications from 1983 to 1985 and also served as Chief Executive Officer and President of GTE Spacenet Corporation from 1983 to 1985. +WENDELL J. SATRE —Director +Mr. Satre, age 84, has been a director of the Company since 1988 and served as Chairman of the Board of Directors from July 1991 through August 1995. Mr. Satre also served as a director from 1983 through 1986 and served as Acting +President of the Company from August 1991 through February 1992. Mr. Satre is the retired Chairman of the Board and Chief Executive Officer of the Washington Water Power Company, a public utility headquartered in Spokane, Washington. Mr. Satre also +serves on the Board of Directors of Output Technology Corporation and The Coeur d’Alenes Company. +YACOV +A. SHAMASH —Director +Dr. Shamash, age 52, has been a director of the Company since 1989. He has been the +Dean of Engineering and Applied Sciences at the State University of New York campus at Stony Brook since 1992. Professor Shamash developed and directed the NSF Industry/University Cooperative Research Center for the Design of Analog/Digital +Integrated Circuits from 1989 to 1992 and also served as Chairman of the Electrical and Computer Engineering Department at Washington State University from 1985 until 1992. +WILLIAM E. TERRY —Director +Mr. Terry, age 69, has been a director of the Company since August 1992. Mr. Terry retired from Hewlett-Packard in December 1993 where he served in a number of executive positions during the past 36 years. He is a member of the +Advisory Committee of the Santa Clara University Engineering School and, in 1983, was elected to the university’s Board of Regents. Mr. Terry also serves on the Board of Directors of Altera Corporation. +PATRICK SWEENEY —Director +Mr. Sweeney, age 67, has been a director of the Company since July 2000. Mr. Sweeney was President and CEO of Hadco Corporation from 1991 through 1995 and formerly served as Hadco’s Vice +President/Chief Financial Officer and Vice President of Operations. Prior to that, Mr. Sweeney was the Vice President of International Manufacturing at Wang—USA from 1981 through 1986 and also served as Managing Director of Ireland for Wang and +Plant Manager of Digital Equipment Corporation’s Galway and Clonmel divisions. Mr. Sweeney also serves on the Board of Directors of Aimware, Zaig Tech., Info. Mosaic, Photo Machining Inc., Piercom, Raidtec, and Titan Transport. He is also a +member of the Advisory Board of Manufacturers’ Services Ltd. +JACK W. OEHLKE —Director, President +and Chief Executive Officer +Mr. Oehlke, age 56, has been President and Chief Executive officer of +the Company since June 1997. From October 1995, he served as Chief Operating Officer. Previously, he served as Senior Vice President of Operations from January 1995 to October 1995 and Vice President of Manufacturing Operations of the Company from +December 1993 to January 1995. Mr. Oehlke served as Director of Operations, Director of Quality and in various management positions within manufacturing, engineering and quality functions of the Microswitch Division of Honeywell, Inc. from 1968 to +1993. +RONALD F. KLAWITTER —Executive Vice President of Administration and Chief Financial +Officer +Mr. Klawitter, age 50, has been Executive Vice President of Administration, CFO, and +Treasurer since July 1997. Previously was Vice President of Finance, Secretary and Treasurer of the Company since October 1995. He was Acting Secretary from November 1994 to October 1995 and Vice President of Finance and Treasurer from 1992 to +October 1995. From 1987 to 1992, Mr. Klawitter was Vice President, Finance at Baker Hughes Tubular Service, a subsidiary of Baker Hughes, Inc. He has a BA degree from Wittenberg University and is a Certified Public Accountant. +29 +Table of Contents +CRAIG D. GATES —Executive Vice President of Marketing, Engineering, +and Sales +Mr. Gates, age 43, has been Executive Vice President of Marketing, Engineering and Sales +since July 1997. Previously he was Vice President and General Manager of New Business Development from October 1995 to July 1997. He joined the Company as Vice President of Engineering in October of 1994. Mr. Gates has a Bachelor of Science Degree +in Mechanical Engineering and a Masters in Business Administration from the University of Illinois, Urbana. From 1982 he held various engineering and management positions within the Microswitch Division of Honeywell, Inc., in Freeport, Illinois, and +from 1991 to October 1994 he served as Director of Operations, Electronics for Microswitch. +EFREN R. +PEREZ —Vice President of S.W. Operations +Mr. Perez, age 62, has served as Vice President of S.W. +Operations since July 1997. Previously he was the Managing Director of S.W. Operations from July 1996 to July 1997 and Director of S.W. Operations from July 1995 to June 1996. Following the Company’s acquisition of the Honeywell, Inc. Keyboard +Division, Mr. Perez served as Plant Manager in Juarez from July 1993 to July 1995. He served as Plant Manager in Juarez for the Keyboard Division of Honeywell, Inc. from February 1989 to July 1993. Mr. Perez is a graduate of the University of Mexico +with a B.S. in Physics. +MICHAEL D. CHARD —Vice President of Materials +Mr. Chard, age 44, has been Vice President of Materials of the Company since July 28, 2000. From February 1999 to July 28, 2000, he held +various management positions with the Company in planning, quality assurance, and materials. From January 1997 to January 1999, he was Vice President of Product Delivery at Wang Global and its predecessor Olivetti North America. From 1983 to 1996, +he held various management positions in finance, marketing, and operations at ISC Systems, the predecessor to Olivetti North America. He holds a BA Degree in Business and Accounting from Washington State University and is a Certified Public +Accountant. +Compliance with Section 16(a) of the Exchange Act: +Incorporated by reference to Key Tronic Corporation’s 2002 Proxy Statement to Shareholders. +Item 11: +Executive Compensation +Information appearing under the caption +“Executive Compensation” in the Company’s 2002 Proxy Statement is incorporated herein by this reference. +Item 12: Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The following table sets forth the aggregate information for the Company’s equity compensation plans in effect as of June 29, 2002. +EQUITY COMPENSATION PLAN INFORMATION +Plan category +Number of securities to be issued upon exercise of outstanding options, warrants and rights (a) +Weighted-average exercise price of outstanding options, warrants and rights (b) +Number of securities remaining available for future issuance under equity compensation plans (excluding securities +reflected in column (a)) (c) +Equity compensation plans approved by security holders +1,742,804 +5.23 +128,250 +Equity compensation plans not approved by security holders(1) +338,500 +2.63 +86,500 +Total +2,081,304 +4.81 +214,750 +(1) +Consists of the Key Tronic Corporation 2000 Employee Stock Option Plan +Information under the caption “Beneficial Ownership of Securities” in the Company’s 2002 Proxy Statement is incorporated herein by this reference. +30 +Table of Contents +Item 13: Certain Relationships and Related Transactions +Information appearing under the caption “Certain Relationships and Transaction” and “Compensation Committee Interlocks and Insider Participation” in the Company’s 2002 Proxy Statement is incorporated herein +by this reference. +PART IV +Item 14: Exhibits, Financial Statement Schedule, and Reports on Form 8-K +(A) FINANCIAL STATEMENTS AND SCHEDULE +Page in +Form 10-K +FINANCIAL STATEMENTS +Independent Auditors’ Report +15 +Consolidated Balance Sheets, as of June 29, 2002, and June 30, 2001 +16 +Consolidated Statements of Operations for the years ended June 29, 2002, June 30, 2001, and July 1, +2000 +17 +Consolidated Statements of Shareholders’ Equity for the years ended June 29, 2002, June 30, 2001, and July 1, 2000 +17 +Consolidated Statements of Cash Flows for the years ended June 29, 2002, June 30, 2001, and July 1, 2000 +18 +Notes to Consolidated Financial Statements +18-28 +SCHEDULE +Independent Auditors’ Consent and Report on Financial Statement Schedule +34 +II. Consolidated Valuation and Qualifying Accounts +35 +Other schedules are omitted because of the absence of conditions +under which they are required, or because required information is given in the financial statements or notes thereto. +REPORTS ON FORM +8-K +(a) June 7, 2002—Key Tronic Announces Stay of Execution of Judgment Pending the Outcome +of Appeal +(b) May 15, 2002—Key Tronic Announces Court Rulings in Lawsuit +(c) December 20, 2001—Key Tronic Announces Verdict in Lawsuit +(C) EXHIBITS +The Company will, upon +request and upon payment of a reasonable fee not to exceed the rate at which such copies are available from the Securities and Exchange Commission, furnish copies of any of the following exhibits to its security holders. +Exhibit No. +(3 +) +(a) Articles of Incorporation +(iii +) +(b) By-Laws, as amended +(iii +) +(c) Officer Certifications +99 +(4) +Certain long-term debt is described in Note 5 to the Consolidated Financial Statements of The Company agrees to furnish to the Commission, upon request, +copies of any instruments defining rights the Company.of holders of long-term debt described in Note 5. +N/A +(10) +Material Contracts +(a) The Key Tronic Corporation Variable Investment Plan. +(iii +) +(b) Key Employee Stock Option Plan, as amended. +(ii +) +31 +Table of Contents +(c) Executive Stock Option Plan. +(iii +) +(d) Stock Bonus Plan (PAYSOP). +(iii +) +(e) Directors and Officers Liability and Company Reimbursement +Policies. +(iii +) +(f) Leases with Spokane Industrial Park, Inc. +(iii +) +(g) Amended and Restated Employment Agreement with Lewis G. +Zirkle. +(iii +) +(h) Agreement Regarding Split Dollar Life Insurance Policies, as +amended. +(iv +) +(i) Executive SAR Stock Option Plan of Key Tronic +Corporation +(v +) +(j) Key Tronic Corporation 1990 Stock Option Plan for Non-Employee +Directors +(v +) +(k) Employee Stock Ownership Plan +(vi +) +(l) Registration Rights Agreement with Hiller Key Tronic +Partners +(vii +) +(m) Officer Severance Agreements +(vii +) +(n) Purchase agreement with Honeywell, Inc. +(viii +) +(o) Officer Employment Agreement +(ix +) +(p) Executive Stock Option Plan 1995 +(x +) +(q) Key Tronic Corporation 2000 Employee Stock Option Plan +(xi +) +(r) Employment Contract (Chard) +(xii +) +(s) Secured Financing Agreement with CIT Group Business Credit, +Inc. +(xiii +) +(t) Addendums to Employment Contracts +(xiv +) +(u) First and Second Amendments to Financing Agreement +10.1 +(v) Addendums to Employment Contracts +10.2 +(13) +2002 Annual Report to Shareholders (to the extent set forth in Parts I, II, and IV (a) of this report). +(i) +Previous filing on Form S-1 is incorporated by reference, exhibit number indicated +(ii) +Incorporated by reference to report on Form 10-K for the year ended 06/30/87 +(iii) +Incorporated by reference to report on Form 10-K for the year ended 06/30/86 +(iv) +Incorporated by reference to report on Form 10-K for the year ended 06/30/85 +(v) +Incorporated by reference, Key Tronic Corporation 1990 Proxy Statement, pages C-1-D3 +(vi) +Incorporated by reference to report on Form 10-K for the year ended 06/30/91 +(vii) +Incorporated by reference to report on Form 10-K for the year ended 07/04/92 +(viii) +Incorporated by reference to report on Form 8-K filed August 12, 1993 +(ix) +Incorporated by reference, Key Tronic Corporation 1996 Proxy Statement, pages 10-11 +(x) +Incorporated by reference, Key Tronic Corporation 1995 Proxy Statement, pages 19-22 +(xi) +Incorporated by reference to report on Form 10-Q for the quarter ended January 1, 2000 +(xii) +Incorporated by reference to report on Form 10-K for the year ended July 1, 2000 +(xiii) +Incorporated by reference to report on Form 10-Q for the quarter ended September 29, 2001 +(xiv) +Incorporated by reference to Form 10-Q for the quarter ended January 1, 2000 +32 +Table of Contents +(21) Subsidiaries of Registrant +1 +KT Services, Inc. +100% owned subsidiary +Incorporated in the State of Washington +2 +KTI Limited +100% owned by Key Tronic Europe, LTD +Incorporated in Ireland +3 +Key Tronic Europe, LTD +100% owned subsidiary0 +Incorporated in the Cayman Islands +4 +Key Tronic Juarez, SA de CV +100% owned subsidiary +Incorporated in Mexico +5 +Key Tronic China LTD +100% owned subsidiary +Incorporated in the State of Washington +6 +Key Tronic Far East Pte LTD +100% owned subsidiary +Incorporated in Singapore +7 +Key Tronic Computer Peripherals (Shanghai) Co. LTD +100% owned +subsidiary +Incorporated in Republic of China +8 +Key Tronic Reynosa, S.A. de CV +100% owned subsidiary +Incorporated in Mexico +33 +Table of Contents +(23) Independent Auditors’ Consent and Report on Financial +Statement Schedule +INDEPENDENT AUDITORS’ CONSENT AND REPORT ON FINANCIAL STATEMENT SCHEDULE +We consent to the incorporation by reference in Registration Statement No. 333-70917 and 333-61202 on Form S-8 of our report +dated August 16, 2002 appearing in this Annual Report on Form 10-K of Key Tronic Corporation and subsidiaries (the Company) for the year ended June 29, 2002. +We have audited the consolidated financial statements of the Company as of June 29, 2002 and June 30, 2001 and July 1, 2000, and for each of the three years in the period ended June 29, 2002 and have +issued our report thereon dated August 16, 2002 such report is included elsewhere in this Form 10-K. Our audits also included the consolidated financial statement schedule of the Company, listed in Item 14(A). This financial statement schedule is +the responsibility of the Company’s management. +Our responsibility is to express an opinion based on our +audits. In our opinion, such 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. +/s/ D ELOITTE & T OUCHE +LLP +DELOITTE & TOUCHE LLP +Seattle, Washington +September 6, 2002 +34 +Table of Contents +PART IV +SCHEDULE II +KEY TRONIC CORPORATION AND +SUBSIDIARIES +CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS +FISCAL YEARS ENDED JUNE 29, 2002, JUNE 30, 2001, AND +JULY 1, 2000 +2002 +2001 +2000 +Allowance for Obsolete Inventory +Balance at beginning of year +$ +2,711,797 +$ +2,348,840 +$ +3,065,901 +Provision charged to income +2,225,000 +435,000 +(358,922 +) +Dispositions +(171,880 +) +(72,043 +) +(358,139 +) +Balance at end of year +$ +4,764,917 +$ +2,711,797 +$ +2,348,840 +Allowance for Doubtful Accounts +Balance at beginning of year +$ +633,000 +$ +855,334 +$ +542,430 +Provision charged to income +174,960 +714,000 +562,000 +Write-offs and reinstatements +(363,477 +) +(936,334 +) +(249,096 +) +Balance at end of year +$ +444,483 +$ +633,000 +$ +855,334 +Accrued Warranty Costs +Balance at beginning of year +$ +326,545 +$ +453,759 +$ +723,884 +Provision charged to income +215,101 +220,000 +371,861 +Costs incurred +(247,376 +(347,214 +) +(641,986 +) +Balance at end of year +$ +294,270 +$ +326,545 +$ +453,759 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by +the undersigned, thereunto duly authorized. +K EY T RONIC C ORPORATION +By: +/s/ J ACK W. O EHLKE +Jack W. Oehlke, +Director, +President, and +Chief Executive Officer +Dated: September 11, 2002 +35 +Table of Contents +Pursuant to the requirements of the Securities Exchange Act of 1934, this +report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated: +/s/ J ACK W. +O EHLKE +September 11, 2002 +Jack W. Oehlke +(Director, President and +Chief Executive Officer) +Date +/s/ R ONALD F. +K LAWITTER +September 11, 2002 +Ronald F. Klawitter +(Principal +Finnancial Officer) +Date +/s/ D ALE F. P ILZ +September 11, 2002 +Dale F. Pilz +(Director) +Date +/s/ W ENDELL J. +S ATRE +September 11, 2002 +Wendell J. Satre +(Director) +Date +/s/ Y ACOV A. +S HAMASH +September 11, 2002 +Yacov A. Shamash +(Director) +Date +/s/ P ATRICK S WEENEY +September 11, 2002 +Patrick Sweeney +(Director) +Date +/s/ W ILLIAM E. +T ERRY +September 11, 2002 +William E. Terry +(Director) +Date +CERTIFICATION +I, Jack W. Oehlke, President and Chief Executive Officer of Key Tronic Corporation, certify that: +(1) I have reviewed this annual report on form 10-K of Key Tronic Corporation; +(2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary +to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; +36 +Table of Contents +(3) Based on my knowledge, the financial statements, and other financial information included +in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report. +Dated: September 11, 2002 +/s/ J ACK W. O EHLKE +Jack W. Oehlke +President and +Chief Executive Officer +CERTIFICATION +I, Ronald F. Klawitter, Chief Financial Officer of Key Tronic Corporation, certify that: +(1) I have reviewed this annual report on form 10-K of Key Tronic Corporation; +(2) Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary +to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; +(3) Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all +material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report. +Dated: September 11, 2002 +/s/ R ONALD F. +K LAWITTER +Ronald F. Klawitter +Executive +Vice President of Administration, Chief +Financial Officer and Treasurer +37 \ No newline at end of file diff --git a/raw/filings/0000719733/2002/0001032210-02-001358/filing_metadata.csv b/raw/filings/0000719733/2002/0001032210-02-001358/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..67f5511e55f1843f319adc52a57cd64b88352f6d --- /dev/null +++ b/raw/filings/0000719733/2002/0001032210-02-001358/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000719733,KTCC,KEY TRONIC CORP,10-K,2002-09-11,2002-06-29,2002-09-11T19:59:02.000Z,0001032210-02-001358,d10k.htm,"FORM 10-K FOR FISCAL YEAR ENDED JUNE 29, 2002",808215,0,0,https://www.sec.gov/Archives/edgar/data/719733/000103221002001358/d10k.htm,https://www.sec.gov/Archives/edgar/data/719733/000103221002001358/,2002,2002,1 diff --git a/raw/filings/0000719733/2002/0001032210-02-001358/item1.txt b/raw/filings/0000719733/2002/0001032210-02-001358/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..64b1424884c0243df6eb661faf77153828a94ce8 --- /dev/null +++ b/raw/filings/0000719733/2002/0001032210-02-001358/item1.txt @@ -0,0 +1,314 @@ +Item 1. +Business +Key Tronic Corporation (dba KeyTronicEMS), a Washington corporation +organized in 1969, and its subsidiaries (hereinafter collectively called the “Company” or “Key Tronic” unless the context otherwise requires) are principally engaged in electronic manufacturing services (EMS) for original +equipment manufacturers (OEMs). The Company also manufactures keyboards for personal computers, terminals, and workstations primarily in standard layouts that can be sold directly from stock. +BACKGROUND +Historically, Key Tronic was a +manufacturer of only electronic keyboards, but about four years ago, after assessing its strengths and capabilities, the Company’s focus was shifted to electronic manufacturing services (EMS). Presently, Key Tronic is known as an independent +provider of a mix of EMS services for OEMs. The Company’s manufacturing capabilities include tool making, precision molding, prototype design, liquid plastic injection molding, printed circuit board assembly (both through-hole and surface- +mount), and full box build. +Operations are currently conducted in facilities in the United States, China, Ireland +and Mexico. This global production capability provides customers with benefits of improved supply-chain management, reduced inventory, lower transportation costs and reduced product fulfillment time. +The EMS industry is comprised of companies that provide a range of manufacturing services for OEMs. The EMS industry has experienced rapid +growth over the past several years as more and more OEMs shift to external manufacturing, and it is expected to continue in this growth pattern for several years. +CUSTOMERS AND MARKETING +OEM MARKETS +The Company provides manufacturing services for outsourced OEM products. Key Tronic is capable of providing a mix of EMS services +including product design, tool making, precision molding, prototype design, liquid plastic injection molding, printed circuit board assembly, full box build, and screened silver flexible circuit membranes. The percentage of revenues from EMS +services for the fiscal years ended June 29, 2002, June 30, 2001, and July 1, 2000 were 89.4%, 76.2%, and 55.5%, respectively. Sales of such products are generally not seasonal in nature. +Hewlett Packard accounted for approximately 10%, 39%, and 38% of the Company’s consolidated revenues in fiscal years 2002, 2001, and 2000, respectively. Lexmark +accounted for 13%, 27%, and 13% of consolidated revenues in fiscal years 2002, 2001, and 2000, respectively. During fiscal year 2002, the Company performed product design, plastic injection molding, and manufacturing for Clorox Products +Manufacturing Company, a new customer who accounted for 39% of consolidated revenue. No other customers accounted for 10% or more of consolidated revenues in the three fiscal years presented. In the fiscal years ended June 29, 2002, June 30, 2001, +and July 1, 2000, the five largest customers accounted for 76%, 81%, and 72% of total sales, respectively. +Although keyboard manufacturing is still included in the Company’s product offerings, annual sales continue to decline. During the fiscal years ended June 29, 2002, June 30, 2001, and July 1, 2000, the Company realized revenues +of approximately $18.3 million, $38.6 million, and $70.5 million, respectively, from the sale of keyboards representing approximately 10.4%, 23.3%, and 42.9% of consolidated revenues. The keyboard market has continued to trend toward standard +keyboard layouts. In order to accommodate the demand for standard products, the Company maintains a purchase-from-stock program. The most popular standard layouts are built and stocked for immediate availability. These products serve as enhancements +to or replacements for the original system-supplied +3 +Table of Contents +keyboards. Keyboard sales can increase somewhat during the last half of each calendar year in conjunction with the holiday season, but generally +sales of these products are not seasonal in nature. +The Company markets its products and services primarily +through its direct sales organization aided by strategically located field sales people and distributors. Although the Company established relationships with several independent sales organizations to assist in marketing the Company’s EMS +product lines in the U.S., commissions earned and paid during fiscal year 2002 were insignificant. +MANUFACTURING +Since inception, the Company has made substantial investments in developing and expanding its now extensive capital equipment +base to achieve selective vertical integration in its manufacturing processes. The Company designs and develops tooling for injection molding machines and manufactures the majority of plastic parts used in the products it manufactures. Additionally, +the Company has invested in equipment to produce screened silver flexible circuit membranes. +The Company’s +automated manufacturing processes enable it to work closely with its customers during design and prototype stages of production for new custom products and to jointly increase productivity and reduce response time to the marketplace. Key Tronic uses +computer-aided design techniques and unique software to assist in preparation of the tool design layout and tool fabrications, to reduce tooling costs, improve component and product quality and enhance turnaround time during product development. +Key Tronic uses a variety of manual and highly automated assembly processes in its facilities, depending upon +product complexity and degree of customization. Automated processes include component insertion, surface-mount technology, flexible robotic assembly, computerized vision system quality inspection, automated switch and keytop installation, and +automated functional testing. +The Company purchases materials and components for its products from a number of +different suppliers both domestic and international. Key Tronic develops close working relationships with its suppliers, many of whom have been supplying products to the Company for several years. +FOREIGN MARKETS +Information concerning geographic areas for the years ended June 29, 2002, June 30, 2001, and July 1, 2000 is summarized in the following table. +Domestic Exports +U.S. Operations +Mexico Operations +Ireland Operations +Far East Operations +Eliminations +Consolidated +(in thousands) +2002 +Net sales: +Unaffiliated Customers +$ +26,888 +$ +143,324 +$ +— +$ +5,291 +$ +88 +$ +— +$ +175,591 +Affiliates +3,187 +40,438 +(60 +) +19,037 +62,602 +— +Total +$ +26,888 +$ +146,511 +$ +40,438 +$ +5,231 +$ +19,125 +$ +(62,602 +) +$ +175,591 +Income (loss) before income Taxes +$ +— +$ +(22,242 +) +$ +2,023 +$ +(885 +) +$ +948 +$ +210 +$ +(19,946 +) +Total assets +$ +— +$ +38,940 +$ +14,658 +$ +3,161 +$ +9,511 +$ +(8,831 +) +$ +57,439 +2001 +Net sales: +Unaffiliated customers +$ +77,842 +$ +76,950 +$ +— +$ +9,617 +$ +1,456 +$ +— +$ +165,865 +Affiliates +— +6,355 +41,829 +12 +22,312 +(70,508 +) +— +Total +$ +77,842 +$ +83,305 +$ +41,829 +$ +9,629 +$ +23,768 +$ +(70,508 +) +$ +165,865 +Income (loss) before income Taxes +$ +— +$ +(14,714 +) +$ +2,955 +$ +(978 +) +$ +1,865 +$ +142 +$ +(10,730 +) +Total assets +$ +— +$ +68,394 +$ +20,703 +$ +5,879 +$ +8,056 +$ +(28,661 +) +$ +74,371 +4 +Table of Contents +2000 +Net sales: +Unaffiliated customers +$ +53,657 +$ +97,956 +$ +— +$ +11,616 +$ +1,124 +$ +— +$ +164,353 +Affiliates +— +10,571 +22,311 +142 +20,987 +(54,011 +) +— +Total +$ +53,657 +$ +108,527 +$ +22,311 +$ +11,758 +$ +22,111 +$ +(54,011 +) +$ +164,353 +Income (loss) before income taxes +$ +— +$ +(6,016 +) +$ +1,318 +$ +(1,786 +) +$ +1,418 +$ +(103 +) +$ +(5,169 +) +Total assets +$ +— +$ +103,271 +$ +7,714 +$ +11,401 +$ +18,854 +$ +(45,425 +) +$ +95,815 +In fiscal year 2002, $32.3 million, or 18.4% of the Company’s +revenues were from foreign sales, primarily sales in Europe, the Far East, and Mexico. Foreign sales in fiscal years 2001 and 2000 were $88.9 million and $65.3 million, respectively. Foreign sales are made primarily through the Company’s direct +sales force in the U.S. and Ireland. Key Tronic Shanghai (KTS), the Company’s facility in Shanghai, China, is used to support customer requirements within the local area as well as for export. +For additional financial information about foreign operations, see Note 12 to the Consolidated Financial Statements. +BACKLOG +At August 3, 2002, the Company had an order backlog of approximately $24.6 million. This compares with a backlog of approximately $81.5 million at August 11, 2001. The decrease in backlog is primarily attributable to a different +order placement process by a major EMS customer in the current fiscal year. As of August 11, 2001, this customer had placed a blanket purchase order with the Company that covered its forecasted annual requirement of product. A few months after this +date, the customer chose instead to cancel the blanket purchase order and replace it with more accurate purchase orders on a monthly basis. Order backlog is not necessarily indicative of future sales. Order backlog consists of purchase orders +received for products expected to be shipped approximately within the next fiscal year, although shipment dates are subject to change due to design modifications or other customer requirements. +RESEARCH, DEVELOPMENT, AND ENGINEERING +The +Company’s research, development, and engineering expenses (RD&E) were $2.6 million, $2.7 million, and $2.8 million in fiscal years 2002, 2001, and 2000, respectively. Research, development and engineering expenses as a percentage of sales +were 1.5%, 1.6%, and 1.7% in fiscal years 2002, 2001, and 2000, respectively. RD&E expenses have remained relatively consistent. +COMPETITION +The Company believes that its principal competitors in the EMS market are: +Plexus Corp, SCI Systems, ACT Manufacturing, Celestica, Flextronics International, Jabil Circuits, and Solectron. The principal methods of competition are price, quality, and the range of services offered. +TRADEMARKS AND PATENTS +The Company owns several keyboard patents; however, since the Company’s focus is now electronic manufacturing services, management believes that these patents will not have a significant impact on future revenues. The Key Tronic +name and logo are federally registered trademarks, and the Company believes they are valuable assets in its business. In fiscal year 2001, Key Tronic began operating under the trade name “KeyTronicEMS” to better represent its primary +business concentration. +EMPLOYEES +As of July 25, 2002, the Company had approximately 1,953 employees compared to 2,151 on July 28, 2001. The Company’s employees in Ireland and Reynosa are represented by local unions. The Company +has never experienced any material interruption of production due to labor disputes. +The Company’s employee +benefit program includes a bonus program involving periodic payments to all employees based on quarterly before-tax income. The Company maintains a tax-qualified profit sharing plan, a 401(k) plan, which provides a matching company contribution on a +portion of the employee’s contribution, and also provides group health, life, and disability insurance plans. The Company also offers an Executive Stock Option Plan and an Employee Stock Ownership Plan to certain individuals. +5 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0000719733/2002/0001032210-02-001358/item13.txt b/raw/filings/0000719733/2002/0001032210-02-001358/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..e681b1ea154a822dc0ab74d433eea7d1cb6ea51e --- /dev/null +++ b/raw/filings/0000719733/2002/0001032210-02-001358/item13.txt @@ -0,0 +1,3 @@ +Item 13: Certain Relationships and Related Transactions +Information appearing under the caption “Certain Relationships and Transaction” and “Compensation Committee Interlocks and Insider Participation” in the Company’s 2002 Proxy Statement is incorporated herein +by this reference. \ No newline at end of file diff --git a/raw/filings/0000719733/2002/0001032210-02-001358/item9a.txt b/raw/filings/0000719733/2002/0001032210-02-001358/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000719733/2002/0001032210-02-001358/rp_note.txt b/raw/filings/0000719733/2002/0001032210-02-001358/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..2f007fbd46c3d52910e7d69a48716daa8a395658 --- /dev/null +++ b/raw/filings/0000719733/2002/0001032210-02-001358/rp_note.txt @@ -0,0 +1,5 @@ +4. RELATED PARTY +TRANSACTIONS +The Company has life insurance policies on the life of its founder with net death benefits +totaling approximately $3,000,000. Of these, policies with death benefits totaling $750,000 have been designated to fund obligations of the Company to the founder’s spouse in the event of his death and, accordingly, such obligations are not +recorded in the financial statements. Net cash values of such policies are recorded in the amount of $91,000 and $40,000 in fiscal 2002 and fiscal 2001, respectively, and are included in other noncurrent assets. \ No newline at end of file diff --git a/raw/filings/0000719733/2002/0001032210-02-001358/rpt_disclosure.txt b/raw/filings/0000719733/2002/0001032210-02-001358/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..9a00d24e3731f24a20b31657c6f7aa2f1a0ae8c0 --- /dev/null +++ b/raw/filings/0000719733/2002/0001032210-02-001358/rpt_disclosure.txt @@ -0,0 +1,14 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +See Compensation Committee Interlocks and Insider Participation in Compensation Decisions, page 9. +In October 2002, the Board of Directors approved retention bonus plans for Messrs. Oehlke, Gates and Klawitter. Under the retention bonus plan, Mr. Oehlke is eligible to +receive retention bonus payments in August of 2003, 2004 and 2005, if he is then employed by the Company or has been terminated by the Company without cause. Maximum payment amounts under Mr. Oehlke’s retention bonus plan are $211,250 for 2003, +$243,750 for 2004 and $276,250 for 2005. The maximum retention bonus payment in each year is reduced by the amount of any payments earned by Mr. Oehlke pursuant to any Company incentive plans during the fiscal year immediately preceding the +retention bonus payment date. +Under the retention bonus plan, Mr. Gates is +eligible to receive retention bonus payments in August of 2003, 2004 and 2005 if he is then employed by the Company or has been terminated by the Company without cause. Maximum payment amounts under Mr. Gates retention bonus plan are $119,000 for +2003, $142,800 for 2004 and $166,600 for 2005. The maximum retention bonus payment in each year is reduced by the amount of any payments earned by Mr. Gates pursuant to any Company incentive plans during the fiscal year immediately preceding the +retention bonus payment date. +Under the retention bonus plan, Mr. Klawitter is +eligible to receive retention bonus payments in August of 2003, 2004 and 2005 if he is then employed by the Company or has been terminated by the Company without cause. Maximum payment amounts under Mr. Klawitter’s retention bonus plan are +$119,000 for 2003, $142,800 for 2004 and $166,600 for 2005. The maximum retention bonus payment in each year is reduced by the amount of any payments earned by Mr. Klawitter pursuant to any Company incentive plans during the fiscal year immediately +preceding the retention bonus payment date. \ No newline at end of file diff --git a/raw/filings/0000719733/2006/0001193125-06-192374/filing.txt b/raw/filings/0000719733/2006/0001193125-06-192374/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..730a5d3378d879332e168eec92caa7f479c50df8 --- /dev/null +++ b/raw/filings/0000719733/2006/0001193125-06-192374/filing.txt @@ -0,0 +1,2919 @@ +10-K +1 +d10k.htm +FORM 10-K +Form 10-K +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended July 1, 2006 +OR +¨ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 0-11559 +KEY TRONIC +CORPORATION +(Exact name of registrant as specified in its charter) +Washington +91-0849125 +(State or other jurisdiction of +Incorporation or organization) +(I.R.S. Employer +Identification No.) +N. 4424 Sullivan Road, Spokane Valley, Washington +99216 +(Address of principal executive offices) +(Zip Code) +(509) 928-8000 +Registrant’s telephone number, including area code) +N/A +(Former name, former address and former fiscal year, if changed since last report) +Securities Registered Pursuant +to Section 12(b) of the Act: None +Title of each class +Name of each exchange on which registered +Common stock, no par value +The NASDAQ Stock Market LLC +Securities Registered Pursuant to Section 12(g) of the Act: None +Indicate by check mark if the +registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x +Indicate by check mark if the registrant is not +required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x +Indicate by check mark whether the registrant +(1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and +(2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ +Indicate by check mark if disclosure of delinquent filers pursuant to +Item 405 of Regulation S-K 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. x +Indicate by check mark whether the registrant is a large accelerated +filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. +Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x +State the aggregate market value of the voting and non-voting common equity held by non affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of +the last business day of the registrant’s most recently completed second fiscal quarter. As of December 31, 2005, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $21.7 million +based on the closing price as reported on the NASDAQ. +Indicate the number of shares outstanding of each of the issuer’s classes of +common stock, as of the latest practicable date: 9,883,378 shares of common stock were outstanding as of September 4, 2006. +Documents Incorporated by Reference: +The following documents are incorporated by reference to the extent specified herein: +Document Description +Part of Form 10-K +Proxy Statement dated September 22, 2006 +Part III +Table of Contents +KEY TRONIC CORPORATION +2006 FORM 10-K +TABLE OF CONTENTS +Page +Part I +Item 1. +Business +3 - 5 +Item 1A. +Risk Factors +5 - 6 +Item 1B. +Unresolved Staff Comments +7 +Item 2. +Properties +7 +Item 3. +Legal Proceedings +8 +Item 4. +Submission of Matters to a Vote of Security Holders +8 +Part II +Item 5. +Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities +9 +Item 6. +Selected Financial Data +9 - 10 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +10 - 17 +Item 7A. +Quantitative and Qualitative Disclosures about Market Risk +18 +Item 8. +Financial Statements and Supplementary Data +18 - 35 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +35 +Item 9A. +Controls and Procedures +35 +Item 9B. +Other Information +35 +Part III +Item 10. +Directors and Executive Officers of the Registrant +36 - 37 +Item 11. +Executive Compensation +37 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +37 - 38 +Item 13. +Certain Relationships and Related Transactions +38 +Item 14. +Principal Accounting Fees and Services +38 +Part IV +Item 15. +Exhibits and Financial Statement Schedules +39 - 41 +Signatures +42 - 43 +2 +Table of Contents +FORWARD-LOOKING STATEMENTS +This Annual Report contains forward-looking statements in addition to historical information. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those +reflected in the forward-looking statements. Risks and uncertainties that might cause such differences include, but are not limited to those outlined in “Management’s Discussion and Analysis of Financial Condition and Results of +Operations—Risks and Uncertainties that May Affect Future Results.” Readers are cautioned not to place undue reliance on forward-looking statements, which reflect management’s opinions only as of the date hereof. The Company +undertakes no obligation to update forward –looking statements to reflect developments or information obtained after the date hereof and disclaims any obligation to do so. Readers should carefully review the risk factors described in periodic +reports the Company files from time to time with the Securities and Exchange Commission, including Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. +PART I +Item 1. BUSINESS +Overview +Key Tronic Corporation (dba KeyTronicEMS Co.), a Washington corporation organized in 1969, and its subsidiaries (hereinafter collectively called the “Company”, “Key Tronic”, or “we” unless the context otherwise +requires) are principally engaged in electronic manufacturing services (EMS) and consumer related products manufacturing for original equipment manufacturers (OEMs). The Company also manufactures keyboards and other input devices for personal +computers, terminals, and workstations primarily in standard layouts that can be sold directly from inventory on hand. +Key Tronic is now known as an +independent provider of product realization services for OEMs in a variety of industries. Historically, Key Tronic was principally a manufacturer of electronic keyboards, but after assessing market conditions and the Company’s strengths and +capabilities, approximately seven years ago the Company shifted its focus to EMS. The EMS industry is comprised of companies that provide a range of manufacturing services for OEMs. The EMS industry has experienced rapid growth over the past several +years as more OEMs shift to outsourcing manufacturing, and this trend is expected to continue in the future. +Operations are currently conducted in +facilities in the United States, Mexico and China. The Company’s global production capability provides customers with benefits of improved supply-chain management, reduced inventory, lower labor costs, lower transportation costs and reduced +product fulfillment time. +Marketing +The Company +provides manufacturing services for outsourced OEM products. Key Tronic provides a mix of EMS services including: product design, surface mount technologies (SMT) for printed circuit board assembly, tool making, precision plastic molding, liquid +injection molding, prototype design, full product builds, and printing screened silver flexible circuit membranes. +Revenues from EMS services for the +fiscal years ended July 1, 2006, July 2, 2005, and July 3, 2004 were 96.4%, 95.0% and 91.0%, respectively. Sales of the majority of the Company’s products have historically not been seasonal in nature, but may be seasonal in +the future, if there are changes in the types of products manufactured. +Although keyboard manufacturing is still included in the Company’s product +offerings, annual keyboard sales continue to decline. During the fiscal years ended July 1, 2006, July 2, 2005, and July 3, 2004, the Company realized revenues of approximately $7.3 million, $10.1 million and $13.4 million, +respectively, from the sale of keyboards representing approximately 3.6%, 5.0% and 9.0% of consolidated revenues. The keyboard market has continued to trend toward standard keyboard layouts. In order to accommodate the demand for standard products, +the Company maintains a purchase-from-stock program. The most popular standard layouts are built and stocked for immediate availability. +The Company +markets its products and services primarily through its direct sales department aided by strategically located field sales people and distributors. Although the Company maintains relationships with several independent sales organizations to assist +in marketing the Company’s EMS product lines in the U.S., commissions earned and paid are insignificant. +3 +Table of Contents +The following customers accounted for 10% or more of consolidated revenues in the three +fiscal years presented below: +Fiscal Year +2006 +2005 +2004 +Zebra Technologies Corporation +20 +% +19 +% +12 +% +International Game Technology, Inc. +18 +% +14 +% +4 +% +Lexmark International, Inc. +17 +% +19 +% +14 +% +The Clorox Company +8 +% +8 +% +16 +% +Transaction Printer Group, Inc. +6 +% +9 +% +10 +% +For the fiscal years ended July 1, 2006, July 2, 2005, and July 3, 2004, the five largest +customers in each year accounted for 71%, 68% and 58% of total sales, respectively. +Manufacturing +Since inception, the Company has made substantial investments in developing and expanding a capital equipment base to achieve selective vertical integration and +efficiencies in its manufacturing processes. The Company has invested significant capital into surface mount technologies (SMT) for high volume manufacturing of complex printed circuit board assemblies. The Company also designs and develops tooling +for injection molding and manufactures the majority of plastic parts used in the products it manufactures. Additionally, the Company has equipment to produce printed flexible circuit membranes. +Key Tronic uses a variety of manual and highly automated assembly processes in its facilities, depending upon product complexity and degree of customization. Automated +processes include component insertion, SMT, flexible robotic assembly, computerized vision system quality inspection, automated switch and keytop installation, and automated functional testing. +The Company’s automated manufacturing processes enable it to work closely with its customers during the design and prototype stages of production and to jointly +increase productivity and reduce response time to the marketplace. Key Tronic uses computer-aided design techniques and unique software to assist in preparation of the tool design layout and tool fabrications, to reduce tooling costs, improve +component and product quality, and enhance turnaround time during product development. +The Company purchases materials and components for its products +from many different suppliers both domestic and international. Key Tronic develops close working relationships with its suppliers, many of whom have been supplying products to the Company for several years. +Backlog +On July 29, 2006, the Company had an order backlog of +approximately $65.9 million. This compares with a backlog of approximately $63.4 million on July 30, 2005. Order backlog is not necessarily indicative of future sales but can be indicative of trends in expected future sales revenue. Order +backlog consists of purchase orders received for products expected to be shipped approximately within the next twelve months, although shipment dates are subject to change due to design modifications, customer forecast changes, or other customer +requirements. +Research, Development, and Engineering +Research, development, and engineering (RD&E) expenses consist principally of employee related costs, third party development costs, program materials costs, depreciation and allocated information technology and facilities costs. The +Company’s RD&E expenses were $2.8 million, $2.9 million and $2.6 million in fiscal years 2006, 2005, and 2004, respectively. In each of these years, the Company focused most of its RD&E efforts on current customer EMS programs. The +lower cost in fiscal year 2004 compared to fiscal years 2006 and 2005 is due primarily to a 10% pay reduction during part of fiscal year 2004. +Competition +The market for the products and services the Company provides is highly competitive. There are numerous competitors in the EMS +industry, many of which have substantially more resources and are more geographically diverse. Key Tronic competes primarily on the basis of responsiveness, creativity, vertical production capability, quality, and price. +Trademarks and Patents +The Key Tronic name and logo are federally +registered trademarks, and the Company believes they are valuable assets of its business. During 2001, Key Tronic began operating under the trade name “KeyTronicEMS Co.” to better identify its primary business concentration. The Company +also owns several keyboard patents; however, since the Company’s focus is EMS, management believes that these patents will not have a significant impact on future revenues. +4 +Table of Contents +Employees +As of +July 1, 2006, the Company had 2,840 employees compared to 2,849 on July 2, 2005 and 2,847 on July 3, 2004. Since the Company can have significant fluctuations in product demand, it seeks to maintain flexibility in its workforce by +utilizing skilled temporary and short-term contract labor in its manufacturing facilities in addition to full-time employees. The Company’s employees in Reynosa, Mexico, which represent approximately 6% of the Company’s employees, are +represented by a local union. The Company has no history of any material interruption of production due to labor disputes. +The Company considers its +employees its primary strength and makes considerable efforts to maintain a well-qualified staff. The Company’s employee benefits include bonus programs involving periodic payments to all employees based on meeting quarterly or fiscal year +performance targets. The Company maintains a 401(k) plan for U.S. employees, which provides a matching company contribution of up to 4% of an employee’s salary, and also provides group health, life, and disability insurance plans. The Company +also maintains stock option plans and other long term incentive plans for certain employees and outside directors. +Foreign Markets +Information concerning net sales and long-lived assets (property, plant, and equipment) by geographic areas is set forth in footnote 9 of the consolidated financial +statements of this Annual Report on Form 10-K, under the caption “Enterprise-Wide Disclosures”, and that information is incorporated herein by reference. +Item 1A. RISK FACTORS +There are risks and uncertainties that could affect the Company’s business. These risks and +uncertainties include but are not limited to, the risk factors described below, in Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” and elsewhere in this Form 10-K. +RISKS AND UNCERTAINTIES THAT COULD AFFECT FUTURE RESULTS +The +following risks and uncertainties could affect the Company’s actual results and could cause results to differ materially from past results or those contemplated by the Company’s forward-looking statements. When used herein, the words +“expects”, “believes”, “anticipates” and similar expressions are intended to identify forward-looking statements. +Potential Fluctuations in Quarterly Results The Company’s quarterly operating results have varied in the past and may vary in the future due to a variety of factors, including changes in overall demand for customers’ +products, success of customers’ programs, timing of new programs, new product introductions or technological advances by the Company, its customers and its competitors and changes in pricing policies by the Company, its customers, its suppliers +and its competitors. For example, the Company relies on customers’ forecasts to plan its business. If those forecasts are overly optimistic, the Company’s revenues and profits may fall short of expectations. Conversely, if those forecasts +are too conservative, the Company could have an unexpected increase in revenues and profits. The products which the Company manufactures for its customers have relatively short product lifecycles, therefore the Company’s business, operating +results and financial condition are dependent in significant part on the Company’s ability to obtain orders from new customers and new product programs from existing customers. +Competition The EMS industry is intensely competitive. Competitors may offer customers lower prices on certain high volume programs. This could result in price reductions, reduced margins and loss of market +share, all of which would materially and adversely affect the Company’s business, operating results and financial condition. The Company’s inability to provide comparable or better manufacturing services at a lower cost than its +competitors could cause sales to decline. In addition, competitors can copy the Company’s non-proprietary designs after the Company has invested in development of products for customers, thereby enabling such competitors to offer lower prices +on such products due to savings in development costs. +Concentration of Major Customers At present, the Company’s customer base is highly +concentrated and could become even more concentrated. The Company’s largest EMS customer accounted for 20% of net sales in fiscal year 2006. This same customer accounted for 19% of sales in 2005 and 12% in 2004. For the fiscal years ended 2006, +2005, and 2004, the five largest customers accounted for 71%, 68% and 58% of total sales, respectively. There can be no assurance that the Company’s principal customers will continue to purchase products from the Company at current levels. +Moreover, the Company typically does not enter into long-term volume purchase contracts with its customers, and the Company’s customers have certain rights to extend or delay the shipment of their orders. The Company, however, requires that its +customers contractually agree to buy back inventory purchased +5 +Table of Contents +to build their products if purchased within specified lead times if not used. The loss of one or more of the Company’s major customers, or the +reduction, delay or cancellation of orders from such customers, could materially and adversely affect the Company’s business, operating results and financial condition. +Dependence on Suppliers The Company is dependent on many suppliers, including sole source suppliers, to provide key components and raw materials used in manufacturing customers’ products. Delays in +deliveries from suppliers or the inability to obtain sufficient quantities of components and raw materials could cause delays or reductions in shipment of products to the Company’s customers which could adversely affect the Company’s +operating results and damage customer relationships. +Dependence on Key Personnel The Company’s future success depends in large part on the +continued service of its key technical, marketing and management personnel and on its ability to continue to attract and retain qualified employees. The competition for such personnel is intense and there can be no assurance that the Company will be +successful in attracting and retaining such personnel. The loss of key employees could have a material adverse effect on the Company’s business, operating results and financial condition. +Foreign Manufacturing Operations Virtually all products manufactured by the Company are produced at the Company’s facilities located in Mexico and China. +Accordingly, the Company’s operations are subject to a variety of risks unique to international operations including import and export duties and value added taxes, import and export regulation changes, the burden and cost of compliance with +foreign laws and foreign economic and political risk. +Technological Change and New Product Risk The markets for the Company’s customers’ +products is characterized by rapidly changing technology, evolving industry standards, frequent new product introductions and relatively short product life cycles. The introduction of products embodying new technologies or the emergence of new +industry standards can render existing products obsolete or unmarketable. The Company’s success will depend upon its customers’ ability to enhance existing products and to develop and introduce, on a timely and cost-effective basis, new +products that keep pace with technological developments and emerging industry standards and address evolving and increasingly sophisticated customer requirements. Failure of the Company’s customers to do so could substantially harm the +Company’s customers’ competitive positions. There can be no assurance that the Company’s customers will be successful in identifying, developing and marketing products that respond to technological change, emerging industry standards +or evolving customer requirements. +Compliance with Current and Future Environmental Regulation The Company is subject to a variety of domestic and +foreign environmental regulations relating to the use, storage, and disposal of materials used in our manufacturing processes. If we fail or choose not to comply with any present or future regulations, we could be subject to future liabilities or +the suspension of current manufactured products. In addition, such regulations could restrict our ability to expand our operations or could require us to acquire costly equipment, substitute materials, or incur other significant expenses to comply +with government regulations. +Foreign Currency Fluctuations A significant portion of the Company’s operations and customers are in foreign +locations. As a result, transactions may occur in currencies other than the U.S. dollar. Exchange rate fluctuations among other currencies used by the Company could directly or indirectly affect our financial results. Future currency fluctuations +are dependent upon a number of factors and cannot be easily predicted. The Company began to use forward Mexican peso contracts subsequent to year end to hedge foreign currency fluctuation for weekly payroll costs. However, unexpected expenses could +occur from future fluctuations in exchange rates. +Dilution and Stock Price Volatility As of July 1, 2006, there were outstanding options for +the purchase of approximately 1,925,000 shares of common stock of the Company (Common Stock), of which options for approximately 1,911,000 shares were vested and exercisable. Holders of the Common Stock will suffer immediate and substantial dilution +to the extent outstanding options to purchase the Common Stock are exercised. The stock price of the Company may be subject to wide fluctuations and possible rapid increases or declines over a short time period. These fluctuations may be due to +factors specific to the Company such as variations in quarterly operating results or changes in analysts’ earnings estimates, or to factors relating to the EMS and computer industries or to the securities markets in general, which, in recent +years, have experienced significant price fluctuations. These fluctuations often have been unrelated to the operating performance of the specific companies whose stocks are traded. +6 +Table of Contents +Item 1B. UNRESOLVED STAFF COMMENTS +None +Item 2. PROPERTIES +The Company has manufacturing and sales operations located in the United States, Mexico and China. The +table below lists the locations and square footage of the Company’s operating facilities: +Location +Approx. +Sq. Ft. +Type of Interest +(Leased/Owned) +Description of Use +Spokane, Washington (1) +49,000 +Leased +Sales, research and administration +Spokane, Washington (2) +36,000 +Leased +Manufacturing +El Paso, Texas +80,000 +Leased +Shipping and warehouse +Total USA +165,000 +Juarez, Mexico +174,000 +Owned +Manufacturing +Juarez, Mexico +49,000 +Leased +Manufacturing and warehouse +Juarez, Mexico (3) +66,000 +Owned +Manufacturing and warehouse +Reynosa, Mexico +140,000 +Leased +Manufacturing +Reynosa, Mexico (4) +57,000 +Leased +Warehouse +Total Mexico +486,000 +Shanghai, China (5) +72,000 +Leased +Manufacturing +Total China +72,000 +Grand Total +723,000 +(1) +On December 27, 2000, the Company sold two contiguous parcels of land and its corporate +headquarters building in Spokane to Royal Hills Associates L.L.C. (RHA) for approximately $6 million in cash. In connection with the sale, the Company entered into a 10-year lease agreement with RHA for one floor of the two-story building, which the +Company continues to occupy as its headquarters (see Note 3 to Consolidated Financial Statements). +(2) +During fiscal 2006, the Company consolidated and moved some of its molding equipment in +Spokane to its facility in Juarez, Mexico and reduced the building space leased in Spokane for manufacturing to 36,000 square feet. +(3) +In fiscal 2005, the Company purchased a 66,000 square foot manufacturing facility in Juarez, +Mexico to replace a previously leased facility and to accommodate the shift of the Las Cruces, New Mexico operations into Juarez. +(4) +In fiscal 2006, the Company leased a 57,000 square foot warehouse in Reynosa, Mexico for +storage capacity. +(5) +The Company began an assembly operation in Shanghai, China in fiscal year 1999. During fiscal +year 2006, the Company increased its leased space in China to 72,000 sq. ft. to accommodate a new surface mount technology (SMT) line and additional assembly space. +The geographic diversity of these locations allows the Company to offer services near its customers and its major electronics markets, while reducing labor costs. The Company considers the productive capacity of its +current facilities sufficient to carry on the Company’s current business. +The Company shifted its flexible circuit printing operation in June 2005 to +Juarez, Mexico from its facility in Las Cruces, New Mexico. The Las Cruces facility is no longer being used for operations and is listed for sale. The Company also closed its keyboard sales office in Ireland in July 2005. +7 +Table of Contents +Item 3. LEGAL PROCEEDINGS +On December 20, 2001, a jury in Seattle federal court rendered a verdict against the +Company in the case of F&G Scrolling Mouse, LLC, Fernando Falcon and Federico Gilligan v. Microsoft Corporation, Honeywell, Inc., and Key Tronic Corporation, United States District Court for the Western District of Washington, Case No. C99-995C +(the “litigation”) and awarded damages to the Plaintiffs in the amount of $16.5 million. On October 24, 2002, the Company reached a settlement of the litigation with the Plaintiffs (hereafter called “F&G”). Under the +terms of the settlement, the Company agreed to pay F&G a total of $7.0 million. On September 1, 2005, the Company made its final payment to F&G in the amount of $812,000, thereby fulfilling the Company’s obligation of the $7.0 +million settlement. The Company may be party to certain lawsuits or claims in the ordinary course of business. We do not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on our financial position, +results of operations or cash flow. +Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS +None +8 +Table of Contents +PART II +Item 5: MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Key Tronic Corporation’s common stock is traded on the NASDAQ Global Market, formerly the NASDAQ National Market +System under the symbol “KTCC”. Quarterly high and low closing sales prices for Key Tronic common stock for fiscal years 2006 and 2005 were as follows: +2006 +2005 +High +Low +High +Low +First Quarter +$ +5.47 +$ +3.50 +$ +3.57 +$ +2.80 +Second Quarter +4.39 +3.02 +3.53 +3.05 +Third Quarter +4.35 +3.20 +3.40 +2.66 +Fourth Quarter +4.60 +3.47 +3.93 +2.23 +High and low stock prices are based on the daily closing price reported by the NASDAQ Stock Market. These +quotations represent prices between dealers without adjustment for markups, markdowns, and commissions, and may not represent actual transactions. +Holders And Dividends +As of July 1, 2006, the Company had 991 shareholders of record. The Company’s current financing agreement +contains a covenant that prohibits the declaration or payment of dividends (see Note 4 to Consolidated Financial Statements). The Company has not paid a cash dividend and does not anticipate payment of dividends in the foreseeable future. +Equity Compensation Plan Information +Information +concerning securities authorized for issuance under our equity compensation plans is set forth in Part III, Item 12 of this Annual Report, under the caption “Securities Authorized for Issuance under Equity Compensation Plans”, and +that information is incorporated herein by reference. +Item 6: SELECTED FINANCIAL DATA +The following selected consolidated financial data of the Company should be read in +conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements and related notes, and other information included in this report. +Financial Highlights +(Dollars in thousands, except per share +amounts) +Fiscal Years +2006 +2005 +2004 +2003 +2002 +Consolidated Statements of Operations Data: +Net sales +$ +187,699 +$ +202,877 +$ +148,901 +$ +130,894 +$ +175,591 +Gross profit +17,304 +16,460 +13,237 +14,958 +14,985 +Gross margin percentage +9.2 +% +8.1 +% +8.9 +% +11.4 +% +8.5 +% +Operating income +5,861 +5,445 +1,789 +2,612 +1,224 +Operating margin percentage +3.1 +% +2.7 +% +1.2 +% +2.0 +% +0.7 +% +Litigation/settlement recovery (expense) +— +— +— +12,186 +(20,214 +) +Net income (loss) +9,753 +4,376 +110 +13,409 +(25,362 +) +Earnings per share – diluted +0.97 +0.44 +0.01 +1.39 +(2.62 +) +Consolidated Cash Flow Data: +Cash flows provided by (used in) operations +(34 +) +6,561 +(17 +) +(544 +) +919 +Capital expenditures +1,638 +2,868 +1,633 +2,128 +1,142 +Consolidated Balance Sheet Data: +Net working capital (1) +31,703 +23,006 +23,468 +21,783 +22,261 +Total assets +88,695 +72,901 +67,938 +59,125 +57,439 +Long-term liabilities +11,665 +9,420 +13,452 +13,553 +26,823 +Shareholders’ equity +37,548 +27,639 +23,234 +23,120 +9,711 +Book value per share (2) +3.85 +2.85 +2.40 +2.39 +1.00 +Supplemental Data: +Number of shares outstanding at year-end (thousands) +9,750 +9,694 +9,676 +9,673 +9,673 +Number of employees at year-end +3,361 +2,849 +2,847 +2,687 +1,995 +Approximate square footage of operational facilities +723,000 +765,000 +786,000 +691,000 +664,000 +(1) +Net working capital is defined as total current assets less total current liabilities. Net +working capital measures the portion of current assets that are financed by long term funds and is an indicator of short term financial management. +9 +Table of Contents +(2) +Book value per share is defined as total shareholders’ equity divided by the number of +shares outstanding at the end of the fiscal year. Book value per share measures shareholders’ value as defined by generally accepted accounting principles. +Item 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +Overview +Key Tronic Corporation is an independent provider of EMS for OEMs. The Company’s core strengths include innovative design and engineering +expertise in SMT, electronics, mechanical engineering, precision molding and tooling, combined with high-quality, low-cost production and assembly on a global basis. The Company’s global production capability provides customers with benefits of +improved supply-chain management, reduced inventories, lower transportation costs, and reduced product fulfillment time. The Company continues to make investments in its Mexico and China facilities which give it the production capacity and +logistical advantages to continue to win new business. The following information should be read in conjunction with the consolidated financial statements included herein and with Item 1A Risk Factors. +The EMS industry has historically experienced growth as more OEMs shift to outsourced manufacturing. However, Key Tronic’s revenue, like that of other EMS +providers’ sales revenue, can fluctuate significantly due to a reliance on a concentrated base of customers. The product demand from the Company’s largest existing customers caused a significant increase in revenues during fiscal year +2005, but these same customers saw moderate decreases in demand during fiscal 2006. +Overall, the Company’s sales in fiscal year 2006 decreased by +7.5% over 2005. The Company has recently won business with new customers that should increase revenues and dilute the current concentration of the existing top customers. Sales for the first quarter of fiscal 2007 are expected to be within the range +of $50 million to $53 million. Actual results will depend on actual levels of customers’ orders and the timing of the production of new product wins. The Company believes that it is well positioned in the EMS industry to expand its customer +base and continue long-term growth. +The concentration of the Company’s largest customers increased during fiscal 2006 as the top five customers’ +sales increased to 71% of total sales in 2006 from 68% in 2005 and 58% in 2004. The Company’s current customer relationships involve a variety of products, including consumer electronics, plastics, household products, gaming devices, specialty +printers, educational toys, medical devices, and computer accessories. The total number of Key Tronic EMS customers continued to increase during fiscal 2006. Some of these added customers have programs that represent small annual sales while others +have multi-million-dollar potential. +The Company continued to improve its operating efficiencies during fiscal year 2006. Gross profit on sales was 9.2% +in fiscal 2006 compared to 8.1% for the prior fiscal year. Net income for fiscal 2006 was $9.8 million or $0.97 per diluted share after recognizing a $5.0 million deferred tax benefit, up from $4.4 million net income or $0.44 per diluted share for +fiscal 2005. The results of both years were affected by unusual events. The Company had the $5.0 million tax benefit in fiscal 2006 and a one-time $1.1 million gain on life insurance proceeds in fiscal 2005. +10 +Table of Contents +The Company maintains a strong balance sheet with a current ratio of 1.80 and a long-term debt to equity ratio of 0.29. +Total cash used in operations was $34,000 as total working capital increased to $31.7 million up $8.7 million from the prior year due in large part to an increase in inventory to support customer requirements while transitioning to meet the European +directive on the restriction of the use of hazardous substances in electrical and electronic equipment (RoHS) and in anticipation of revenue growth. However, the Company maintains sufficient liquidity for its expected future operations and had +approximately $13.3 million available from its revolving line of credit based on eligible collateral at July 1, 2006. The Company maintains a good working relationship with CIT Group/Business Credit, Inc., its asset-based lender, and the +Company believes that internally generated funds and its revolving line of credit should provide adequate capital for planned growth over the long term. +The EMS industry is intensely competitive, and Key Tronic, at this time, estimates it has less than 1% of the potential market. The Company believes that it can acquire new business in the future, particularly those programs that require +innovative design and engineering, short lead times, or small initial volumes. The Company is planning for long term growth by utilizing current capacity, improving manufacturing processes, and investing in additional manufacturing equipment. +Current challenges facing the Company include the following: continuing to win new programs, improving operating efficiencies, labor constraints and more competitive labor markets, controlling costs and developing competitive price strategies. +Results of Operations +The following table sets forth +for the periods indicated certain items of the consolidated statements of income expressed as a percentage of net sales. The financial information and discussion below should be read in conjunction with the consolidated financial statements and +notes contained in this Annual Report. +Years Ended +July 1, 2006 +July 2, 2005 +July 3, 2004 +Net sales +100.0 +% +100.0 +% +100.0 +% +Cost of sales +90.8 +91.9 +91.1 +Gross profit +9.2 +8.1 +8.9 +Operating expenses (income) +Research, development and engineering +1.5 +1.4 +1.7 +Selling +1.1 +1.1 +1.3 +General and administrative +3.5 +3.4 +4.7 +Gain on life insurance proceeds +0 .0 +(0.5 +) +0.0 +Operating income +3.1 +2.7 +1.2 +Interest expense +0.6 +0.6 +0.7 +Income before income taxes +2.5 +2.1 +0.5 +Income tax provision (benefit) +(2.7 +) +0.0 +0.4 +Net income +5.2 +% +2.2 +% +0.1 +% +Net Sales +Net sales in fiscal 2006 were $187.7 million compared to $202.9 million and $148.9 million in fiscal years 2005 and 2004, respectively. +The decline in net sales during 2006 relates to a moderate decrease in the demand for the Company’s top existing customers’ products from the very high level of demand seen in fiscal 2005. Customers’ +demand will fluctuate based on changes in the sell-through of their products. The Company anticipates that several new customer programs will enter production in fiscal year 2007 and begin contributing to revenue. Sales of keyboards accounted for +3.6% of revenues compared to 5.0% in 2005. +The increase in net sales during 2005 compared to 2004 was related to the Company’s successful expansion +of the number of manufacturing programs with existing customers. Many of the Company’s top customers saw large increases in product demand in a variety of industries including specialty printers, gaming devices and consumer electronics. Sales +of keyboards accounted for approximately 5.0 % of revenues in 2005 compared to 9.0% in 2004. +11 +Table of Contents +Cost of Sales +Total cost of sales as a percentage of net sales was 90.8 %, 91.9%, and 91.1% for fiscal years 2006, 2005, and 2004, respectively. The decrease in cost of sales as a percentage of net sales in 2006 was due to +production efficiencies achieved on existing customer programs together with decreases in warranty accruals and reserves for obsolete keyboard inventory. The increase in cost of sales as a percent of sales in 2005 when compared to 2004 was due +mainly to continuing price reductions in the competitive EMS industry and changes in the Company’s product mix, offset in part by increasing manufacturing efficiencies as the Company began to utilize a larger percentage of its fixed cost +capacity. +Total costs of materials as a percentage of sales were approximately 64.6%, 67.0%, and 58.1% in fiscal years 2006, 2005, and 2004, respectively. +The change from year-to-year is directly related to changes in product mix. Products sold in fiscal 2006 contained lower materials costs, thereby decreasing costs of materials as a percentage of sales from fiscal 2005. +Direct production costs (direct labor and manufacturing overhead) were 13.2% of total sales in fiscal 2006 compared to costs of 12.9% of total sales in 2005. Direct +production costs were 18.3% of total sales in 2004. The decrease in 2005 from 2004 is related to utilization of excess manufacturing capacity (both equipment and indirect support costs). Included in fiscal 2004 were start-up costs associated with +new manufacturing programs. These start-up costs included the costs to increase the Company’s manufacturing and storage space in Juarez, Mexico. +The +Company provides for obsolete and non-saleable inventories based on specific identification of inventory against current demand and recent usage. The amounts charged to expense were $361,000, $730,000, and $162,000 in fiscal years 2006, 2005, and +2004, respectively. The majority of the provision in each year was related to domestic computer keyboards that were deemed obsolete during the year. Approximately $350,000 of the provision in 2005 was due to the decision to cease supporting direct +European sales of keyboards, with the remainder of the increase relating to domestic keyboards and other computer peripherals that were determined to be obsolete. +The Company provides warranties on certain products it sells and estimates warranty costs based on historical experience and anticipated product returns. The amounts charged to expense are determined based on an estimate of warranty +exposure. Warranty expense (recovery) was approximately $(10,000), $345,000, and $193,000 in fiscal years 2006, 2005, and 2004, respectively. The recovery in 2006 related to the less than expected warranty expense related to the workmanship of a +particular EMS product and a decrease in the estimated future keyboard warranty costs. Most of the increase in fiscal 2005 related to a single warranty claim relating to workmanship of a particular EMS product that was resolved during fiscal 2006. +Gross Profit +In +fiscal year 2006, gross profit on sales was 9.2% of revenues compared to 8.1% in fiscal year 2005 and 8.9% in fiscal year 2004. The increase in fiscal year 2006 relates to improved manufacturing efficiencies, decreased warranty costs, and reductions +in required obsolete inventory expense as discussed above. Additionally, the Company has obtained early pay discounts from its vendors that totaled $431,000 and $132,000 in fiscal years 2006 and 2005, respectively. The decrease in gross profit in +2005 from 2004 was due primarily to product mix changes and receipt of an insurance settlement of $475,000 in fiscal 2004. +Gross profit margins reflect +the impact of a number of factors that can vary from period to period, including product mix, start-up costs and efficiencies associated with new programs, product life cycles, sales volumes, capacity utilization of the Company’s resources, +management of inventories, component pricing and shortages, end market demand for customers’ products, fluctuations in and timing of customer orders, and competition within the EMS industry. These and other factors can cause variations in +operating results. There can be no assurance that gross margins will not decrease in future periods. +Research, +Development and Engineering +Research, development and engineering expenses (RD&E) consists principally of employee related costs, third party +development costs, program materials, depreciation and allocated information technology and facilities costs. As a percentage of net sales, RD&E increased slightly in fiscal 2006 when compared to 2005. The increase as a percent of sales is due +to decreasing sales with no significant decrease in costs. In each of the fiscal years presented, the Company has focused most of its RD&E efforts on current customers’ EMS programs. +The Company’s total RD&E expenses were $2.8 million, $2.9 million, and $2.6 million in fiscal years 2006, 2005, and 2004, respectively. The slight decrease in +2006 from 2005 is related to a decrease in product support costs as sales revenue decreased during the year. The increase in fiscal 2005 compared to 2004 is related to the elimination of a 10% pay reduction that occurred during 2004 and incentive +plan payments to employees for achieving 2005 profitability goals. +12 +Table of Contents +Selling +Sales and marketing expenses consist principally of salaries and benefits for sales and marketing personnel, advertising and marketing programs, sales commissions, and travel expenses. Similar to RD&E expenses, +selling expenses decreased as a percent of sales relative to the allocated fixed costs in each of the years presented. Approximately half of selling expense relates to fixed salary costs. +The Company’s total selling expenses were $2.1 million, $2.2 million, and $1.9 million in fiscal years 2006, 2005, and 2004, respectively. The slight decrease in +2006 from 2005 is related to a reduction in promotional programs and commissions offset in part by additional internal sales support costs. The increase in 2005 from 2004 was related to the elimination of a 10% pay reduction, incentive plan bonuses +earned in fiscal 2005, and increased sales commissions. +General and Administrative +General and administrative expenses (G&A) consist of employee related costs, travel expenses and allocated information technology and facilities costs for finance, +legal, human resources and executive functions, outside legal and accounting fees, provision for doubtful accounts and business insurance costs. As a percent of sales G&A was 3.5%, 3.4%, and 4.7% in fiscal years 2006, 2005, and 2004, +respectively. +Total G&A was $6.6 million, $7.0 million and $7.0 million in fiscal years 2006, 2005, and 2004, respectively. In 2006, the Company was +able to reduce its business insurance premiums and eliminated its administrative support costs in Ireland and reduced the write-off of bad debt. Partially offsetting these decreases, the Company expensed approximately $120,000 of due diligence costs +relating to a potential acquisition that is no longer being pursued subsequent to year end. An additional $500,000 relating to the potential acquisition of due diligence expenses, attorneys’ fees, and bank fees are expected to be expensed in +the first quarter of 2007 for services provided after July 1, 2006 prior to the decision to not proceed with the potential acquisition. +Gain on Life Insurance Proceeds +Operating expenses in fiscal 2005 included a gain on life insurance proceeds paid +on policies insuring a former executive in the amount of $1.1 million. The Company does not hold life insurance policies on any other executives or former executives and does not anticipate any gains on life insurance proceeds in the future. +Interest Expense +The +Company had net interest expenses of $1.1 million, $1.2 million, and $1.1 million in fiscal years 2006, 2005, and 2004, respectively. Interest expense has remained fairly constant, as the Company has decreased its average borrowings during the year +while interest rates have increased. The Company does not currently use derivatives to hedge interest rate risk. During 2006, the Company began to utilize short-term fixed LIBOR rates on portions of its revolving line of credit for short-term +interest savings in anticipation of rate increases. The Company successfully negotiated a variable rate decrease charged by its lender on its revolving line of credit and term debt subsequent to July 1, 2006. +Income Tax Provision +The Company +had an income tax benefit of $(5.0) million in fiscal year 2006 compared to a benefit of $(75,000) in fiscal year 2005 and $611,000 provision in fiscal year 2004. The large income tax benefit in 2006 relates to the Company releasing a portion of the +valuation allowance on its net deferred tax asset in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes . The Company has domestic tax net operating loss carryforwards (NOLs) of +approximately $56.5 million at July 1, 2006. In accordance with SFAS No. 109, management assessed the Company’s recent operating levels and the sources of future taxable income to estimate a valuation allowance. A valuation allowance +against deferred tax assets is required if it is more likely than not that some of the deferred tax assets will not be realized. Management has determined that a valuation allowance of approximately 80% of the total net deferred tax asset is +appropriate at this time. Therefore, the valuation allowance for $5.0 million of the NOLs was reversed in 2006. +The tax provisions (benefits) of fiscal +2005 and 2004 are the result of foreign taxes on the earnings of foreign subsidiaries. The benefit for fiscal year 2005 relates to the Company’s Mexican subsidiaries revising intercompany agreements upon completing new transfer pricing studies +in the fourth quarter of fiscal 2005, applying certain Mexican tax credits for the calendar years 2005 and 2004, and a reduction of Mexican statutory rates. The tax expense in 2004 relates to tax expense at the former intercompany transfer rates and +higher Mexican statutory rates. +13 +Table of Contents +International Subsidiaries +The Company offers customers a complete global manufacturing solution. The Company’s facilities provide its customers the opportunity to have their products +manufactured in the facility that best serves specific cost, product manufacturing, and distribution needs. Active foreign subsidiaries are located in the following locations: +• +Key Tronic Juarez SA de CV owns an SMT, assembly, and molding facility and an assembly facility in Juarez, Mexico and currently leases one other facility for assembly and storage. +This subsidiary is primarily used to support the Company’s U.S. operations. +• +Key Tronic Reynosa SA de CV leases manufacturing and warehouse facilities in Reynosa, Mexico. This subsidiary is used exclusively to manufacture products for one EMS customer. +• +Key Tronic Computer Peripheral Co., Ltd. leases a facility with SMT and assembly capabilities in Shanghai, China, which began operations in 1999. Its primary function is to provide +EMS services for export; however, it is also currently utilized to manufacture electronic keyboards. +Foreign sales (based on destination of +shipments) from worldwide operations, including domestic exports, were $13.7 million in fiscal year 2006 compared to $15.8 million and $14.5 million in fiscal years 2005 and 2004, respectively. The decrease in foreign sales in fiscal 2006 is +primarily related to a decrease in foreign sales of keyboards. The Company closed its subsidiary sales office in Ireland in July 2005 due to declining keyboard sales. The increase in foreign sales for fiscal year 2005 compared to fiscal year 2004 is +a result of direct shipments to a European subsidiary for an existing domestic EMS customer. Products and manufacturing services provided by the Company’s subsidiary operations are sold to customers directly by the parent company. Key Tronic +Computer Peripheral Co., Ltd., the Company’s subsidiary in Shanghai, China, had only minimal sales to customers in China over the past three fiscal years. +Capital Resources and Liquidity +Cash flows used by operating activities were $(34,000) in fiscal year 2006 compared to $6.6 million +provided by operating activities in fiscal year 2005 and $(17,000) used in fiscal year 2004. Even though the Company had $9.7 million in net income, $5.0 million was in the form of a non-cash deferred income tax benefit. The Company also increased +inventory levels by $6.6 million in response to forecasted increases in sales for the first quarter of 2007 and in support of transitioning customers to RoHS compliant products. There was also a $4.8 million increase in accounts receivable due to +the volume of shipments close to year end and making the final payment of a litigation settlement in the amount of $812,000; offset in part by an increase in accounts payable of $5.8 million. The Company has begun to take advantage of early pay +discounts available from its vendors due to higher availability on the revolving credit facility. The past two years have shown a decrease in accounts payable days outstanding as the Company has taken advantage of early pay discounts resulting in +discounts of $431,000 and $132,000 being recorded for the fiscal years 2006 and 2005, respectively. +The increase in cash provided by operations during +fiscal year 2005 compared to 2004 was due primarily to an increase in net income year-over-year which included non-cash charges for obsolete inventory, warranty, and doubtful accounts totaling $1.2 million in 2005. The increase in operating cash was +offset by an increase of $2.6 million in inventory while accounts payable only increased $1.1 million as the Company began taking advantage of early pay discounts from vendors. Also contributing to the use of cash was $1.6 million paid to F&G +under the settlement agreement. +Cash used in investing activities includes capital expenditures. Capital expenditures were $1.6 million, $2.9 million, and +$1.6 million in fiscal years 2006, 2005, and 2004, respectively. The Company’s capital expenditures are primarily for purchases of manufacturing assets to support Company operations in Mexico and China. The Company also uses a variety of +operating leases to fund the purchases of operating equipment. Total operating leases increased during fiscal 2006, as the Company further utilized leases to finance new equipment purchases. +The Company’s primary financing activity in fiscal years 2006, 2005, and 2004 was borrowing and repayment under the Company’s financing agreement with CIT +Group/Business Credit, Inc. (CIT). The Company’s financing agreement with CIT provides a revolving credit facility of up to $25 million. The revolving loan is secured by the assets of the Company. The interest rate provisions allow for a +variable rate based on either the prime rate or LIBOR rate. The agreement specifies four alternative levels of margin to be added to these base rates depending on compliance with certain financial covenants. The range of interest being paid to CIT +on outstanding balances was 7.46% – 8.25% as of July 1, 2006. The financing agreement and subsequent amendments contain financial covenants that relate to total equity, earnings before interest, taxes, depreciation and amortization, and a +minimum fixed charge ratio. The revolving loan matures August 22, 2009. As of July 1, 2006, the Company was in compliance with all loan covenants. At July 1, 2006, the outstanding revolving loan balance was $10.1 million compared to +$7.4 million at fiscal year end July 2, 2005. The loan balance increased as the Company increased its working capital. Based on eligible collateral, approximately $13.3 million was available for drawdown from the revolving line of credit as of +July 1, 2006. +14 +Table of Contents +In addition to the Company’s revolving credit facility payment obligations at July 1, 2006, the Company had a +$1.0 million payable on a term loan with CIT, various lease commitments, and other long term obligations. The Company believes that projected cash from operations, funds available under the revolving credit facility, and leasing capabilities will be +sufficient to meet working and fixed capital requirements through fiscal year 2007 and into the foreseeable future. +Contractual Obligations and +Commitments +In the normal course of business, the Company enters into contracts which obligate the Company to make payments in the future. +The table below sets forth the Company’s significant future obligations by fiscal year: +Payments Due by Fiscal Year (in thousands) +Total +2007 +2008 +2009 +2010 +2011 +Thereafter +CIT Revolving Loan (1) +$ +10,069 +— +— +— +10,069 +— +— +CIT Term Loan (2) +$ +1,127 +585 +542 +— +— +— +— +Capital and Operating Leases (3) +$ +9,403 +3,151 +2,139 +1,710 +1,325 +1,048 +30 +Purchase Orders (4) +(1) +The terms of the CIT revolving loan are discussed in the consolidated financial statements at +Note 4, “Long-Term Obligations”. The Company’s current financing agreement with CIT terminates on August 22, 2009, at which time the unpaid balance of the revolving loan will become immediately payable. However, the Company will +more likely than not extend or replace its revolving loan agreement prior to that date. The amount payable on the Company’s revolving loan changes daily depending upon the amount of cash borrowed to support its operations and the amount of +customer payments received. The amount presented does not include any interest payable. Under the terms of the Company’s agreement with CIT, customers’ payments are applied against the outstanding revolving loan balance as soon as the +amounts clear through the banking system. +Under the terms of the revolving credit agreement, the Company must meet a number +of financial covenants. As of July 1, 2006 the Company was in compliance with all of its loan covenants. Breaching one or more of these covenants could have a material impact on the Company’s operations or financial condition. +(2) +In May 2005, the Company purchased a manufacturing facility in Juarez, Mexico. The purchase +was funded by a $1.5 million term loan with CIT to be repaid ratably over three years. +(3) +The Company maintains vertically integrated manufacturing operations in Mexico and Shanghai, +China. Such operations are heavily dependent upon technically superior manufacturing equipment including molding machines in various tonnages, SMT lines, and automated insertion and test equipment for the various products the Company is capable of +producing. +In addition, the Company leases some of its administrative and manufacturing facilities. A complete discussion of +properties can be found in Part 1, Item 2 at “Properties”. Leases have proven to be an acceptable method for the Company to acquire new or replacement equipment and to maintain facilities with a minimum impact on its operating cash +flows. +(4) +As of July 1, 2006, the Company had open purchase order commitments for materials and +other supplies of approximately $70 million. Included in the open purchase orders, there are various blanket orders for annual requirements. Actual needs under these blanket purchase orders fluctuate with the Company’s manufacturing levels. In +addition, the Company has contracts with its customers that minimize its exposure to losses for material purchased within lead-times necessary to meet customer forecasts. Purchase orders generally can be cancelled without penalty within specified +ranges that are determined in negotiations with the Company’s suppliers. These agreements depend in part on the type of materials purchased as well as the circumstances surrounding any requested cancellations. +In addition to the cash requirements presented in tabular format and open purchase orders, the Company has various other accruals which are not included. The Company +owes its suppliers approximately $31.2 million for accounts payable and shipments in transit at the end of the fiscal year. The Company generally pays its suppliers in a range from 30 to 120 days depending on terms offered. Quarterly payments to +suppliers normally average between $30 and $35 million. These payments are financed by operating cash flows and the Company’s revolving line of credit. +The Company believes that internally generated cash flows and funds available under the revolving credit facility will satisfy cash requirements for a period in excess of 12 months and into the foreseeable future. +15 +Table of Contents +Critical Accounting Policies +Revenue Recognition : The Company recognizes revenue when products are shipped. Securities and Exchange Commission (SEC) Staff Accounting Bulletin 104, Revenue Recognition states that revenue generally is realized or realizable +and earned when all of the following criteria are met: +• +Persuasive evidence of an arrangement exists. +• +Delivery has occurred or services have been rendered. +• +The seller’s price to the buyer is fixed or determinable. +• +Collectibility is reasonably assured. +The Company believes that it meets +the above criteria for the following reasons: +• +Customer purchase orders confirming the price, shipping terms, and payment terms are required prior to shipment. +• +The terms of the Company’s sales are generally FOB shipping point, meaning that the customer takes ownership of the goods and assumes the risk of loss when the goods leave the +Company’s premises. +• +The seller’s price to the buyer is fixed or determinable – as noted, the Company requires customer purchase order, which confirms the price, shipping and payment terms. +• +Collectibility is reasonably assured – the credit terms for customers are pre-established based on a review of the customers perceived ability to pay so that collection of the +account can be reasonably assured. +Inactive, Obsolete and Surplus Inventory Reserve : The Company reserves for inventories that it +deems inactive, obsolete or surplus. This reserve is calculated based upon the demand for the products that the Company produces. Demand is determined by expected sales or customer forecasts. If expected sales do not materialize, then the Company +would have inventory in excess of its reserves and would have to charge the excess against future earnings. In the case where the Company has purchased material based upon a customer’s forecast, the Company is usually covered by lead-time +assurance agreements with each customer. These contracts state that the financial liability for material purchased within agreed upon lead-time and based upon the customer’s forecasts, lies with the customer. If the Company purchases material +outside the lead-time assurance agreement and the customer’s forecasts do not materialize, the Company would have the financial liability and would have to charge any excess obsolete inventory against earnings. +Allowance for Doubtful Accounts : The Company values its accounts receivable net of an allowance for doubtful accounts. This allowance is based on estimates of the +portion of accounts receivable that may not be collected in the future, and the amount of this allowance is disclosed in the Company’s consolidated balance sheets. The estimates used are based primarily on specific identification of potentially +uncollectible accounts. Such accounts are identified using publicly available information in conjunction with evaluations of current payment activity. However, if any of the Company’s customers were to develop unexpected and immediate financial +problems that would prevent payment of open invoices, the Company could incur additional and possibly material expenses that would negatively impact earnings. +Accrued Warranty : An accrual is made for expected warranty costs, with the related expense recognized in cost of goods sold. Management reviews the adequacy of this accrual quarterly based on historical analysis and anticipated +product returns and rework costs. As the Company has made the transition from manufacturing primarily keyboards to primarily EMS products, its exposure to warranty claims has declined significantly. The Company’s warranty period for keyboards +is generally longer than that for EMS products. Also the Company does not warrant design defects for EMS customers. +Income Taxes +The Company has domestic tax loss carryforwards of approximately $56.5 million at July 1, 2006. In accordance with SFAS +No. 109, Accounting for Income Taxes , management assesses the sources of future taxable income, which may be available to recognize the deductible differences that comprise deferred tax assets. A valuation allowance against deferred tax +assets is required if it is more likely than not that some or all of the deferred tax assets will not be realized. Management has determined that a valuation allowance of approximately 80% of the total deferred tax asset is appropriate at this time. +16 +Table of Contents +Goodwill +In accordance with SFAS No. 142, Goodwill and Other Intangibles , the Company records intangible assets that are acquired individually or with a group of other assets in the financial statements at +acquisition. Goodwill is tested for impairment annually. The Company adopted SFAS No. 142 on June 30, 2002, and completed its impairment test during the second quarters of each of the subsequent fiscal years. The tests did not indicate an +impairment of the Company’s stated goodwill of $765,000. +Derivatives +The Company has adopted SFAS No. 133, Accounting for Derivative Instruments and Certain Hedging Activities , as amended by SFAS No. 138, Accounting for +Certain Derivative Instruments and Certain Hedging Activity , an Amendment of SFAS 133, and SFAS No. 149 Amendment on Statement 133 on Derivative Instruments and Hedging Activities . In accordance with these standards all derivative +instruments are recorded on the balance sheet at their respective fair values. Generally, if a derivative instrument is specifically designated as a cash flow hedge, the change in the fair value of the derivative is recorded in other comprehensive +income to the extent the derivative is effective, and recognized in the statement of operations when the hedged item affects earnings. If a derivative instrument is designated as a fair value hedge, the change in fair value of the derivative and of +the hedged item attributable to the hedged risk are recognized in earnings in the current period. Subsequent to year end July 1, 2006, the Company began entering into forward contracts to hedge transactional exposure associated with commitments +arising from future cash commitments in a currency other than the functional U.S. dollar. +New Accounting Pronouncements +In March 2005, the Financial Accounting Standards Board (FASB) issued Financial Interpretation 47 (FIN), Accounting for Conditional Asset Retirement +Obligations , as an interpretation of SFAS No. 143, Accounting for Asset Retirement Obligations . This interpretation clarifies that the term conditional asset retirement obligation as used in SFAS No. 143, refers to a legal +obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is +unconditional even though uncertainty exists about the timing and/or method of settlement. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability +can be reasonably estimated. This interpretation also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 was effective no later than the end of fiscal years +ending after December 15, 2005. The implementation of FIN 47 did not have a material effect on the consolidated financial statements. +In +May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections . SFAS No. 154 is a replacement of Accounting Principles Board Opinion No. 20 and SFAS No. 3. SFAS No. 154 provides guidance on the +accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a +correction of an error. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, and it is required to be adopted by the Company in the first quarter of fiscal 2007. +The Company does not anticipate that the provision of SFAS No. 154 will have a material effect on the consolidated financial statements. +In June +2006, FIN 48, Accounting for Uncertainty in Income Taxes was issued which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for +Income Taxes . This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also +provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006, and earlier application +of the provisions of this Interpretation is encouraged if the enterprise has not yet issued financial statements, including interim financial statements, in the period this Interpretation is adopted. The Company does not anticipate that the +provisions of FIN 48 will have a material effect on the consolidated financial statements. +17 +Table of Contents +Item 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +The Company is subject to the risk of fluctuating +interest rates in the normal course of business. The Company’s major market risk relates to its secured debt. The Company’s debt is secured by substantially all of the Company’s assets. The interest rates applicable to the +Company’s revolving loan fluctuate with the JP Morgan Chase Bank prime rate and LIBOR rates. The Company does not currently enter into derivative transactions or leveraged swap agreements. +Although the Company has international operations, the functional currency for all subsidiaries is the U.S. dollar. The Company imports raw materials that are used in +its manufacturing operations. The majority of the Company’s purchases is denominated in U.S. dollars and is paid under normal trade terms. In July 2006, the Company began to hedge its foreign currency exposure in Mexico by utilizing weekly +forward contracts to cover local payroll costs paid in Mexican pesos. +The table below presents principal (or notional) amounts of debt outstanding at +July 1, 2006 and related weighted average variable rates by fiscal year of maturity. The weighted average variable interest rates for fiscal years 2007 through 2011 are estimated based on current rates as of July 1, 2006. These forward +rates have been increased by current levels of margins based on the financing agreement with CIT. The Company’s long term debt could increase or decrease depending upon cash needs over the period of time that the financing agreement remains in +place with CIT. The JP Morgan Chase Bank prime rate and LIBOR will fluctuate with the market and could go up or down depending on market conditions. +Fiscal Years +Fair Value +July 1, 2006 +(In thousands) +2007 +2008 +2009 +2010 +2011 +Total +Long term debt: +Secured revolving debt +— +— +— +— +$ +10,069 +$ +10,069 +$ +10,069 +Secured term loan +$ +500 +$ +500 +— +— +— +$ +1,000 +$ +1,000 +Average interest rate +8.50 +% +8.50 +% +— +— +7.57 +% +7.65 +% +— +18 +Table of Contents +Item 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Report of Independent Registered Public Accounting Firm +The Board of Directors and +Shareholders +Key Tronic Corporation +Spokane Valley, Washington +We have audited +the accompanying consolidated balance sheets of Key Tronic Corporation and subsidiaries (the Company) as of July 1, 2006 and July 2, 2005, and the related consolidated statements of earnings, shareholders’ equity and cash flows for +each of the three years in the period ended July 1, 2006. We have also audited the schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is +to express an opinion on these financial statements and schedule based on our audits. +We conducted our audits in accordance with the standards of the +Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedule are free of material misstatement. The Company +is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are +appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a +test basis, evidence supporting the amounts and disclosures in the financial statements and schedule, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the +financial statements and schedule. 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 Key Tronic Corporation and subsidiaries at July 1, 2006 and July 2, 2005, and the results of its operations and its cash flows for each of the +three years in the period ended July 1, 2006 in conformity with accounting principles generally accepted in the United States of America. +Also, in +our opinion, the schedule presents fairly, in all material respects, the information set forth therein. +/s/ BDO Seidman, LLP +Spokane, Washington +August 10, 2006 +19 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED BALANCE SHEETS +(In thousands) +July 1, 2006 +July 2, 2005 +ASSETS +Current assets: +Cash and cash equivalents +$ +2,428 +$ +1,463 +Trade receivables, less allowance for doubtful accounts of $0 and $158 +29,003 +24,191 +Inventories +36,338 +29,712 +Other +3,416 +3,482 +Total current assets +71,185 +58,848 +Property, plant and equipment, net +9,807 +10,011 +Other assets: +Restricted cash +874 +1,158 +Real estate +1,698 +1,693 +Deferred income tax assets +3,500 +— +Other, net of accumulated amortization of $60 and $758 +866 +426 +Goodwill +765 +765 +Total assets +$ +88,695 +$ +72,901 +LIABILITIES AND SHAREHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +31,228 +$ +25,475 +Accrued compensation and vacation +4,477 +5,241 +Current portion of litigation settlement +— +812 +Current portion of other long-term obligations +689 +735 +Other +3,088 +3,579 +Total current liabilities +39,482 +35,842 +Long-term liabilities: +Revolving loan +10,069 +7,412 +Other long-term obligations +1,596 +2,008 +Total long-term liabilities +11,665 +9,420 +Commitments and contingencies (Notes 4 and 8) +Shareholders’ equity +Common stock, no par value, authorized 25,000 shares; issued and outstanding 9,750 and 9,694 shares, respectively +38,582 +38,426 +Accumulated deficit +(1,034 +) +(10,787 +) +Total shareholders’ equity +37,548 +27,639 +Total liabilities and shareholders’ equity +$ +88,695 +$ +72,901 +See accompanying notes to consolidated financial statements. +20 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF EARNINGS +Years Ended +(In thousands, except per share amounts) +July 1, 2006 +July 2, 2005 +July 3, 2004 +Net sales +$ +187,699 +$ +202,877 +$ +148,901 +Cost of sales +170,395 +186,417 +135,664 +Gross margin +17,304 +16,460 +13,237 +Operating expenses (income): +Research, development and engineering +2,762 +2,880 +2,583 +Selling +2,111 +2,229 +1,900 +General and administrative +6,570 +6,966 +6,965 +Gain on life insurance proceeds +— +(1,060 +) +— +Operating income +5,861 +5,445 +1,789 +Interest expense, net +1,108 +1,144 +1,068 +Income before income taxes +4,753 +4,301 +721 +Income tax provision (benefit) +(5,000 +) +(75 +) +611 +Net income +$ +9,753 +$ +4,376 +$ +110 +Earnings per share: +Earnings per common share – basic +$ +1.00 +$ +0.45 +$ +0.01 +Weighted average shares outstanding – basic +9,707 +9,684 +9,673 +Earnings per common share – diluted +$ +0.97 +$ +0.44 +$ +0.01 +Weighted average shares outstanding – diluted +10,070 +9,926 +9,793 +See accompanying notes to consolidated financial statements. +21 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY +Common Stock +Accumulated +Deficit +(In thousands) +Shares +Amount +Total +Balances, June 28, 2003 +9,673 +$ +38,393 +$ +(15,273 +) +$ +23,120 +Net income – 2004 +— +— +110 +110 +Exercise of stock options +3 +4 +— +4 +Balances, July 3, 2004 +9,676 +38,397 +(15,163 +) +23,234 +Net income – 2005 +— +— +4,376 +4,376 +Exercise of stock options +18 +29 +— +29 +Balances, July 2, 2005 +9,694 +38,426 +(10,787 +) +27,639 +Net income – 2006 +— +— +9,753 +9,753 +Stock based compensation +— +40 +— +40 +Exercise of stock options +56 +116 +— +116 +Balances, July 1, 2006 +9,750 +$ +38,582 +$ +(1,034 +) +$ +37,548 +See accompanying notes to consolidated financial statements. +22 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF CASH FLOWS +Years Ended +(In thousands) +July 1, 2006 +July 2, 2005 +July 3, 2004 +Increase (decrease) in cash and cash equivalents: +Cash flows from operating activities: +Net income +$ +9,753 +$ +4,376 +$ +110 +Adjustments to reconcile net income to cash provided (used) by operating activities: +Depreciation and amortization +1,890 +2,366 +2,957 +Accretion of deferred gain on sale of building +(78 +) +(78 +) +(78 +) +Provision for obsolete inventory +361 +730 +162 +Provision for doubtful receivables +6 +140 +— +Provision for (recovery of) warranty +(10 +) +345 +193 +(Gain) loss on sale of assets +(101 +) +149 +14 +Stock based compensation expense +40 +— +— +Deferred income tax benefit +(5,000 +) +— +— +Changes in operating assets and liabilities: +Trade receivables +(4,818 +) +108 +(7,361 +) +Inventories +(6,987 +) +(2,594 +) +(3,859 +) +Other assets +1,084 +(1,596 +) +145 +Accounts payable +5,753 +1,121 +11,209 +Accrued compensation and vacation +(764 +) +1,226 +(198 +) +Litigation settlement +(812 +) +(1,649 +) +(1,256 +) +Other liabilities +(351 +) +1,917 +(2,055 +) +Cash provided (used) by operating activities +(34 +) +6,561 +(17 +) +Cash flows from investing activities: +Purchase of property and equipment +(1,638 +) +(2,868 +) +(1,633 +) +Proceeds from sale of property and equipment +140 +8 +4 +Cash used by investing activities +(1,498 +) +(2,860 +) +(1,629 +) +Cash flows from financing activities: +Payment of financing costs +(50 +) +(90 +) +(35 +) +Proceeds from exercise of stock options +116 +29 +4 +Proceeds from long-term debt +— +1,500 +538 +Repayment of long-term debt +(510 +) +(385 +) +(641 +) +Borrowing under revolving credit agreement +202,168 +210,152 +146,805 +Repayment of revolving credit agreement +(199,511 +) +(213,591 +) +(145,818 +) +Decrease (increase) in restricted cash +284 +(453 +) +437 +Cash provided (used) by financing activities +2,497 +(2,838 +) +1,290 +Increase (decrease) in cash and cash equivalents +965 +863 +(356 +) +Cash and cash equivalents, beginning of year +1,463 +600 +956 +Cash and cash equivalents, end of year +$ +2,428 +$ +1,463 +$ +600 +Supplemental cash flow information: +Interest payments +$ +1,100 +$ +1,100 +$ +865 +Income tax payments, net of refunds +$ +194 +$ +247 +$ +1,015 +See accompanying notes to consolidated financial statements. +23 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. SIGNIFICANT ACCOUNTING POLICIES +Business +Key Tronic Corporation and subsidiaries (the Company) is +engaged in electronic manufacturing services (EMS) for original equipment manufacturers (OEMs), and also manufactures keyboards and other input devices. +Principles of Consolidation +The consolidated financial statements include the Company and its wholly owned subsidiaries in Ireland, Mexico, +and China. Intercompany balances and transactions have been eliminated in consolidation. +Use of Estimates +The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates +and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. +Significant estimates include the allowance for doubtful receivables, the provision for obsolete and non-saleable inventories, the valuation allowances on deferred tax assets, valuation of goodwill, and the provision for warranty costs. Actual +results could differ from those estimates. +Cash Equivalents +The Company considers investments with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost, which approximates fair value. +The restricted cash balance includes an approximately $500,000 deposit required by the State of Washington for the Company’s estimated maximum workers’ compensation liability for the period in which the +Company was self-insured. The Company no longer self insures workers’ compensation liabilities but the deposit is required to be maintained for a number of years into the future. The remaining amounts in restricted cash are amounts in the +Company’s bank account that cannot be used for any other purpose than to pay down the Company’s long term revolving line of credit. +Allowance +for Doubtful Accounts +The Company evaluates the collectibility of accounts receivable and records an allowance for doubtful accounts, which reduces the +receivables to an amount that management reasonably estimates will be collected. A specific allowance is recorded against receivables that are considered to be impaired based on the Company’s knowledge of the financial condition of the +customer. In determining the amount of the allowance, the Company considers several factors including the aging of the receivables, the current business environment, and historical experience. After all attempts to collect a receivable have failed, +the receivable is written off against the allowance. +Inventories +Inventories are stated at the lower of cost or market. Cost is determined principally using the first-in, first-out (FIFO) method. The Company provides for obsolete and non-saleable inventories based on specific +identification of inventory against current demand forecasts and recent usage. +Property, Plant and Equipment +Property, plant and equipment are carried at cost and depreciated using straight-line methods over the expected useful lives of the assets. Internally constructed molds +and dies are depreciated over the expected useful lives of one to two years. +24 +Table of Contents +Impairment of Long-lived Assets +The Company, using its best estimates based on reasonable and supportable assumptions and projections, reviews assets for impairment whenever events or changes in circumstances have indicated that the carrying amount +of its assets might not be recoverable. Impaired assets are reported at the lower of cost or fair value. +Deferred Loan Fees +Deferred loan fees included in other assets are amortized over the term of the related loan agreement. +Accrued Warranty +An accrual is made for expected warranty costs, with the related expense recognized in cost of +goods sold. Management reviews the adequacy of this accrual quarterly based on historical analyses and anticipated product returns. +Self-funded +Insurance +The Company began to self-fund its domestic employee health plan on June 30, 2004. The Company contracted a separate administrative +service company to supervise and administer the program and act as its representative. The Company also insures for claims exceeding $50,000 and if the aggregate annual claims amount to more than 125% of expected claims for the plan year. The +Company estimates its exposure for claims incurred but not paid at the end of each reporting period and use historical information supplied by the Company’s insurance carrier and broker to estimate our liability for these claims. This liability +is subject to a total limitation that varies based on employee enrollment and factors that are established at each annual contract renewal. Actual claims experience may differ from the Company’s estimates. +Revenue Recognition +Sales revenue from manufacturing is recognized +upon shipment of the manufactured product under contractual terms, which are generally FOB shipping point. Upon shipment, title transfers and the customer assumes risks and rewards of ownership of the product. Generally, there are no formal customer +acceptance requirements or further obligations related to the manufacturing services; if any such requirements exist, then sales revenue is recognized at the time when such requirements are completed and such obligations are fulfilled. Revenue is +recorded net of estimated returns of manufactured product based on management’s analysis of historical returns. +Revenues and associated costs from +engineering design and development services, which are generally performed under contract of short term durations, are recognized only after the completed performance of the service. Revenue from engineering design and development services is +approximately two percent of total revenue in fiscal 2006. +Shipping and Handling Fees +The Company classifies costs associated with shipping and handling fees as a component of cost of goods sold. Customer billings related to shipping and handling fees are reported in net sales. +Research, Development and Engineering +Research, development and +engineering expenses include unreimbursed EMS costs as well as design and engineering costs associated with the production of EMS programs. Such costs are charged to expense as incurred. +Income Taxes +The Company accounts for income taxes in accordance with provisions of Statement of Financial +Accounting Standards (SFAS) No. 109, “Accounting for Income Taxes.” Under the asset and liability method prescribed by SFAS No. 109, deferred income taxes are provided for temporary differences between the financial reporting and +tax bases of assets and liabilities. Deferred taxes are measured using provisions of currently enacted tax laws. Tax credits are accounted for as a reduction of income taxes in the year the credit originates. Valuation allowances are +established when necessary to reduce deferred tax assets to the amount that will likely be realized. The effect of changes in tax rates is recognized in the period in which the rate change occurs. Management has no intent to repatriate undistributed +earnings of its foreign subsidiaries. Therefore, the determination of the unrecognized deferred tax liability on foreign subsidiary undistributed earnings is not practicable. +25 +Table of Contents +Earnings Per Share +Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of +common and common equivalent shares outstanding during the period using the treasury stock method. The computation assumes the proceeds from the exercise of stock options were used to repurchase common shares at the average market price during the +period. The computation of diluted earnings per share does not assume conversion, exercise, or contingent issuance of common stock equivalent shares that would have an antidilutive effect on earnings per share. +Foreign Currency Transactions +The functional currency of the +Company’s subsidiaries in Mexico, China and its former operating subsidiary in Ireland is the U.S. dollar. Realized foreign currency transaction gains and losses are included in general and administrative expenses. +Fair Value of Financial Instruments +The carrying values of financial +instruments reflected on the balance sheets at July 1, 2006 and July 2, 2005, reasonably approximate their fair value. Based on the borrowing rates currently available to the Company for loans with similar terms and average maturities, the +fair value of long-term debt is estimated to be $11.1 million and $8.9 million, respectively, as of July 1, 2006 and July 2, 2005, which approximates the carrying values. +Stock-based Compensation +Effective July 3, 2005, the Company adopted the provisions of SFAS No. 123R, +Share-Based Payment , for its share-based compensation plans. The Company previously accounted for these plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock +Issued to Employees, and related interpretations and disclosure requirements established by SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation – +Transition and Disclosure. +Under APB 25, no compensation expense was recorded in earnings for the Company’s stock options. The pro forma +effects on net income and earnings per share for stock options were instead disclosed in a footnote to the financial statements. Under SFAS No. 123R, all share-based compensation cost is measured at the grant date, based on the fair value of +the award, and is recognized as an expense in earnings over the requisite service period. Because the Company does not have a significant number of non-vested options outstanding, the adoption of SFAS No. 123R did not have a material impact on +operating results. +The Company adopted SFAS No. 123R using the modified prospective method. Under this transition method, compensation cost +recognized in fiscal year 2006 of $40,000 includes the cost for all share-based awards granted prior to, but not yet vested as of July 2, 2005. This cost was based on the grant-date fair value estimated in accordance with the original +provisions of SFAS No. 123. Results for prior periods have not been restated. The Company did not grant any stock options in fiscal 2006. As of July 1, 2006, there was $6,000 of total unrecognized compensation costs related to remaining +unvested stock options. These costs will be recognized over the next two quarters. +Reclassifications +Certain prior year amounts have been reclassified to conform with current year financial statement presentation. Such reclassifications had no impact on previously +reported net income or shareholders’ equity. +Goodwill +The Company records intangible assets that are acquired individually or with a group of other assets in the financial statements at acquisition. Goodwill is tested for impairment annually. These tests have not indicated an impairment of the +Company’s stated goodwill of $765,000. +26 +Table of Contents +New Accounting Pronouncements +In March 2005, the Financial Accounting Standards Board (FASB) issued Financial Interpretation 47 (FIN), Accounting for Conditional Asset Retirement Obligations , as an interpretation of SFAS No. 143, Accounting for Asset +Retirement Obligations . This interpretation clarifies that the term conditional asset retirement obligation as used in SFAS No. 143, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of +settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of +settlement. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. This interpretation also clarifies when an entity +would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 was effective no later than the end of fiscal years ending after December 15, 2005. The implementation of FIN 47 did not have a +material effect on the consolidated financial statements. +In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error +Corrections . SFAS No. 154 is a replacement of Accounting Principles Board Opinion No. 20 and SFAS No. 3. SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It +establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS No. 154 is effective for accounting changes and +corrections of errors made in fiscal years beginning after December 15, 2005, and it is required to be adopted by the Company in the first quarter of fiscal 2007. The Company does not anticipate that the provision of SFAS No. 154 will have +a material effect on the consolidated financial statements. +In June 2006, FIN 48 Accounting for Uncertainty in Income Taxes was issued which +clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes . This Interpretation prescribes a recognition threshold and +measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on de-recognition, classification, interest and penalties, +accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006, and earlier application of the provisions of this Interpretation is encouraged if the enterprise has +not yet issued financial statements, including interim financial statements, in the period this Interpretation is adopted. The Company does not anticipate that the provisions of FIN 48 will have a material effect on the consolidated financial +statements. +Fiscal Year +The Company operates on a +52/53 week fiscal year. Fiscal years end on the Saturday nearest June 30. As such, fiscal years 2006, 2005, and 2004 ended on July 1, 2006, July 2, 2005, and July 3, 2004, respectively. Fiscal year 2007 will end on +June 30, 2007. Fiscal 2006 and 2005 were 52 week years and fiscal 2004 was a 53 week year. +2. INVENTORIES +Components of inventories were as follows: +July 1, 2006 +July 2, 2005 +(in thousands) +Finished goods +$ +5,429 +$ +10,932 +Work-in-process +3,026 +3,414 +Raw materials +29,552 +18,531 +Reserve for obsolescence +(1,669 +) +(3,165 +) +$ +36,338 +$ +29,712 +3. PROPERTY, PLANT AND EQUIPMENT +Life +July 1, 2006 +July 2, 2005 +(in years) +(in thousands) +Land +— +$ +970 +$ +970 +Buildings and improvements +3 to 30 +11,107 +10,179 +Equipment +1 to 10 +38,170 +50,940 +Furniture and fixtures +3 to 5 +5,261 +6,259 +55,508 +68,348 +Accumulated depreciation +(45,701 +) +(58,337 +) +$ +9,807 +$ +10,011 +27 +Table of Contents +In July 2005, the Company completed its transition of operations in Las Cruces, New Mexico to its Juarez, Mexico +facility. The Las Cruces real estate is listed for sale and the associated net book value of $1.7 million is separately classified on the balance sheet. +In December 2000, the Company sold its headquarters building, located in Spokane, Washington. In conjunction with the sale, the Company entered into a ten year lease back agreement for a portion of the building. The gain on the sale of the +building was deferred under other long-term obligations and is amortized to offset lease expenses over the remaining lease term. +4. LONG-TERM DEBT +The Company has entered into a financing agreement with CIT Group/Business Credit, Inc. (CIT) which provides a revolving credit facility up to $25 +million is secured by the assets of the Company. The interest rate provisions allow for a variable rate based on either the prime rate or a set LIBOR rate on specific short term traunches. The agreement specifies four alternative levels of margin to +be added to these base rates depending on compliance with certain financial covenants. The range of interest being paid to CIT on outstanding balances was 7.46%– 8.25% as of July 1, 2006. The Company successfully negotiated a decrease in +the level of margin added in a loan agreement amendment signed in August 2006. The agreement and subsequent amendments contain financial covenants that relate to total equity, earnings before interest, taxes, depreciation and amortization, and a +minimum fixed charge ratio. The revolving loan matures August 22, 2009. As of July 1, 2006, the Company was in compliance with all loan covenants. At July 1, 2006, the outstanding revolving loan balance was $10.1 million compared to +$7.4 million at fiscal year end July 2, 2005. Based on eligible collateral, approximately $13.3 million was available to draw from the revolving line of credit as of July 1, 2006. +In addition to the Company’s revolving credit facility payment obligations, the Company has outstanding a $1.0 million term loan with CIT which is included in other +long term liabilities. The loan requires ratable principal payments over the next two years with a variable rate of 8.50% at July 1, 2006. The term loan was used to purchase the new Juarez, Mexico manufacturing facility in May 2005 and is +collateralized by the real estate in Las Cruces, New Mexico. +5. INCOME TAXES +Income tax expense (benefit) consists of the following: +Year Ended +July 1, 2006 +July 2, 2005 +July 3, 2004 +(in thousands) +Current income tax expense (benefit): +Federal +$ +— +$ +— +$ +— +Foreign +— +(75 +) +611 +State +— +— +— +— +(75 +) +611 +Deferred income tax expense (benefit): +Federal +2,184 +810 +(464 +) +Foreign +— +— +— +State +66 +90 +(16 +) +2,250 +900 +(480 +) +Change in valuation allowance +(7,250 +) +(900 +) +480 +(5,000 +) +— +— +Total income tax expense (benefit) +$ +(5,000 +) +$ +(75 +) +$ +611 +The Company had income tax expense (benefit) in the fiscal years ended July 1, 2006, July 2, 2005 +and July 3, 2004 approximating $(5.0) million, $(75) thousand and $611 thousand, respectively. The income tax benefit in 2006 related to the recognition of a portion of the domestic deferred tax assets, including NOLs, in accordance with SFAS +109. Management assessed the Company’s recent operating levels and the sources of future taxable income and determined it was more likely than not that the Company will utilize a portion of their deferred tax assets and NOLs in the carryfoward +period. Thus, management has determined that a valuation allowance approximating 80% of the total net domestic deferred tax asset is appropriate at this time. +28 +Table of Contents +The foreign tax provisions (benefits) for fiscal years ended July 2, 2005 and July 3, 2004 are the result of +earnings of foreign subsidiaries. The benefit in 2005 primarily related to a revision of the Mexican subsidiaries intercompany transfer pricing agreements, based upon new transfer price studies in the fourth quarter of fiscal 2005, application of +certain Mexican tax credits and a reduction in statutory rates in Mexico. The tax provision in 2004 related to the former intercompany transfer rates and higher statutory rates. +The Company does not provide for domestic income taxes on the undistributed earnings of its foreign subsidiaries, as such earnings are not intended by management to be repatriated in the foreseeable future. +Determination of the amount of the unrecognized deferred tax liability on these undistributed earnings is not practicable. +The Company’s effective +tax rate differs from the federal tax rate as follows: +Year Ended +July 1, 2006 +July 2, 2005 +July 3, 2004 +(in thousands) +Federal income tax expense at statutory rates +$ +1,616 +$ +1,462 +$ +245 +Effect of foreign vs. domestic taxes +(550 +) +(574 +) +110 +State tax (net of federal effect) +48 +43 +7 +Life insurance +— +(274 +) +65 +Expired NOLs +1,176 +— +— +Other +(40 +) +168 +(296 +) +Change in valuation allowance +(7,250 +) +(900 +) +480 +Income tax provision (benefit) +$ +(5,000 +) +$ +(75 +) +$ +611 +The domestic and foreign components of income (loss) before income taxes were: +Year Ended +July 1, 2006 +July 2, 2005 +July 3, 2004 +(in thousands) +Domestic +$ +3,181 +$ +2,874 +$ +(709 +) +Foreign +1,572 +1,427 +1,430 +Income before income taxes +$ +4,753 +$ +4,301 +$ +721 +Deferred income taxes result from temporary differences in the timing of recognition of revenue and expenses. +Deferred income tax assets and liabilities consist of the following at: +July 1, 2006 +July 2, 2005 +(in thousands) +Inventory +$ +1,107 +$ +1,467 +Vacation accrual +320 +341 +Litigation settlement +— +276 +Other +205 +316 +Net operating loss carryforwards +1,095 +— +Current deferred income tax assets +2,727 +2,400 +Current portion of valuation allowance +(1,227 +) +(2,400 +) +Current deferred income tax assets, net of valuation allowance +$ +1,500 +$ +— +Depreciation and amortization +$ +(740 +) +$ +(261 +) +State deferred taxes +524 +597 +Net operating loss carryforwards +18,313 +20,317 +Tax credit carryforwards +388 +388 +Other +238 +259 +Noncurrent deferred income tax assets +18,723 +21,300 +Valuation allowance, net of current portion +(15,223 +) +(21,300 +) +Noncurrent deferred income tax assets, net of valuation allowance +$ +3,500 +$ +— +Total deferred income tax assets +$ +5,000 +$ +— +29 +Table of Contents +At July 1, 2006, the Company had net operating loss carryforwards approximating $56.5 million. The remaining net +operating loss carryforwards expire in varying amounts through 2026. The Company also has general business credits and alternative minimum tax credits approximating $169,000 and $220,000, respectively. The general business credits expire in varying +amounts from fiscal years ending in years 2007 through 2009 and the alternative minimum tax credits do not expire. Utilization of net operating loss carryforwards would be limited in the event the Company’s ownership changes more than 50% in a +three-year period. +6. EARNINGS PER SHARE +Basic +earnings per share (EPS) is calculated by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is computed by including both the weighted-average number of +shares outstanding and any dilutive common share equivalents in the denominator. The following table presents a reconciliation of the denominator and the number of antidilutive common share options that were not included. These antidilutive +securities occur when options outstanding have an option price greater than the average market price for the period. +Years Ended +July 1, 2006 +July 2, 2005 +July 3, 2004 +Total weighted average shares – basic +9,707,020 +9,684,399 +9,673,128 +Effect of dilutive common stock options +362,871 +241,355 +119,707 +Total weighted average shares – diluted +10,069,891 +9,925,754 +9,792,835 +Antidilutive options not included in diluted earnings per share +896,800 +930,150 +1,759,391 +7. STOCK OPTION AND BENEFIT PLANS +The Company has executive stock option plans for certain key employees. Options under these plans vest over one to five years and become exercisable as they vest. Options under the plans become exercisable in full +immediately prior to the occurrence of a “Change in Control” as defined in the plan documents. The Company has reserved 2,795,000 shares for issuance under these plans. As of July 1, 2006, 1,655,800 options were outstanding of which +1,653,300 shares were exercisable. There are 84,867 shares available for future grant under these option plans. These options expire five to ten years from the date of grant or date of vesting. +The Company also has a stock option plan for “Nonemployee Directors.” Options under this plan vest over a three-year period and are exercisable as they vest. +The Company has reserved 300,000 shares for issuance under this plan. As of July 1, 2006, 269,650 options were outstanding of which 257,325 shares were exercisable. There are no shares available for future grant under this plan. These options +expire five to ten years from the date of grant or date of vesting. +On July 3, 2005, the Company adopted SFAS No. 123R and compensation expense +for options totaled approximately $40,000 in fiscal 2006. There was no compensation expense incurred in conjunction with options issued in fiscal years 2005 or 2004. +The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair-value recognition provisions of SFAS No. 123 to all of its share-based compensation awards +for periods prior to the adoption of SFAS No. 123R, (in thousands, except per share data): +30 +Table of Contents +Years Ended +July 2, 2005 +July 3, 2004 +(in thousands, except per share information) +Net income as reported +$ +4,376 +$ +110 +Add: Stock-based employee compensation +Expense in reported net income +— +— +Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards +(93 +) +(130 +) +Pro forma net income (loss) +$ +4,283 +$ +(20 +) +Earnings (loss) per share: +Basic – as reported +$ +0.45 +$ +0.01 +Diluted – as reported +$ +0.44 +$ +0.01 +Basic – pro forma +$ +0.44 +$ +(0.00 +) +Diluted – pro forma +$ +0.43 +$ +(0.00 +) +The following table summarizes option activity from July 2, 2005 through July 1, 2006: +Shares +Available +For Grant +Options +Outstanding +Aggregate +Intrinsic Value +(in thousands) +Weighted +Average +Exercise +Price +Weighted +Average +Remaining +Contractual +Life +Balance at July 2, 2005 +149,667 +1,985,650 +$ +4.22 +4.6 +Expiration of option plan +(84,867 +) +— +Options canceled +3,700 +(3,700 +) +$ +5.14 +Options exercised +— +(56,500 +) +$ +2.04 +Balance at July 1, 2006 +68,500 +1,925,450 +$ +1,422 +$ +4.28 +3.6 +Exercisable at July 1, 2006 +— +1,910,625 +$ +1,413 +$ +4.29 +3.6 +The following is a summary of plan activity: +Price Range +Number +Of Options +Weighted Average +Exercise Price +Outstanding, June 28, 2003 +$ +2.75 to $16.25 +2,086,086 +$ +4.44 +Granted during 2004 +$ +2.20 +37,500 +$ +2.20 +Exercised +$ +1.15 +(3,333 +) +$ +1.15 +Canceled +$ +1.15 to $ 9.50 +(48,362 +) +$ +7.62 +Outstanding, July 3, 2004 +$ +1.15 to $16.25 +2,071,891 +$ +4.33 +Granted during 2005 +$ +2.96 to $ 3.40 +29,650 +$ +3.33 +Exercised +$ +1.15 to $ 2.81 +(18,000 +) +$ +1.61 +Canceled +$ +1.15 to $ 9.50 +(97,891 +) +$ +6.78 +Outstanding, July 2, 2005 +$ +1.15 to $16.25 +1,985,650 +$ +4.22 +Exercised during 2006 +$ +1.15 to $ 2.81 +(56,500 +) +$ +2.04 +Canceled +$ +5.03 to $ 5.63 +(3,700 +) +$ +5.14 +Outstanding July 1, 2006 +$ +1.15 to $16.25 +1,925,450 +$ +4.28 +31 +Table of Contents +Additional information regarding options outstanding as of July 1, 2006, is as +follows: +Options +Outstanding +Options +Exercisable +Range of +Exercise Prices +Number +Outstanding +Weighted Avg. +Remaining +Contractual +Life (yrs.) +Weighted +Avg. Exercise +Price +Number +Exercisable +Weighted +Avg. Exercise +Price +$1.15 - $ 1.73 +105,000 +4.4 +$ +1.17 +105,000 +$ +1.17 +$ 1.74 -$ 2.60 +167,500 +4.1 +$ +2.10 +167,500 +$ +2.10 +$ 2.61 -$ 3.92 +756,150 +4.5 +$ +2.81 +741,325 +$ +2.80 +$ 3.93 -$ 5.89 +680,800 +2.9 +$ +5.07 +680,800 +$ +5.07 +$ 5.90 -$ 8.85 +151,000 +2.7 +$ +7.54 +151,000 +$ +7.54 +$13.31 - $16.25 +65,000 +0.6 +$ +16.25 +65,000 +$ +16.25 +$ 1.15 - $16.25 +1,925,450 +3.6 +$ +4.28 +1,910,625 +$ +4.29 +The Company also has a defined contribution plan (401(k)) available to U.S. employees who have attained age +21. The Company contributes an amount equal to 100% of the employee’s contribution on the first 3% of the employee’s compensation and an additional 50% of the employee’s contribution on the following 2% of the employee’s +compensation. Company contributions to the plan were $418,372, $380,153, and $370,336 in fiscal years 2006, 2005 and 2004, respectively. +8. COMMITMENTS +AND CONTINGENCIES +Leases: The Company has operating leases for certain equipment and production facilities, which expire at various dates during +the next six years. Future minimum payments under non-cancelable operating and capital leases with initial or remaining terms of one year or more at July 1, 2006, are summarized as follows (in thousands): +Fiscal Years Ending +Operating +Leases +Capital +Leases +2007 +$ +3,145 +$ +6 +2008 +2,133 +6 +2009 +1,705 +5 +2010 +1,325 +— +2011 +1,048 +— +Thereafter +30 +— +Total minimum lease payments +$ +9,386 +17 +Amount representing interest +(2 +) +Present value of lease payments +15 +Current portion +6 +Capital lease obligations, net of current portion +$ +9 +Rental expenses under operating leases were approximately $4.3 million, $4.5 million, and $5.0 million in 2006, +2005, and 2004, respectively. +Warranty Costs: The Company provides warranties on certain product sales and allowances for estimated warranty costs +are recorded during the period of sale. The determination of such allowances requires us to make estimates of product return rates and expected costs to repair or to replace the products under warranty. The Company currently establishes warranty +reserves based on historical warranty costs for each product line combined with liability estimates based on the prior twelve months’ sales activities. +If actual return rates and/or repair and replacement costs differ significantly from our estimates, adjustments to recognize additional cost of sales may be required in future periods. +32 +Table of Contents +Components of the reserve for warranty costs during 2006, 2005, and 2004 were as +follows: +Balance at June 28, 2003 +$ +161,144 +Additions related to current period sales +192,715 +Warranty costs incurred in the period +(180,127 +) +Balance at July 3, 2004 +173,732 +Additions related to current period sales +345,226 +Warranty costs incurred in the period +(273,103 +) +Balance at July 2, 2005 +245,855 +Recovery related to current period sales +(9,900 +) +Warranty costs incurred in the period +(145,955 +) +Balance at July 1, 2006 +$ +90,000 +Litigation : The Company may be party to certain lawsuits or claims in the ordinary course of business. The +Company does not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on the financial position, results of operations or cash flow. +Indemnification Rights : Under the Company’s Bylaws, the Company’s directors and officers have certain rights to indemnification by the Company against certain liabilities that may arise by reason of +their status or service as directors or officers. The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers and former directors in certain +circumstances. +9. ENTERPRISE-WIDE DISCLOSURES +Management organizes its business around EMS and keyboards based on geographic area. These businesses have been aggregated into one segment as each has similar economic characteristics, and the nature of the business, its production +processes, customers and distribution methods are similar. +Of the revenues for the years ended July 1, 2006, July 2, 2005, and July 3, +2004, EMS sales were $180.4 million, $192.8 million, and $135.5 million, respectively. Keyboard sales for the years ended July 1, 2006, July 2, 2005, and July 3, 2004 were $7.3 million, $10.1 million, and $13.4 million, +respectively. +Net sales and long-lived assets (property, plant, and equipment) by geographic area as of and for the years ended July 1, +2006, July 2, 2005, and July 3, 2004 are summarized in the following table. Net sales set forth below are based on the shipping destination. +Domestic (U.S.) +Foreign +Total +(in thousands) +2006 +Net sales +$ +173,978 +$ +13,721 +$ +187,699 +Long-lived assets +$ +8,184 +$ +1,623 +$ +9,807 +2005 +Net sales +$ +187,063 +$ +15,814 +$ +202,877 +Long-lived assets +$ +9,348 +$ +663 +$ +10,011 +2004 +Net sales +$ +134,413 +$ +14,488 +$ +148,901 +Long-lived assets +$ +10,153 +$ +978 +$ +11,131 +For the year ended July 1, 2006, 56.3% of the Company’s foreign net sales were to customers in +Switzerland, 23.8% were to Asia, 13.2% were to Canada, and the remaining 6.7% were spread among customers in other parts of Europe and Australia. +33 +Table of Contents +For the year ended July 2, 2005, 49.9% of the Company’s foreign net sales were to customers in Switzerland, +17.7% were to customers in Canada, 16.8 % were to customers in Mexico, 12.4% to customers in other parts of Europe, and the remaining 3.2% were spread among customers in Asia and South America. +For the year ended July 3, 2004, 44.5% of the Company’s foreign net sales were to customers in Mexico, 29.7% were to customers in Europe, 20.1% were to +customers in Canada, and the remaining 5.7% were spread among customers in Asia and South America. +Significant Customers +The following customers accounted for 10% or more of consolidated revenues in the three fiscal years presented below: +Fiscal Year +2006 +2005 +2004 +Zebra Technologies Corporation +20 +% +19 +% +12 +% +International Game Technology, Inc. +18 +% +14 +% +4 +% +Lexmark International, Inc. +17 +% +19 +% +14 +% +The Clorox Company +8 +% +8 +% +16 +% +Transaction Printer Group, Inc. +6 +% +9 +% +10 +% +Accounts receivable related to these customers represented approximately 21%, 16%, 21%, 2%, and 8%, respectively +of the Company’s total accounts receivable balance as of July 1, 2006. +There can be no assurance that the Company’s principal customers +will continue to purchase products from the Company at current levels. Moreover, the Company typically does not enter into long-term volume purchase contracts with its customers, and the Company’s customers have certain rights to extend or +delay the shipment of their orders. The loss of one or more of the Company’s major customers, or the reduction, delay or cancellation of orders from such customers, could materially and adversely affect the Company’s business, operating +results and financial condition. +10. QUARTERLY FINANCIAL DATA +(Unaudited) +Year Ended July 1, 2006 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +Net sales +$ +44,250 +$ +45,360 +$ +45,567 +$ +52,522 +Gross profit +3,852 +4,100 +3,977 +5,375 +Income before income taxes +709 +1,011 +917 +2,116 +Net income +702 +1,018 +917 +7,116 +Earnings per common share-basic +0.07 +0.10 +0.09 +0.73 +Earnings per common share-diluted +0.07 +0.10 +0.09 +0.71 +Weighted average shares outstanding +Basic +9,696 +9,703 +9,705 +9,724 +Diluted +10,140 +10,022 +10,064 +10,093 +34 +Table of Contents +Year Ended July 2, 2005 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +Net sales +$ +48,774 +$ +51,226 +$ +49,726 +$ +53,151 +Gross profit +3,548 +3,991 +4,050 +4,871 +Income before income taxes +383 +610 +762 +2,546 +Net income +266 +490 +852 +2,768 +Earnings per common share-basic +0.03 +0.05 +0.09 +0.29 +Earnings per common share-diluted +0.03 +0.05 +0.09 +0.28 +Weighted average shares outstanding +Basic +9,677 +9,681 +9,687 +9,692 +Diluted +9,914 +9,966 +9,901 +9,939 +Item 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES +None +Item 9A: CONTROLS AND PROCEDURES +a) +As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s chief executive +officer and chief financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the chief executive officer and chief +financial officer concluded that the Company’s disclosure controls and procedures are effective. +b) +There have been no changes in the Company’s internal controls over financial reporting during the quarter ended July 1, 2006 that have materially affected, or are +reasonable likely to materially affect, the Company’s internal control over financial reporting. +Item 9B: OTHER INFORMATION +None +35 +Table of Contents +PART III +Item 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT +DALE F. PILZ – +Director, Chairman of the Board +Dale F. Pilz, age 80, has served as Chairman of the Board since January 2000 and has been a director of the Company +since April 1992. Mr. Pilz was Chief Executive Officer of Flowind Corporation from 1986 to 1990. He served as President of Omninet Corporation from 1985 to 1986. Prior to that, Mr. Pilz was Chief Executive Officer and +President of GTE Sprint Communications from 1983 to 1985 and also served as Chief Executive Officer and President of GTE Spacenet Corporation from 1983 to 1985. +WENDELL J. SATRE - Director +Wendell J. Satre, age 88, has been a director of the Company since 1988 and served as Chairman of the +Board of Directors from July 1991 through August 1995. Mr. Satre also served as a director from 1983 through 1986 and served as President and CEO of the Company from August 1991 through February 1992. Mr. Satre is the retired +Chairman of the Board and Chief Executive Officer of the Washington Water Power Company (now Avista Corp.), a public utility headquartered in Spokane, Washington. Mr. Satre also serves on the Board of Directors of Output Technology +Corporation and The Coeur d’Alenes Company. +YACOV A. SHAMASH - Director +Yacov A. Shamash, age 56, has been a director of the Company since 1989. He has been the Dean of Engineering and Applied Sciences at the State University of New York campus at Stony Brook since +1992. Professor Shamash developed and directed the NSF Industry/University Cooperative Research Center for the Design of Analog/Digital Integrated Circuits from 1989 to 1992 and also served as Chairman of the Electrical and Computer Engineering +Department at Washington State University from 1985 until 1992. Dr. Shamash also serves on the Board of Directors of American Medical Alert Corp, Netsmart Technologies, Inc., and APDN. +WILLIAM E. TERRY - Director +William +E. Terry, age 73, has been a director of the Company since August 1992. Mr. Terry retired from Hewlett-Packard in November 1993 where he served in a number of executive positions during the prior 36 years. He is a Trustee of Santa +Clara University and also serves on the Board of Directors of Altera Corporation. +PATRICK SWEENEY- Director +Patrick Sweeney, age 71, has been a director of the Company since July 2000. Mr. Sweeney was President and CEO of Hadco Corporation from 1991 through 1995 and +formerly served as Hadco’s Vice President/Chief Financial Officer and Vice President of Operations. Prior to that Mr. Sweeney was the Vice President of International Manufacturing at Wang - USA from 1981 through 1986 and also served +as Managing Director of Ireland for Digital and as Plant Manager of its Galway and Clonmel divisions. Mr. Sweeney also serves on the Board of Directors of Aimware, Info. Mosaic and Photo Machining Inc., and Event Medical (Ireland). +JACK W. OEHLKE - Director, President and Chief Executive Officer +Jack W. Oehlke, age 60, has been President and Chief Executive Officer of the Company since June 1997. From October 1995, he served as Chief Operating Officer. Previously, he served as Senior Vice President +of Operations from January 1995 to October 1995 and Vice President of Manufacturing Operations of the Company from December 1993 to January 1995. Mr. Oehlke served as Director of Operations, Director of Quality and in various management +positions within manufacturing, engineering and quality functions of the Microswitch Division of Honeywell, Inc. from 1968 to 1993. Mr. Oehlke has a Bachelor of Science Degree in Industrial Technology from the University of Wisconsin at +Menomonie. +RONALD F. KLAWITTER - Executive Vice President of Administration and Chief Financial Officer +Mr. Klawitter, age 54, has been Executive Vice President of Administration, CFO, and Treasurer since July 1997. Previously he was Vice President of Finance, +Secretary and Treasurer of the Company since October 1995. He was Acting Secretary from +36 +Table of Contents +November 1994 to October 1995 and Vice President of Finance and Treasurer from 1992 to October 1995. From 1987 to 1992, Mr. Klawitter was Vice +President, Finance at Baker Hughes Tubular Service, a subsidiary of Baker Hughes, Inc. He has a BA degree from Wittenberg University and is a Certified Public Accountant. +CRAIG D. GATES - Executive Vice President and General Manager +Mr. Gates, age 47, has been Executive Vice +President and General Manager since August 2002. Previously he was Executive Vice President of Marketing, Engineering and Sales since July 1997. He served as Vice President and General Manager of New Business Development from October 1995 to July +1997. He joined the Company as Vice President of Engineering in October of 1994. Mr. Gates has a Bachelor of Science Degree in Mechanical Engineering and a Masters in Business Administration from the University of Illinois, Urbana. From 1982 he +held various engineering and management positions within the Microswitch Division of Honeywell, Inc., in Freeport, Illinois, and from 1991 to October 1994 he served as Director of Operations, Electronics for Microswitch. +EFREN R. PEREZ – Vice President of S.W. Operations +Mr. Perez, age 66, has served as Vice President of S.W. Operations since July 1997. Previously he was the Managing Director of S.W. Operations from July 1996 to July 1997 and Director of S.W. Operations from July +1995 to June 1996. Following the Company’s acquisition of the Honeywell, Inc. Keyboard Division, Mr. Perez served as Plant Manager in Juarez from July 1993 to July 1995. He served as Plant Manager in Juarez for the Keyboard Division of +Honeywell, Inc. from February 1989 to July 1993. Mr. Perez is a graduate of the University of Mexico with a B.S. in Physics. +GEORGE R. ALFORD +– Vice President of Materials +George R. Alford, age 53, has been Vice President of Materials of the Company since July 2006. From August 2005 to +July 2006 he served as Director of Materials (HID Group) at Cooper Industries. From October 2000 to August 2005, he served in various procurement and materials management positions with Solectron Corporation. Mr. Alford has a B.S. in Industrial +Technology and a M.A. in Management from Middle Tennessee State University and a J.D. in Civil Law from Nashville School of Law. +Compliance with +Section 16(a) of the Exchange Act: +Incorporated by reference to Key Tronic Corporation’s 2003 Proxy +Statement to Shareholders. +Code of Conduct +The Board +of Directors has adopted a written Code of Conduct which applies to its directors and employees, including its executive officers. The Code of Conduct is available on the Company’s website at www.keytronic.com . The Company intends to +disclose on its website any amendments to or waivers of the Code of Conduct. +Item 11: EXECUTIVE COMPENSATION +Information appearing under the caption “Executive Compensation” in the +Company’s 2006 Proxy Statement is incorporated herein by this reference. +Item 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT +The following table sets forth the aggregate +information for the Company’s equity compensation plans in effect as of July 1, 2006. +37 +Table of Contents +EQUITY COMPENSATION PLAN INFORMATION +Plan category +Number of securities to +be issued upon +exercise +of outstanding options, +warrants and rights +(a) +Weighted-average +exercise price +of +outstanding options, +warrants and rights +(b) +Number of +securities +remaining available for +future issuance under +equity compensation +plans (excluding +securities reflected in +column (a)) +(c) +Equity compensation plans approved by security holders +1,625,950 +$ +4.64 +0 +Equity compensation plans not approved by security holders (1) +299,500 +$ +2.34 +68,500 +Total +1,925,450 +$ +4.28 +68,500 +(1) +Consists of the Key Tronic Corporation 2000 Employee Stock Option Plan +Information under the caption “Beneficial Ownership of Securities” in the Company’s 2006 Proxy Statement is incorporated herein by this reference. +Item 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +Information appearing under the caption “Certain +Relationships and Transactions” and “Compensation Committee Interlocks and Insider Participation” in the Company’s 2006 Proxy Statement is incorporated herein by this reference. +Item 14: PRINCIPAL ACCOUNTING FEES AND SERVICES +Information appearing under the caption “Principal Accountant Fees +and Services” in the Company’s 2006 Proxy Statement is incorporated herein by this reference. +38 +Table of Contents +PART IV +Item 15: EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a) 1. FINANCIAL STATEMENTS +Page in +Form 10-K +FINANCIAL STATEMENTS +Report of Independent Registered Public Accounting Firm +19 +Consolidated Balance Sheets, as of July 1, 2006, and July 2, 2005 +20 +Consolidated Statements of Earnings for the years ended July 1, 2006, July 2, 2005, and July 3, 2004 +21 +Consolidated Statements of Shareholders’ Equity for the years ended July 1, 2006, July 2, 2005, and July 3, 2004 +22 +Consolidated Statements of Cash Flows for the years ended July 1, 2006, July 2, 2005, and July 3, 2004 +23 +Notes to Consolidated Financial Statements +24-35 +2. SCHEDULES +Report of Independent Registered Public Accounting Firm on Financial Statement Schedule +19 +II. Consolidated Valuation and Qualifying Accounts +41 +Other schedules are omitted because of the absence of conditions under which they are required, or because +required information is given in the financial statements or notes thereto. +3. EXHIBITS +Exhibit No. +Description +3.1 +Articles of Incorporation, incorporated by reference to the Exhibits to the Company’s form 10-K for the year ended June 30, 1986 +3.2 +Bylaws, as amended, incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended June 30, 1986 +10.1* +Executive Stock Option Plan, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended June 30, 1986 +10.2* +Amended and Restated 1990 Stock Option Plan for Non-Employee Directors, as amended, incorporated by reference to the Company’s 1997 Proxy Statement (dated October 10, 1997), pages +14-17 +10.3* +1995 Executive Stock Option Plan, incorporated by reference to the Company’s 1995 Proxy Statement, pages 19-22 +10.4* +2000 Employee Stock Option Plan, incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended January 1, 2000 +10.5* +Officers’ Employment Contracts, incorporated by reference to the Company’s 1998 Proxy Statement, pages 10 and 11 +10.6* +Employment Contract with Michael D. Chard, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended July 1, 2000 +10.7* +Addenda to Officers’ Employment Contracts, incorporated by reference to Exhibits to the Company’s Form 10-Q for the quarter ended January 1, 2000 +10.8* +Description of Retention Bonus Plan, incorporated by reference to the Exhibits to the Company’s 10-Q for the quarter ended December 28, 2002 +10.9* +Addenda to Officers’ Employment Contracts, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended June 29, 2002 +10.10 +Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended September 29, 2001 +10.11 +First and Second Amendments to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended June 29, +2002 +39 +Table of Contents +10.12 +Third Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended December 29, +2002 +10.13 +Fourth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended June 28, +2003 +10.14 +Fifth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended December 27, +2003 +10.15 +Sixth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended April 3, +2004 +10.16 +Seventh Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended July 3, +2004 +10.17 +Eighth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s From 10-K for the year ended July 3, +2004 +10.18 +Ninth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended October 2, +2004 +10.19 +Tenth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibit to the Company’s Form 8-K filed April 4, 2005 +10.20 +Promise to execute a Purchase and Sale Agreement with Key Safety Systems de Mexico, S.A. de C.V., incorporated by reference to the Exhibit to the Company’s Form 8-K filed April 26, +2005 +10.21 +Summary of material terms and conditions of the Purchase and Sale Agreement with Key Safety Systems de Mexico, S.A. de C.V., incorporated by reference to the Exhibit to the Company’s +Form 8-K filed June 6, 2005 +10.22 +Twelfth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibit to the Company’s Form 8-K filed September 7, 2006 +10.23* +Summary of Key Tronic Corporation Incentive Compensation Plan, incorporated by reference to Exhibit 10.23* the Company’s Form 10-K for the year ended July 2, 2005 +10.24* +Summary of Key Tronic Corporation Long Term Incentive Compensation Plan, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed September 27, 2005 +10.25* +Employment Contract between Key Tronic Corporation and George Robert Alford, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed July 26, 2006 +10.26* +Summary of Incentive Compensation Plan Performance goals and Target Payments for fiscal year 2007, incorporated by reference to the Company’s Form 8-K filed July 28, +2006 +10.27* +Summary of Fiscal Years 2007 – 2009 Long Term Incentive Plan Performance Measures and Awards, incorporated by reference to the Company’s From 8-K filed July 28, +2006 +21. +Subsidiaries of Registrant, submitted herewith +23.1 +Consent of Independent Registered Public Accounting Firm, submitted herewith +31.1 +Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer, submitted herewith +31.2 +Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer, submitted herewith +32.1 +Section 1350 Certification of Chief Executive Officer, submitted herewith +32.2 +Section 1350 Certification of Chief Financial Officer, submitted herewith +* +Management contract or compensatory plan or arrangement +40 +Table of Contents +PART IV +SCHEDULE II +KEY TRONIC CORPORATION AND SUBSIDIARIES +CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS +FISCAL YEARS ENDED JULY 1, 2006, JULY 2, 2005, AND +JULY 3, 2004 +2006 +2005 +2004 +(in thousands) +Allowance for Obsolete Inventory +Balance at beginning of year +$ +3,165 +$ +3,181 +$ +3,513 +Provisions +361 +730 +162 +Dispositions +(1,857 +) +(746 +) +(494 +) +Balance at end of year +$ +1,669 +$ +3,165 +$ +3,181 +Allowance for Doubtful Accounts +Balance at beginning of year +$ +158 +$ +60 +$ +105 +Provisions +6 +140 +— +Write-offs +(164 +) +(42 +) +(45 +) +Balance at end of year +$ +0 +$ +158 +$ +60 +41 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the +registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: September 18, 2006 +KEY TRONIC CORPORATION +By: +/s/ Jack W. Oehlke +Jack W. Oehlke, Director, President, and Chief Executive Officer +42 +Table of Contents +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by +the following persons on behalf of the registrant and in the capacities and on the dates indicated: +/s/ Jack W. Oehlke +September 18, 2006 +Jack W. Oehlke +Date +(Director, President and Chief Executive Officer) +/s/ Ronald F. Klawitter +September 18, 2006 +Ronald F. Klawitter +Date +(Principal Financial Officer) +/s/ Dale F. Pilz +September 18, 2006 +Dale F. Pilz +Date +(Director, Chairman of the Board) +/s/ Wendell J. Satre +September 18, 2006 +Wendell J. Satre +Date +(Director) +/s/ Yacov A. Shamash +September 18, 2006 +Yacov A. Shamash +Date +(Director) +/s/ Patrick Sweeney +September 18, 2006 +Patrick Sweeney +Date +(Director) +/s/ William E. Terry +September 18, 2006 +William E. Terry +Date +(Director) +43 \ No newline at end of file diff --git a/raw/filings/0000719733/2006/0001193125-06-192374/filing_metadata.csv b/raw/filings/0000719733/2006/0001193125-06-192374/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..6d84b8c081f08e45819525d921c600220a1cb43f --- /dev/null +++ b/raw/filings/0000719733/2006/0001193125-06-192374/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000719733,KTCC,KEY TRONIC CORP,10-K,2006-09-18,2006-07-01,2006-09-18T18:09:58.000Z,0001193125-06-192374,d10k.htm,FORM 10-K,652339,0,0,https://www.sec.gov/Archives/edgar/data/719733/000119312506192374/d10k.htm,https://www.sec.gov/Archives/edgar/data/719733/000119312506192374/,2006,2006,1 diff --git a/raw/filings/0000719733/2006/0001193125-06-192374/item1.txt b/raw/filings/0000719733/2006/0001193125-06-192374/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..430f115584000a132163a6eb39b6298bfce75a6b --- /dev/null +++ b/raw/filings/0000719733/2006/0001193125-06-192374/item1.txt @@ -0,0 +1,112 @@ +Item 1. BUSINESS +Overview +Key Tronic Corporation (dba KeyTronicEMS Co.), a Washington corporation organized in 1969, and its subsidiaries (hereinafter collectively called the “Company”, “Key Tronic”, or “we” unless the context otherwise +requires) are principally engaged in electronic manufacturing services (EMS) and consumer related products manufacturing for original equipment manufacturers (OEMs). The Company also manufactures keyboards and other input devices for personal +computers, terminals, and workstations primarily in standard layouts that can be sold directly from inventory on hand. +Key Tronic is now known as an +independent provider of product realization services for OEMs in a variety of industries. Historically, Key Tronic was principally a manufacturer of electronic keyboards, but after assessing market conditions and the Company’s strengths and +capabilities, approximately seven years ago the Company shifted its focus to EMS. The EMS industry is comprised of companies that provide a range of manufacturing services for OEMs. The EMS industry has experienced rapid growth over the past several +years as more OEMs shift to outsourcing manufacturing, and this trend is expected to continue in the future. +Operations are currently conducted in +facilities in the United States, Mexico and China. The Company’s global production capability provides customers with benefits of improved supply-chain management, reduced inventory, lower labor costs, lower transportation costs and reduced +product fulfillment time. +Marketing +The Company +provides manufacturing services for outsourced OEM products. Key Tronic provides a mix of EMS services including: product design, surface mount technologies (SMT) for printed circuit board assembly, tool making, precision plastic molding, liquid +injection molding, prototype design, full product builds, and printing screened silver flexible circuit membranes. +Revenues from EMS services for the +fiscal years ended July 1, 2006, July 2, 2005, and July 3, 2004 were 96.4%, 95.0% and 91.0%, respectively. Sales of the majority of the Company’s products have historically not been seasonal in nature, but may be seasonal in +the future, if there are changes in the types of products manufactured. +Although keyboard manufacturing is still included in the Company’s product +offerings, annual keyboard sales continue to decline. During the fiscal years ended July 1, 2006, July 2, 2005, and July 3, 2004, the Company realized revenues of approximately $7.3 million, $10.1 million and $13.4 million, +respectively, from the sale of keyboards representing approximately 3.6%, 5.0% and 9.0% of consolidated revenues. The keyboard market has continued to trend toward standard keyboard layouts. In order to accommodate the demand for standard products, +the Company maintains a purchase-from-stock program. The most popular standard layouts are built and stocked for immediate availability. +The Company +markets its products and services primarily through its direct sales department aided by strategically located field sales people and distributors. Although the Company maintains relationships with several independent sales organizations to assist +in marketing the Company’s EMS product lines in the U.S., commissions earned and paid are insignificant. +3 +Table of Contents +The following customers accounted for 10% or more of consolidated revenues in the three +fiscal years presented below: +Fiscal Year +2006 +2005 +2004 +Zebra Technologies Corporation +20 +% +19 +% +12 +% +International Game Technology, Inc. +18 +% +14 +% +4 +% +Lexmark International, Inc. +17 +% +19 +% +14 +% +The Clorox Company +8 +% +8 +% +16 +% +Transaction Printer Group, Inc. +6 +% +9 +% +10 +% +For the fiscal years ended July 1, 2006, July 2, 2005, and July 3, 2004, the five largest +customers in each year accounted for 71%, 68% and 58% of total sales, respectively. +Manufacturing +Since inception, the Company has made substantial investments in developing and expanding a capital equipment base to achieve selective vertical integration and +efficiencies in its manufacturing processes. The Company has invested significant capital into surface mount technologies (SMT) for high volume manufacturing of complex printed circuit board assemblies. The Company also designs and develops tooling +for injection molding and manufactures the majority of plastic parts used in the products it manufactures. Additionally, the Company has equipment to produce printed flexible circuit membranes. +Key Tronic uses a variety of manual and highly automated assembly processes in its facilities, depending upon product complexity and degree of customization. Automated +processes include component insertion, SMT, flexible robotic assembly, computerized vision system quality inspection, automated switch and keytop installation, and automated functional testing. +The Company’s automated manufacturing processes enable it to work closely with its customers during the design and prototype stages of production and to jointly +increase productivity and reduce response time to the marketplace. Key Tronic uses computer-aided design techniques and unique software to assist in preparation of the tool design layout and tool fabrications, to reduce tooling costs, improve +component and product quality, and enhance turnaround time during product development. +The Company purchases materials and components for its products +from many different suppliers both domestic and international. Key Tronic develops close working relationships with its suppliers, many of whom have been supplying products to the Company for several years. +Backlog +On July 29, 2006, the Company had an order backlog of +approximately $65.9 million. This compares with a backlog of approximately $63.4 million on July 30, 2005. Order backlog is not necessarily indicative of future sales but can be indicative of trends in expected future sales revenue. Order +backlog consists of purchase orders received for products expected to be shipped approximately within the next twelve months, although shipment dates are subject to change due to design modifications, customer forecast changes, or other customer +requirements. +Research, Development, and Engineering +Research, development, and engineering (RD&E) expenses consist principally of employee related costs, third party development costs, program materials costs, depreciation and allocated information technology and facilities costs. The +Company’s RD&E expenses were $2.8 million, $2.9 million and $2.6 million in fiscal years 2006, 2005, and 2004, respectively. In each of these years, the Company focused most of its RD&E efforts on current customer EMS programs. The +lower cost in fiscal year 2004 compared to fiscal years 2006 and 2005 is due primarily to a 10% pay reduction during part of fiscal year 2004. +Competition +The market for the products and services the Company provides is highly competitive. There are numerous competitors in the EMS +industry, many of which have substantially more resources and are more geographically diverse. Key Tronic competes primarily on the basis of responsiveness, creativity, vertical production capability, quality, and price. +Trademarks and Patents +The Key Tronic name and logo are federally +registered trademarks, and the Company believes they are valuable assets of its business. During 2001, Key Tronic began operating under the trade name “KeyTronicEMS Co.” to better identify its primary business concentration. The Company +also owns several keyboard patents; however, since the Company’s focus is EMS, management believes that these patents will not have a significant impact on future revenues. +4 +Table of Contents +Employees +As of +July 1, 2006, the Company had 2,840 employees compared to 2,849 on July 2, 2005 and 2,847 on July 3, 2004. Since the Company can have significant fluctuations in product demand, it seeks to maintain flexibility in its workforce by +utilizing skilled temporary and short-term contract labor in its manufacturing facilities in addition to full-time employees. The Company’s employees in Reynosa, Mexico, which represent approximately 6% of the Company’s employees, are +represented by a local union. The Company has no history of any material interruption of production due to labor disputes. +The Company considers its +employees its primary strength and makes considerable efforts to maintain a well-qualified staff. The Company’s employee benefits include bonus programs involving periodic payments to all employees based on meeting quarterly or fiscal year +performance targets. The Company maintains a 401(k) plan for U.S. employees, which provides a matching company contribution of up to 4% of an employee’s salary, and also provides group health, life, and disability insurance plans. The Company +also maintains stock option plans and other long term incentive plans for certain employees and outside directors. +Foreign Markets +Information concerning net sales and long-lived assets (property, plant, and equipment) by geographic areas is set forth in footnote 9 of the consolidated financial +statements of this Annual Report on Form 10-K, under the caption “Enterprise-Wide Disclosures”, and that information is incorporated herein by reference. \ No newline at end of file diff --git a/raw/filings/0000719733/2006/0001193125-06-192374/item13.txt b/raw/filings/0000719733/2006/0001193125-06-192374/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..d1d01d087516143b188084d7c353d458c4691d51 --- /dev/null +++ b/raw/filings/0000719733/2006/0001193125-06-192374/item13.txt @@ -0,0 +1,3 @@ +Item 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +Information appearing under the caption “Certain +Relationships and Transactions” and “Compensation Committee Interlocks and Insider Participation” in the Company’s 2006 Proxy Statement is incorporated herein by this reference. \ No newline at end of file diff --git a/raw/filings/0000719733/2006/0001193125-06-192374/item9a.txt b/raw/filings/0000719733/2006/0001193125-06-192374/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..7508bd019590f59e0b8704b5376d8e113c4e51ad --- /dev/null +++ b/raw/filings/0000719733/2006/0001193125-06-192374/item9a.txt @@ -0,0 +1,8 @@ +Item 9A: CONTROLS AND PROCEDURES +a) +As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s chief executive +officer and chief financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the chief executive officer and chief +financial officer concluded that the Company’s disclosure controls and procedures are effective. +b) +There have been no changes in the Company’s internal controls over financial reporting during the quarter ended July 1, 2006 that have materially affected, or are +reasonable likely to materially affect, the Company’s internal control over financial reporting. \ No newline at end of file diff --git a/raw/filings/0000719733/2006/0001193125-06-192374/rp_note.txt b/raw/filings/0000719733/2006/0001193125-06-192374/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000719733/2006/0001193125-06-192374/rpt_disclosure.txt b/raw/filings/0000719733/2006/0001193125-06-192374/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..a357be28ac9bc3323a5805d8eaa44f7f696cf0be --- /dev/null +++ b/raw/filings/0000719733/2006/0001193125-06-192374/rpt_disclosure.txt @@ -0,0 +1,19 @@ +Related Person Transactions +In April 2007, the Board of Directors +adopted a written policy and procedures for the approval or ratification of Interested Transactions with Related Parties. The policy and procedures supplement the Company’s Code of Conduct. The policy defines an “Interested +Transaction” as any transaction, arrangement or relationship or series of similar transactions, arrangements or relationships (including any indebtedness or guarantee of indebtedness) in which (1) the aggregate amount involved will or may +be expected to exceed $120,000 in any calendar year, (2) the Company is a participant, and (3) any Related Party has or will have a direct or indirect interest (other than solely as a result of being a director or a less than 10 percent +beneficial owner of another entity). +The policy defines a “Related Party” as any (a) person who is or was (since the beginning of the last +fiscal year for which the Company has filed a Form 10-K and proxy statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director, (b) greater than 5 percent +4 +beneficial owner of the Company’s common stock, or (c) immediate family member of any of the foregoing. +Immediate family member includes a person’s spouse, parents, stepparents, children, stepchildren, siblings, mothers- and fathers-in-law, sons- and daughters-in-law, and brothers- and sisters-in-law and anyone residing in such person’s home +(other than a tenant or employee). +The Audit Committee is responsible for review, approval, ratification or disapproval of Interested Transactions. In +determining whether to approve or ratify an Interested Transaction, the Committee will take into account, among other factors it deems appropriate, whether the Interested Transaction is on terms no less favorable than terms generally available to an +unaffiliated third party under the same or similar circumstances and the extent of the Related Party’s interest in the Transaction. The Company had no related Party Transactions during fiscal year 2007. +Compensation Committee Interlocks and Insider Participation in Compensation Decisions +The Board of Directors has a Compensation Committee presently consisting of Messrs. Shamash and Pilz. No member of the Compensation Committee was an officer or employee of the Company or any of its subsidiaries during +fiscal year 2007. None of the executive officers of the Company has served on the Board of Directors or on the Compensation Committee of any other entity, any of whose officers served either on the Board of Directors or on the Compensation Committee +of the Company. \ No newline at end of file diff --git a/raw/filings/0000719733/2008/0001193125-08-195739/filing.txt b/raw/filings/0000719733/2008/0001193125-08-195739/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..078fc32af640b90f4a57b7b1d456da04d1d01ba7 --- /dev/null +++ b/raw/filings/0000719733/2008/0001193125-08-195739/filing.txt @@ -0,0 +1,2904 @@ +10-K +1 +d10k.htm +FORM 10-K +Form 10-K +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +þ +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended June 28, 2008 +OR +¨ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission +File Number 0-11559 +KEY TRONIC CORPORATION +(Exact name of registrant as specified in its charter) +Washington +91-0849125 +(State or other jurisdiction of +Incorporation or organization) +(I.R.S. Employer +Identification No.) +N. 4424 Sullivan Road, Spokane Valley, Washington +99216 +(Address of principal executive offices) +(Zip Code) +(509) 928-8000 +(Registrant’s telephone number, including area code) +N/A +(Former name, former address and former fiscal year, if changed since last report) +Securities Registered Pursuant to Section 12(b) of the Act: None +Title of each class +Name of each exchange on which registered +Common stock, no par value +The NASDAQ Stock Market LLC +Securities Registered Pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. +Yes ¨ No þ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. +Yes ¨ No þ +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 þ No ¨ +Table of Contents +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is +not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a +non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +(Check one): +Large accelerated filer ¨ +Accelerated filer ¨ +Non-accelerated filer ¨ +Smaller reporting company þ +(Do not check if a smaller reporting company) +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the +Exchange Act). +Yes ¨ No þ +State the aggregate market value of the voting and non-voting common equity held by non affiliates computed +by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. +As of December 29, 2007, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $24.2 million +based on the closing price as reported on the NASDAQ. +Indicate the number of shares outstanding of each of the issuer’s classes of +common stock, as of the latest practicable date: 10,052,641 shares of common stock were outstanding as of September 1, 2008. +Documents Incorporated by Reference: +The following documents are incorporated by reference to the extent specified herein: +Document Description +Part of Form 10-K +Proxy Statement dated September 19, 2008 +Part III +Table of Contents +KEY TRONIC CORPORATION +2008 FORM 10-K +TABLE OF CONTENTS +Page +Part I +Item 1. +Business +4 - 6 +Item 1A. +Risk Factors +6 - 8 +Item 1B. +Unresolved Staff Comments +9 +Item 2. +Properties +9 +Item 3. +Legal Proceedings +10 +Item 4. +Submission of Matters to a Vote of Security Holders +10 +Executive Officers of the Registrant +10 - 11 +Part II +Item 5. +Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity +Securities +11 - 12 +Item 6. +Selected Financial Data +13 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +13 - 21 +Item 7A. +Quantitative and Qualitative Disclosures about Market Risk +22 +Item 8. +Financial Statements and Supplementary Data +23 - 38 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +38 +Item 9A(T). +Controls and Procedures +38 - 39 +Item 9B. +Other Information +39 +Part III +Item 10. +Directors, Executive Officers and Corporate Governance +40 +Item 11. +Executive Compensation +40 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +40 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +41 +Item 14. +Principal Accounting Fees and Services +41 +Part IV +Item 15. +Exhibits and Financial Statement Schedule +42 - 44 +Signatures +45 - 46 +3 +Table of Contents +FORWARD-LOOKING STATEMENTS +References in this report to “the Company”, “Key Tronic”, “we”, “our”, or “us” mean Key Tronic Corporation together with its subsidiaries, except where the context otherwise requires. +This Annual Report contains forward-looking statements in addition to historical information. Forward-looking statements are subject to certain +risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Risks and uncertainties that might cause such differences include, but are not limited to those outlined in +“Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risks and Uncertainties that May Affect Future Results.” Readers are cautioned not to place undue reliance on forward-looking statements, +which reflect management’s opinions only as of the date hereof. The Company undertakes no obligation to update forward-looking statements to reflect developments or information obtained after the date hereof and disclaims any obligation to do +so. Readers should carefully review the risk factors described in periodic reports the Company files from time to time with the Securities and Exchange Commission, including Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. +PART I +Item 1. +BUSINESS +Overview +Key Tronic Corporation (dba: KeyTronicEMS Co.), was organized in 1969 as a Washington corporation that locally manufactured computer keyboards. Our goal was to become the +world’s largest manufacturer of input devices for terminals, word processors and personal computers. The ability to design, build and deliver a quality product led to a reputation in the industry, allowing us to be a leading independent +manufacturer of keyboards for computers in the United States. Our fully integrated design, tooling and automated manufacturing capabilities enabled us to rapidly respond to customers’ needs for keyboards in production quantities worldwide. We +supported our sales growth through the development and purchase of international manufacturing facilities. As the computer keyboard market matured with increasing competition from other international providers, we determined that our business could +no longer solely rely on keyboard sales. +After assessing market conditions and our strengths and capabilities in 1999, we shifted focus from keyboard +manufacturing to contract manufacturing for a wide range of products. Our new strategy was based on our original core strengths of innovative design and engineering expertise in electronics, mechanical engineering and precision plastics combined +with high-quality, low cost production and assembly on a global basis. These strengths have made our company a strong competitor in the electronic manufacturing services “EMS” market. As we fully transitioned into an EMS provider, our new +customer base became comprised of world-class customers from a wide range of industries. +The EMS industry has experienced growth over the past several +years as more original equipment manufacturers “OEMs” seek to outsource manufacturing and this trend is expected to continue in the future. This expansion of the EMS industry has allowed us to continue to expand our customer base and the +industries that we serve. We currently offer our customers the following services: integrated electronic and mechanical engineering; precision plastic molding; assembly, component selection, sourcing and procurement; worldwide logistics; competitive +pricing; and new product testing and production. +We operate in facilities in the United States, Mexico and China. This global production capability +provides our customers with the benefits of improved supply-chain management, reduced inventory, lower labor costs, lower transportation costs and reduced product fulfillment time. +Our principal executive offices are located at N. 4424 Sullivan Road, Spokane Valley, Washington 99216, and our telephone number is (509) 928-8000. Our website is located at http://www.keytronicems.com where +filings of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q or current reports on Form 8-K are available after they have been filed with the Securities and Exchange Commission. The information presented on our website currently and in +the future is not considered to be part of this document or any document incorporated by reference in this document. +Marketing +We provide a mix of manufacturing services for outsourced OEM products. We provide the following EMS services: product design, surface mount technologies “SMT” +for printed circuit board assembly, tool making, precision plastic molding, liquid injection molding, automated tape winding, prototype design and full product builds. +4 +Table of Contents +Sales of the majority of our products have historically not been seasonal in nature, but may be seasonal in the future if +there are changes in the types of products manufactured. Sales can, however, fluctuate significantly between quarters from changes in customers’ demand due to our revenue concentration in a few specific customers. +For the fiscal years ended June 28, 2008, June 30, 2007, and July 1, 2006, the five largest customers in each year accounted for 68%, 73% and 71% of +total sales, respectively. The following customers represented 10 percent or more of total net sales over the last three fiscal years: International Game Technology, Inc. (18%, 17%, 18%), Zebra Technologies Corporation (18%, 22%, 20%) and Lexmark +International, Inc. (15%, 18%, 17%). It is anticipated that our new customer program wins will dilute our concentration of revenue in our current top five customers in the future. +Although keyboard manufacturing is still included in our product offerings, we expect annual keyboard sales to decline over time. During the fiscal years ended June 28, 2008, June 30, 2007, and +July 1, 2006, we realized revenues of approximately $5.8 million, $5.6 million and $7.3 million, respectively, from the sale of keyboards. In order to accommodate the demand for standard keyboard layouts, we maintain a purchase-from-stock +program. The more popular standard layouts are built and stocked for immediate availability. +We market our products and services primarily through our +direct sales department aided by strategically located field sales people and distributors. Although we maintain relationships with several independent sales organizations to assist in marketing our EMS product lines, commissions earned and paid are +not material to the consolidated financial statements. +Manufacturing +Since inception, we have made substantial investments in developing and expanding a capital equipment base to achieve vertical integration and efficiencies in our manufacturing processes. We have invested significant +capital into SMT for volume manufacturing of complex printed circuit board assemblies. We also design and develop tooling for injection molding and manufacture the majority of plastic parts used in the products we manufacture. Additionally, we have +equipment to maintain a controlled clean environment for manufacturing processes that require a high level of precise control. +We use a variety of manual +and highly automated assembly processes in our facilities, depending upon product complexity and degree of customization. Some examples of automated processes include component insertion, SMT, flexible robotic assembly, automated storage tape +winding, computerized vision system quality inspection, automated switch and key top installation, and automated functional testing. +Our engineering +expertise and automated manufacturing processes enable us to work closely with our customers during the design and prototype stages of production and to jointly increase productivity and reduce response time to the marketplace. We use computer-aided +design techniques and software to assist in preparation of the tool design layout and component placement, to reduce tooling and production costs, improve component and product quality, and enhance turnaround time during product development. +We purchase materials and components for our products from many different suppliers, including both domestic and international sources. We develop close +working relationships with our suppliers, many of whom have been supplying products to us for several years. +Research, Development, and Engineering +Research, development, and engineering “RD&E” expenses consist principally of employee related costs, third party development costs, +program materials costs, depreciation and allocated information technology and facilities costs. Our RD&E expenses were $2.7 million, $3.2 million and $2.8 million in fiscal years 2008, 2007, and 2006 respectively. In each of these years, we +focused most of our RD&E efforts on current customer EMS programs. The decrease in RD&E during fiscal 2008 is related to lower incentive compensation and the transfer of certain engineers and support personnel from RD&E to manufacturing +costs of sales as their job roles changed to support the new SMT production line in Spokane Valley, Washington. +Competition +The market for the products and services we provide is highly competitive. There are numerous competitors in the EMS industry, many of which have substantially more +resources and are more geographically diverse than we are. Some of our competitors have similar international production capabilities, large financial resources and some have substantially greater manufacturing, research and development, and +marketing resources. There is also competition from the manufacturing operations of our current and potential customers, who are continually evaluating the merits of manufacturing their products internally versus the advantages of +5 +Table of Contents +outsourcing. We believe that we can currently compete favorably to these factors primarily on the basis of our global footprint, responsiveness, creativity, +vertical production capability, quality, and cost. +Trademarks and Patents +Our name and logo are federally registered trademarks, and we believe they are valuable assets of our business. During 2001, we began operating under the trade name “KeyTronicEMS Co.” to better identify our +primary business concentration. We also own several keyboard patents; however, since our focus is EMS, management believes that these patents will not have a significant impact on future revenues. +Employees +We consider our employees to be our primary strength and +we make considerable efforts to maintain a well-qualified workforce. Our employee benefits include bonus programs involving periodic payments to all employees based on meeting quarterly or fiscal year performance targets. We regularly provide +transportation, medical services and meals to all of our employees in foreign locations. We maintain a 401(k) plan for U.S. employees, which provides a discretionary matching company contribution of up to 4% of an employee’s salary. We provide +group health, life, and disability insurance plans. We also maintain stock option plans and other long term incentive plans for certain employees and outside directors. +As of June 28, 2008, we had 2,502 employees compared to 2,227 on June 30, 2007 and 2,840 on July 1, 2006. Since we can have significant fluctuations in product demand, we seek to maintain flexibility in +our workforce by utilizing skilled temporary and short-term contract labor in our manufacturing facilities in addition to full-time employees. The change in the number of employees was a result of a change in product mix. Certain products require +more hand assembly than others. Our employees in Reynosa, Mexico, which represent approximately 7% of the Company’s employees, are represented by a local union. We have no history of any material interruption of production due to labor +disputes. +Backlog +On July 27, 2008, our order +backlog was valued at approximately $42.2 million, compared to approximately $34.1 million on July 29, 2007. Even though our order backlog is comprised of firm purchase orders, the amount of backlog is not necessarily indicative of future sales +but can be indicative of trends in expected future sales revenue. Due to the relationships with our customers, we will occasionally allow orders to be canceled or rescheduled and as a result is not a meaningful indicator of future financial results. +If there are canceled or rescheduled orders, we will attempt to negotiate fees to cover the costs we have incurred. The change in backlog at July 27, 2008, when compared to July 29, 2007, was in part due to our increasing customer base and +the timing of purchase orders of existing customers. Order backlog consists of purchase orders received for products expected to be shipped approximately within the next twelve months, although shipment dates are subject to change due to design +modifications, customer forecast changes, or other customer requirements. +Foreign Markets +Information concerning net sales and long-lived assets (property, plant, and equipment) by geographic areas is set forth in footnote 9 of the consolidated financial +statements of this Annual Report on Form 10-K, under the caption “Enterprise-Wide Disclosures”, and that information is incorporated herein. +Item 1A. +RISK FACTORS +There are risks and uncertainties that could affect +our business. These risks and uncertainties include but are not limited to, the risk factors described below, in Item 7A: “Quantitative and Qualitative Disclosures about Market Risk” and elsewhere in this Form 10-K. +RISKS AND UNCERTAINTIES THAT COULD AFFECT FUTURE RESULTS +The +following risks and uncertainties could affect our actual results and could cause results to differ materially from past results or those contemplated by our forward-looking statements. When used herein, the words “expects”, +“believes”, “anticipates” and similar expressions are intended to identify forward-looking statements. +Potential Fluctuations in +Quarterly Results Our quarterly operating results have varied in the past and may vary in the future due to a variety of factors, including changes in overall demand for customers’ products, success of customers’ programs, timing of +new programs, new product introductions or technological advances by us, our customers and our competitors and changes in pricing policies by us, our customers, our suppliers and our competitors. +6 +Table of Contents +Component procurement, production schedules, personnel and other resource requirements are based on estimates of customer +requirements. Occasionally, our customers may request accelerated production that can stress resources and reduce operating margins. In addition, because many of our operating expenses are relatively fixed, a reduction in customer demand can harm +our gross profit and operating results. The products which we manufacture for our customers have relatively short product lifecycles, therefore our business, operating results and financial condition are dependent in significant part on our ability +to obtain orders from new customers and new product programs from existing customers. +Operating results can also fluctuate if changes are made to +significant estimates and assumptions. Significant estimates and assumptions include the allowance for doubtful receivables, provision for obsolete and non-saleable inventory, the valuation allowance on deferred tax assets, valuation of goodwill, +impairment of long-lived assets, long-term incentive compensation accrual, and the provision for warranty costs. +Competition The EMS industry is +intensely competitive. Competitors may offer customers lower prices on certain high volume programs. This could result in price reductions, reduced margins and loss of market share, all of which would materially and adversely affect our business, +operating results and financial condition. If we were unable to provide comparable or better manufacturing services at a lower cost than our competitors, it could cause sales to decline. In addition, competitors can copy our non-proprietary designs +after we have invested in development of products for customers, thereby enabling such competitors to offer lower prices on such products due to savings in development costs. +Concentration of Major Customers At present, our customer base is highly concentrated and could become more or less concentrated. Our largest EMS customer accounted for 18% of net sales in fiscal year 2008. +This same customer accounted for 17% of sales in 2007 and 18% in 2006. For the fiscal years ended 2008, 2007, and 2006, the five largest customers accounted for 68%, 73% and 71% of total sales, respectively. There can be no assurance that our +principal customers will continue to purchase products from us at current levels. Moreover, we typically do not enter into long-term volume purchase contracts with our customers, and our customers have certain rights to extend or delay the shipment +of their orders. We, however, require that our customers contractually agree to buy back inventory purchased within specified lead times to build their products if not used. The loss of one or more of our major customers, or the reduction, delay or +cancellation of orders from such customers, could materially and adversely affect our business, operating results and financial condition. +Dependence +on Suppliers We are dependent on many suppliers, including sole source suppliers, to provide key components and raw materials used in manufacturing customers’ products. Delays in deliveries from suppliers or the inability to obtain +sufficient quantities of components and raw materials could cause delays or reductions in shipment of products to our customers which could adversely affect our operating results and damage customer relationships. +Dependence on Key Personnel Our future success depends in large part on the continued service of our key technical, marketing and management personnel and on our +ability to continue to attract and retain qualified employees. The competition for such personnel is intense and there can be no assurance that we will be successful in attracting and retaining such personnel. The loss of key employees could have a +material adverse effect on our business, operating results and financial condition. +Foreign Manufacturing Operations Most of the products +manufactured by us are produced at our facilities located in Mexico and China. Accordingly, our operations are subject to a variety of risks unique to international operations including import and export duties and value added taxes, import and +export regulation changes, the burden and cost of compliance with foreign laws and foreign economic and political risk. +Technological Change and New +Product Risk The markets for our customers’ products is characterized by rapidly changing technology, evolving industry standards, frequent new product introductions and relatively short product life cycles. The introduction of products +embodying new technologies or the emergence of new industry standards can render existing products obsolete or unmarketable. Our success will depend upon our customers’ ability to enhance existing products and to develop and introduce, on a +timely and cost-effective basis, new products that keep pace with technological developments and emerging industry standards and address evolving and increasingly sophisticated customer requirements. Failure of our customers to do so could +substantially harm our customers’ competitive positions. There can be no assurance that our customers will be successful in identifying, developing and marketing products that respond to technological change, emerging industry standards or +evolving customer requirements. +Compliance with Current and Future Environmental Regulation We are subject to a variety of domestic and foreign +environmental regulations relating to the use, storage, and disposal of materials used in our manufacturing processes. If we fail to comply with +7 +Table of Contents +any present or future regulations, we could be subject to future liabilities or the suspension of current manufactured products. In addition, such +regulations could restrict our ability to expand our operations or could require us to acquire costly equipment, substitute materials, or incur other significant expenses to comply with government regulations. +Foreign Currency Fluctuations A significant portion of our operations and customers are in foreign locations. As a result, transactions may occur in currencies +other than the U.S. dollar. Exchange rate fluctuations among other currencies used by us could directly or indirectly affect our financial results. Future currency fluctuations are dependent upon a number of factors and cannot be easily predicted. +We have used Mexican peso forward contracts to hedge foreign currency fluctuation for a portion of weekly payroll costs. However, unexpected expenses could occur from future fluctuations in exchange rates. +Dilution and Stock Price Volatility As of June 28, 2008, there were outstanding options for the purchase of 1,268,375 shares of our common stock (Common +Stock), all of which were vested and exercisable. Holders of the Common Stock will suffer immediate and substantial dilution to the extent outstanding options to purchase the Common Stock are exercised. Our stock price may be subject to wide +fluctuations and possible rapid increases or declines over a short time period. These fluctuations may be due to factors specific to us such as variations in quarterly operating results or changes in analysts’ earnings estimates, or to factors +relating to the EMS or to the securities markets in general, which, in recent years, have experienced significant price fluctuations. These fluctuations often have been unrelated to the operating performance of the specific companies whose stocks +are traded. +Disclosure and Internal Controls Management does not expect that our disclosure controls and internal controls and procedures will +prevent all errors or fraud. A control system is designed to give reasonable, and not absolute, assurance that the objectives of the control system are met. In addition, any control system reflects resource constraints and the benefits of controls +must be considered relative to their costs. Inherent limitations of a control system may include: judgments in decision making may be faulty, breakdowns can occur simply because of error or mistake and that controls can be circumvented by collusion +or management override. Because of inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected. +8 +Table of Contents +Item 1B. +UNRESOLVED STAFF COMMENTS +None +Item 2. +PROPERTIES +We have manufacturing and sales operations located in +the United States, Mexico and China. The table below lists the locations and square footage of our operating facilities: +Location +Approx. +Sq. Ft. +Type of Interest +(Leased/Owned) +Description of Use +Spokane Valley, Washington (1) +49,000 +Leased +Sales, research, administration and manufacturing +Spokane Valley, Washington (2) +36,000 +Leased +Manufacturing +El Paso, Texas +80,000 +Leased +Shipping and warehouse +Total USA +165,000 +Juarez, Mexico +174,000 +Owned +Manufacturing +Juarez, Mexico (3) +60,000 +Owned +Manufacturing and warehouse +Juarez, Mexico (4) +66,000 +Owned +Manufacturing and warehouse +Reynosa, Mexico +140,000 +Leased +Manufacturing +Reynosa, Mexico (5) +100,000 +Leased +Warehouse +Total Mexico +540,000 +Shanghai, China (6) +72,000 +Leased +Manufacturing +Total China +72,000 +Grand Total +777,000 +(1) +On December 27, 2000, we sold two contiguous parcels of land and our corporate headquarters building in Spokane to +Royal Hills Associates L.L.C. (RHA) for approximately $6 million in cash. In connection with the sale, we entered into a 10-year lease agreement with RHA for one floor of the two-story building, which we continue to occupy as our headquarters (see +Note 3 to Consolidated Financial Statements). +(2) +During fiscal 2006, we consolidated and moved some of our molding equipment in Spokane to our facility in Juarez, Mexico +and reduced the building space leased in Spokane for manufacturing to 36,000 square feet. +(3) +In fiscal 2005, we purchased a 60,000 square foot manufacturing facility in Juarez, Mexico to replace a previously +leased facility and to accommodate the shift of the Las Cruces, New Mexico operations into Juarez. +(4) +In fiscal 2007, we purchased a 66,000 square foot manufacturing facility in Juarez, Mexico to replace a previously +leased facility. +(5) +In fiscal 2008, we leased a new facility in Reynosa, Mexico for storage capacity that replaced two other leased +warehouses. +( 6 ) +We began an assembly operation in Shanghai, China in fiscal year 1999. During fiscal year 2006, we increased our leased +space in China to 72,000 sq. ft. to accommodate an additional SMT line and for additional assembly space. +The geographic diversity of +these locations allows us to offer services near certain of our customers and major electronics markets with the additional benefit of reduced labor costs. We consider the productive capacity of our current facilities sufficient to carry on our +current business. In addition, one of the facilities in Juarez, Mexico includes adjacent vacant land that could be developed into additional manufacturing and warehouse space. All of our facilities are ISO certified to ISO 9001:2000 standards and +are certified or compliant with ISO-14001 environmental standards. +9 +Table of Contents +Item 3. +LEGAL PROCEEDINGS +We may be party to certain lawsuits or claims in +the ordinary course of business. We do not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on our financial position, results of operations or cash flow. +Item 4. +SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS +None +EXECUTIVE OFFICERS OF THE REGISTRANT +JACK W. OEHLKE - Director, President and Chief Executive Officer +Jack W. Oehlke, age 62, has been President and Chief Executive Officer of +the Company since June 1997. From October 1995, he served as Chief Operating Officer. Previously, he served as Senior Vice President of Operations from January 1995 to October 1995 and Vice President of Manufacturing Operations of the +Company from December 1993 to January 1995. Mr. Oehlke served as Director of Operations, Director of Quality and in various management positions within manufacturing, engineering and quality functions of the Microswitch Division of +Honeywell, Inc. from 1968 to 1993. Mr. Oehlke has a Bachelor of Science Degree in Industrial Technology from the University of Wisconsin at Menomonie. +RONALD F. KLAWITTER - Executive Vice President of Administration, Chief Financial Officer and Treasurer +Mr. Klawitter, age 56, has +been Executive Vice President of Administration, CFO, and Treasurer since July 1997. Previously he was Vice President of Finance, Secretary and Treasurer of the Company since October 1995. He was Acting Secretary from November 1994 to October 1995 +and Vice President of Finance and Treasurer from 1992 to October 1995. From 1987 to 1992, Mr. Klawitter was Vice President, Finance at Baker Hughes Tubular Service, a subsidiary of Baker Hughes, Inc. He has a BA degree from Wittenberg +University and is a Certified Public Accountant. +CRAIG D. GATES - Executive Vice President and General Manager of Sales and Program Management +Mr. Gates, age 49, has been Executive Vice President and General Manager since August 2002. Previously he was Executive Vice President of Marketing, +Engineering and Sales since July 1997. He served as Vice President and General Manager of New Business Development from October 1995 to July 1997. He joined the Company as Vice President of Engineering in October of 1994. Mr. Gates has a +Bachelor of Science Degree in Mechanical Engineering and a Masters in Business Administration from the University of Illinois, Urbana. From 1982 he held various engineering and management positions within the Microswitch Division of Honeywell, Inc., +in Freeport, Illinois, and from 1991 to October 1994 he served as Director of Operations, Electronics for Microswitch. +GEORGE R. ALFORD – +Executive Vice President of Materials +George R. Alford, age 55, was appointed Executive Vice President of Materials for the Company effective +January 6, 2008. He served as Vice President of Materials of the Company since July 21, 2006. From August 2005 to July 2006 he served as Director of Materials (HID Group) at Cooper Industries. From October 2000 to August 2005, he served in +various procurement and materials management positions with Solectron Corporation. Mr. Alford has a B.S. in Industrial Technology and a M.A. in Management from Middle Tennessee State University and a J.D. in Civil Law from Nashville School of +Law. +DOUGLAS G. BURKHARDT – Vice President of Worldwide Operations +Douglas G. Burkhardt, age 50, has been Vice President of Worldwide Operations of the company since July 1, 2008. Previously Mr. Burkhardt was Director of China Operations and Program Management since January +2006. Mr. Burkhardt served as Director of Northwest and China Operations from November of 1998 to January of 2006. Mr. Burkhardt also served as Director of Customer Satisfaction from March 1997 to November 1998 and Director of Molding from +September of 1995 to March of 1997. Prior to this, Mr. Burkhardt served in other various senior management positions within the company. Mr. Burkhardt has been with the company since May of 1989. Prior to joining Key Tronic, +Mr. Burkhardt worked for House of Aluminum and Glass for 12 years where he was the plant manager. +10 +Table of Contents +LAWRENCE J. BOSTWICK – Vice President of Engineering and Quality +Lawrence J. Bostwick, age 56, has been Vice President of Engineering and Quality since July 2008. Previously he was Director of Engineering and Quality since February +2007. He joined the company in February 2006 as Corporate Director of Quality. From 2003 to 2006 he was Director of Supply Chain Management and Quality for the Lancer Corporation and from 1998 to 2003 he was Vice President of Operations for +Thermacore International. He is a graduate of the Westinghouse and General Electric - Engineering and Manufacturing Professional Development Programs. He is certified in both Quality and Industrial Engineering and is a Lean – Six Sigma Master +Black Belt. He has a combined B.S. degree in Production and Operation and Industrial Engineering from Bowling Green State University and a Masters degree in Industrial Engineering and Business Administration from Syracuse University. +PART II +Item 5: +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Our common stock is traded on the NASDAQ Global +Market, formerly the NASDAQ National Market System under the symbol “KTCC”. Quarterly high and low closing sales prices for our common stock for fiscal years 2008 and 2007 were as follows: +2008 +2007 +High +Low +High +Low +First Quarter +$ +5.50 +$ +4.30 +$ +7.16 +$ +3.98 +Second Quarter +4.89 +4.11 +5.85 +4.53 +Third Quarter +4.29 +2.46 +4.91 +3.88 +Fourth Quarter +3.75 +2.43 +5.55 +3.94 +High and low stock prices are based on the daily closing price reported by the NASDAQ Stock Market. These +quotations represent prices between dealers without adjustment for markups, markdowns, and commissions, and may not represent actual transactions. +Holders And Dividends +As of June 28, 2008, we had 847 shareholders of record. Our current financing agreement contains a covenant that +prohibits the declaration or payment of dividends or the repurchase of our stock (see Note 4 to Consolidated Financial Statements). We have not paid a cash dividend and do not anticipate payment of dividends or stock buyback in the foreseeable +future. +Equity Compensation Plan Information +Information concerning securities authorized for issuance under our equity compensation plans is set forth in Part III, Item 12 of this Annual Report, under the caption “Securities Authorized for Issuance under Equity Compensation +Plans”, and that information is incorporated herein by reference. +11 +Table of Contents +Performance Graph +Set forth below is a line graph comparing the cumulative total shareholder return on our common stock with the cumulative total return of the NASDAQ Stock Market (U.S. & Foreign) Index and the NASDAQ Electronic Components Index in +fiscal 2008. +COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN * +Among Key Tronic Corporation, The +NASDAQ Composite Index +And The NASDAQ Electronic Components Index +* +$100 invested on 6/28/03 in stock or 6/30/03 in index-including reinvestment of dividends. Indexes calculated on month-end basis. +12 +Table of Contents +Item 6: +SELECTED FINANCIAL DATA +The following selected data from our +consolidated financial statements should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements and related notes, and other +information included in this report. +Financial Highlights +(Dollars in thousands, except per share amounts) +Fiscal Years +2008 +2007 +2006 +2005 +2004 +Consolidated Statements of Operations Data : +Net sales +$ +204,122 +$ +201,712 +$ +187,699 +$ +202,877 +$ +148,901 +Gross profit +16,820 +17,670 +17,304 +16,460 +13,237 +Gross margin percentage +8.2 +% +8.8 +% +9.2 +% +8.1 +% +8.9 +% +Operating income +6,834 +6,810 +5,861 +5,445 +1,789 +Operating margin percentage +3.3 +% +3.4 +% +3.1 +% +2.7 +% +1.2 +% +Net income +5,584 +5,230 +9,753 +4,376 +110 +Earnings per share – diluted +0.54 +0.51 +0.97 +0.44 +0.01 +Consolidated Cash Flow Data : +Cash flows provided by (used in) operations +(718 +) +(1,857 +) +(34 +) +6,561 +(17 +) +Capital expenditures +1,180 +3,137 +1,638 +2,868 +1,633 +Consolidated Balance Sheet Data : +Net working capital (1) +45,695 +41,222 +31,703 +23,006 +23,468 +Total assets +98,344 +89,388 +88,695 +72,901 +67,938 +Long-term liabilities +13,241 +14,719 +11,665 +9,420 +13,452 +Shareholders’ equity +49,081 +43,244 +37,548 +27,639 +23,234 +Book value per share (2) +4.90 +4.36 +3.85 +2.85 +2.40 +Supplemental Data : +Number of shares outstanding at year-end +10,024 +9,921 +9,750 +9,694 +9,676 +Number of employees at year-end +2,502 +2,227 +2,840 +2,849 +2,847 +Approximate square footage of operational facilities +777,000 +784,000 +723,000 +765,000 +786,000 +(1) +Net working capital is defined as total current assets less total current liabilities. Net working capital measures the +portion of current assets that are financed by long term funds and is an indicator of short term financial management. +(2) +Book value per share is defined as total shareholders’ equity divided by the number of shares outstanding at the +end of the fiscal year. Book value per share measures shareholders’ value as defined by generally accepted accounting principles. +Item 7: +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +Overview +We are an independent provider of EMS for OEMs. Our core strengths include innovative design and +engineering expertise in SMT, electronics, mechanical engineering, precision molding, design and build of molding tools, combined with high-quality, low-cost production and assembly on a global basis. Our global production capability provides +customers with benefits of improved supply-chain management, reduced inventories, lower transportation costs, and reduced product fulfillment time. We continue to make investments in our Mexico and China facilities to give us the production capacity +and logistical advantages to continue to win new business. The following information should be read in conjunction with the consolidated financial statements included herein and with Item 1A, Risk Factors. +13 +Table of Contents +The EMS industry has historically experienced growth as more OEMs shift to outsourced manufacturing. However, our +revenue, like that of other EMS providers, can fluctuate significantly due to our reliance on a concentrated base of customers. New customer programs combined with continued product demand from our largest existing customers resulted in an increase +in revenues during fiscal years 2008 and 2007. +Overall, our sales of $204.1 million in fiscal year 2008 increased by 1.2% over sales of $201.7 million in +fiscal 2007. This growth was driven by increased demand from new customer programs which are continuing to ramp up. During the year, eight new customers contributed approximately 13% of total revenue, and in fiscal 2009 we expect to have revenue +from 10 additional new customers. We expect these 18 new customers to contribute approximately 40% of our revenue in fiscal 2009, offsetting the anticipated decline in demand from some of our existing customers. Sales for the first quarter of fiscal +2009 are expected to be within the range of $45 million to $48 million, as we are expecting lower demand from a number of established customers while these new programs ramp up. Results will depend on actual levels of customers’ orders and the +timing of the start up of production of new product programs. We believe that we are well positioned in the EMS industry to continue expansion of our customer base and continue long-term growth. +The concentration of our largest customers decreased during fiscal 2008 with the top five customers’ sales decreasing slightly to 68% of total sales in 2008 from +73% in 2007 and 71% in 2006. Our current customer relationships involve a variety of products, including consumer electronics, electronic storage devices, plastics, household products, gaming devices, specialty printers, exercise equipment, +telecommunications, industrial equipment, fuel cell technology and computer accessories. The total number of our customers continued to increase during fiscal 2008. Some of these new customers have programs that represent small annual sales while +others have multi-million-dollar potential. +Gross profit as a percent of sales was 8.2% in fiscal 2008 compared to 8.8% for the prior fiscal year. The +decrease in gross profit percentage is related mainly to start-up costs incurred throughout the year in association with new customer programs, inefficiencies of overtime and expedite costs associated with accelerated customer demand, increased +freight costs, and increasing costs of raw materials. +Net income for fiscal 2008 was $5.6 million or $0.54 per diluted share, up from $5.2 million net +income or $0.51 per diluted share for fiscal 2007. The results of both years were affected by unusual events. We realized a gain on the sale of real estate of $951,000 in fiscal 2008 and $1.5 million in fiscal 2007. The gain in 2007 was offset by +$460,000 in costs incurred during the year in connection with a potential acquisition that the Company chose not to pursue and the write off of $404,000 of inventory and tooling and an associated write-off of $536,000 in bad debt of a customer that +filed bankruptcy. +We maintain a strong balance sheet with a current ratio of 2.27 and a long-term debt to equity ratio of 0.25. Total cash used in +operations was $718,000 during fiscal year 2008. We maintain sufficient liquidity for our expected future operations and had approximately $12.7 million available from our revolving line of credit based on eligible collateral at June 28, 2008. +We believe that internally generated funds, our revolving line of credit, and leases on equipment should provide adequate capital for planned growth over the long term. +The EMS industry is intensely competitive. We estimate that we have less than 1% of the potential market. We believe that we can acquire new business in the future, particularly those programs that require flexibility +in forecasting, innovative design and engineering, short lead times, or small initial volumes. Our competitiveness is enhanced by our capacity to provide SMT, plastic injection molding, and final assembly. We are planning for long term growth by +utilizing current capacity, improving manufacturing processes, and investing in additional manufacturing equipment. Current challenges facing us include: continuing to win new programs, improving operating efficiencies, controlling costs and +developing new competitive price strategies. +14 +Table of Contents +Results of Operations +The following table sets forth for the periods indicated certain items of the consolidated statements of income expressed as a percentage of net sales. The financial information and discussion below should be read in conjunction with the +consolidated financial statements and notes contained in this Annual Report. +June 28, 2008 +Years Ended +June 30, 2007 +July 1, 2006 +Net sales +100.0 +% +100.0 +% +100.0 +% +Cost of sales +91.8 +91.2 +90.8 +Gross profit +8.2 +8.8 +9.2 +Operating expenses (income) +Research, development and engineering +1.3 +1.6 +1.5 +Selling +0.8 +0.9 +1.1 +General and administrative +3.2 +3.6 +3.5 +Gain on sale of real estate held for sale +(0.4 +) +(0.7 +) +0.0 +Total operating expenses +4.9 +5.4 +6.1 +Operating income +3.3 +3.4 +3.1 +Interest expense +0.5 +0.7 +0.6 +Income before income taxes +2.8 +2.7 +2.5 +Income tax provision (benefit) +0.1 +0.1 +(2.7 +) +Net income +2.7 +% +2.6 +% +5.2 +% +Net Sales +Net +sales in fiscal 2008 were $204.1 million compared to $201.7 million and $187.7 million in fiscal years 2007 and 2006 respectively. +The increase in net +sales during fiscal 2008 relates to an increase in sales revenue from new customer programs offset by a moderate decrease in the demand from some of our existing customers. New customer programs contributed approximately 13% of our total revenue in +fiscal 2008. We anticipate that several more new customer programs will enter production in fiscal year 2009 and begin contributing to revenue. +The +increase in net sales during fiscal 2007 compared to fiscal 2006 resulted from an increase in the demand for certain of our largest existing customers’ products along with revenue from new customers’ programs. Customer demand will +fluctuate based on changes in the sell-through of customers’ products. +The table below shows the revenue by industry sectors as a percentage of +revenue for the following fiscal years: +June 28, 2008 +Years Ended +June 30, 2007 +July 1, 2006 +Commercial Printer +16 +% +19 +% +18 +% +Communication +9 +% +9 +% +8 +% +Computer and Peripheral +8 +% +3 +% +4 +% +Consumer +9 +% +14 +% +16 +% +Gaming +19 +% +17 +% +18 +% +Industrial +3 +% +2 +% +2 +% +Transaction Printer +36 +% +36 +% +34 +% +Total +100 +% +100 +% +100 +% +We provide services to customers in a number of industries and produce a variety of products for our customers in +each industry. As we continue to diversify our customer base and win new customers we may see a change in the industry concentrations of our revenue. +Sales to foreign customers represented 5.6% of our total net sales in fiscal year 2008 and 9.0% in fiscal year 2007. The decrease in foreign customer sales was due to exiting production of a consumer product for a customer in Asia. +15 +Table of Contents +Cost of Sales +Total +cost of sales as a percentage of net sales was 91.8%, 91.2%, and 90.8% in fiscal years 2008, 2007, and 2006, respectively. +Total cost of materials as a +percentage of sales was approximately 66.9%, 65.4%, and 64.6% in fiscal years 2008, 2007, and 2006, respectively. The change from year-to-year is directly related to changes in product mix and increased costs of raw materials. Products sold in +fiscal 2008 contained higher materials costs, thereby increasing costs of materials as a percentage of sales compared to fiscal 2007 and 2006. +Direct +production costs (direct labor and manufacturing overhead) were 13.0% of total sales in fiscal 2008 compared to 13.7% of total sales in fiscal 2007 and 13.2% of total sales in 2006. The decrease in 2008 compared to 2007 and 2006 is related to +product mix and utilization of excess manufacturing capacity (both equipment and indirect support costs). Additionally, included in production costs of fiscal 2007 were start-up costs associated with the installation and start up of an SMT line at +our headquarters in Spokane Valley, Washington. The SMT production line in Spokane Valley was developed for complex or low volume production and for new product introduction. +We provide for obsolete and non-saleable inventories based on specific identification of inventory against current demand and recent usage. The amounts charged to expense for these inventories were $159,000, $544,000, +and $361,000 in fiscal years 2008, 2007, and 2006, respectively. Approximately $240,000 of the provision in fiscal 2007 was related to a specific customer filing bankruptcy during the year. The majority of the remaining provision in each year +related to stocked computer keyboards and other computer peripherals, and various inventory items that were deemed obsolete during the period. +We provide +warranties on certain products we sell and estimate warranty costs based on historical experience and anticipated product returns. The amounts charged to expense are determined based on an estimate of warranty exposure. Warranty expense (recovery) +was approximately $196,000, $31,000, and $(10,000) in fiscal years 2008, 2007, and 2006, respectively. Warranty expense for fiscal years 2008 and 2007 is related to workmanship claims on keyboards and certain EMS products. The recovery in 2006 +related to lower than expected warranty expense related to a previously identified workmanship issue with a particular EMS product and a decrease in the estimated future keyboard warranty costs. +Gross Profit +In fiscal year 2008, gross profit on sales was 8.2% of +revenues compared to 8.8% in fiscal year 2007 and 9.2% in fiscal year 2006. +The decrease in gross profit is related mainly to start-up costs we incurred +throughout the year in association with new customer programs, inefficiencies of overtime and expedite costs associated with accelerated customer demand, increased freight costs, and increasing costs of raw materials. The decrease in fiscal year +2007 relates to certain customer sales price decreases in the aggregate in excess of achieved cost savings, a write off of $240,000 in inventory and $164,000 tooling related to a customer that filed for bankruptcy, and the additional costs incurred +with the installation and start up of a new SMT line in Spokane Valley. We took early pay discounts to suppliers that totaled $51,000, $211,000, and $431,000 in fiscal years 2008, 2007 and 2006, respectively. Early pay discounts will fluctuate based +on our liquidity and changes in the discounts and terms offered by our suppliers. +Changes in gross profit margins reflect the impact of a number of +factors that can vary from period to period, including product mix, start-up costs and efficiencies associated with new programs, product life cycles, sales volumes, capacity utilization of our resources, management of inventories, component pricing +and shortages, end market demand for customers’ products, fluctuations in and timing of customer orders, and competition within the EMS industry. These and other factors can cause variations in operating results. There can be no assurance that +gross margins will not decrease in future periods. +Research, Development and Engineering +Research, development and engineering expenses (RD&E) consists principally of employee related costs, third party development costs, program materials, depreciation +and allocated information technology and facilities costs. The decrease in RD&E in fiscal 2008 from fiscal 2007 is related to transferring engineers and support personnel from RD&E to manufacturing costs of sales as their job roles changed +to support the new SMT line in Spokane Valley, Washington. As a percentage of net sales, RD&E increased slightly in fiscal 2007 to 1.6% of sales compared to 1.5% of sales in fiscal 2006. The increase is related to the hiring of new program +managers to service new customer programs. In each of the fiscal years presented, we have focused most of our RD&E efforts on development of new and current customers’ EMS programs. +16 +Table of Contents +Selling +Sales and +marketing expenses consist principally of salaries and benefits for sales and marketing personnel, advertising and marketing programs, sales commissions, and travel expenses. Similar to RD&E expenses, selling expenses change as a percent of +sales relative to the allocated fixed costs in each of the years presented. Approximately half of selling expense relates to salary costs of our employees. +Our total selling expenses were $ 1.7 million, $1.8 million, and $2.1 million in fiscal years 2008, 2007, and 2006, respectively. The decrease in selling expenses in fiscal 2008 compared to fiscal 2007 is mainly the result of a +decrease in incentive and bonus expenses. The decrease in selling expenses in fiscal 2007 compared to fiscal 2006 was due to us decreasing our outside marketing service expense. +General and Administrative +General and administrative expenses “G&A” consist of employee related +costs, travel expenses and allocated information technology and facilities costs for finance, legal, human resources and executive functions, outside legal and accounting fees, provision for doubtful accounts and business insurance costs. As a +percent of sales G&A was 3.2%, 3.6%, and 3.5% in fiscal years 2008, 2007, and 2006, respectively. +Total G&A was $6.6 million, $7.4 million and +$6.6 million in fiscal years 2008, 2007, and 2006, respectively. The increase in G&A in fiscal 2007 was the result of our having approximately $555,000 in bad debt expense in fiscal 2007, of which $536,000 was related to a customer filing +bankruptcy during the year. G&A included a provision for bad debt of $122,000 in fiscal 2008 and $6,000 in fiscal 2006. In addition $460,000 and $120,000 of due diligence expenses, attorneys’ fees, and bank fees were expensed in fiscal 2007 +and 2006, respectively, as we decided not to proceed with a potential acquisition. +Gain on Real Estate Held for Sale +During the fourth quarter of fiscal 2007, we sold our under-utilized Las Cruces, New Mexico facility. The total sales price for the facility and adjacent vacant land was +$4.3 million. Sales proceeds were in the form of $2.8 million in cash and an additional $1.5 million note from the buyer. The cash received was for the purchase of the building and approximately 9 acres of land while the note was to pay for the +adjacent 14 acres of additional land. The note was payable within 45 days of the flood plain designation being removed from the adjacent vacant land. Due to the contingent nature of the note, we recognized a $1.5 million gain on real estate held for +the sale of the building and 9 acres of land in fiscal 2007 and deferred the gain on sale of the adjacent land. During the second quarter of fiscal 2008, the flood plain designation was removed on the adjacent 14 acres of land resulting in a gain on +sale of real estate of $951,000, with the cash proceeds being received in January 2008. +Interest Expense +We had net interest expenses of $1.0 million, $1.4 million, and $1.1 million in fiscal years 2008, 2007, and 2006, respectively. Interest expense decreased in fiscal 2008 +when compared to fiscal 2007 and 2006 as the average balance of the revolving line of credit was lower along with a decrease in variable interest rates. The Company does not currently use derivatives to hedge interest rate risk. Starting in 2006, we +began to utilize short-term fixed LIBOR rates on portions of its revolving line of credit for short-term interest savings in anticipation of rate increases. We successfully negotiated a variable rate decrease on interest charged by our lender on our +revolving line of credit and term debt during fiscal year 2007. +Income Tax Provision +We had an income tax provision of $261,000 in fiscal 2008 compared to a provision of $206,000 in fiscal 2007 and a $(5.0) million benefit in fiscal 2006. The tax provision in fiscal 2008 is primarily related to income +taxes paid in China and Mexico. The income tax expense of fiscal 2007 primarily related to income taxes in the United States, which was primarily caused by a one-time repatriation of earnings from our Mexico subsidiaries. We applied certain tax +credits to offset tax liabilities of our Mexican subsidiaries during calendar years 2006 and 2007. We expect to pay income taxes in calendar year 2008 due to recently enacted tax laws in Mexico. The large income tax benefit in 2006 related to +reducing the valuation allowance on our net deferred tax asset in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes . We have domestic tax net operating loss carryforwards (NOLs) of +approximately $42.9 million at June 28, 2008. In accordance with SFAS No. 109, we assessed our recent operating levels and the sources of future taxable income to estimate a deferred tax asset. A valuation allowance against deferred tax +assets is required if it is more likely than not that some of the deferred tax assets will not be realized. We have determined that the $10.8 million valuation allowance is appropriate at this time. +17 +Table of Contents +International Subsidiaries +We offer customers a complete global manufacturing solution. Our facilities provide our customers the opportunity to have their products manufactured in the facility that best serves specific cost, product manufacturing, and distribution +needs. The locations of active foreign subsidiaries are as follows: +• +Key Tronic Juarez, SA de CV owns an SMT, assembly, and molding facility and two assembly and storage facilities in Juarez, Mexico. This subsidiary is primarily used +to support our U.S. operations. +• +Key Tronic Reynosa, SA de CV leases manufacturing and warehouse facilities in Reynosa, Mexico. This subsidiary is used exclusively to manufacture products for one +EMS customer. +• +Key Tronic Computer Peripherals (Shanghai) Co., Ltd. leases a facility with SMT and assembly capabilities in Shanghai, China, which began operations in 1999. Its +primary function is to provide EMS services for export; however, it is also currently manufacturing certain electronic keyboards. +Foreign sales (based on location of customer) from our worldwide operations, including domestic exports, were $11.4 million in fiscal year 2008 compared to $18.5 million and $13.7 million in fiscal years 2007 and 2006, respectively. The +decrease in fiscal year 2008 foreign sales is mainly related to a specific foreign customer program. Products and manufacturing services provided by our subsidiary operations are sold to customers directly by the parent company. Key Tronic Computer +Peripherals (Shanghai) Co., Ltd., our subsidiary in Shanghai, China, had only minimal sales to customers in China during the past three fiscal years. +Capital Resources and Liquidity +Cash flows used by operating activities were $(718,000) in fiscal year 2008 compared to $(1.9) million used +in operating activities in fiscal year 2007 and $(34,000) used in fiscal year 2006. +The decrease in cash used by operating activities in fiscal year 2008 +from 2007 was primarily due to an increase in accounts payable. Accounts payable increased by $5.4 million during fiscal 2008, but it was more than offset by an increase of inventory of $5.6 million. The increase in accounts payable and inventory at +the end of fiscal 2008 was related to our increasing inventory for new customers. In addition, trade receivables increased $5.6 million as the result of higher sales during our fourth quarter. +The increase in cash used by operating activities in fiscal year 2007 from 2006 was due primarily to a $7.1 million decrease in accounts payable offset in part by a +decrease in inventory of $3.4 million. The decrease in accounts payable at the end of fiscal 2007 was related to decreasing inventory purchases and a change in vendors’ terms as certain new customer programs had new supply channels that +required earlier payments. Even though the Company had $9.8 million in net income in fiscal 2006, $5.0 million was in the form of a non-cash deferred income tax benefit. +Cash used in investing activities includes capital expenditures and proceeds from the sale of property and equipment. Capital expenditures were $1.2 million, $3.1 million, and $1.6 million in fiscal years 2008, 2007, +and 2006, respectively. Our capital expenditures are primarily for purchases of manufacturing assets to support our operations in Spokane Valley, Washington, Mexico and China. The increase in capital expenditures in fiscal 2007 was the result of +purchasing a facility in Juarez to replace a leased manufacturing location. We have also continued to use a variety of operating leases to fund the purchase of manufacturing equipment. +Our primary financing activity in fiscal years 2008, 2007, and 2006 was borrowing and repayment under our financing agreement with CIT Group/Business Credit, Inc. (CIT). Our financing agreement with CIT provides a +revolving credit facility of up to $25 million. The revolving loan is secured by our assets. The interest rate provisions allow for a variable rate based on either the prime rate or LIBOR rate. The agreement specifies four alternative levels of +margin to be added to these base rates depending on compliance with certain financial covenants. The range of interest being paid to CIT on outstanding balances was 4.38% – 6.71% as of June 28, 2008. The financing agreement contained +financial covenants that relate to total equity, earnings before interest, taxes, depreciation and amortization, and a minimum fixed charge ratio. All but one of the financial covenants, the fixed charge ratio, have been removed by subsequent +amendments to the financing agreement. The revolving loan matures August 22, 2009, but we will likely renew the revolving loan prior to that date with CIT or another lender. As of June 28, 2008, we were in compliance with our remaining +loan covenant. At June 28, 2008, the outstanding revolving loan balance was $12.3 million compared to $13.1 million at fiscal year end June 30, 2007. The loan balance decreased as we generated positive cash flow from operations. Based on +eligible collateral, approximately $12.7 million was available for drawdown from the revolving line of credit as of June 28, 2008. +18 +Table of Contents +Contractual Obligations and Commitments +In the normal course of business, we enter into contracts which obligate us to make payments in the future. +The table +below sets forth our significant future obligations by fiscal year: +Payments Due by Fiscal Year (in thousands) +Total +2009 +2010 +2011 +2012 +2013 +CIT revolving loan (1) +$ +12,348 +$ +— +$ +12,348 +$ +— +$ +— +$ +— +Capital and operating leases (2) +7,796 +3,212 +2,804 +1,748 +27 +5 +Purchase orders (3) +(1) +The terms of the CIT revolving loan are discussed in the consolidated financial statements at Note 4, “Long-Term +Obligations”. Our current financing agreement with CIT terminates on August 22, 2009, at which time the unpaid balance of the revolving loan will become immediately payable. However, we will likely extend or replace our revolving loan +agreement prior to that date. The amount payable on our revolving loan changes daily depending upon the amount of cash borrowed to support our operations and the amount of customer payments received. The amount presented does not include any +interest payable. Under the terms of our agreement with CIT, customers’ payments are applied against the outstanding revolving loan balance as soon as the amounts clear through the banking system. +Under the terms of the revolving credit agreement, we must meet a fixed coverage ratio financial covenant. As of June 28, 2008 we were in compliance +with our loan covenant. Breaching this covenant could have a material impact on our operations or financial condition. +(2) +We maintain vertically integrated manufacturing operations in Mexico and Shanghai, China. Such operations are heavily +dependent upon technically superior manufacturing equipment including molding machines in various tonnages, SMT lines, clean rooms, and automated insertion and test equipment for the various products we are capable of producing. +In addition, we lease some of our administrative and manufacturing facilities. A complete discussion of properties can be +found in Part 1, Item 2 at “Properties”. Leases have proven to be an acceptable method for us to acquire new or replacement equipment and to maintain facilities with a minimum impact on our short term cash flows for operations. +Amounts presented above include interest and principal, if applicable. +(3) +As of June 28, 2008, we had open purchase order commitments for materials and other supplies of approximately $28.3 +million. Included in the open purchase orders are various blanket orders for annual requirements. Actual needs under these blanket purchase orders fluctuate with our manufacturing levels. In addition, we have contracts with our customers that +minimize our exposure to losses for material purchased within lead-times necessary to meet customer forecasts. Purchase orders generally can be cancelled without penalty within specified ranges that are determined in negotiations with our suppliers. +These agreements depend in part on the type of materials purchased as well as the circumstances surrounding any requested cancellations. +In addition to the cash requirements presented above, we have various other accruals which are not included in the table above. We owe our suppliers approximately $29.5 million for accounts payable and shipments in transit at the end of the +fiscal year. We generally pay our suppliers in a range from 30 to 120 days depending on terms offered. Quarterly payments to suppliers normally average between $30 and $35 million. These payments are financed by operating cash flows and our +revolving line of credit. +We believe that internally generated cash flows, leasing facilities, and funds available under the revolving credit facility +will satisfy cash requirements for a period in excess of 12 months and into the foreseeable future. +Critical Accounting Policies +Revenue Recognition : We recognize revenue when products are shipped and the sales revenue becomes realizable. Securities and Exchange Commission (SEC) Staff +Accounting Bulletin (SAB) 104, Revenue Recognition states that revenue generally is realized or realizable and earned when all of the following criteria are met: +• +Persuasive evidence of an arrangement exists. +• +Delivery has occurred or services have been rendered. +• +The seller’s price to the buyer is fixed or determinable. +• +Collectibility is reasonably assured. +We believe +that we meet the above criteria for the following reasons: +• +Customer purchase orders confirming the price, shipping terms, and payment terms are required prior to shipment. +19 +Table of Contents +• +The terms of our sales are generally FOB shipping point, meaning that the customer takes ownership of the goods and assumes the risk of loss when the goods leave +our premises. +• +The seller’s price to the buyer is fixed or determinable – as noted, we require a customer purchase order, which confirms the price, shipping and payment +terms. +• +Collectibility is reasonably assured – the credit terms for customers are pre-established based on a review of the customers perceived ability to pay so that +collection of the account can be reasonably assured. +Inactive, Obsolete and Surplus Inventory Reserve : We reserve for inventories +that we deem inactive, obsolete or surplus. This reserve is calculated based upon the demand for the products that we produce. Demand is determined by expected sales or customer forecasts. If expected sales do not materialize, then we would have +inventory in excess of our reserves and would have to charge the excess against future earnings. In the case where we have purchased material based upon a customer’s forecast, we are usually covered by lead-time assurance agreements with each +customer. These contracts state that the financial liability for material purchased within agreed upon lead-time and based upon the customer’s forecasts, lies with the customer. If we purchase material outside the lead-time assurance agreement +and the customer’s forecasts do not materialize or if we have no lead-time assurance agreement for a specific program, we would have the financial liability and would have to charge any excess obsolete inventory against earnings. +Allowance for Doubtful Accounts : We value our accounts receivable net of an allowance for doubtful accounts. This allowance is based on estimates of the portion +of accounts receivable that may not be collected in the future and is disclosed in our consolidated balance sheets. The estimates used are based primarily on specific identification of potentially uncollectible accounts. Such accounts are identified +using publicly available information in conjunction with evaluations of current payment activity. However, if any of our customers were to develop unexpected and immediate financial problems that would prevent payment of open invoices, we could +incur additional and possibly material expenses that would negatively impact earnings. +Accrued Warranty : An accrual is made for expected warranty +costs, with the related expense recognized in cost of goods sold. We review the adequacy of this accrual quarterly based on historical analysis and anticipated product returns and rework costs. As we have made the transition from manufacturing +primarily keyboards to primarily EMS products, our exposure to warranty claims has declined significantly. Our warranty period for keyboards is generally longer than that for EMS products. We only warrant materials and workmanship on EMS products, +and we do not warrant design defects for EMS customers. +Income Taxes +We have domestic tax loss carryforwards of approximately $42.9 million and other future deductible temporary differences and tax credit carryforwards at June 28, 2008. In accordance with SFAS No. 109, we +assess the sources of future taxable income, which may be available to recognize the deductible differences that comprise deferred tax assets. A valuation allowance against deferred tax assets is required if it is more likely than not that some or +all of the deferred tax assets will not be realized. We have determined that a valuation allowance of $10.8 million on the total deferred tax asset is appropriate at this time. Our judgments regarding future use of deferred tax assets may change due +to changes in market condition, changes in tax laws or other factors. If our assumptions and estimates change in the future the valuation allowance will be adjusted accordingly and any resulting increase or decrease will result in an additional +income tax expense or benefit. +Goodwill +In accordance +with SFAS No. 142, Goodwill and Other Intangibles , we record intangible assets that are acquired individually or with a group of other assets in the financial statements at acquisition. We test goodwill for impairment annually as +required by SFAS 142. We adopted SFAS No. 142 on June 30, 2002, and completed our impairment test during the second quarters of each of the subsequent fiscal years. The tests did not indicate an impairment of our stated goodwill of +$765,000. +Derivatives +We have adopted SFAS +No. 133, Accounting for Derivative Instruments and Certain Hedging Activities , as amended. In accordance with these standards all derivative instruments are recorded on the balance sheet at their respective fair values. Generally, if a +derivative instrument is specifically designated as a cash flow hedge, the change in the fair value of the derivative is recorded in other comprehensive income to the extent the derivative is effective, and recognized in the statement of operations +when the hedged item affects earnings. If a derivative instrument is designated as a fair value hedge, the change in fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings in the current +period. We had no derivatives at the end of fiscal year 2008. +20 +Table of Contents +New Accounting Pronouncements +In December 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 141R, Business Combinations . SFAS No. 141R states that all business combinations (whether full, partial or step acquisitions) will result in +all assets and liabilities of an acquired business being recorded at their fair values. Certain forms of contingent consideration and certain acquired contingencies will be recorded at fair value at the acquisition date. SFAS No. 141R also +states acquisition costs will generally be expensed as incurred and restructuring costs will be expensed in periods after the acquisition date. This statement applies prospectively to business combinations for which the acquisition date is on or +after the beginning of the first annual reporting period beginning on or after December 15, 2008. SFAS No. 141R will affect how we account for future business acquisitions beginning in fiscal year 2010. +In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51 . SFAS +No. 160 requires a company to clearly identify and present ownership interest in subsidiaries held by parties other than the company in the consolidated financial statements within the equity section but separate from the company’s equity. +It also requires the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; changes in ownership interest be accounted +for similarly, as equity transactions; and when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary and the gain or loss on the deconsolidation of the subsidiary be measured at fair value. This +statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. We do not anticipate a material effect of adopting SFAS No. 160 on our consolidated financial statements. +In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities . SFAS No. 161 changes the +disclosure requirements for derivative instruments and hedging activities. The Company will be required to provide enhanced disclosures about how and why derivative instruments are used, how derivative instruments and related hedged items are +accounted for under SFAS No. 133, Accounting for Derivative Instruments and Certain Hedging Activities, and its related interpretations, and how derivative instruments and related hedged items affect the Company’s financial position, +financial performance, and cash flows. This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. We do not anticipate a material effect of adopting SFAS No. 161 on +our consolidated financial statements. +In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles . +SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements presented in conformity with U.S. generally accepted accounting principles. +SFAS No. 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting +Principles . The implementation of this standard will not have a material impact on our consolidated financial position and results of operations. +21 +Table of Contents +Item 7A: +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +We are +subject to the risk of fluctuating interest rates in the normal course of business. Our major market risk relates to our secured debt. Our debt is secured by substantially all of our assets. The interest rates applicable to our revolving loan +fluctuate with the JP Morgan Chase Bank prime rate and LIBOR rates. We do not currently enter into derivative transactions or leveraged swap agreements. +Although we have international operations, the functional currency for all subsidiaries is the U.S. dollar. We import raw materials that are used in our manufacturing operations. The majority of our purchases is denominated in U.S. dollars +and is paid under normal trade terms. In July 2006, we began to periodically hedge our foreign currency exposure in Mexico by utilizing weekly forward contracts to cover local payroll costs paid in Mexican pesos. There were no hedges outstanding as +of June 28, 2008. +The table below presents principal amounts of debt outstanding at June 28, 2008 and related weighted average variable rates by +fiscal year of maturity. The weighted average variable interest rate is estimated based on current rates as of June 28, 2008. These forward rates have been increased by current levels of margins based on the financing agreement with CIT. Our +long term debt could increase or decrease depending upon cash needs over the period of time that the financing agreement remains in place with CIT. The JP Morgan Chase Bank prime rate and LIBOR will fluctuate with the market and could go up or down +depending on market conditions. +Fiscal Years +Fair Value +June 28, 2008 +(In thousands) +2009 +2010 +2011 +2012 +2013 +Total +Long term debt: +Secured revolving debt +$ +— +$ +12,348 +$ +— +$ +— +$ +— +$ +12,348 +$ +12,348 +Average interest rate +— +5.39 +% +— +— +— +5.39 +% +— +22 +Table of Contents +Item 8: +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Report of Independent Registered Public Accounting Firm +The Board of Directors and Shareholders +Key Tronic Corporation +Spokane Valley, Washington +We have audited the accompanying consolidated balance sheets of Key Tronic Corporation and subsidiaries (the Company) as of June 28, 2008 and June 30, 2007, +and the related consolidated statements of earnings, shareholders’ equity and cash flows for each of the three years in the period ended June 28, 2008. In connection with our audits of the financial statements, we have also audited the +financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule +based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those +standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its +internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an +opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the +financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. 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 Key Tronic Corporation and subsidiaries at June 28, 2008 and June 30, 2007, and the results of its operations and its cash flows for each of the three years in the period ended June 28, 2008, in conformity with accounting +principles generally accepted in the United States of America. +Also, in our opinion, the financial statement schedule, when considered in relation to the +basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. +/s/ BDO Seidman, +LLP +Spokane, Washington +September 12, 2008 +23 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED BALANCE SHEETS +(In thousands) +June 28, 2008 +June 30, 2007 +ASSETS +Current assets: +Cash and cash equivalents +$ +2,879 +$ +3,386 +Trade receivables, less allowance for doubtful accounts of $110 and $20 +36,018 +30,383 +Inventories +37,927 +32,346 +Other +4,893 +6,532 +Total current assets +81,717 +72,647 +Property, plant and equipment, net +10,798 +11,248 +Other assets: +Restricted cash +39 +509 +Deferred income tax assets +4,210 +3,500 +Other, net of accumulated amortization of $111 and $98 +815 +719 +Goodwill +765 +765 +Total assets +$ +98,344 +$ +89,388 +LIABILITIES AND SHAREHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +29,497 +$ +24,104 +Accrued compensation and vacation +4,388 +3,713 +Current portion of other long-term obligations +470 +344 +Other +1,667 +3,264 +Total current liabilities +36,022 +31,425 +Long-term liabilities: +Revolving loan +12,348 +13,081 +Other long-term obligations +893 +1,638 +Total long-term liabilities +13,241 +14,719 +Commitments and contingencies (Notes 4 and 8) +Shareholders’ equity +Common stock, no par value, authorized 25,000 shares; issued and outstanding 10,024 and 9,921 shares, respectively +39,301 +39,048 +Retained earnings +9,780 +4,196 +Total shareholders’ equity +49,081 +43,244 +Total liabilities and shareholders’ equity +$ +98,344 +$ +89,388 +See accompanying notes to consolidated financial statements. +24 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF EARNINGS +(In thousands, except per share amounts) +June 28, 2008 +Years Ended +June 30, 2007 +July 1, 2006 +Net sales +$ +204,122 +$ +201,712 +$ +187,699 +Cost of sales +187,302 +184,042 +170,395 +Gross margin +16,820 +17,670 +17,304 +Operating expenses (income): +Research, development and engineering +2,676 +3,162 +2,762 +Selling +1,650 +1,776 +2,111 +General and administrative +6,611 +7,387 +6,570 +Gain on sale of real estate +(951 +) +(1,465 +) +— +Total operating expense +9,986 +10,860 +11,443 +Operating income +6,834 +6,810 +5,861 +Interest expense, net +989 +1,374 +1,108 +Income before income taxes +5,845 +5,436 +4,753 +Income tax provision (benefit) +261 +206 +(5,000 +) +Net income +$ +5,584 +$ +5,230 +$ +9,753 +Earnings per share: +Earnings per common share – basic +$ +0.56 +$ +0.53 +$ +1.00 +Weighted average shares outstanding – basic +9,997 +9,898 +9,707 +Earnings per common share – diluted +$ +0.54 +$ +0.51 +$ +0.97 +Weighted average shares outstanding – diluted +10,267 +10,342 +10,070 +See accompanying notes to consolidated financial statements. +25 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY +Common Stock +Retained Earnings +(Accumulated +Deficit) +Total +(In thousands) +Shares +Amount +Balances, July 2, 2005 +9,694 +$ +38,426 +$ +(10,787 +) +$ +27,639 +Stock based compensation +— +40 +— +40 +Exercise of stock options +56 +116 +— +116 +Net income – 2006 +— +— +9,753 +9,753 +Balances, July 1, 2006 +9,750 +38,582 +(1,034 +) +37,548 +Stock based compensation +— +6 +— +6 +Exercise of stock options +171 +460 +— +460 +Net income – 2007 +— +— +5,230 +5,230 +Balances, June 30, 2007 +9,921 +39,048 +4,196 +43,244 +Exercise of stock options +103 +253 +— +253 +Net income – 2008 +— +— +5,584 +5,584 +Balances, June 28, 2008 +10,024 +$ +39,301 +$ +9,780 +$ +49,081 +See accompanying notes to consolidated financial statements. +26 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +June 28, 2008 +Years Ended +June 30, 2007 +July 1, 2006 +Increase (decrease) in cash and cash equivalents: +Cash flows from operating activities: +Net income +$ +5,584 +$ +5,230 +$ +9,753 +Adjustments to reconcile net income to cash (used) by operating activities: +Depreciation and amortization +1,768 +1,814 +1,890 +Accretion of deferred gain on sale of building +(78 +) +(78 +) +(78 +) +Provision for obsolete inventory +159 +544 +361 +Provision for doubtful receivables +122 +555 +6 +Provision for (recovery of) warranty +196 +31 +(10 +) +Gain on sale of assets +(949 +) +(1,463 +) +(101 +) +Stock based compensation expense +— +6 +40 +Deferred income tax benefit +— +— +(5,000 +) +Changes in operating assets and liabilities: +Trade receivables +(5,757 +) +(1,935 +) +(4,818 +) +Inventories +(5,740 +) +3,448 +(6,987 +) +Other assets +(742 +) +(1,557 +) +1,084 +Accounts payable +5,393 +(7,124 +) +5,753 +Accrued compensation and vacation +675 +(764 +) +(764 +) +Litigation payable +— +— +(812 +) +Other liabilities +(1,349 +) +(564 +) +(351 +) +Cash used by operating activities +(718 +) +(1,857 +) +(34 +) +Cash flows from investing activities: +Purchase of property and equipment +(1,180 +) +(3,137 +) +(1,638 +) +Proceeds from sale of property and equipment +1,485 +2,691 +140 +Cash provided (used) by investing activities +305 +(446 +) +(1,498 +) +Cash flows from financing activities: +Payment of financing costs +(50 +) +(50 +) +(50 +) +Proceeds from exercise of stock options +253 +460 +116 +Proceeds from long-term debt +215 +499 +— +Repayment of long-term debt +(249 +) +(1,025 +) +(510 +) +Borrowing under revolving credit agreement +204,940 +213,266 +202,168 +Repayment of revolving credit agreement +(205,673 +) +(210,254 +) +(199,511 +) +Decrease in restricted cash +470 +365 +284 +Cash provided (used) by financing activities +(94 +) +3,261 +2,497 +Increase (decrease) in cash and cash equivalents +(507 +) +958 +965 +Cash and cash equivalents, beginning of year +3,386 +2,428 +1,463 +Cash and cash equivalents, end of year +$ +2,879 +$ +3,386 +$ +2,428 +Supplemental cash flow information: +Interest payments +$ +1,013 +$ +1,303 +$ +1,100 +Income tax payments, net of refunds +$ +301 +$ +258 +$ +194 +See accompanying notes to consolidated financial statements. +27 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. +SIGNIFICANT ACCOUNTING POLICIES +Business +Key Tronic Corporation and subsidiaries (the Company) is engaged in electronic manufacturing services (EMS) for original equipment manufacturers (OEMs), and also +manufactures keyboards and other input devices. The Company is headquarterd in Spokane Valley, Washington and has manufacturing operations in Spokane Valley; Juarez and Reynosa, Mexico; and Shanghai, China. +Principles of Consolidation +The consolidated financial statements +include the Company and its wholly owned subsidiaries in Mexico, China and the former operating subsidiary in Ireland. Intercompany balances and transactions have been eliminated in consolidation. +Use of Estimates +The preparation of financial statements in +conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and +liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates include the allowance for doubtful receivables, the provision for obsolete and non-saleable +inventories, the valuation allowances on deferred tax assets, valuation of goodwill, impairment of long-lived assets, medical self insurance liability, long-term incentive compensation accrual and the provision for warranty costs. Due to +uncertainties with respect to the assumptions and estimates actual results could differ from those estimates. +Cash Equivalents +The Company considers investments with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost, which approximates fair +value. The Company has restricted cash amounts in the Company’s bank account that cannot be used for any other purpose than to pay down the Company’s long term revolving line of credit. +Allowance for Doubtful Accounts +The Company evaluates the +collectibility of accounts receivable and records an allowance for doubtful accounts, which reduces the receivables to an amount that management reasonably estimates will be collected. A specific allowance is recorded against receivables considered +to be impaired based on the Company’s knowledge of the financial condition of the customer. In determining the amount of the allowance, the Company considers several factors including the aging of the receivables, the current business +environment, and historical experience. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. +Inventories +Inventories are stated at the lower of cost or market. Cost is determined principally using the first-in, first-out (FIFO) +method. The Company provides for obsolete and non-saleable inventories based on specific identification of inventory against current demand forecasts and recent usage. +Property, Plant and Equipment +Property, plant and equipment are carried at cost and depreciated using straight-line +methods over the expected useful lives of the assets. Internally constructed molds and dies are depreciated over the expected useful lives of one to two years. Repairs and maintenance costs are expensed as incurred. +28 +Table of Contents +Impairment of Long-lived Assets +The Company, using its best estimates based on reasonable and supportable assumptions and projections, reviews assets for impairment whenever events or changes in circumstances have indicated that the carrying amount +of its assets might not be recoverable. Impaired assets are reported at the lower of cost or fair value. +Deferred Loan Fees +Deferred loan fees included in other assets are amortized over the term of the related loan agreement. +Accrued Warranty +An accrual is made for expected warranty costs, with the related expense recognized in cost of +goods sold. Management reviews the adequacy of this accrual quarterly based on historical analyses and anticipated product returns. +Self-funded +Insurance +The Company self-funds its domestic employee health plan. The Company contracted with a separate administrative service company to supervise +and administer the program and act as its representative. The Company also insures for claims exceeding $65,000 and if the aggregate annual claims amount to more than 125% of expected claims for the plan year. The Company estimates its exposure for +claims incurred but not paid at the end of each reporting period and uses historical information supplied by the Company’s insurance carrier and broker to estimate its liability for these claims. This liability is subject to a total limitation +that varies based on employee enrollment and factors that are established at each annual contract renewal. Actual claims experience may differ from the Company’s estimates. +Revenue Recognition +Sales revenue from manufacturing is recognized upon shipment of the manufactured product per +contractual terms. Upon shipment, title transfers and the customer assumes risks and rewards of ownership of the product. Unless specifically stated in contractual terms, there are no formal customer acceptance requirements or further obligations +related to the manufacturing services; if any such requirements exist, then sales revenue is recognized at the time when such requirements are completed and such obligations are fulfilled. Revenue is recorded net of estimated returns of manufactured +product based on management’s analysis of historical returns. +Revenues and associated costs from engineering design and development services, which +are performed under contract of short term durations, are recognized only after the completed performance of the service. Revenue from engineering design and development services represented approximately three percent of total revenue in fiscal +year 2008 and two percent in fiscal year 2007 and 2006. +Shipping and Handling Fees +The Company classifies costs associated with shipping and handling fees as a component of cost of goods sold. Customer billings related to shipping and handling fees are reported as revenue. +Research, Development and Engineering +Research, development and +engineering expenses include unreimbursed EMS costs as well as design and engineering costs associated with the production of EMS programs. Such costs are charged to expense as incurred. +Income Taxes +The Company accounts for income taxes in accordance with provisions of Statement of Financial +Accounting Standards (SFAS) No. 109, Accounting for Income Taxes . Under the asset and liability method prescribed by SFAS No. 109, deferred income taxes are provided for temporary differences between the financial reporting and tax +bases of assets and liabilities. Deferred taxes are measured using provisions of currently enacted tax laws. Tax credits are accounted for as a reduction of income taxes in the year the credit is utilized. Valuation allowances are established +when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized. The effect of changes in tax rates is recognized in the period in which the rate change occurs. +29 +Table of Contents +Management has no future intent to repatriate remaining undistributed earnings of its foreign subsidiaries. Therefore, +the determination of the unrecognized deferred tax liability on foreign subsidiary undistributed earnings is not practicable. +Earnings Per Share +Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings +per share is computed by dividing net income by the weighted average number of common and common equivalent shares outstanding during the period using the treasury stock method. The computation assumes the proceeds from the exercise of stock options +were used to repurchase common shares at the average market price during the period. The computation of diluted earnings per share does not assume conversion, exercise, or contingent issuance of common stock equivalent shares that would have an +anti-dilutive effect on earnings per share. +Foreign Currency Transactions +The functional currency of the Company’s subsidiaries in Mexico, China and its former operating subsidiary in Ireland is the U.S. dollar. Realized foreign currency transaction gains and losses are included in +general and administrative expenses. +Fair Value of Financial Instruments +The carrying values of financial instruments reflected on the balance sheets at June 28, 2008 and June 30, 2007, reasonably approximate their fair value. Based on the borrowing rates currently available to +the Company for loans with similar terms and average maturities, the fair value of long-term debt is estimated to be $12.8 million and $13.6 million, respectively, as of June 28, 2008 and June 30, 2007, which approximates the carrying +values. +Stock-based Compensation +Effective +July 3, 2005, the Company adopted the provisions of SFAS No. 123R, Share-Based Payment , for its share-based compensation plans. The Company previously accounted for these plans under the recognition and measurement principles of +Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations and disclosure requirements established by SFAS No. 123, Accounting for Stock-Based Compensation, as +amended by SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure. +Under APB 25, prior to 2005 no +compensation expense was recorded in earnings for the Company’s stock options. The pro forma effects on net income and earnings per share for stock options were instead disclosed in a footnote to the financial statements. Under SFAS No. +123R, all share-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense in earnings over the requisite service period. Because the Company did not have a significant number of +non-vested options outstanding, the adoption of SFAS No. 123R did not have a material impact on operating results. +The Company adopted SFAS No. +123R using the modified prospective method. Under this transition method, compensation cost recognized in fiscal year 2006 of $40,000 includes the cost for all share-based awards granted prior to, but not yet vested as of July 3, 2005. This +cost was based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123. Results for prior periods have not been restated. The Company has not granted any stock options since fiscal 2005. As of +June 28, 2008, there were no unrecognized compensation costs related to remaining unvested stock options. +Goodwill +The Company records intangible assets that are acquired individually or with a group of other assets in the financial statements at acquisition. Goodwill is tested for +impairment at least annually at the end of the Company’s fiscal second quarter, or as circumstances dictate per SFAS 142. These tests have not indicated an impairment of the Company’s stated goodwill of $765,000. +New Accounting Pronouncements +In December 2007, the Financial +Accounting Standards Board (FASB) issued SFAS No. 141R, Business Combinations . SFAS No. 141R states that all business combinations (whether full, partial or step acquisitions) will result in all assets and liabilities of an acquired +business being recorded at their fair values. Certain forms of contingent consideration and certain acquired contingencies will be recorded at fair value at the acquisition date. SFAS No. 141R also states acquisition costs will generally be +expensed as incurred and restructuring costs will be expensed in periods after the acquisition date. This statement applies prospectively to +30 +Table of Contents +business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after +December 15, 2008. SFAS No. 141R will affect how the Company accounts for future business combinations beginning in fiscal year 2010. +In +December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51 . SFAS No. 160 requires a company to clearly identify and present ownership interest in +subsidiaries held by parties other than the company in the consolidated financial statements within the equity section but separate from the company’s equity. It also requires the amount of consolidated net income attributable to the parent and +to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; changes in ownership interest be accounted for similarly, as equity transactions; and when a subsidiary is deconsolidated, any +retained noncontrolling equity investment in the former subsidiary and the gain or loss on the deconsolidation of the subsidiary be measured at fair value. This statement is effective for fiscal years, and interim periods within those fiscal years, +beginning on or after December 15, 2008. The Company does not anticipate a material effect of adopting SFAS No. 160 on its consolidated financial statements. +In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities . SFAS No. 161 changes the disclosure requirements for derivative instruments and hedging +activities. The Company will be required to provide enhanced disclosures about how and why derivative instruments are used, how derivative instruments and related hedged items are accounted for under SFAS No. 133, Accounting for Derivative +Instruments and Certain Hedging Activities , and its related interpretations, and how derivative instruments and related hedged items affect the Company’s financial position, financial performance, and cash flows. This statement is effective +for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company does not anticipate a material effect of adopting SFAS No. 161 on its consolidated financial statements. +In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles . SFAS No. 162 identifies the sources of accounting +principles and the framework for selecting the principles to be used in the preparation of financial statements presented in conformity with U.S. generally accepted accounting principles. SFAS No. 162 is effective 60 days following the +SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles . The implementation of this standard will not +have a material impact on the Company’s consolidated financial position and results of operations. +Fiscal Year +The Company operates on a 52/53 week fiscal year. Fiscal years end on the Saturday nearest June 30. As such, fiscal years 2008, 2007, and 2006 ended on June 28, +2008, June 30, 2007, and July 1, 2006, respectively. Fiscal year 2009 will end on June 27, 2009. Fiscal 2008, 2007 and 2006 were 52 week years. +2. +INVENTORIES +Components of inventories were as follows: +June 28, 2008 +June 30, 2007 +(in thousands) +Finished goods +$ +8,915 +$ +6,757 +Work-in-process +3,521 +3,486 +Raw materials +25,727 +22,314 +Reserve for obsolescence +(236 +) +(211 +) +$ +37,927 +$ +32,346 +3. +PROPERTY, PLANT AND EQUIPMENT +Life +June 28, 2008 +June 30, 2007 +(in years) +(in thousands) +Land +— +$ +970 +$ +970 +Buildings and improvements +3 to 30 +13,096 +13,045 +Equipment +1 to 10 +32,709 +38,945 +Furniture and fixtures +3 to 5 +1,722 +5,050 +48,497 +58,010 +Accumulated depreciation +(37,699 +) +(46,762 +) +$ +10,798 +$ +11,248 +31 +Table of Contents +During the fourth quarter of fiscal 2007, the Company sold its under-utilized Las Cruces, New Mexico facility. The total +sales price for the facility and adjacent vacant land was $4.3 million. Sales proceeds were in the form of $2.8 million in cash and an additional $1.5 million note from the buyer. The cash received was for the purchase of the building and +approximately 9 acres of land while the note was to pay for the adjacent 14 acres of additional land. The note was payable within 45 days of the flood plain designation being removed from the adjacent vacant land. Due to the contingent nature of the +note, the Company recognized a $1.5 million gain on real estate held for the sale of the building and 9 acres of land in fiscal 2007 and deferred the gain on sale of the adjacent land. During the second quarter of fiscal 2008, the flood plain +designation was removed on the adjacent 14 acres of land resulting in the recognition of a gain on sale of real estate of $951,000 with the cash proceeds being received in January 2008. +In December 2000, the Company sold its headquarters building, located in Spokane, Washington. In conjunction with the sale, the Company entered into a ten year leaseback agreement for a portion of the building. The +gain on the sale of the building was deferred under other long-term obligations and is amortized to offset lease expenses over the remaining lease term, which expires in December 2010. +4. +LONG-TERM DEBT +The Company has entered into a financing agreement +with CIT Group/Business Credit, Inc. (CIT) which provides a revolving credit facility up to $25 million secured by the assets of the Company. The interest rate provisions allow for a variable rate based on either the prime rate or a set LIBOR rate +on specific short term traunches. The agreement specifies four alternative levels of margin to be added to these base rates depending on achieving a defined financial ratio. The range of interest being paid to CIT on outstanding balances was 4.38% - +6.71% as of June 28, 2008 and 6.83% - 8.25% as of June 30, 2007. The decrease in interest rates was a result of lower published prime and LIBOR rates. +The Company negotiated a decrease in the level of margin added in a loan agreement amendment signed in August 2006. The agreement contains financial covenants that relate to total equity, earnings before interest, taxes, depreciation and +amortization, and a minimum fixed charge ratio. All but one of the financial covenants, the minimum fixed charge ratio, have been removed by subsequent amendments to the financing agreement as of August 2006. The revolving loan matures +August 22, 2009, but the Company plans to renew the revolving loan prior to that date with CIT or another lender. As of June 28, 2008, the Company was in compliance with the remaining financial covenant. At June 28, 2008, the +outstanding revolving loan balance was $12.3 million compared to $13.1 million at fiscal year end June 30, 2007. Based on eligible collateral, approximately $12.7 million was available to draw from the revolving line of credit as of +June 28, 2008. +5. +INCOME TAXES +Income tax expense (benefit) consists of the +following: +June 28, 2008 +Year Ended +June 30, 2007 +July 1, 2006 +(in thousands) +Current income tax expense (benefit): +United States +$ +45 +$ +154 +$ +— +Foreign +216 +52 +— +261 +206 +— +Deferred income tax expense: +United States +— +— +(5,000 +) +Foreign +— +— +— +— +— +(5,000 +) +Total income tax expense (benefit) +$ +261 +$ +206 +$ +(5,000 +) +The Company had an income tax provision of $261,000 in fiscal year 2008 compared to a provision of $206,000 in +fiscal year 2007 and a $(5.0) million benefit in fiscal year 2006. The tax provision in fiscal 2008 is primarily related to income taxes in China and Mexico. The income tax provision in 2007 was primarily related to income taxes in the United States +which was caused by a one-time repatriation of earnings from our Mexico operations. +32 +Table of Contents +In addition to its domestic operations, the Company has subsidiaries in Mexico and China. The Company is currently +applying certain tax credits to offset the income tax liabilities of its Mexican subsidiaries. However, as of January 1, 2008, the Company is subject to a recently enacted Mexican business flat tax called Impuesto Empresarial a Tasa Unica +(IETU). The effect of IETU and an associated presidential decree on fiscal 2008 has been included in the effective tax rate as of June 28, 2008 and was approximately $60,000. The Company continues to pay income tax in China. +The income tax benefit in 2006 related to the Company reducing the valuation allowance on its net deferred tax asset in accordance with SFAS No. 109. The Company +has domestic tax net operating loss carryforwards (NOLs) of approximately $42.9 million at June 28, 2008. In accordance with SFAS No. 109, management assessed the Company’s recent operating levels and the sources of future taxable +income to estimate a valuation allowance. A valuation allowance against deferred tax assets is required if it is more likely than not that some of the deferred tax assets will not be realized. Management has determined that the $10.8 million +valuation allowance is appropriate. +The Company does not provide for domestic income taxes on the undistributed earnings of its foreign subsidiaries, due +to the fact that unremitted earnings are not intended by management to be repatriated in the foreseeable future. If such earnings were subsequently recognized in the United States, the Company would be subject to U.S. federal and state income taxes +and potential withholding taxes in foreign jurisdictions. +FASB Interpretation No. 48 requires the Company to recognize in its financial statements +uncertainties in tax positions taken that may not be sustained upon examination by the taxing authorities. If interest or penalties are assessed, the Company would recognize these charges as income tax expense. Upon adoption of FIN 48 and +subsequently, the Company determined that no adjustments were necessary in implementing FIN 48. Unrecognized tax benefits are not anticipated to increase or decrease over the next 12 months. +The Company’s effective tax rate differs from the federal tax rate as follows: +June 28, 2008 +Year Ended +June 30, 2007 +July 1, 2006 +(in thousands) +Federal income tax expense at statutory rates +$ +1,987 +$ +1,848 +$ +1,616 +Effect of foreign vs. domestic taxes +(899 +) +(636 +) +(550 +) +Expired NOLs +977 +447 +1,176 +Repatriation of accumulated foreign subsidiary income +— +2,048 +— +Other +158 +194 +8 +Change in valuation allowance +(1,962 +) +(3,695 +) +(7,250 +) +Income tax provision (benefit) +$ +261 +$ +206 +$ +(5,000 +) +The domestic and foreign components of income before income taxes were: +June 28, 2008 +Year Ended +June 30, 2007 +July 1, 2006 +(in thousands) +Domestic +$ +2,710 +$ +3,420 +$ +3,181 +Foreign +3,135 +2,016 +1,572 +Income before income taxes +$ +5,845 +$ +5,436 +$ +4,753 +33 +Table of Contents +Deferred income taxes result from temporary differences in the timing of recognition of revenue and expenses. Deferred +income tax assets and liabilities consist of the following at: +June 28, 2008 +June 30, 2007 +(in thousands) +Inventory +$ +621 +$ +533 +Vacation accrual +329 +312 +Other +229 +218 +Net operating loss carryforwards +1,020 +1,700 +Current deferred income tax assets +2,199 +2,763 +Current portion of valuation allowance +(1,409 +) +(1,263 +) +Current deferred income tax assets, net of valuation allowance +$ +790 +$ +1,500 +Depreciation and amortization +$ +(1,009 +) +$ +(966 +) +State deferred taxes +377 +414 +Net operating loss carryforwards +13,581 +14,595 +Tax credit carryforwards +389 +515 +Other +256 +434 +Noncurrent deferred income tax assets +13,594 +14,992 +Valuation allowance, net of current portion +(9,384 +) +(11,492 +) +Noncurrent deferred income tax assets, net of valuation allowance +$ +4,210 +$ +3,500 +Total deferred income tax assets +$ +5,000 +$ +5,000 +At June 28, 2008, the Company had NOLs of approximately $42.9 million. The remaining net operating loss +carryforwards expire in varying amounts through 2025. Utilization of NOLs would be limited in the event the Company’s ownership changes more than 50% in a three-year period. The Company also has general business credits and alternative minimum +tax credits approximating $114,000 and $368,000, respectively. The general business credits expire in varying amounts through fiscal year 2009. The alternative minimum tax credits do not expire. +6. +EARNINGS PER SHARE +Basic earnings per share (EPS) is calculated by +dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is computed by including both the weighted-average number of shares outstanding and any dilutive common +share equivalents in the denominator. The following table presents a reconciliation of the denominator and the number of antidilutive common share options that were not included. These antidilutive securities occur when options outstanding have an +option price greater than the average market price for the period. +June 28, 2008 +Years Ended +June 30, 2007 +July 1, 2006 +Total weighted average shares – basic +9,997,431 +9,898,009 +9,707,020 +Effect of dilutive common stock options +269,480 +444,457 +362,871 +Total weighted average shares – diluted +10,266,911 +10,342,466 +10,069,891 +Antidilutive options not included in diluted earnings per share +515,550 +397,750 +896,800 +7. +STOCK OPTION AND BENEFIT PLANS +The Company has an executive stock +option plans for certain key employees. Options under this plan vest over one to three years and become exercisable as they vest. Options under the plan become exercisable in full immediately prior to the occurrence of a “Change in +Control” as defined in the plan documents. The Company has reserved 2,795,000 shares for issuance under this plan. As of June 28, 2008, 1,078,875 options were outstanding all of which were exercisable. There are 68,500 shares available for +future grant under the plan. These options expire five to ten years from the date of vesting. +34 +Table of Contents +The Company also has a stock option plan for “Nonemployee Directors.” Options under this plan vested over a +three-year period and are exercisable. The Company reserved 300,000 shares for issuance under this plan. As of June 28, 2008, 189,500 options were outstanding. The plan has terminated and no more options can be granted under this plan. +Outstanding options expire five to ten years from the date of vesting. +Compensation expense for vested options totaled approximately $6,000 in fiscal 2007 +and $40,000 in fiscal year 2006. There was no compensation expense incurred in conjunction with options vesting in fiscal year 2008. +The following table +summarizes option activity of both plans from June 30, 2007 through June 28, 2008: +Shares +Available +For Grant +Options +Outstanding +Aggregate +Intrinsic Value +(in thousands) +Weighted +Average +Exercise +Price +Weighted +Average +Remaining +Contractual +Life +Balance at June 30, 2007 +68,500 +1,650,838 +$ +4.08 +Options canceled and expired +— +(279,200 +) +$ +6.96 +Options exercised +— +(103,263 +) +226 +$ +2.45 +Balance at June 28, 2008 +68,500 +1,268,375 +$ +755 +$ +3.58 +1.9 +Exercisable at June 28, 2008 +1,268,375 +$ +755 +$ +3.58 +1.9 +The following is a summary of plan activity: +Price Range +Number +Of Options +Weighted Average +Exercise Price +Outstanding, July 2, 2005 +$ +1.15 to $16.25 +1,985,650 +$ +4.22 +Granted during 2006 +$ +1.15 to $ 2.81 +(56,500 +) +$ +2.04 +Canceled +$ +5.03 to $ 5.63 +(3,700 +) +$ +5.14 +Outstanding, July 1, 2006 +$ +1.15 to $16.25 +1,925,450 +$ +4.28 +Exercised during 2007 +$ +1.20 to $ 3.94 +(170,632 +) +$ +2.70 +Canceled +$ +3.40 to $16.25 +(103,980 +) +$ +10.08 +Outstanding June 30, 2007 +$ +1.15 to $16.25 +1,650,838 +$ +4.08 +Exercised during 2008 +$ +1.20 to $4.19 +(103,263 +) +$ +2.45 +Canceled +$ +2.75 to $16.25 +(279,200 +) +$ +6.96 +Outstanding, June 28, 2008 +$ +1.15 to $6.50 +1,268,375 +$ +3.58 +Additional information regarding options outstanding as of June 28, 2008, is as follows: +Options +Outstanding +Weighted Avg. +Remaining +Contractual Life (yrs.) +Options Exercisable +Range of Exercise Prices +Number Outstanding +Weighted +Avg. Exercise Price +Number Exercisable +Weighted +Avg. Exercise +Price +$ +1.15 - 1.73 +82,500 +1.9 +$ +1.16 +82,500 +$ +1.16 +1.74 - 2.60 +90,000 +2.0 +2.09 +90,000 +2.09 +2.61 - 3.92 +580,325 +2.4 +2.80 +580,325 +2.80 +3.93 - 5.89 +475,550 +1.2 +4.98 +475,550 +4.98 +5.90 - 6.50 +40,000 +2.5 +6.50 +40,000 +6.50 +$ +1.15 - 6.50 +1,268,375 +1.9 +$ +3.58 +1,268,375 +$ +3.58 +The Company also has a defined contribution plan (401(k)) available to U.S. employees who have attained age +21. The Company contributes an amount equal to 100% of the employee’s contribution on the first 3% of the employee’s compensation and an +35 +Table of Contents +additional 50% of the employee’s contribution on the following 2% of the employee’s compensation. Company contributions to the plan were $416,000, +$427,000, and $418,000 in fiscal years 2008, 2007 and 2006, respectively. +8. +COMMITMENTS AND CONTINGENCIES +Leases: As of June 28, +2008, the Company had $740,000 of property and equipment financed under capital leases. The related accumulated depreciation for these capital leases amounted to $193,000 as of June 28, 2008. The Company also has operating leases for certain +equipment and production facilities, which expire at various dates during the next five years. Future minimum payments under non-cancelable operating and capital leases with initial or remaining terms of one year or more at June 28, 2008, are +summarized as follows (in thousands): +Fiscal Years Ending +Operating +Leases +Capital +Leases +2009 +$ +2,899 +$ +313 +2010 +2,609 +195 +2011 +1,748 +— +2012 +27 +— +2013 +5 +— +Total minimum lease payments +$ +7,288 +508 +Amount representing interest +(35 +) +Present value of lease payments +473 +Current portion +313 +Capital lease obligations, net of current portion +$ +160 +Rental expenses under operating leases were approximately $3.7 million, $4.4 million, and $4.3 million in 2008, +2007, and 2006, respectively. +Warranty Costs: The Company provides warranties on certain product sales, and allowances for estimated warranty costs +are recorded during the period of sale. The determination of such allowances requires the Company to make estimates of product return rates and expected costs to repair or to replace the products under warranty. The Company establishes warranty +reserves based on historical warranty costs for each product line combined with liability estimates based on the prior twelve months’ sales activities. +If actual return rates and/or repair and replacement costs differ significantly from estimates, adjustments to recognize additional cost of sales may be required in future periods. +Components of the reserve for warranty costs during 2008, 2007 and 2006 were as follows: +Balance at July 2, 2005 +$ +245,855 +Recovery +(9,900 +) +Warranty costs incurred +(145,955 +) +Balance at July 1, 2006 +90,000 +Additions +30,680 +Warranty costs incurred +(80,680 +) +Balance at June 30, 2007 +40,000 +Additions +196,200 +Warranty costs incurred +(69,085 +) +Balance at June 28, 2008 +$ +167,115 +Litigation : The Company may be party to certain lawsuits or claims in the ordinary course of business. The +Company does not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on the financial position, results of operations or cash flow of the Company. +36 +Table of Contents +Indemnification Rights : Under the Company’s Bylaws, the Company’s directors and officers have certain +rights to indemnification by the Company against certain liabilities that may arise by reason of their status or service as directors or officers. The Company maintains director and officer insurance, which may cover certain liabilities arising from +its obligation to indemnify its directors and officers and former directors in certain circumstances. +9. +ENTERPRISE-WIDE DISCLOSURES +Products and Services +Of the revenues for the years ended June 28, 2008, June 30, 2007, and July 1, 2006, EMS sales were $198.3 million, $196.1 million, +and $180.4 million, respectively. Keyboard sales for the years ended June 28, 2008, June 30, 2007, and July 1, 2006 were $5.8 million, $5.6 million, and $7.3 million, respectively. +Geographic Areas +Net sales and long-lived assets (property, plant, +and equipment) by geographic area as of and for the years ended June 28, 2008, June 30, 2007, and July 1, 2006 are summarized in the following table. Net sales set forth below are based on the shipping destination. +Domestic (U.S.) +Foreign +Total +(in thousands) +2008 +Net sales +$ +192,748 +$ +11,374 +$ +204,122 +Long-lived assets +$ +3,936 +$ +6,862 +$ +10,798 +2007 +Net sales +$ +183,261 +$ +18,451 +$ +201,712 +Long-lived assets +$ +5,433 +$ +5,815 +$ +11,248 +2006 +Net sales +$ +173,978 +$ +13,721 +$ +187,699 +Long-lived assets +$ +3,489 +$ +6,318 +$ +9,807 +For the year ended June 28, 2008, 65.8% of the Company’s foreign net sales were to customers in +Switzerland, 11.7% were to Canada, 10.2 % were to Asia, and the remaining 12.3% were spread among customers in other parts of Europe and Australia. +For the year ended June 30, 2007, 43.4% of the Company’s foreign net sales were to customers in Switzerland, 9.2% were to Canada, 46.3% were to Asia, and the remaining 1.1% were spread among customers in other parts of Europe and +Australia. +For the year ended July 1, 2006, 56.3% of the Company’s foreign net sales were to customers in Switzerland, 23.8% were to customers +in Asia, 13.2% were to Canada, and the remaining 6.7% were spread among customers in other parts of Europe and Australia. +Significant Customers +The percentage of net sales to customers representing 10 percent or more of total net sales were as follows: +Fiscal Year +2008 +2007 +2006 +Customer A +18 +% +17 +% +18 +% +Customer B +18 +% +22 +% +20 +% +Customer C +15 +% +18 +% +17 +% +Accounts receivable related to these customers represented approximately 14%, 6%, and 17%, respectively, of the +Company’s total accounts receivable balance as of June 28, 2008. An additional customer’s accounts receivable also accounted for 10% of the Company’s total accounts receivable as of June 28, 2008. +37 +Table of Contents +There can be no assurance that the Company’s principal customers will continue to purchase products from the Company +at current levels. Moreover, the Company typically does not enter into long-term volume purchase contracts with its customers, and the Company’s customers have certain rights to extend or delay the shipment of their orders. The loss of one or +more of the Company’s major customers, or the reduction, delay or cancellation of orders from such customers, could materially and adversely affect the Company’s business, operating results and financial condition. +10. +QUARTERLY FINANCIAL DATA +(Unaudited) +Year Ended June 28, 2008 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +Net sales +$ +44,550 +$ +50,824 +$ +51,461 +$ +57,287 +Gross profit +3,062 +3,507 +4,227 +6,024 +Income before income taxes +218 +1,704 +1,213 +2,710 +Net income +183 +1,636 +1,167 +2,598 +Earnings per common share-basic +$ +0.02 +$ +0.16 +$ +0.12 +$ +0.26 +Earnings per common share-diluted +$ +0.02 +$ +0.16 +$ +0.11 +$ +0.25 +Weighted average shares outstanding +Basic +9,928 +10,013 +10,024 +10,024 +Diluted +10,328 +10,341 +10,207 +10,187 +Year Ended June 30, 2007 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +Net sales +$ +55,512 +$ +49,829 +$ +47,212 +$ +49,159 +Gross profit +5,294 +4,201 +3,720 +4,455 +Income before income taxes +1,484 +366 +723 +2,863 +Net income +1,419 +345 +742 +2,724 +Earnings per common share-basic +$ +0.14 +$ +0.03 +$ +0.07 +$ +0.27 +Earnings per common share-diluted +$ +0.14 +$ +0.03 +$ +0.07 +$ +0.26 +Weighted average shares outstanding +Basic +9,842 +9,915 +9,915 +9,920 +Diluted +10,458 +10,390 +10,272 +10,302 +Item 9: +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES +None +Item 9A(T): +CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls +and Procedures +It is the responsibility of our management to establish, maintain, and monitor disclosure controls and procedures that are designed +to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 are recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange +Commission rules and forms. Additionally, these disclosure controls include controls and procedures that are designed to accumulate and communicate the information required to be disclosed to our company’s Chief Executive Officer and Chief +Financial Officer, allowing for timely decisions regarding required disclosures. As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and with the participation of the Chief Executive +Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(f). Based on our assessment, we believe that as of June 28, 2008, the +Company’s disclosure controls and procedures are effective based on that criteria. +38 +Table of Contents +Management’s Report on Internal Control over Financial Reporting +Our management has the responsibility to establish and maintain adequate internal controls over our financial reporting, as defined in Rule 13a-15(f) under the Securities +and Exchange Act of 1934. Our internal controls are designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our external financial statements in accordance with generally accepted +accounting principles (GAAP). +Due to inherent limitations of any internal control system, management acknowledges that there are limitations as to the +effectiveness of internal controls over financial reporting and therefore recognize that only reasonable assurance can be gained from any internal control system. Accordingly, our internal control system may not detect or prevent material +misstatements in our financial statements and projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the +policies or procedures may deteriorate. +Under the supervision and participation of management, including the Chief Executive Officer and Chief Financial +Officer, we have performed an assessment of the effectiveness of our internal controls over financial reporting as of June 28, 2008. This assessment was based on the criteria established in Internal Control-Integrated Framework, issued by the +Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we believe that as of June 28, 2008, the Company’s internal control over financial reporting is effective based on that criteria. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s +report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this annual report. +Changes in Internal Control over Financial Reporting +There +have been no significant changes in our internal controls over financial reporting during our fourth fiscal quarter ended June 28, 2008 that have materially affected, or are reasonable likely to materially affect, the Company’s internal +control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)). +Item 9B: +OTHER INFORMATION +None +39 +Table of Contents +PART III +Item 10: +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +Directors of the Registrant +Information on the nominees for election as Directors of the Company is incorporated by reference from the +Company’s definitive proxy statement for the 2008 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A under the Exchange Act no later than 120 days after the end of the Company’s 2008 fiscal year. +Executive Officers of the Registrant +This information is included in +a separate item captioned “Executive Officers of the Registrant” in Part 1 of this report pursuant to Instruction G(3) of Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K. +Compliance with Section 16(a) of the Exchange Act: +Incorporated +by reference to Key Tronic Corporation’s 2008 Proxy Statement to Shareholders. +Code of Conduct +The Board of Directors has adopted a written Code of Conduct which applies to its directors and employees, including its executive officers. The Code of Conduct is +available on the Company’s website at www.keytronic.com . The Company intends to disclose on its website any amendments to or waivers of the Code of Conduct. +Item 11: +EXECUTIVE COMPENSATION +Information appearing under the caption +“Executive Compensation” in the Company’s 2008 Proxy Statement is incorporated herein by this reference. +Item 12: +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The following table sets forth the aggregate information for the Company’s equity compensation plans in effect as of June 28, 2008. +EQUITY COMPENSATION PLAN INFORMATION +Plan category +Number of securities to +be issued upon exercise +of outstanding options, +warrants and rights +(a) +Weighted-average +exercise price of +outstanding options, +warrants and rights +(b) +Number of securities +remaining available for +future issuance under +equity compensation +plans +(excluding +securities reflected in +column (a)) +(c) +Equity compensation plans approved by security holders +1,078,875 +$ +3.83 +0 +Equity compensation plans not approved by security holders (1) +189,500 +$ +2.18 +68,500 +Total +1,268,375 +$ +3.58 +68,500 +(1) +Consists of the Key Tronic Corporation 2000 Employee Stock Option Plan +Information under the caption “Beneficial Ownership of Securities” in the Company’s 2008 Proxy Statement is incorporated herein by this reference. +40 +Table of Contents +Item 13: +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Information appearing under the caption “Related Person Transactions”, “Compensation Committee Interlocks and Insider Participation” and “Directors’ Independence” in the Company’s 2008 Proxy Statement +is incorporated herein by this reference. +Item 14: +PRINCIPAL ACCOUNTING FEES AND SERVICES +Information appearing under +the caption “Principal Accountant Fees and Services” in the Company’s 2008 Proxy Statement is incorporated herein by this reference. +41 +Table of Contents +PART IV +Item 15: +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a) +1. FINANCIAL STATEMENTS +Page in +Form 10-K +FINANCIAL STATEMENTS +Report of Independent Registered Public Accounting Firm +23 +Consolidated Balance Sheets, as of June 28, 2008, and June 30, 2007 +24 +Consolidated Statements of Earnings for the years ended June 28, 2008, June 30, 2007, and July +1, 2006 +25 +Consolidated Statements of Shareholders’ Equity for the years ended June 28, 2008, June +30, 2007, and July 1, 2006 +26 +Consolidated Statements of Cash Flows for the years ended June 28, 2008, June 30, 2007, and July +1, 2006 +27 +Notes to Consolidated Financial Statements +28 -38 +2. SCHEDULES +Report of Independent Registered Public Accounting Firm on Financial Statement Schedule +23 +II. Consolidated Valuation and Qualifying Accounts +44 +Other schedules are omitted because of the absence of conditions under which they are required, or because +required information is given in the financial statements or notes thereto. +3. +EXHIBITS +Exhibit No. +Description +3.1 +Articles of Incorporation, incorporated by reference to the Exhibits to the Company’s form 10-K for the year ended June 30, 1986 +3.2 +Bylaws, as amended, incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended June 30, 1986 +10.1* +Executive Stock Option Plan, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended June 30, 1986 +10.2* +Amended and Restated 1990 Stock Option Plan for Non-Employee Directors, as amended, incorporated by reference to the Company’s 1997 Proxy Statement (dated October 10, 1997), pages 14-17 +10.3* +1995 Executive Stock Option Plan, incorporated by reference to the Company’s 1995 Proxy Statement, pages +19-22 +10.4* +2000 Employee Stock Option Plan, incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended January 1, 2000 +10.5* +Officers’ Employment Contracts, incorporated by reference to the Company’s 1998 Proxy Statement, pages 10 and 11 +10.6* +Employment Contract with Michael D. Chard, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended July 1, 2000 +10.7* +Addenda to Officers’ Employment Contracts, incorporated by reference to Exhibits to the Company’s Form 10-Q for the quarter ended January 1, 2000 +10.8* +Description of Retention Bonus Plan, incorporated by reference to the Exhibits to the Company’s 10-Q for the quarter ended December 28, 2002 +10.9* +Addenda to Officers’ Employment Contracts, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended June 29, 2002 +10.10 +Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended September 29, 2001 +10.11 +First and Second Amendments to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended June 29, +2002 +42 +Table of Contents +10.12 +Third Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended December 29, +2002 +10.13 +Fourth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended June 28, +2003 +10.14 +Fifth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended December 27, 2003 +10.15 +Sixth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended April 3, +2004 +10.16 +Seventh Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended July 3, +2004 +10.17 +Eighth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s From 10-K for the year ended July 3, +2004 +10.18 +Ninth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended October 2, +2004 +10.19 +Tenth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibit to the Company’s Form 8-K filed April 4, 2005 +10.20 +Promise to execute a Purchase and Sale Agreement with Key Safety Systems de Mexico, S.A. de C.V., incorporated by reference to the Exhibit to the Company’s Form 8-K filed April 26, 2005 +10.21 +Summary of material terms and conditions of the Purchase and Sale Agreement with Key Safety Systems de Mexico, S.A. de C.V., incorporated by reference to the Exhibit to the Company’s Form +8-K filed June 6, 2005 +10.22* +Summary of Key Tronic Corporation Incentive Compensation Plan, incorporated by reference to Exhibit 10.23* the Company’s Form 10-K for the year ended July 2, 2005 +10.23* +Employment Contract between Key Tronic Corporation and George Robert Alford, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed July 26, 2006 +10.24* +Summary of Incentive Compensation Plan Performance goals and Target Payments for fiscal year 2007, incorporated by reference to the Company’s Form 8-K filed July 28, 2006 +10.25* +Summary of Fiscal Years 2007 – 2009 Long Term Incentive Plan Performance Measures and Awards, incorporated by reference to the Company’s From 8-K filed July 28, 2006 +10.26* +Summary of Key Tronic Corporation Long Term Incentive Compensation Plan, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed September 27, 2005 +10.27 +Twelfth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibit to the Company’s Form 8-K filed September 7, 2006 +10.28 +Summary of material terms and conditions of the Purchase and Sale Agreement with Todenko Mexico S.A. de C.V., incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed +October 12, 2006 +10.29 +Summary of material terms and conditions of the Purchase and Sale Agreement with Todenko Mexico S.A. de C.V., incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed +November 20, 2006 +10.30 +Summary of material terms and conditions of the Sale and Purchase Agreement with Adevco Corporation, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed January 5, +2007 +10.31 +Summary of Second Amendment to Agreement of Sale and Purchase Agreement with Adevco Corporation, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed April 11, 2007 +10.32* +Summary of Incentive Compensation Plan Performance Goals and Target Payments for Fiscal Year 2008 and Fiscal Years 2008-2010 Long Term Incentive Plan Performance Measures and Awards incorporated +by reference to the Company’s Form 8-K filed July 27, 2007 +10.33* +Summary of Incentive Compensation Plan Performance Goals and Target payments for Fiscal Year 2009 and Fiscal Years 2009 – 2011 Long Term Incentive Plan Performance Measures and Awards +incorporated by reference to the Company’s Form 8-K filed July 24, 2008 +21. +Subsidiaries of Registrant, submitted herewith +23.1 +Consent of Independent Registered Public Accounting Firm, submitted herewith +31.1 +Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer, submitted herewith +31.2 +Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer, submitted herewith +32.1 +Section 1350 Certification of Chief Executive Officer, submitted herewith +32.2 +Section 1350 Certification of Chief Financial Officer, submitted herewith +* +Management contract or compensatory plan or arrangement +43 +Table of Contents +PART IV +SCHEDULE II +KEY TRONIC CORPORATION AND SUBSIDIARIES +CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS +FISCAL YEARS ENDED JUNE 28, 2008, JUNE 30, 2007, AND +JULY 1, 2006 +2008 +2007 +2006 +(in thousands) +Allowance for Obsolete Inventory +Balance at beginning of year +$ +211 +$ +1,669 +$ +3,165 +Provisions +159 +544 +361 +Dispositions +(134 +) +(2,002 +) +(1,857 +) +Balance at end of year +$ +236 +$ +211 +$ +1,669 +Allowance for Doubtful Accounts +Balance at beginning of year +$ +20 +$ +0 +$ +158 +Provisions +122 +555 +6 +Write-offs +(32 +) +(535 +) +(164 +) +Balance at end of year +$ +110 +$ +20 +$ +0 +44 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed +on its behalf by the undersigned, thereunto duly authorized. +Dated: September 12, 2008 +KEY TRONIC CORPORATION +By: +/s/ Jack W. Oehlke +Jack W. Oehlke, Director, President, +and +Chief Executive Officer +45 +Table of Contents +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by +the following persons on behalf of the registrant and in the capacities and on the dates indicated: +/s/ Jack W. Oehlke +September 12, 2008 +Jack W. Oehlke +Date +(Director, President and +Chief Executive +Officer) +/s/ Ronald F. Klawitter +September 12, 2008 +Ronald F. Klawitter +Date +(Principal Financial Officer) +/s/ James R. Bean +September 12, 2008 +James R. Bean +Date +(Director) +/s/ Dale F. Pilz +September 12, 2008 +Dale F. Pilz +Date +(Director, Chairman of the Board) +/s/ Yacov A. Shamash +September 12, 2008 +Yacov A. Shamash +Date +(Director) +/s/ Patrick Sweeney +September 12, 2008 +Patrick Sweeney +Date +(Director) +46 \ No newline at end of file diff --git a/raw/filings/0000719733/2008/0001193125-08-195739/filing_metadata.csv b/raw/filings/0000719733/2008/0001193125-08-195739/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..668238310f7281bafd6cdb9b6277fa8c6bddbc0e --- /dev/null +++ b/raw/filings/0000719733/2008/0001193125-08-195739/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000719733,KTCC,KEY TRONIC CORP,10-K,2008-09-15,2008-06-28,2008-09-15T14:49:14.000Z,0001193125-08-195739,d10k.htm,FORM 10-K,681780,0,0,https://www.sec.gov/Archives/edgar/data/719733/000119312508195739/d10k.htm,https://www.sec.gov/Archives/edgar/data/719733/000119312508195739/,2008,2008,1 diff --git a/raw/filings/0000719733/2008/0001193125-08-195739/item1.txt b/raw/filings/0000719733/2008/0001193125-08-195739/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..f6c2af5fb58299912e4ba0f30d52a3faaeb2d234 --- /dev/null +++ b/raw/filings/0000719733/2008/0001193125-08-195739/item1.txt @@ -0,0 +1,84 @@ +Item 1. +BUSINESS +Overview +Key Tronic Corporation (dba: KeyTronicEMS Co.), was organized in 1969 as a Washington corporation that locally manufactured computer keyboards. Our goal was to become the +world’s largest manufacturer of input devices for terminals, word processors and personal computers. The ability to design, build and deliver a quality product led to a reputation in the industry, allowing us to be a leading independent +manufacturer of keyboards for computers in the United States. Our fully integrated design, tooling and automated manufacturing capabilities enabled us to rapidly respond to customers’ needs for keyboards in production quantities worldwide. We +supported our sales growth through the development and purchase of international manufacturing facilities. As the computer keyboard market matured with increasing competition from other international providers, we determined that our business could +no longer solely rely on keyboard sales. +After assessing market conditions and our strengths and capabilities in 1999, we shifted focus from keyboard +manufacturing to contract manufacturing for a wide range of products. Our new strategy was based on our original core strengths of innovative design and engineering expertise in electronics, mechanical engineering and precision plastics combined +with high-quality, low cost production and assembly on a global basis. These strengths have made our company a strong competitor in the electronic manufacturing services “EMS” market. As we fully transitioned into an EMS provider, our new +customer base became comprised of world-class customers from a wide range of industries. +The EMS industry has experienced growth over the past several +years as more original equipment manufacturers “OEMs” seek to outsource manufacturing and this trend is expected to continue in the future. This expansion of the EMS industry has allowed us to continue to expand our customer base and the +industries that we serve. We currently offer our customers the following services: integrated electronic and mechanical engineering; precision plastic molding; assembly, component selection, sourcing and procurement; worldwide logistics; competitive +pricing; and new product testing and production. +We operate in facilities in the United States, Mexico and China. This global production capability +provides our customers with the benefits of improved supply-chain management, reduced inventory, lower labor costs, lower transportation costs and reduced product fulfillment time. +Our principal executive offices are located at N. 4424 Sullivan Road, Spokane Valley, Washington 99216, and our telephone number is (509) 928-8000. Our website is located at http://www.keytronicems.com where +filings of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q or current reports on Form 8-K are available after they have been filed with the Securities and Exchange Commission. The information presented on our website currently and in +the future is not considered to be part of this document or any document incorporated by reference in this document. +Marketing +We provide a mix of manufacturing services for outsourced OEM products. We provide the following EMS services: product design, surface mount technologies “SMT” +for printed circuit board assembly, tool making, precision plastic molding, liquid injection molding, automated tape winding, prototype design and full product builds. +4 +Table of Contents +Sales of the majority of our products have historically not been seasonal in nature, but may be seasonal in the future if +there are changes in the types of products manufactured. Sales can, however, fluctuate significantly between quarters from changes in customers’ demand due to our revenue concentration in a few specific customers. +For the fiscal years ended June 28, 2008, June 30, 2007, and July 1, 2006, the five largest customers in each year accounted for 68%, 73% and 71% of +total sales, respectively. The following customers represented 10 percent or more of total net sales over the last three fiscal years: International Game Technology, Inc. (18%, 17%, 18%), Zebra Technologies Corporation (18%, 22%, 20%) and Lexmark +International, Inc. (15%, 18%, 17%). It is anticipated that our new customer program wins will dilute our concentration of revenue in our current top five customers in the future. +Although keyboard manufacturing is still included in our product offerings, we expect annual keyboard sales to decline over time. During the fiscal years ended June 28, 2008, June 30, 2007, and +July 1, 2006, we realized revenues of approximately $5.8 million, $5.6 million and $7.3 million, respectively, from the sale of keyboards. In order to accommodate the demand for standard keyboard layouts, we maintain a purchase-from-stock +program. The more popular standard layouts are built and stocked for immediate availability. +We market our products and services primarily through our +direct sales department aided by strategically located field sales people and distributors. Although we maintain relationships with several independent sales organizations to assist in marketing our EMS product lines, commissions earned and paid are +not material to the consolidated financial statements. +Manufacturing +Since inception, we have made substantial investments in developing and expanding a capital equipment base to achieve vertical integration and efficiencies in our manufacturing processes. We have invested significant +capital into SMT for volume manufacturing of complex printed circuit board assemblies. We also design and develop tooling for injection molding and manufacture the majority of plastic parts used in the products we manufacture. Additionally, we have +equipment to maintain a controlled clean environment for manufacturing processes that require a high level of precise control. +We use a variety of manual +and highly automated assembly processes in our facilities, depending upon product complexity and degree of customization. Some examples of automated processes include component insertion, SMT, flexible robotic assembly, automated storage tape +winding, computerized vision system quality inspection, automated switch and key top installation, and automated functional testing. +Our engineering +expertise and automated manufacturing processes enable us to work closely with our customers during the design and prototype stages of production and to jointly increase productivity and reduce response time to the marketplace. We use computer-aided +design techniques and software to assist in preparation of the tool design layout and component placement, to reduce tooling and production costs, improve component and product quality, and enhance turnaround time during product development. +We purchase materials and components for our products from many different suppliers, including both domestic and international sources. We develop close +working relationships with our suppliers, many of whom have been supplying products to us for several years. +Research, Development, and Engineering +Research, development, and engineering “RD&E” expenses consist principally of employee related costs, third party development costs, +program materials costs, depreciation and allocated information technology and facilities costs. Our RD&E expenses were $2.7 million, $3.2 million and $2.8 million in fiscal years 2008, 2007, and 2006 respectively. In each of these years, we +focused most of our RD&E efforts on current customer EMS programs. The decrease in RD&E during fiscal 2008 is related to lower incentive compensation and the transfer of certain engineers and support personnel from RD&E to manufacturing +costs of sales as their job roles changed to support the new SMT production line in Spokane Valley, Washington. +Competition +The market for the products and services we provide is highly competitive. There are numerous competitors in the EMS industry, many of which have substantially more +resources and are more geographically diverse than we are. Some of our competitors have similar international production capabilities, large financial resources and some have substantially greater manufacturing, research and development, and +marketing resources. There is also competition from the manufacturing operations of our current and potential customers, who are continually evaluating the merits of manufacturing their products internally versus the advantages of +5 +Table of Contents +outsourcing. We believe that we can currently compete favorably to these factors primarily on the basis of our global footprint, responsiveness, creativity, +vertical production capability, quality, and cost. +Trademarks and Patents +Our name and logo are federally registered trademarks, and we believe they are valuable assets of our business. During 2001, we began operating under the trade name “KeyTronicEMS Co.” to better identify our +primary business concentration. We also own several keyboard patents; however, since our focus is EMS, management believes that these patents will not have a significant impact on future revenues. +Employees +We consider our employees to be our primary strength and +we make considerable efforts to maintain a well-qualified workforce. Our employee benefits include bonus programs involving periodic payments to all employees based on meeting quarterly or fiscal year performance targets. We regularly provide +transportation, medical services and meals to all of our employees in foreign locations. We maintain a 401(k) plan for U.S. employees, which provides a discretionary matching company contribution of up to 4% of an employee’s salary. We provide +group health, life, and disability insurance plans. We also maintain stock option plans and other long term incentive plans for certain employees and outside directors. +As of June 28, 2008, we had 2,502 employees compared to 2,227 on June 30, 2007 and 2,840 on July 1, 2006. Since we can have significant fluctuations in product demand, we seek to maintain flexibility in +our workforce by utilizing skilled temporary and short-term contract labor in our manufacturing facilities in addition to full-time employees. The change in the number of employees was a result of a change in product mix. Certain products require +more hand assembly than others. Our employees in Reynosa, Mexico, which represent approximately 7% of the Company’s employees, are represented by a local union. We have no history of any material interruption of production due to labor +disputes. +Backlog +On July 27, 2008, our order +backlog was valued at approximately $42.2 million, compared to approximately $34.1 million on July 29, 2007. Even though our order backlog is comprised of firm purchase orders, the amount of backlog is not necessarily indicative of future sales +but can be indicative of trends in expected future sales revenue. Due to the relationships with our customers, we will occasionally allow orders to be canceled or rescheduled and as a result is not a meaningful indicator of future financial results. +If there are canceled or rescheduled orders, we will attempt to negotiate fees to cover the costs we have incurred. The change in backlog at July 27, 2008, when compared to July 29, 2007, was in part due to our increasing customer base and +the timing of purchase orders of existing customers. Order backlog consists of purchase orders received for products expected to be shipped approximately within the next twelve months, although shipment dates are subject to change due to design +modifications, customer forecast changes, or other customer requirements. +Foreign Markets +Information concerning net sales and long-lived assets (property, plant, and equipment) by geographic areas is set forth in footnote 9 of the consolidated financial +statements of this Annual Report on Form 10-K, under the caption “Enterprise-Wide Disclosures”, and that information is incorporated herein. \ No newline at end of file diff --git a/raw/filings/0000719733/2008/0001193125-08-195739/item13.txt b/raw/filings/0000719733/2008/0001193125-08-195739/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..05565f5dae94e1873a2c3b5bc54a39ffa5943a44 --- /dev/null +++ b/raw/filings/0000719733/2008/0001193125-08-195739/item13.txt @@ -0,0 +1,4 @@ +Item 13: +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Information appearing under the caption “Related Person Transactions”, “Compensation Committee Interlocks and Insider Participation” and “Directors’ Independence” in the Company’s 2008 Proxy Statement +is incorporated herein by this reference. \ No newline at end of file diff --git a/raw/filings/0000719733/2008/0001193125-08-195739/item9a.txt b/raw/filings/0000719733/2008/0001193125-08-195739/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..88f0b24430e87cd35c1470842e7302eb233feb12 --- /dev/null +++ b/raw/filings/0000719733/2008/0001193125-08-195739/item9a.txt @@ -0,0 +1,29 @@ +Item 9A(T): +CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls +and Procedures +It is the responsibility of our management to establish, maintain, and monitor disclosure controls and procedures that are designed +to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 are recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange +Commission rules and forms. Additionally, these disclosure controls include controls and procedures that are designed to accumulate and communicate the information required to be disclosed to our company’s Chief Executive Officer and Chief +Financial Officer, allowing for timely decisions regarding required disclosures. As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and with the participation of the Chief Executive +Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(f). Based on our assessment, we believe that as of June 28, 2008, the +Company’s disclosure controls and procedures are effective based on that criteria. +38 +Table of Contents +Management’s Report on Internal Control over Financial Reporting +Our management has the responsibility to establish and maintain adequate internal controls over our financial reporting, as defined in Rule 13a-15(f) under the Securities +and Exchange Act of 1934. Our internal controls are designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our external financial statements in accordance with generally accepted +accounting principles (GAAP). +Due to inherent limitations of any internal control system, management acknowledges that there are limitations as to the +effectiveness of internal controls over financial reporting and therefore recognize that only reasonable assurance can be gained from any internal control system. Accordingly, our internal control system may not detect or prevent material +misstatements in our financial statements and projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the +policies or procedures may deteriorate. +Under the supervision and participation of management, including the Chief Executive Officer and Chief Financial +Officer, we have performed an assessment of the effectiveness of our internal controls over financial reporting as of June 28, 2008. This assessment was based on the criteria established in Internal Control-Integrated Framework, issued by the +Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we believe that as of June 28, 2008, the Company’s internal control over financial reporting is effective based on that criteria. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s +report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this annual report. +Changes in Internal Control over Financial Reporting +There +have been no significant changes in our internal controls over financial reporting during our fourth fiscal quarter ended June 28, 2008 that have materially affected, or are reasonable likely to materially affect, the Company’s internal +control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)). \ No newline at end of file diff --git a/raw/filings/0000719733/2008/0001193125-08-195739/rp_note.txt b/raw/filings/0000719733/2008/0001193125-08-195739/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000719733/2008/0001193125-08-195739/rpt_disclosure.txt b/raw/filings/0000719733/2008/0001193125-08-195739/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..54084ae8e86f7dcc50adfbc6bca5782e7e7214c0 --- /dev/null +++ b/raw/filings/0000719733/2008/0001193125-08-195739/rpt_disclosure.txt @@ -0,0 +1,16 @@ +Related Person Transactions +In April 2007, the Board of Directors adopted a written policy and procedures for the approval or ratification of Interested Transactions with Related Parties. The policy and procedures supplement the Company’s Code of Conduct. The +policy defines an “Interested Transaction” as any transaction, arrangement or relationship or series of similar transactions, arrangements or relationships (including any indebtedness or guarantee of indebtedness) in which (1) the +aggregate amount involved will or may be expected to exceed $120,000 in any calendar year, (2) the Company is a participant, and (3) any Related Party has or will have a direct or indirect interest (other than solely as a result of being a +director or a less than 10 percent beneficial owner of another entity). +The policy defines a “Related Party” as any (a) person who is or +was (since the beginning of the last fiscal year for which the Company has filed a Form 10-K and proxy statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director, +(b) greater than 5 percent beneficial owner of the Company’s common stock, or (c) immediate family member of any of the foregoing. Immediate family member includes a person’s spouse, parents, stepparents, children, stepchildren, +siblings, mothers- and fathers-in-law, sons- and daughters-in-law, and brothers- and sisters-in-law and anyone residing in such person’s home (other than a tenant or employee). +The Audit Committee is responsible for review, approval, ratification or disapproval of Interested Transactions. In determining whether to approve or ratify an Interested Transaction, the Committee will take into +account, among other factors it deems appropriate, whether the Interested Transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the Related +Party’s interest in the Transaction. With the exception of the Transition Agreement with Mr. Oehlke (see “Employment Contracts”, pages 11-12), the Company had no related Party Transactions during fiscal year 2009. +Compensation Committee Interlocks and Insider Participation in Compensation Decisions +The Board of Directors has a Compensation Committee presently consisting of Messrs. Shamash and Pilz. No member of the Compensation Committee was an officer or employee of the Company or any of its subsidiaries during +fiscal year 2009. None of the executive officers of the Company has served on the Board of Directors or on the Compensation Committee of any other entity, any of whose officers served either on the Board of Directors or on the Compensation Committee +of the Company. \ No newline at end of file diff --git a/raw/filings/0000719733/2009/0001193125-09-190584/filing.txt b/raw/filings/0000719733/2009/0001193125-09-190584/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..ef0037bbbee87fda00fab51d1766b08dfa51fdf8 --- /dev/null +++ b/raw/filings/0000719733/2009/0001193125-09-190584/filing.txt @@ -0,0 +1,3167 @@ +10-K +1 +d10k.htm +FORM 10-K +Form 10-K +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended June 27, 2009 +OR +¨ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 0-11559 +KEY TRONIC CORPORATION +(Exact name of registrant as specified in its charter) +Washington +91-0849125 +(State or other jurisdiction of +Incorporation or organization) +(I.R.S. Employer +Identification No.) +N. 4424 Sullivan Road, Spokane Valley, Washington +99216 +(Address of principal executive offices) +(Zip Code) +(509) 928-8000 +(Registrant’s telephone number, including area code) +N/A +(Former name, former address and former fiscal year, if changed since last report) +Securities Registered Pursuant to Section 12(b) of the Act: None +Title of each class +Name of each exchange on which registered +Common stock, no par value +The NASDAQ Stock Market LLC +Securities Registered Pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes ¨ No x +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange +Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 +days. Yes x No ¨ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of +Regulations S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨ +Indicate by check mark if +disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in +Part III of this Form 10-K or any amendment to this Form 10-K. x +Indicate by check mark +whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting +company” in Rule 12b-2 of the Exchange Act. +(Check one): +Large accelerated filer +¨ +Accelerated filer +¨ +Non-accelerated filer +¨ (Do not check if a smaller reporting company) +Smaller reporting company +x +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the +Exchange Act). Yes ¨ No x +State the aggregate market value of the voting and non-voting common equity held by non affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of +such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. +As of +December 27, 2008, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $5.6 million based on the closing price as reported on the NASDAQ. +Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 10,065,974 shares of +common stock were outstanding as of August 31, 2009. +Documents Incorporated by Reference: +The following documents are incorporated by reference to the extent specified herein: +Document Description +Part of Form 10-K +Proxy Statement dated September 18, 2009 +Part III +Table of Contents +KEY TRONIC CORPORATION +2009 FORM 10-K +TABLE OF CONTENTS +Page +Part I +Item 1. +Business +3 - 6 +Item 1A. +Risk Factors +6 - 8 +Item 1B. +Unresolved Staff Comments +9 +Item 2. +Properties +9 +Item 3. +Legal Proceedings +10 +Item 4. +Submission of Matters to a Vote of Security Holders +10 +Executive Officers of the Registrant +10 +Part II +Item 5. +Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities +11 - 12 +Item 6. +Selected Financial Data +13 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +13 - 22 +Item 7A. +Quantitative and Qualitative Disclosures about Market Risk +23 +Item 8. +Financial Statements and Supplementary Data +24 - 43 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +43 +Item 9A(T). +Controls and Procedures +43 - 44 +Item 9B. +Other Information +44 +Part III +Item 10. +Directors, Executive Officers and Corporate Governance +45 +Item 11. +Executive Compensation +45 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +45 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +46 +Item 14. +Principal Accounting Fees and Services +46 +Part IV +Item 15. +Exhibits and Financial Statement Schedule +47 - 49 +Signatures +50 - 51 +2 +Table of Contents +FORWARD-LOOKING STATEMENTS +References in this report to “the Company”, “Key Tronic”, “we”, “our”, or “us” mean Key Tronic Corporation together with its subsidiaries, except where the context otherwise requires. +This Annual Report on Form 10-K contains forward-looking statements in addition to historical information. Forward-looking statements are subject +to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Risks and uncertainties that might cause such differences include, but are not limited to those outlined +in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risks and Uncertainties that May Affect Future Results.” Readers are cautioned not to place undue reliance on forward-looking statements, +which reflect management’s opinions only as of the date hereof. The Company undertakes no obligation to update forward-looking statements to reflect developments or information obtained after the date hereof and disclaims any obligation to do +so. Readers should carefully review the risk factors described in periodic reports the Company files from time to time with the Securities and Exchange Commission, including Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. +PART I +Item 1. +BUSINESS +Overview +Key Tronic Corporation (dba: KeyTronicEMS Co.), was organized in 1969 as a Washington corporation that locally manufactured computer keyboards. Our goal was to become the +world’s largest manufacturer of input devices for terminals, word processors and personal computers. The ability to design, build and deliver a quality product led to a reputation in the industry, allowing us to be a leading independent +manufacturer of keyboards for computers in the United States. Our fully integrated design, tooling, and automated manufacturing capabilities enabled us to rapidly respond to customers’ needs for keyboards in production quantities worldwide. We +supported our sales growth through the development and purchase of international manufacturing facilities. As the computer keyboard market matured with increasing competition from other international providers, we determined that our business could +no longer solely rely on keyboard sales. +After assessing market conditions and our strengths and capabilities in 1999, we shifted focus from keyboard +manufacturing to contract manufacturing for a wide range of products. Our new strategy was based on our original core strengths of innovative design and engineering expertise in electronics, mechanical engineering, and precision plastics combined +with high-quality, low cost production, and assembly on a global basis. These strengths have made our company a strong competitor in the electronic manufacturing services (EMS) market. As we fully transitioned into an EMS provider, our new customer +base became comprised of world-class customers from a wide range of industries. +The EMS industry experienced growth over the past several years as more +original equipment manufacturers (OEMs) chose to outsource manufacturing. This expansion of the EMS industry allowed us to continue to expand our customer base and the industries that we serve. However, the challenging global economic environment +has had a negative impact on our results of operations as the demand from our customers has declined. We successfully confronted the challenging global economic environment in fiscal year 2009 by reducing our costs while ramping up new customer +programs, which allowed us to maintain profitability and strengthen our balance sheet. The ramp up for our new programs was slowed by the recession, but these new programs continue to represent a growing portion of our revenue and a promising +foundation for our future. In keeping with our long-term strategic objectives, we have been successfully building a more diversified customer portfolio and a less concentrated revenue base, spanning a wider range of industries. We currently offer +our customers the following services: integrated electronic and mechanical engineering, precision plastic molding, assembly, component selection, sourcing and procurement, worldwide logistics, and new product testing and production all at +competitive pricing due to our global footprint. +We believe that we are well positioned in the EMS industry to continue the expansion of our customer base +and achieve long term growth. Our core strengths continue to support our growth and our customers’ needs. We continue to focus on controlling operating expenses and leveraging the synergistic capabilities of our world-class facilities in the +United States, Mexico, and China. This global production capability provides our customers with the benefits of improved supply-chain management, reduced inventory, lower labor costs, lower transportation costs, and reduced product fulfillment time. +Given our competitive advantages and the growing need for some potential customers to move forward with their outsourcing strategies, we are strongly positioned to win new business in coming periods and grow our revenue and profits as the global +economic environment improves. +3 +Table of Contents +The EMS industry is intensely competitive. We have less than 1% of the potential global market and our revenue can +fluctuate significantly due to reliance on a concentrated base of customers. We are planning for new customer growth in the coming quarters by securing new programs, increasing our worldwide manufacturing capacity, and continuing to improve our +manufacturing processes. Ongoing challenges that we face include the following: continuing to win programs from new and existing customers, balancing production capacity and key personnel in each of our manufacturing locations, improving operating +efficiencies, controlling costs while developing competitive pricing strategies, and successfully transitioning new program wins to full production. +Our +principal executive offices are located at N. 4424 Sullivan Road, Spokane Valley, Washington 99216, and our telephone number is (509) 928-8000. Our website is located at http://www.keytronicems.com where filings of our Annual Report on Form +10-K, Quarterly Reports on Form 10-Q or current reports on Form 8-K are available after they have been filed with the Securities and Exchange Commission. The information presented on our website currently and in the future is not considered to be +part of this document or any document incorporated by reference in this document. +Marketing +We provide a mix of manufacturing services for outsourced OEM products. We provide the following EMS services: product design, surface mount technologies (SMT) for +printed circuit board assembly, tool making, precision plastic molding, liquid injection molding, automated tape winding, prototype design and full product builds. +Sales of the majority of our products have historically not been seasonal in nature, but may be seasonal in the future if there are changes in the types of products manufactured. Sales can, however, fluctuate significantly between quarters +from changes in customer demand due to our revenue concentration in a few specific customers. +For the fiscal years ended June 27, +2009, June 28, 2008, and June 30, 2007, the five largest customers in each year accounted for 52%, 68%, and 73% of total sales, respectively. The following customers represented 10 percent or more of total net sales over the last +three fiscal years: Lexmark International, Inc. (14%, 15%, 18%), International Game Technology, Inc. (13%, 18%, 17%), Zebra Technologies Corporation (less than 10%, 18%, 22%), and Imation Corporation (10%, less than 10%, less than 10%). It is +anticipated that our new customer program wins will dilute our concentration of revenue in our current top five customers in the future. +Although keyboard +manufacturing is still included in our product offerings, we expect annual keyboard sales to decline over time. We realized revenues of approximately $4.2 million, $5.8 million, and $5.6 million in fiscal years 2009, 2008, and 2007, respectively, +from the sale of keyboards. In order to accommodate the demand for standard keyboard layouts, we maintain a purchase-from-stock program. The more popular standard layouts are built and stocked for immediate availability. +We market our products and services primarily through our direct sales department aided by strategically located field sales people and distributors. Although we +maintain relationships with several independent sales organizations to assist in marketing our EMS product lines, commissions earned and paid are not material to the consolidated financial statements. +Manufacturing +Since inception, we have made substantial investments +in developing and expanding a capital equipment base to achieve vertical integration and efficiencies in our manufacturing processes. We have invested significant capital into SMT for volume manufacturing of complex printed circuit board assemblies. +We also design and develop tooling for injection molding and manufacture the majority of plastic parts used in the products we manufacture. Additionally, we have equipment to maintain a controlled clean environment for manufacturing processes that +require a high level of precise control. +We use a variety of manual and highly automated assembly processes in our facilities, depending upon product +complexity and degree of customization. Some examples of automated processes include component insertion, SMT, flexible robotic assembly, automated storage tape winding, computerized vision system quality inspection, automated switch and key top +installation, and automated functional testing. +Our engineering expertise and automated manufacturing processes enable us to work closely with our +customers during the design and prototype stages of production and to jointly increase productivity and reduce response time to the marketplace. We use computer-aided design techniques and software to assist in preparation of the tool design layout +and component placement, to reduce tooling and production costs, improve component and product quality, and enhance turnaround time during product development. +4 +Table of Contents +We purchase materials and components for our products from many different suppliers, including both domestic and +international sources. We develop close working relationships with our suppliers, many of whom have been supplying products to us for several years. +Research, Development, and Engineering +Research, development, and engineering (RD&E) expenses consist principally of employee related +costs, third party development costs, program materials costs, depreciation, and allocated information technology and facilities costs. Our RD&E expenses were $2.3 million, $2.7 million, and $3.2 million in fiscal years 2009, 2008, and 2007 +respectively. In each of these years, we focused most of our RD&E efforts on current customer EMS programs. The decrease in RD&E in fiscal year 2009 compared to fiscal year 2008 is the result of cost reduction efforts and lower incentive and +bonus expenses. The decrease in RD&E in fiscal year 2008 compared to fiscal year 2007 is related to transferring engineers and support personnel from RD&E to manufacturing costs of sales as their job roles changed to support the new SMT line +in Spokane Valley, Washington. +Competition +The market +for the products and services we provide is highly competitive. There are numerous competitors in the EMS industry, many of which have substantially more resources and are more geographically diverse than we are. Some of our competitors have similar +international production capabilities, large financial resources and some have substantially greater manufacturing, research and development, and marketing resources. There is also competition from the manufacturing operations of our current and +potential customers, who are continually evaluating the merits of manufacturing their products internally versus the advantages of outsourcing. We believe that we can currently compete favorably to these factors primarily on the basis of our global +footprint, responsiveness, creativity, vertical production capability, quality, and cost. +Trademarks and Patents +Our name and logo are federally registered trademarks, and we believe they are valuable assets of our business. During 2001, we began operating under the trade name +“KeyTronicEMS Co.” to better identify our primary business concentration. We also own several keyboard patents; however, since our focus is EMS, management believes that these patents will not have a significant impact on future revenues. +Employees +We consider our employees to be our primary +strength and we make considerable efforts to maintain a well-qualified workforce. Our employee benefits include bonus programs involving periodic payments to all employees based on meeting quarterly or fiscal year performance targets. We regularly +provide transportation, medical services, and meals to all of our employees in foreign locations. We maintain a 401(k) plan for U.S. employees, which provides a discretionary matching company contribution of up to 4% of an employee’s salary. We +provide group health, life, and disability insurance plans. We also maintain stock option plans and other long term incentive plans for certain employees and outside directors. +As of June 27, 2009, we had 1,963 employees compared to 2,502 on June 28, 2008, and 2,227 on June 30, 2007. Since we can have significant fluctuations in product demand, we seek to maintain flexibility +in our workforce by utilizing skilled temporary and short-term contract labor in our manufacturing facilities in addition to full-time employees. The change in the number of employees was a result of a change in product mix. Certain products require +more hand assembly than others. Our employees in Reynosa, Mexico, which represent approximately 13% of the Company’s employees, are represented by a local union. We have no history of any material interruption of production due to labor +disputes. +Backlog +On July 25, 2009, our order +backlog was valued at approximately $29.9 million, compared to approximately $42.2 million on July 27, 2008. Even though our order backlog is comprised of firm purchase orders, the amount of backlog is not necessarily indicative of future sales +but can be indicative of trends in expected future sales revenue. Due to the relationships with our customers, we will occasionally allow orders to be canceled or rescheduled and as a result is not a meaningful indicator of future financial results. +If there are canceled or rescheduled orders, we will attempt to negotiate fees to cover the costs we have incurred. The change in backlog at July 25, 2009, when compared to July 27, 2008, is due to a decrease in demand from our customers +as the result of the unfavorable global economic environment. Order backlog consists of purchase orders received for products expected to be shipped approximately within the next twelve months, although shipment dates are subject to change due to +design modifications, customer forecast changes, or other customer requirements. +5 +Table of Contents +Foreign Markets +Information concerning net sales and long-lived assets (property, plant, and equipment) by geographic areas is set forth in footnote 12 of the consolidated financial statements of this Annual Report on Form 10-K, under the caption +“Enterprise-Wide Disclosures”, and that information is incorporated herein. +Item 1A. +RISK FACTORS +There are risks and uncertainties that could affect +our business. These risks and uncertainties include but are not limited to, the risk factors described below, in Item 7A: “Quantitative and Qualitative Disclosures about Market Risk” and elsewhere in this Form 10-K. +RISKS AND UNCERTAINTIES THAT COULD AFFECT FUTURE RESULTS +The +following risks and uncertainties could affect our actual results and could cause results to differ materially from past results or those contemplated by our forward-looking statements. When used herein, the words “expects”, +“believes”, “anticipates” and similar expressions are intended to identify forward-looking statements. +Potential Fluctuations +in Quarterly Results +Our quarterly operating results have varied in the past and may vary in the future due to a variety of factors, including adverse +changes in the U.S. and global economic environment, volatility in overall demand for our customers’ products, success of customers’ programs, timing of new programs, new product introductions or technological advances by us, our customers +and our competitors, and changes in pricing policies by us, our customers, our suppliers, and our competitors. Our customer base is diverse in the markets they serve, however, decreases in demand, particularly from customers that supply the banking +and gambling industries, could affect future quarterly results. Additionally, our customers could be impacted by the illiquidity of the credit markets which could directly impact our operating results. +Component procurement, production schedules, personnel and other resource requirements are based on estimates of customer requirements. Occasionally, our customers may +request accelerated production that can stress resources and reduce operating margins. In addition, because many of our operating expenses are relatively fixed, a reduction in customer demand can harm our gross profit and operating results. The +products which we manufacture for our customers have relatively short product lifecycles. Therefore, our business, operating results and financial condition are dependent in significant way on our ability to obtain orders from new customers and new +product programs from existing customers. +Operating results can also fluctuate if changes are made to significant estimates and assumptions. Significant +estimates and assumptions include the allowance for doubtful receivables, provision for obsolete and non-saleable inventory, the valuation allowance on deferred tax assets, valuation of goodwill, impairment of long-lived assets, long-term incentive +compensation accrual, and the provision for warranty costs. +Economic Conditions +Recently there have been adverse conditions and uncertainty in the global economy as the result of unstable global financial and credit markets, inflation, and recession. These unfavorable economic conditions and the +weakness of the credit market could affect the demand for our customers’ products. If the current global economic environment continues some of our customers could continue to reduce orders and change forecasts which could adversely affect our +sales in future periods. Additionally, the financial strength of our customers and suppliers and their ability to obtain and rely on credit financing may affect their ability to fulfill their obligations to us and have an adverse affect on our +financial results. +Credit Markets +The current +illiquidity and financial instability in the credit markets could adversely impact lenders and potentially limit the ability of our suppliers and customers to borrow. This may affect their ability to fulfill their obligations to us and have an +adverse affect on our financial results. +Competition +The EMS industry is intensely competitive. Competitors may offer customers lower prices on certain high volume programs. This could result in price reductions, reduced margins and loss of market share, all of which would materially and +adversely affect our business, operating results, and financial condition. If we were unable to provide comparable or better manufacturing services at a +6 +Table of Contents +lower cost than our competitors, it could cause sales to decline. In addition, competitors can copy our non-proprietary +designs after we have invested in development of products for customers, thereby enabling such competitors to offer lower prices on such products due to savings in development costs. +Concentration of Major Customers +At present, our customer base is highly concentrated and could become more or less +concentrated. Our largest EMS customer accounted for 14% of net sales in fiscal year 2009. This same customer accounted for 15% of sales in 2008, and 18% in 2007. For the fiscal years ended 2009, 2008, and 2007, the five largest customers accounted +for 52%, 68%, and 73% of total sales, respectively. There can be no assurance that our principal customers will continue to purchase products from us at current levels. Moreover, we typically do not enter into long-term volume purchase contracts +with our customers, and our customers have certain rights to extend or delay the shipment of their orders. We, however, require that our customers contractually agree to buy back inventory purchased within specified lead times to build their +products if not used. +The loss of one or more of our major customers, or the reduction, delay or cancellation of orders from such customers, due to +economic conditions or other forces, could materially and adversely affect our business, operating results and financial condition. Specifically, some of our major customers provide products to the banking and gambling industries which have been +adversely affected by the unfavorable economic environment. The contraction in demand from our customers in these industries could continue to impact our customer orders and continue to have a negative impact on our operations over the next several +fiscal quarters. +Dependence on Suppliers +We are +dependent on many suppliers, including sole source suppliers, to provide key components and raw materials used in manufacturing customers’ products. Delays in deliveries from suppliers or the inability to obtain sufficient quantities of +components and raw materials could cause delays or reductions in shipment of products to our customers which could adversely affect our operating results and damage customer relationships. +Foreign Manufacturing Operations +Most of the products manufactured +by us are produced at our facilities located in Mexico and China. Accordingly, our operations are subject to a variety of risks and factors unique to international operations including foreign economic and political risk; civil unrest; import and +export duties; currency fluctuations; value added taxes; import and export regulation changes; and the burden; and cost of compliance with foreign laws. +Dependence on Key Personnel +Our future success depends in large part on the continued service of our key technical, marketing and +management personnel and on our ability to continue to attract and retain qualified employees. There can be no assurance that we will be successful in attracting and retaining such personnel. The loss of key employees could have a material adverse +effect on our business, operating results and financial condition. +Technological Change and New Product Risk +The markets for our customers’ products is characterized by rapidly changing technology, evolving industry standards, frequent new product introductions and +relatively short product life cycles. The introduction of products embodying new technologies or the emergence of new industry standards can render existing products obsolete or unmarketable. Our success will depend upon our customers’ ability +to enhance existing products and to develop and introduce, on a timely and cost-effective basis, new products that keep pace with technological developments and emerging industry standards and address evolving and increasingly sophisticated customer +requirements. Failure of our customers to do so could substantially harm our customers’ competitive positions. There can be no assurance that our customers will be successful in identifying, developing and marketing products that respond to +technological change, emerging industry standards or evolving customer requirements. +Interest Rate Risk +We are exposed to interest rate risk under our revolving credit facility with interest rates based on various levels of margin added to published prime rate and LIBOR +rates depending on the calculation of a certain financial covenant. +7 +Table of Contents +Compliance with Current and Future Environmental Regulation +We are subject to a variety of domestic and foreign environmental regulations relating to the use, storage, and disposal of materials used in our manufacturing processes. +If we fail to comply with any present or future regulations, we could be subject to future liabilities or the suspension of current manufacturing operations. In addition, such regulations could restrict our ability to expand our operations or could +require us to acquire costly equipment, substitute materials, or incur other significant expenses to comply with government regulations. +Foreign +Currency Fluctuations +A significant portion of our operations are in foreign locations. As a result, transactions occur in currencies other than the +U.S. dollar. Exchange rate fluctuations among other currencies used by us could directly or indirectly affect our financial results. Future currency fluctuations are dependent upon a number of factors and cannot be easily predicted. We currently use +Mexican peso forward contracts to hedge foreign currency fluctuations for a portion of our Mexican peso denominated expenses. However, unexpected expenses could occur from future fluctuations in exchange rates. +Dilution and Stock Price Volatility +As of June 27, 2009, there +were outstanding options for the purchase of 784,827 shares of our common stock, all of which were vested and exercisable. Holders of the common stock will suffer immediate and substantial dilution to the extent outstanding options to purchase the +common stock are exercised. Our stock price may be subject to wide fluctuations and possible rapid increases or declines over a short time period. These fluctuations may be due to factors specific to us such as variations in quarterly operating +results or changes in earnings estimates, or to factors relating to the EMS industry or to the securities markets in general, which, in recent years, have experienced significant price fluctuations. These fluctuations often have been unrelated to +the operating performance of the specific companies whose stocks are traded. +Disclosure and Internal Controls +Management does not expect that our disclosure controls and internal controls and procedures will prevent all errors or fraud. A control system is designed to give +reasonable, but not absolute, assurance that the objectives of the control system are met. In addition, any control system reflects resource constraints and the benefits of controls must be considered relative to their costs. Inherent limitations of +a control system may include: judgments in decision making may be faulty, breakdowns can occur simply because of error or mistake and controls can be circumvented by collusion or management override. Because of inherent limitations in a +cost-effective control system, misstatements due to error or fraud may occur and may not be detected. +8 +Table of Contents +Item 1B. +UNRESOLVED STAFF COMMENTS +None +Item 2. +PROPERTIES +We have manufacturing and sales operations located in +the United States, Mexico, and China. The table below lists the locations and square footage of our operating facilities: +Location +Approx. +Sq. Ft. +Type of Interest +(Leased/Owned) +Description of Use +Spokane Valley, Washington (1) +49,000 +Leased +Sales, research, administration and manufacturing +Spokane Valley, Washington (2) +36,000 +Leased +Manufacturing +El Paso, Texas +80,000 +Leased +Shipping and warehouse +Total USA +165,000 +Juarez, Mexico +174,000 +Owned +Manufacturing +Juarez, Mexico (3) +60,000 +Owned +Manufacturing and warehouse +Juarez, Mexico (4) +66,000 +Owned +Manufacturing and warehouse +Juarez, Mexico (5) +72,000 +Leased +Manufacturing and warehouse +Reynosa, Mexico +140,000 +Leased +Manufacturing +Reynosa, Mexico (6) +100,000 +Leased +Warehouse +Total Mexico +612,000 +Shanghai, China (7) +72,000 +Leased +Manufacturing +Total China +72,000 +Grand Total +849,000 +(1) +On December 27, 2000, we sold two contiguous parcels of land and our corporate headquarters building in Spokane to Royal Hills Associates L.L.C. (RHA) for +approximately $6 million in cash. In connection with the sale, we entered into a 10-year lease agreement with RHA for one floor of the two-story building, which we continue to occupy as our headquarters (see Note 3 to Consolidated Financial +Statements). +(2) +During fiscal year 2006, we consolidated and moved some of our molding equipment in Spokane to our facility in Juarez, Mexico and reduced the building space leased +in Spokane for manufacturing to 36,000 square feet. +(3) +In fiscal year 2005, we purchased a 60,000 square foot manufacturing facility in Juarez, Mexico to replace a previously leased facility and to accommodate the shift +of the Las Cruces, New Mexico operations into Juarez. +(4) +In fiscal year 2007, we purchased a 66,000 square foot manufacturing facility in Juarez, Mexico to replace a previously leased facility. +(5) +In fiscal year 2009, we leased a new facility in Juarez, Mexico for more storage capacity and additional assembly space. +(6) +In fiscal year 2008, we leased a new facility in Reynosa, Mexico for storage capacity that replaced two other leased warehouses. +(7) +In fiscal year 2006, we increased our leased space in China to 72,000 sq. ft. to accommodate an additional SMT line and for additional assembly space. +The geographic diversity of these locations allows us to offer services near certain of our customers and major electronics markets with +the additional benefit of reduced labor costs. We consider the productive capacity of our current facilities sufficient to carry on our current business. In addition, one of the facilities in Juarez, Mexico includes adjacent vacant land that could +be developed into additional manufacturing and warehouse space. All of our facilities are ISO certified to ISO 9001:2008 standards and are certified or compliant with ISO-14001 environmental standards and ISO-13485:2003 medical devices standards. +9 +Table of Contents +Item 3. +LEGAL PROCEEDINGS +We may be party to certain lawsuits or claims in +the ordinary course of business. We do not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on our financial position, results of operations or cash flow. +Item 4. +SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS +None +EXECUTIVE OFFICERS OF THE REGISTRANT +CRAIG D. GATES – President and Chief Executive Officer +Mr. Gates, age 50, has been President and Chief Executive +officer of the Company since April 2009. Previously he was Executive Vice President and General Manager since August 2002 to April 2009. Previously he was Executive Vice President of Marketing, Engineering and Sales since July 1997. He served as +Vice President and General Manager of New Business Development from October 1995 to July 1997. He joined the Company as Vice President of Engineering in October of 1994. Mr. Gates has a Bachelor of Science Degree in Mechanical Engineering and a +Masters in Business Administration from the University of Illinois, Urbana. From 1982 he held various engineering and management positions within the Microswitch Division of Honeywell, Inc., in Freeport, Illinois, and from 1991 to October 1994 he +served as Director of Operations, Electronics for Microswitch. +RONALD F. KLAWITTER – Executive Vice President of Administration, Chief +Financial Officer, and Treasurer +Mr. Klawitter, age 57, has been Executive Vice President of Administration, CFO, and Treasurer since July +1997. Previously he was Vice President of Finance, Secretary, and Treasurer of the Company since October 1995. He was Acting Secretary from November 1994 to October 1995 and Vice President of Finance and Treasurer from 1992 to October 1995. From +1987 to 1992, Mr. Klawitter was Vice President, Finance at Baker Hughes Tubular Service, a subsidiary of Baker Hughes, Inc. He has a BA degree from Wittenberg University and is a Certified Public Accountant. +DOUGLAS G. BURKHARDT – Vice President of Worldwide Operations +Douglas G. Burkhardt, age 51, has been Vice President of Worldwide Operations of the company since July 1, 2008. Previously Mr. Burkhardt was Director of China Operations and Program Management since January 2006. +Mr. Burkhardt served as Director of Northwest and China Operations from November of 1998 to January of 2006. Mr. Burkhardt also served as Director of Customer Satisfaction from March 1997 to November 1998 and Director of Molding from +September of 1995 to March of 1997. Prior to this, Mr. Burkhardt served in other various senior management positions within the company. Mr. Burkhardt has been with the company since May of 1989. Prior to joining Key Tronic, +Mr. Burkhardt worked for House of Aluminum and Glass for 12 years where he was the plant manager. +LAWRENCE J. BOSTWICK – Vice President +of Engineering and Quality +Lawrence J. Bostwick, age 57, has been Vice President of Engineering and Quality since July 2008. Previously he was Director of +Engineering and Quality since February 2007. He joined the company in February 2006 as Corporate Director of Quality. From 2003 to 2006 he was Director of Supply Chain Management and Quality for the Lancer Corporation and from 1998 to 2003 he was +Vice President of Operations for Thermacore International. He is a graduate of the Westinghouse and General Electric – Engineering and Manufacturing Professional Development Programs. He is certified in both Quality and Industrial Engineering +and is a Lean – Six Sigma Master Black Belt. He has a combined B.S. degree in Production and Operation and Industrial Engineering from Bowling Green State University and a Masters degree in Industrial Engineering and Business Administration +from Syracuse University. +10 +Table of Contents +PART II +Item 5: +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Our common stock is traded on the NASDAQ Global +Market, formerly the NASDAQ National Market System under the symbol “KTCC”. Quarterly high and low closing sales prices for our common stock for fiscal years 2009 and 2008 were as follows: +2009 +2008 +High +Low +High +Low +First Quarter +$ +3.84 +$ +2.47 +$ +5.50 +$ +4.30 +Second Quarter +2.56 +0.97 +4.89 +4.11 +Third Quarter +1.22 +0.86 +4.29 +2.46 +Fourth Quarter +1.94 +0.91 +3.75 +2.43 +High and low stock prices are based on the daily closing price reported by the NASDAQ Stock Market. These +quotations represent prices between dealers without adjustment for markups, markdowns, and commissions, and may not represent actual transactions. +Holders and Dividends +As of June 27, 2009, we had 843 shareholders of common stock on record. Our financing agreement with CIT +Group/Business Credit, Inc. (CIT) contained a covenant that prohibits the declaration or payment of dividends or the repurchase of our stock (see Note 4 to Consolidated Financial Statements). On August 19, 2009, we entered into a credit +agreement with Wells Fargo Bank, N.A. providing for a revolving line credit facility and paid off the CIT revolving loan. The agreement restricts us from declaring or paying dividends in cash or stock. The agreement does allow us to repurchase our +stock. We have not paid a cash dividend and do not anticipate payment of dividends in the foreseeable future. +Equity Compensation Plan Information +Information concerning securities authorized for issuance under our equity compensation plans is set forth in Part III, Item 12 of this Annual Report, +under the caption “Securities Authorized for Issuance under Equity Compensation Plans”, and that information is incorporated herein by reference. +11 +Table of Contents +Performance Graph +Set forth below is a line graph comparing the cumulative total shareholder return on our common stock with the cumulative total return of the NASDAQ Stock Market (U.S. & Foreign) Index and the NASDAQ Electronic Components Index in +fiscal 2009. +7/3/04 +7/2/05 +7/01/06 +6/30/07 +6/28/08 +6/27/09 +Key Tronic Corporation +100.00 +96.63 +109.83 +142.98 +99.44 +46.35 +NASDAQ Composite +100.00 +101.09 +109.49 +132.47 +117.33 +92.91 +NASDAQ Electronic Components +100.00 +89.67 +84.92 +100.02 +90.32 +64.98 +12 +Table of Contents +Item 6: +SELECTED FINANCIAL DATA +The following selected data from our +consolidated financial statements should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements and related notes, and other +information included in this report. +Financial Highlights +(In thousands, except for Supplemental Data and Book Value per Share) +2009 +2008 +Fiscal Years +2007 +2006 +2005 +Consolidated Statements of Operations Data : +Net sales +$ +184,924 +$ +204,122 +$ +201,712 +$ +187,699 +$ +202,877 +Gross profit +13,180 +16,820 +17,670 +17,304 +16,460 +Gross margin percentage +7.1 +% +8.2 +% +8.8 +% +9.2 +% +8.1 +% +Operating income +1,783 +6,834 +6,810 +5,861 +5,445 +Operating margin percentage +1.0 +% +3.3 +% +3.4 +% +3.1 +% +2.7 +% +Net income +1,063 +5,584 +5,230 +9,753 +4,376 +Earnings per share – diluted +0.11 +0.54 +0.51 +0.97 +0.44 +Consolidated Cash Flow Data : +Cash flows provided by (used in) operations +10,038 +(718 +) +(1,857 +) +(34 +) +6,561 +Capital expenditures +1,891 +1,180 +3,137 +1,638 +2,868 +Consolidated Balance Sheet Data : +Net working capital (1) +37,444 +45,695 +41,222 +31,703 +23,006 +Total assets +77,755 +98,344 +89,388 +88,695 +72,901 +Long-term liabilities +3,030 +13,241 +14,719 +11,665 +9,420 +Shareholders’ equity +51,114 +49,081 +43,244 +37,548 +27,639 +Book value per share (2) +5.08 +4.90 +4.36 +3.85 +2.85 +Supplemental Data : +Number of shares outstanding at year-end +10,065,974 +10,024,308 +9,921,045 +9,750,413 +9,693,913 +Number of employees at year-end +1,963 +2,502 +2,227 +2,840 +2,849 +Approximate square footage of operational facilities +849,000 +777,000 +784,000 +723,000 +765,000 +(1) +Net working capital is defined as total current assets less total current liabilities. Net working capital measures the portion of current assets that are financed +by long term funds and is an indicator of short term financial management. +(2) +Book value per share is defined as total shareholders’ equity divided by the number of shares outstanding at the end of the fiscal year. Book value per share +measures shareholders’ value as defined by generally accepted accounting principles. +Item 7: +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +Overview +We are an independent provider of EMS for OEMs. Our core strengths include innovative design and +engineering expertise in SMT, electronics, mechanical engineering, precision molding, design and build of molding tools, combined with high-quality, low-cost production, and assembly on a global basis. Our global production capability provides +customers with benefits of improved supply-chain management, reduced inventories, lower transportation costs, and reduced product fulfillment time. We continue to make investments in our Mexico and China facilities to give us the production capacity +and logistical advantages to continue to win new business. The following information should be read in conjunction with the consolidated financial statements included herein and with Item 1A, Risk Factors. +13 +Table of Contents +The EMS industry experienced growth over the past several years as more original equipment manufacturers (OEMs) chose to +outsource manufacturing. This expansion of the EMS industry allowed us to continue to expand our customer base and the industries that we serve. However, the challenging global economic environment has had a negative impact on our results of +operations as the demand from our customers has declined. We successfully confronted the challenging global economic environment in fiscal year 2009 by reducing our costs while ramping up new customer programs, which allowed us to maintain +profitability and strengthen our balance sheet. The ramp up for our new programs was slowed by the recession, but these new programs continue to represent a growing portion of our revenue and a promising foundation for our future. In keeping with +our long-term strategic objectives, we have been successfully building a more diversified customer portfolio and a less concentrated revenue base, spanning a wider range of industries. +Our sales of $184.9 million in fiscal year 2009 decreased by 9.4% over sales of $204.1 million in fiscal year 2008. This decrease in sales reflects the lower demand from established customers due to the unfavorable +global economic environment. The decline in demand from our established customers was partially offset by revenue from new customers. In fiscal year 2008 new customers contributed approximately 9% of revenue. These same customers plus new customers +in 2009 contributed approximately 29% of revenue. Sales for the first quarter of fiscal year 2010 are expected to be within the range of $41 million to $44 million. Results will depend on actual levels of customers’ orders and the timing of the +start up of production of new product programs. We believe that we are well positioned in the EMS industry to win new business in coming periods and profitably grow our revenue as the economy recovers. +The concentration of our largest customers decreased during fiscal year 2009 with the top five customers’ sales decreasing to 52% of total sales in 2009 from 68% in +2008, and 73% in 2007. Our current customer relationships involve a variety of products, including consumer electronics, electronic storage devices, plastics, household products, gaming devices, specialty printers, exercise equipment, +telecommunications, industrial equipment, fuel cell technology and computer accessories. The total number of our customers continued to increase during fiscal year 2009. Some of these new customers have programs that represent small annual sales +while others have multi-million-dollar potential. +Gross profit as a percent of sales was 7.1% in fiscal year 2009 compared to 8.2% for the prior fiscal +year. The decrease in gross profit as a percentage of net sales was the result of lower fixed cost absorption due to sales decreasing. Additionally we incurred charges of approximately $1.3 million for severance charges related to cost reduction +efforts. +Net income for fiscal year 2009 was $1.1 million or $0.11 per diluted share, down from $5.6 million net income or $0.54 per diluted share for +fiscal year 2008. The results of both years were affected by unusual events. In fiscal year 2009 we incurred charges of $765,000 for goodwill impairment, approximately $533,000 for the write-off of a foreign receivable and approximately $1.3 million +for severance charges related to cost reduction efforts. In fiscal year 2008 we realized a gain on the sale of real estate of $951,000. +We maintain a +strong balance sheet with a current ratio of 2.59 and a long-term debt to equity ratio of 0.05. Total cash provided by operations was $10.0 million during fiscal year 2009. We maintain sufficient liquidity for our expected future operations and had +approximately $15.3 million available from our revolving line of credit based on eligible collateral at June 27, 2009. We believe that internally generated funds, our revolving line of credit, and leases on equipment should provide adequate +capital for planned growth over the long term. +The revolving credit facility with CIT was set to mature on August 22, 2009. On August 19, 2009, +we entered into a credit agreement with Wells Fargo Bank, N.A. providing for a revolving line of credit facility for up to $20 million and paid off the CIT revolving loan. The agreement specifies that we, and our subsidiaries, use the proceeds of +the revolving line of credit primarily for working capital and general corporate purposes. We may elect to borrow under this revolving line of credit at an interest rate of either a “Base Rate” or a “Fixed Rate”. The base rate is +the higher of the prime rate, daily one month LIBOR plus 1.5%, or the Federal Funds rate plus 1.5% and the fixed rate is LIBOR plus 2.1% or LIBOR plus 2.5% depending on the level of trailing four quarters EBITDA. Based on the trailing four quarters +EBITDA as of June 27, 2009, we could borrow up to $14.4 million under the new line of credit. +The EMS industry is intensely competitive. We estimate +that we have less than 1% of the potential market. We believe that we can acquire new business in the future, particularly those programs that require flexibility in forecasting, innovative design and engineering, short lead times, or small initial +volumes. Our competitiveness is enhanced by our capacity to provide SMT, plastic injection molding, and final assembly. We are planning for long term growth by utilizing current capacity, improving manufacturing processes, and investing in +additional manufacturing equipment. Current challenges facing us include: continuing to win new programs, improving operating efficiencies, controlling costs, and developing new competitive price strategies. +14 +Table of Contents +Results of Operations +The following table sets forth for the periods indicated certain items of the consolidated statements of income expressed as a percentage of net sales. The financial information and discussion below should be read in conjunction with the +consolidated financial statements and notes contained in this Annual Report. +June 27, 2009 +Years Ended +June 28, 2008 +June 30, 2007 +Net sales +100.0 +% +100.0 +% +100.0 +% +Cost of sales +92.9 +91.8 +91.2 +Gross profit +7.1 +8.2 +8.8 +Operating expenses (income) +Research, development and engineering +1.2 +1.3 +1.6 +Selling, general and administrative +4.5 +4.0 +4.5 +Goodwill impairment +0.4 +— +— +Gain on sale of real estate held for sale +— +(0.4 +) +(0.7 +) +Total operating expenses +6.1 +4.9 +5.4 +Operating income +1.0 +3.3 +3.4 +Interest expense +0.3 +0.5 +0.7 +Income before income taxes +0.7 +2.8 +2.7 +Income tax provision (benefit) +0.1 +0.1 +0.1 +Net income +0.6 +% +2.7 +% +2.6 +% +Net Sales +Net +sales were $184.9 million, $204.1 million, and $201.7 million in fiscal years 2009, 2008, and 2007, respectively. +This decrease in net sales during fiscal +year 2009 reflects the expected lower demand from established customers due to the unfavorable global economic environment. However, new customer programs from 2008 and 2009 partially offset this decline in demand, contributing approximately 29% of +our total revenue in fiscal year 2009. We anticipate that several more new customer programs will enter production in fiscal year 2010 and begin contributing to revenue. +The increase in net sales during fiscal year 2008 compared to fiscal year 2007 resulted from an increase in sales revenue from new customer programs offset by a moderate decrease in the demand from some of our +existing customers. New customer programs contributed approximately 9% of our total revenue in fiscal year 2008. Customer demand will fluctuate based on changes in the sell-through of customers’ products. +The table below shows the revenue by industry sectors as a percentage of revenue for the following fiscal years: +June 27, 2009 +Years Ended +June 28, 2008 +June 30, 2007 +Commercial Printer +15 +% +16 +% +19 +% +Communication +10 +% +9 +% +9 +% +Computer and Peripheral +17 +% +8 +% +3 +% +Consumer +19 +% +9 +% +14 +% +Gaming +13 +% +19 +% +17 +% +Industrial +4 +% +3 +% +2 +% +Transaction Printer +22 +% +36 +% +36 +% +Total +100 +% +100 +% +100 +% +We provide services to customers in a number of industries and produce a variety of products for our customers in +each industry. As we continue to diversify our customer base and win new customers we may see a change in the industry concentrations of our revenue. +15 +Table of Contents +Sales to foreign customers represented 11.3%, 5.6%, and 9.0% of our total net sales in fiscal years 2009, 2008, and 2007, +respectively. The increase in sales to foreign customers from fiscal year 2009 compared to fiscal year 2008 is the result of new customers in foreign locations. The decrease in sales to foreign customers from fiscal year 2008 compared to fiscal year +2007 was due to exiting production of a consumer product for a customer in Asia. +Cost of Sales +Total cost of sales as a percentage of net sales was 92.9%, 91.8%, and 91.2% in fiscal years 2009, 2008, and 2007, respectively. +Total cost of materials as a percentage of sales was approximately 61.0%, 61.2%, and 61.8% in fiscal years 2009, 2008, and 2007, respectively. The change from +year-to-year is directly related to changes in product mix. +Production costs as a percentage of net sales were 31.9%, 30.6%, and 29.4% in fiscal years +2009, 2008, and 2007, respectively. The increase in fiscal year 2009 compared to fiscal year 2008 is related to lower fixed cost abortion due to sales decreasing and $1.3 million for severance charges related to cost reduction efforts. The increase +in fiscal year 2008 compared to fiscal year 2007 is related to start-up cost we incurred throughout the year in association with new customer programs, inefficiencies of overtime and expedite costs associated with accelerated customer demand, and +increased freight costs. +We provide for obsolete and non-saleable inventories based on specific identification of inventory against current demand and +recent usage. The amounts charged to expense for these inventories were $303,000, $159,000, and $544,000 in fiscal years 2009, 2008, and 2007, respectively. Approximately $240,000 of the provision in fiscal year 2007 was related to a specific +customer filing bankruptcy during the year. The majority of the remaining provision in each year related to stocked computer keyboards and other computer peripherals, and various inventory items that were deemed obsolete during the period. +We provide warranties on certain products we sell and estimate warranty costs based on historical experience and anticipated product returns. The amounts +charged to expense are determined based on an estimate of warranty exposure. The net warranty expense (recovery) was approximately $(93,000), $196,000, and $31,000 in fiscal years 2009, 2008, and 2007, respectively. The recovery in fiscal year 2009 +related to the release of a warranty claim for a specific product that was identified in fiscal year 2008. Warranty expense for fiscal years 2008 and 2007 is related to workmanship claims on keyboards and certain EMS products. +Gross Profit +Gross profit as a percentage of net sales was 7.1%, +8.2%, and 8.8% in fiscal years 2009, 2008, and 2007, respectively. +The decrease in gross profit from fiscal year 2008 to 2009 was the result of lower +fixed cost absorption due to sales decreasing. Additionally we incurred charges of approximately $1.3 million for severance charges related to cost reduction efforts. +The decrease in gross profit from fiscal year 2007 to 2008 is related mainly to start-up costs we incurred throughout the year in association with new customer programs, inefficiencies of overtime and expedite costs +associated with accelerated customer demand, increased freight costs, and increasing costs of raw materials. In fiscal year 2007 there were certain customer sales price decreases in the aggregate in excess of achieved cost savings, a write off of +$240,000 in inventory and $164,000 tooling related to a customer that filed for bankruptcy, and the additional costs incurred with the installation and start up of a new SMT line in Spokane Valley. We took early pay discounts to suppliers that +totaled $142,000, $51,000, and $211,000 in fiscal years 2009, 2008, and 2007, respectively. Early pay discounts will fluctuate based on our liquidity and changes in the discounts and terms offered by our suppliers. +Changes in gross profit margins reflect the impact of a number of factors that can vary from period to period, including product mix, start-up costs and efficiencies +associated with new programs, product life cycles, sales volumes, capacity utilization of our resources, management of inventories, component pricing and shortages, end market demand for customers’ products, fluctuations in and timing of +customer orders, and competition within the EMS industry. These and other factors can cause variations in operating results. There can be no assurance that gross margins will not decrease in future periods. +Research, Development and Engineering +Research, development and +engineering expenses (RD&E) consists principally of employee related costs, third party development costs, program materials, depreciation and allocated information technology, and facilities costs. Total RD&E was $2.3 million, $2.7 million, +and $3.2 million in fiscal years 2009, 2008, and 2007, respectively. As a percentage of net sales, RD&E was 1.2%, 1.3%, and 1.6% in fiscal years 2009, 2008, and 2007, respectively. +16 +Table of Contents +The decrease in RD&E in fiscal year 2009 compared to fiscal year 2008 is the result of cost reduction efforts and +lower incentive and bonus expenses. The decrease in RD&E in fiscal year 2008 compared to fiscal year 2007 is related to transferring engineers and support personnel from RD&E to manufacturing costs of sales as their job roles changed to +support the new SMT line in Spokane Valley, Washington. +Selling, General and Administrative +Selling, general and administrative expenses (SG&A) consist principally of salaries and benefits, advertising and marketing programs, sales commissions, travel +expenses, provision for doubtful accounts, facilities costs, and professional services. Total SG&A expenses were $8.4 million, $8.3 million, and $9.2 million in fiscal years 2009, 2008, and 2007, respectively. As a percentage of sales SG&A +was 4.5%, 4.0%, and 4.5% in fiscal years 2009, 2008, and 2007, respectively. Approximately half of our SG&A expenses relates to salary costs of our employees. +The increase in SG&A expenses in fiscal year 2009 compared to fiscal year 2008 is mainly attributable to foreign exchange losses on Mexican peso denominated financial assets and the addition of a sales representative which were +partially offset by cost reduction efforts. Additionally, in fiscal year 2009 there was a charge of $604,000 to provide for doubtful collection of receivables, of which $533,000 was related to the write off of a foreign receivable. The decrease in +SG&A expenses in fiscal year 2008 compared to fiscal year 2007 was due to $122,000, and $550,000, respectively, in bad debt expense, of which $536,000 was related to a customer filing bankruptcy during fiscal year 2007. In addition $460,000 of +due diligence expenses, attorneys’ fees, and bank fees were expensed in fiscal year 2007 as we decided not to proceed with a potential acquisition. +Goodwill Impairment +In accordance with SFAS No. 142, Goodwill and Other Intangible Assets , we recorded goodwill in the amount +of $765,000, which related to the acquisition of Honeywell’s manufacturing facilities in Juarez, Mexico in fiscal year 1994. In accordance with SFAS No. 142, goodwill is not amortized, but must be analyzed for impairment at least annually. +Our goodwill impairment analysis was performed at the end of the second quarter each year using the two-step method. +As of December 27, 2008, we +completed our annual impairment test. We performed the first step of our goodwill impairment test and determined that our book value exceeded our fair value based on the quoted market price of our stock as of December 26, 2008. The result of +the first step indicated that goodwill was impaired and therefore, we performed the second step of the goodwill analysis in accordance with SFAS No. 142. The second step analyzes any excess or implied fair value of goodwill upon allocating our +fair value to all our assets and liabilities other than goodwill and then comparing the residual amount, if any, to the book value of the goodwill. There was no residual amount of goodwill to allocate upon completing this step. As the deteriorating +global economy adversely affected our common stock price, we concluded that 100% of the goodwill was impaired due to the significant and sustained decline in our market capitalization to below the book value. We recorded an impairment charge of +$765,000 for the quarter ended December 27, 2008. As of June 27, 2009 there was no goodwill recorded in our Consolidated Balance Sheet. +Gain +on Real Estate Held for Sale +During the fourth quarter of fiscal year 2007, we sold our under-utilized Las Cruces, New Mexico facility. The total sales +price for the facility and adjacent vacant land was $4.3 million. Sales proceeds were in the form of $2.8 million in cash and an additional $1.5 million note from the buyer. The cash received was for the purchase of the building and approximately 9 +acres of land while the note was to pay for the adjacent 14 acres of additional land. The note was payable within 45 days of the flood plain designation being removed from the adjacent vacant land. Due to the contingent nature of the note, we +recognized a $1.5 million gain on real estate held for the sale of the building and 9 acres of land in fiscal year 2007 and deferred the gain on sale of the adjacent land. During the second quarter of fiscal year 2008, the flood plain designation +was removed on the adjacent 14 acres of land resulting in a gain on sale of real estate of $951,000, with the cash proceeds being received in January 2008. +Interest Expense +We had net interest expense of $590,000, $1.0 million, and $1.4 million in fiscal years 2009, 2008, and 2007, +respectively. Interest expense decreased in fiscal year 2009 when compared to fiscal years 2008 and 2007 as the average balance of the revolving line of credit was lower along with a decrease in variable interest rates. We do not currently use +derivatives to hedge interest rate risk. We do utilize short-term fixed LIBOR rates on portions of our revolving line of credit for short-term interest savings in anticipation of rate increases. We successfully negotiated a variable rate decrease on +interest charged by our lender on our revolving line of credit and term debt during fiscal year 2007. +17 +Table of Contents +Income Tax Provision +We had an income tax provision of $130,000, $261,000, and $206,000 in fiscal years 2009, 2008, and 2007. The tax provision in fiscal years 2009 and 2008 is primarily related to income taxes paid in China and Mexico. The income tax expense +of fiscal year 2007 primarily related to income taxes in the United States, which was primarily caused by a one-time repatriation of earnings from our Mexico subsidiaries. We applied certain tax credits to offset tax liabilities of our Mexican +subsidiaries during calendar year 2007. We expect to pay income taxes in calendar year 2009 due to recently enacted tax laws in Mexico. We recognized a United States income tax benefit in fiscal year 2009 of $104,000 related to reducing the +valuation allowance on our net deferred tax asset in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes . We have domestic tax net operating loss carryforwards (NOLs) of approximately +$33.2 million as of June 27, 2009. In accordance with SFAS No. 109, we assessed our recent operating levels and the sources of future taxable income to estimate a deferred tax asset. A valuation allowance against deferred tax assets is +required if it is more likely than not that some of the deferred tax assets will not be realized. We have determined that the $8.3 million valuation allowance is appropriate at this time. +International Subsidiaries +We offer customers a complete global +manufacturing solution. Our facilities provide our customers the opportunity to have their products manufactured in the facility that best serves specific cost, product manufacturing, and distribution needs. The locations of active foreign +subsidiaries are as follows: +• +Key Tronic Juarez, SA de CV owns an SMT, assembly and molding facility, and two assembly and storage facilities in Juarez, Mexico. This subsidiary is primarily used +to support our U.S. operations. +• +Key Tronic Reynosa, SA de CV leases manufacturing and warehouse facilities in Reynosa, Mexico. This subsidiary is used exclusively to manufacture products for one +EMS customer. +• +Key Tronic Computer Peripherals (Shanghai) Co., Ltd. leases a facility with SMT and assembly capabilities in Shanghai, China, which began operations in 1999. Its +primary function is to provide EMS services for export; however, it is also currently manufacturing certain electronic keyboards. +Foreign sales (based on location of customer) from our worldwide operations, including domestic exports, were $20.9 million, $11.4 million, and $18.5 million in fiscal years 2009, 2008, and 2007, respectively. The decrease in fiscal year +2009 foreign sales is mainly related to a specific foreign customer program. Products and manufacturing services provided by our subsidiary operations are sold to customers directly by the parent company. Key Tronic Computer Peripherals (Shanghai) +Co., Ltd., our subsidiary in Shanghai, China, had only minimal sales to customers in China during the past three fiscal years. +Capital Resources and +Liquidity +Cash flows provided by operating activities were $10.0 million in fiscal year 2009 compared to $(718,000) used in operating activities in +fiscal year 2008 and $(1.9) million used in fiscal year 2007. +The increase in cash provided by operating activities in fiscal year 2009 from 2008 was +primarily due to a decrease in trade receivables and inventory. Trade receivables and inventory decreased by $10.5 million and $5.3 million, respectively, during fiscal year 2009. These decreases were partially offset by a decrease of accounts +payable of $10.8 million. These decreases are the result of lower sales in the fourth quarter of fiscal year 2009 as compared to 2008 and a concerted effort to reduce our inventory and align it with our current level of business. +The decrease in cash used in operating activities in fiscal year 2008 from 2007 was primarily due to an increase in cash provided by net income of $5.6 million and +increases in accounts payable and accrued compensation and vacation totaling $6.1 million. These sources of cash were partially offset by $5.7 million increase in inventory and $5.8 million increase in accounts receivable. The increases in accounts +payable and inventory at the end of fiscal year 2008 were related to our increasing inventory for new customers. In addition, trade receivables increased $5.6 million as the result of higher sales during our fourth quarter. +Cash used in investing activities includes capital expenditures and proceeds from the sale of property and equipment. Capital expenditures were $1.9 million, $1.2 +million, and $3.1 million in fiscal years 2009, 2008, and 2007, respectively. Our capital expenditures are primarily for purchases of manufacturing assets to support our operations in Spokane Valley, Washington, Mexico and China. Capital +expenditures increased for fiscal year 2009 as compared to 2008 as we invested in manufacturing equipment to support the requirements of new customers. Capital expenditures were higher in fiscal year 2007 as compared to fiscal year 2008 as the +result of purchasing a facility in Juarez to replace a leased manufacturing location. We have also continued to use a variety of operating leases to fund the purchase of manufacturing equipment. +18 +Table of Contents +Our primary financing activity in fiscal years 2009, 2008, and 2007 was borrowing and repayment under our financing +agreement with CIT Group/Business Credit, Inc. (CIT). Our financing agreement with CIT provided a revolving credit facility of up to $25 million. The revolving loan was secured by our assets. The interest rate provisions allow for a variable rate +based on either the prime rate or LIBOR rate. The agreement specified four alternative levels of margin to be added to these base rates depending on compliance with certain financial covenants. The range of interest being paid to CIT on outstanding +balances was 1.82%-3.25% as of June 27, 2009. The financing agreement contained financial covenants that relate to total equity, earnings before interest, taxes, depreciation and amortization, and a minimum fixed charge ratio. All but one of +the financial covenants, the fixed charge ratio, had been removed by subsequent amendments to the financing agreement. As of June 27, 2009, we were in compliance with our remaining loan covenant. At June 27, 2009, the outstanding revolving +loan balance was $2.4 million compared to $12.3 million at fiscal year end June 28, 2008. The loan balance decreased as we generated positive cash flow from operations. Based on eligible collateral, approximately $15.3 million was available for +drawdown from the revolving line of credit as of June 27, 2009. +The revolving credit facility with CIT was set to mature on August 22, 2009. On +August 19, 2009, the Company entered into a credit agreement with Wells Fargo Bank, N.A. providing for a revolving line credit facility for up to $20 million and paid off the CIT revolving loan. The agreement specifies that the proceeds of the +revolving line of credit be used primarily for working capital and general corporate purposes of the Company and its subsidiaries. Borrowings under this revolving line of credit bear interest at either a “Base Rate” or a “Fixed +Rate”, as elected by the Company. The base rate is the higher of the prime rate, daily one month LIBOR plus 1.5%, or the Federal Funds rate plus 1.5% and the fixed rate is LIBOR plus 2.1% or LIBOR plus 2.5% depending on the level of trailing +four quarters EBITDA. +The new line of credit is secured by substantially all of the assets of the Company. The agreement is for a term of two years +beginning on August 19, 2009 and ending on August 18, 2011. The Company must comply with certain financial covenants, including a cash flow leverage ratio and a trading ratio. The credit agreement requires the Company to maintain a minimum +profit threshold, limits the maximum lease expenditures and restricts the Company from declaring or paying dividends in cash or stock. +Contractual +Obligations and Commitments +In the normal course of business, we enter into contracts which obligate us to make payments in the future. +The table below sets forth our significant future obligations by fiscal year: +Payments Due by Fiscal Year (in thousands) +Total +2010 +2011 +2012 +2013 +2014 +CIT revolving loan (1) +$ +2,412 +$ +2,412 +$ +— +$ +— +$ +— +$ +— +Capital and operating leases (2) +6,740 +3,652 +2,585 +496 +7 +— +Purchase orders (3) +(1) +The terms of the CIT revolving loan are discussed in the consolidated financial statements at Note 4, “Long-Term Debt”. Our current financing agreement +with CIT was set to mature on August 22, 2009. On August 19, 2009, the Company entered into a credit agreement with Wells Fargo Bank, N.A. for up to $20 million and paid off the CIT revolving loan. The amount payable on our revolving loan +changes daily depending upon the amount of cash borrowed to support our operations and the amount of customer payments received. The amount presented does not include any interest payable. Under the terms of our agreement with CIT, customers’ +payments are applied against the outstanding revolving loan balance as soon as the amounts clear through the banking system. +Under the terms of the CIT revolving credit agreement, we were required to meet a fixed coverage ratio financial covenant. As of June 27, 2009 we were in compliance with our loan covenant. Breaching this covenant could have resulted in +a material impact on our operations or financial condition. +(2) +We maintain vertically integrated manufacturing operations in Mexico and Shanghai, China. Such operations are heavily dependent upon technically superior +manufacturing equipment including molding machines in various tonnages, SMT lines, clean rooms, and automated insertion, and test equipment for the various products we are capable of producing. +In addition, we lease some of our administrative and manufacturing facilities. A complete discussion of properties can be found in Part 1, Item 2 at +“Properties”. Leases have proven to be an acceptable method for us to acquire new or replacement equipment and to maintain facilities with a minimum impact on our short term cash flows for operations. Amounts presented above include +interest and principal, if applicable. +(3) +As of June 27, 2009, we had open purchase order commitments for materials and other supplies of approximately $52.2 million. Included in the open purchase +orders are various blanket orders for annual requirements. Actual needs under these blanket purchase orders fluctuate with our manufacturing levels. In addition, we have contracts with our customers that minimize our exposure to losses for material +purchased within lead-times necessary to meet customer forecasts. Purchase orders generally can be cancelled without penalty within specified ranges that are determined in negotiations with our suppliers. These agreements depend in part on the type +of materials purchased as well as the circumstances surrounding any requested cancellations. +19 +Table of Contents +In addition to the cash requirements presented above, we have various other accruals which are not included in the table +above. We owe our suppliers approximately $18.7 million for accounts payable and shipments in transit at the end of the fiscal year. We generally pay our suppliers in a range from 30 to 120 days depending on terms offered. Quarterly payments to +suppliers normally average between $25 and $35 million. These payments are financed by operating cash flows and our revolving line of credit. +We believe +that internally generated cash flows, leasing facilities, and funds available under the revolving credit facility will satisfy cash requirements for a period in excess of 12 months and into the foreseeable future. +Critical Accounting Policies and Estimates +Revenue Recognition +We recognize revenue when products are shipped and the sales revenue becomes realizable. Securities and Exchange Commission (SEC) Staff Accounting +Bulletin (SAB) 104, Revenue Recognition states that revenue generally is realized or realizable and earned when all of the following criteria are met: +• +Persuasive evidence of an arrangement exists. +• +Delivery has occurred or services have been rendered. +• +The seller’s price to the buyer is fixed or determinable. +• +Collectibility is reasonably assured. +We believe +that we meet the above criteria for the following reasons: +• +Customer purchase orders confirming the price, shipping terms, and payment terms are required prior to shipment. +• +The terms of our sales are generally FOB shipping point, meaning that the customer takes ownership of the goods and assumes the risk of loss when the goods leave +our premises. +• +The seller’s price to the buyer is fixed or determinable – as noted, we require a customer purchase order, which confirms the price, shipping, and payment +terms. +• +Collectibility is reasonably assured – the credit terms for customers are pre-established based on a review of the customers perceived ability to pay so that +collection of the account can be reasonably assured. +Inactive, Obsolete, and Surplus Inventory Reserve +We reserve for inventories that we deem inactive, obsolete or surplus. This reserve is calculated based upon the demand for the products that we produce. Demand is +determined by expected sales or customer forecasts. If expected sales do not materialize, then we would have inventory in excess of our reserves and would have to charge the excess against future earnings. In the case where we have purchased +material based upon a customer’s forecast, we are usually covered by lead-time assurance agreements with each customer. These contracts state that the financial liability for material purchased within agreed upon lead-time and based upon the +customer’s forecasts, lies with the customer. If we purchase material outside the lead-time assurance agreement and the customer’s forecasts do not materialize or if we have no lead-time assurance agreement for a specific program, we would +have the financial liability and may have to charge inactive, obsolete or surplus inventory against earnings. +Allowance for Doubtful Accounts +We value our accounts receivable net of an allowance for doubtful accounts of $111,000 and $110,000 at June 27, 2009 and June 28, 2008, +respectively. This allowance is based on estimates of the portion of accounts receivable that may not be collected in the future. The estimates used are based primarily on specific identification of potentially uncollectible accounts. Such accounts +are identified using publicly available information in conjunction with evaluations of current payment activity. However, if any of our customers were to develop unexpected and immediate financial problems that would prevent payment of open +invoices, we could incur additional and possibly material expenses that would negatively impact earnings. +Accrued Warranty +An accrual is made for expected warranty costs, with the related expense recognized in cost of goods sold. We review the adequacy of this accrual quarterly based on +historical analysis and anticipated product returns and rework costs. As we have made the transition from manufacturing primarily keyboards to primarily EMS products, our exposure to warranty claims has declined significantly. Our warranty period +for keyboards is generally longer than that for EMS products. We only warrant materials and workmanship on EMS products, and we do not warrant design defects for EMS customers. +20 +Table of Contents +Income Taxes +We had +domestic tax loss carryforwards of approximately $33.2 million and other future deductible temporary differences and tax credit carryforwards at June 27, 2009. In accordance with SFAS No. 109, we assess the sources of future taxable +income, based on management’s estimates, which may be available to recognize the deductible differences that comprise deferred tax assets. A valuation allowance against deferred tax assets is required if it is more likely than not that some or +all of the deferred tax assets will not be realized. We have determined that a valuation allowance of $8.3 million on the total deferred tax asset is appropriate as of June 27, 2009. Our judgments regarding future use of deferred tax assets may +change due to changes in market conditions, changes in tax laws or other factors. If our assumptions and estimates change in the future, the valuation allowance will be adjusted accordingly and any increase or decrease will result in an additional +income tax expense or benefit. +Goodwill +In accordance +with SFAS No. 142, Goodwill and Other Intangible Assets , we recorded goodwill in the amount of $765,000, which related to the acquisition of Honeywell’s manufacturing facilities in Juarez, Mexico in fiscal year 1994. In accordance +with SFAS No. 142, goodwill is not amortized, but must be analyzed for impairment at least annually. Our goodwill impairment analysis was performed at the end of the second quarter each year using the two-step method. +As of December 27, 2008, we completed our annual impairment test. We performed the first step of our goodwill impairment test and determined that our book value +exceeded our fair value based on the quoted market price of our stock as of December 26, 2008. The result of the first step indicated that goodwill was impaired and therefore, we performed the second step of the goodwill analysis in accordance +with SFAS No. 142. The second step analyzes any excess or implied fair value of goodwill upon allocating our fair value to all our assets and liabilities other than goodwill and then comparing the residual amount, if any, to the book value of +the goodwill. There was no residual amount of goodwill to allocate upon completing this step. As the deteriorating global economy adversely affected our common stock price, we concluded that 100% of the goodwill was impaired due to the significant +and sustained decline in our market capitalization to below the book value. We recorded an impairment charge of approximately $765,000 for the quarter ended December 27, 2008. As of June 27, 2009 there was no goodwill recorded in our +Consolidated Balance Sheet. +Derivatives +We adopted +SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities – an amendment to SFAS No. 133 as of March 28, 2009. All material derivative instruments are recorded on the balance sheet at their respective +fair values. Generally, if a derivative instrument is specifically designated as a cash flow hedge, the change in the fair value of the derivative is recorded in other comprehensive income to the extent the derivative is effective, and recognized in +the statement of operations when the hedged item affects earnings. As of June 27, 2009, we had forward contracts to lock in known future cash outflows for payroll, utility, tax, and accounts payable expenses denominated in the Mexican peso. As +of June 27, 2009, the fair value of these contracts was an asset of approximately $912,000 which was included in other current assets and recorded as unrealized income in accumulated other comprehensive income. +Newly Adopted and Recent Accounting Pronouncements +In +June 2009, the Financial Accounting Standards Board (FASB) issued SFAS No. 168, The FASB Accounting Standards Codification TM and the Hierarchy of Generally Accepted Accounting Principles . SFAS No. 168 +establishes the FASB Accounting Standards Codification TM (Codification) as the single source of authoritative U.S. generally accepted accounting principles (U.S. GAAP) recognized by the FASB to be applied by nongovernmental +entities. Rules and interpretive releases of the United States Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. SFAS No. 168 is +effective for interim and annual periods ending after September 15, 2009 and will be adopted by the Company in the first quarter of its fiscal year 2010. The Company does not expect the adoption of SFAS No. 168 to have a material impact on +the consolidated financial statements. +In May 2009, the FASB issued SFAS No. 165, Subsequent Events. SFAS No. 165 establishes general +standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. SFAS No. 165 updates previous guidance under GAAP by replacing “type 1” and +“type 2” with “recognized” and “unrecognized.” Additionally, it requires disclosure in financial statements of the date through which subsequent events have been evaluated. SFAS No. 165 is effective for +interim or annual financial periods ending after June 15, 2009. The Company adopted SFAS No. 165 in June 2009 and it did not have a material impact on the Company’s consolidated results of operations, financial position and cash +flows. +21 +Table of Contents +In April 2009, the FASB issued FASB Staff Position (FSP) No. FAS 107-1, APB 28-1, Interim Disclosures about Fair Value +of Financial Instruments . FSP No. 107-1, 28-1 requires disclosure about fair value of financial instruments in interim financial statements in order to provide more timely information about the effects of current market conditions on +financial instruments. The adoption of this disclosure only guidance is not expected to have a material impact on the Company’s consolidated financial statements and will be effective beginning the Company’s first interim period of fiscal +2010. +In April 2009, the FASB issued FSP No. FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise +from Contingencies . FSP No. 141(R)-1 requires that assets acquired and liabilities assumed in a business combination that arise from contingencies be recognized at fair value if fair value can be reasonably determined. If the fair value of +such assets or liabilities cannot be reasonably determined, then they would generally be recognized in accordance with SFAS No. 5, Accounting for Contingencies and FASB Interpretation No. 14, Reasonable Estimation of the Amount +of a Loss – an interpretation of FASB Statement No. 5 . This FSP also amends the subsequent accounting for assets and liabilities arising from contingencies in a business combination and certain other disclosure requirements. FSP +No. 141(R)-1 is effective for the Company as of June 28, 2009. The Company does not expect the adoption of this standard to have a material impact on our consolidated financial statements. +In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities . SFAS No. 161 changes the disclosure +requirements for derivative instruments and hedging activities. The Company will be required to provide enhanced disclosures about how and why derivative instruments are used, how derivative instruments and related hedged items are accounted for +under SFAS No. 133, Accounting for Derivative Instruments and Certain Hedging Activities , and its related interpretations, and how derivative instruments and related hedged items affect the Company’s financial position, financial +performance, and cash flows. This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company adopted SFAS No. 161 as of March 28, 2009. The adoption of +this standard did not have a material impact on our consolidated financial statements. +In February 2007, the FASB issued SFAS No. 159, Fair Value +Option for Financial Assets and Financial Liabilities, including an amendment of SFAS No. 115 . SFAS No. 159 permits entities to choose to measure certain financial instruments and certain other items at fair value at specified election +dates. The fair value option may be applied instrument by instrument with certain exceptions and is applied generally on an irrevocable basis to the entire instrument. SFAS No. 159 is effective in fiscal years beginning after November 15, +2007 and is required to be adopted by the Company in the first quarter of fiscal year 2009. SFAS No. 159 was effective for the Company as of June 29, 2008. The Company did not elect the fair value option for our financial instruments. The +adoption of this standard did not have a material impact on our consolidated financial statements. +In September 2006, the FASB issued SFAS No. 157, +Fair Value Measurements , which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands the requisite disclosure for fair value measurements. SFAS No. 157 is +effective in fiscal years beginning after November 15, 2007 and is required to be adopted by the Company in the first quarter of fiscal year 2009. The Company adopted SFAS No. 157 as of September 27, 2008. The adoption of this +standard did not have a material impact on our consolidated financial statements. +22 +Table of Contents +Item 7A: +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Interest Rate Risk +We are subject to the risk of fluctuating interest rates in the normal course of business. Our major market risk relates +to our secured debt. Our revolving credit facility is secured by substantially all of our assets. The interest rates applicable to our revolving credit facility fluctuate with the JP Morgan Chase Bank prime rate and LIBOR rates. There was +outstanding $2.4 million in borrowings under our revolving credit facility as of June 27, 2009, with an average interest rate of 2.36%. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – +Capital Resources and Liquidity” and Note 4 – “Long-Term Debt” to the Consolidated Financial Statements for additional information regarding our revolving credit facility. +Foreign Currency Exchange Risk +A significant portion of our +operations are in foreign locations. As a result, transactions occur in currencies other than the U.S. dollar. Exchange rate fluctuations among other currencies used by us would directly or indirectly affect our financial results. We currently use +Mexican peso forward contracts to hedge foreign currency fluctuations for a portion of our Mexican peso denominated expenses. There was outstanding $17.8 million of foreign currency forward contracts as of June 27, 2009. The fair value of these +contracts was $912,000 and was recorded in other current assets in the Consolidated Balance Sheet as of June 27, 2009. See Note 11 – “Derivative Financial Instruments” to the Consolidated Financial Statements for additional +information regarding our derivative instruments. +23 +Table of Contents +Item 8: +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Report of Independent Registered Public Accounting Firm +The Board of Directors and Shareholders +Key Tronic Corporation +Spokane Valley, Washington +We have audited the accompanying consolidated balance sheets of Key Tronic Corporation and subsidiaries (the Company) as of June 27, 2009 and June 28, 2008, +and the related consolidated statements of earnings, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended June 27, 2009. In connection with our audits of the financial statements, we +have also audited the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial +statements and schedule based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board +(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, +an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of +expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures +in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. 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 Key Tronic Corporation and subsidiaries at June 27, 2009 and June 28, 2008, and the results of its operations and its cash flows for each of the three years in the period ended June 27, 2009, in conformity with +accounting principles generally accepted in the United States of America. +Also, in our opinion, the financial statement schedule, when considered in +relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. +/s/ BDO Seidman, LLP +Spokane, Washington +September 11, 2009 +24 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED BALANCE SHEETS +(In thousands) +June 27, 2009 +June 28, 2008 +ASSETS +Current assets: +Cash and cash equivalents +$ +729 +$ +2,879 +Trade receivables, net of allowance for doubtful accounts of $111 and $110 +24,867 +36,018 +Inventories +32,291 +37,927 +Other +3,168 +4,893 +Total current assets +61,055 +81,717 +Property, plant and equipment, net +11,199 +10,798 +Other assets: +Restricted cash +124 +39 +Deferred income tax asset +4,611 +4,210 +Other, net of accumulated amortization of $118 and $111 +766 +815 +Goodwill +— +765 +Total assets +$ +77,755 +$ +98,344 +LIABILITIES AND SHAREHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +18,703 +$ +29,497 +Accrued compensation and vacation +3,198 +4,388 +Current portion of other long-term obligations +359 +470 +Other +1,351 +1,667 +Total current liabilities +23,611 +36,022 +Long-term liabilities: +Revolving loan +2,412 +12,348 +Other long-term obligations +618 +893 +Total long-term liabilities +3,030 +13,241 +Commitments and contingencies (Notes 4 and 8) +Shareholders’ equity +Common stock, no par value, authorized 25,000 shares; issued and outstanding 10,066 and 10,024 shares, respectively +39,359 +39,301 +Retained earnings +10,843 +9,780 +Accumulated other comprehensive income +912 +— +Total shareholders’ equity +51,114 +49,081 +Total liabilities and shareholders’ equity +$ +77,755 +$ +98,344 +See accompanying notes to consolidated financial statements. +25 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF EARNINGS +(In thousands, except per share amounts) +June 27, 2009 +Years Ended +June 28, 2008 +June 30, 2007 +Net sales +$ +184,924 +$ +204,122 +$ +201,712 +Cost of sales +171,744 +187,302 +184,042 +Gross margin +13,180 +16,820 +17,670 +Operating expenses (income): +Research, development and engineering +2,266 +2,676 +3,162 +Selling, general and administrative +8,366 +8,261 +9,163 +Goodwill impairment +765 +— +— +Gain on sale of real estate +— +(951 +) +(1,465 +) +Total operating expense +11,397 +9,986 +10,860 +Operating income +1,783 +6,834 +6,810 +Interest expense, net +590 +989 +1,374 +Income before income taxes +1,193 +5,845 +5,436 +Income tax provision +130 +261 +206 +Net income +$ +1,063 +$ +5,584 +$ +5,230 +Earnings per share: +Earnings per common share – basic +$ +0.11 +$ +0.56 +$ +0.53 +Weighted average shares outstanding – basic +10,059 +9,997 +9,898 +Earnings per common share – diluted +$ +0.11 +$ +0.54 +$ +0.51 +Weighted average shares outstanding – diluted +10,075 +10,267 +10,342 +See accompanying notes to consolidated financial statements. +26 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(In thousands) +June 27, 2009 +Years Ended +June 28, 2008 +June 30, 2007 +Net income +$ +1,063 +$ +5,584 +$ +5,230 +Other comprehensive income: +Unrealized gain on foreign exchange contracts +912 +— +— +Comprehensive income +$ +1,975 +$ +5,584 +$ +5,230 +See accompanying notes to consolidated financial statements. +27 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY +Retained Earnings +Accumulated +Other +Common Stock +(Accumulated +Comprehensive +(In thousands) +Shares +Amount +Deficit) +Income +Total +Balances, July 1, 2006 +9,750 +$ +38,582 +$ +(1,034 +) +$ +— +$ +37,548 +Stock based compensation +— +6 +— +— +6 +Exercise of stock options +171 +460 +— +— +460 +Net income – 2007 +— +— +5,230 +— +5,230 +Balances, June 30, 2007 +9,921 +39,048 +4,196 +— +43,244 +Exercise of stock options +103 +253 +— +— +253 +Net income – 2008 +— +— +5,584 +— +5,584 +Balances, June 28, 2008 +10,024 +39,301 +9,780 +— +49,081 +Exercise of stock options +42 +58 +— +— +58 +Net income – 2009 +— +— +1,063 +— +1,063 +Other comprehensive income +— +— +— +912 +912 +Balances, June 27, 2009 +10,066 +$ +39,359 +$ +10,843 +$ +912 +$ +51,114 +See accompanying notes to consolidated financial statements. +28 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +June 27, 2009 +Year Ended +June 28, 2008 +June 30, 2007 +Increase (decrease) in cash and cash equivalents: +Cash flows from operating activities: +Net income +$ +1,063 +$ +5,584 +$ +5,230 +Adjustments to reconcile net income to cash provided by (used in) operating activities: +Depreciation and amortization +1,595 +1,768 +1,814 +Goodwill impairment charge +765 +— +— +Accretion of deferred gain on sale of building +(78 +) +(78 +) +(78 +) +Provision for obsolete inventory +303 +159 +544 +Provision for doubtful receivables +604 +122 +555 +Provision for (recovery of) warranty +(93 +) +196 +31 +Loss (gain) on sale of assets +14 +(949 +) +(1,463 +) +Stock based compensation expense +— +— +6 +Deferred income tax benefit +(104 +) +— +— +Changes in operating assets and liabilities: +Trade receivables +10,547 +(5,757 +) +(1,935 +) +Inventories +5,333 +(5,740 +) +3,448 +Other assets +2,320 +(742 +) +(1,557 +) +Accounts payable +(10,794 +) +5,393 +(7,124 +) +Accrued compensation and vacation +(1,190 +) +675 +(764 +) +Other liabilities +(247 +) +(1,349 +) +(564 +) +Cash provided by (used in) operating activities +10,038 +(718 +) +(1,857 +) +Cash flows from investing activities: +Purchase of property and equipment +(1,891 +) +(1,180 +) +(3,137 +) +Proceeds from sale of property and equipment +— +1,485 +2,691 +Cash provided by (used in) investing activities +(1,891 +) +305 +(446 +) +Cash flows from financing activities: +Payment of financing costs +(50 +) +(50 +) +(50 +) +Proceeds from exercise of stock options +58 +253 +460 +Proceeds from long-term debt +— +215 +499 +Repayment of long-term debt +(284 +) +(249 +) +(1,025 +) +Borrowing under revolving credit agreement +194,066 +204,940 +213,266 +Repayment of revolving credit agreement +(204,002 +) +(205,673 +) +(210,254 +) +(Increase) decrease in restricted cash +(85 +) +470 +365 +Cash provided by (used in) financing activities +(10,297 +) +(94 +) +3,261 +Increase (decrease) in cash and cash equivalents +(2,150 +) +(507 +) +958 +Cash and cash equivalents, beginning of year +2,879 +3,386 +2,428 +Cash and cash equivalents, end of year +$ +729 +$ +2,879 +$ +3,386 +Supplemental cash flow information: +Interest payments +$ +621 +$ +1,013 +$ +1,303 +Income tax payments, net of refunds +$ +327 +$ +301 +$ +258 +See accompanying notes to consolidated financial statements. +29 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. SIGNIFICANT ACCOUNTING POLICIES +Business +Key Tronic Corporation and subsidiaries (the Company) is engaged in electronic manufacturing services (EMS) for original equipment manufacturers (OEMs), and also +manufactures keyboards and other input devices. The Company is headquarterd in Spokane Valley, Washington and has manufacturing operations in Spokane Valley; Juarez and Reynosa, Mexico; and Shanghai, China. +Principles of Consolidation +The consolidated financial statements +include the Company and its wholly owned subsidiaries in Mexico, China and the former operating subsidiary in Ireland. Intercompany balances and transactions have been eliminated in consolidation. +Use of Estimates +The preparation of financial statements in +conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and +liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates include the allowance for doubtful receivables, the provision for obsolete and non-saleable +inventories, the valuation allowances on deferred tax assets, valuation of goodwill, impairment of long-lived assets, medical self insurance liability, long-term incentive compensation accrual, and the provision for warranty costs. Due to +uncertainties with respect to the assumptions and estimates actual results could differ from those estimates. +Cash Equivalents +The Company considers investments with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost, which approximates fair +value. The Company has restricted cash amounts in the Company’s bank account that cannot be used for any other purpose than to pay down the Company’s long term revolving line of credit. +Allowance for Doubtful Accounts +The Company evaluates the +collectibility of accounts receivable and records an allowance for doubtful accounts, which reduces the receivables to an amount that management reasonably estimates will be collected. A specific allowance is recorded against receivables considered +to be impaired based on the Company’s knowledge of the financial condition of the customer. In determining the amount of the allowance, the Company considers several factors including the aging of the receivables, the current business +environment, and historical experience. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. +Inventories +Inventories are stated at the lower of cost or market. Cost is determined principally using the first-in, first-out (FIFO) +method. The Company provides for obsolete and non-saleable inventories based on specific identification of inventory against current demand forecasts and recent usage. +Property, Plant and Equipment +Property, plant and equipment are carried at cost and depreciated using straight-line +methods over the expected useful lives of the assets. Internally constructed molds and dies are depreciated over the expected useful lives of one to two years. Repairs and maintenance costs are expensed as incurred. +30 +Table of Contents +Impairment of Long-lived Assets +The Company, using its best estimates based on reasonable and supportable assumptions and projections, reviews assets for impairment whenever events or changes in circumstances have indicated that the carrying amount +of its assets might not be recoverable. Impaired assets are reported at the lower of cost or fair value. +Deferred Loan Fees +Deferred loan fees included in other assets are amortized over the term of the related loan agreement. +Accrued Warranty +An accrual is made for expected warranty costs, with the related expense recognized in cost of +goods sold. Management reviews the adequacy of this accrual quarterly based on historical analyses and anticipated product returns. +Self-funded +Insurance +The Company self-funds its domestic employee health plan. The Company contracted with a separate administrative service company to supervise +and administer the program and act as its representative. The Company reduces its risk under this self-funded platform by purchasing insurance coverage for claims exceeding $60,000. Under this contract, the Company will also pay the first $25,000 +(in addition to the $60,000) for the first individual claim of the year. Thereafter, each subsequent claim begins at $60,000. If the aggregate annual claims amount to more than 125% of expected claims for the plan year, this insurance will also pay +those claims amounts, exceeding that level, on behalf of the Company. +The Company estimates its exposure for claims incurred but not paid at the end of +each reporting period and uses historical data supplied by the Company’s broker to estimate its liability for these claims. This liability is subject to a total limitation that varies based on employee enrollment and factors that are +established at each annual contract renewal. Actual claims experience may differ from the Company’s estimates. +Revenue Recognition +Sales revenue from manufacturing is recognized upon shipment of the manufactured product per contractual terms. Upon shipment, title transfers and the customer assumes +risks and rewards of ownership of the product. Unless specifically stated in contractual terms, there are no formal customer acceptance requirements or further obligations related to the manufacturing services; if any such requirements exist, then +sales revenue is recognized at the time when such requirements are completed and such obligations are fulfilled. Revenue is recorded net of estimated returns of manufactured product based on management’s analysis of historical returns. +Revenues and associated costs from engineering design and development services, which are performed under contract of short term durations, are recognized +only after the completed performance of the service. Revenue from engineering design and development services represented approximately 3%, 3%, and 2% of total revenue in fiscal years 2009, 2008, and 2007, respectively. +Shipping and Handling Fees +The Company classifies costs associated +with shipping and handling fees as a component of cost of goods sold. Customer billings related to shipping and handling fees are reported as revenue. +Research, Development and Engineering +Research, development and engineering expenses include unreimbursed EMS costs as well as design and +engineering costs associated with the production of EMS programs. Such costs are charged to expense as incurred. +31 +Table of Contents +Income Taxes +The +Company accounts for income taxes in accordance with provisions of Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes . Under the asset and liability method prescribed by SFAS No. 109, deferred +income taxes are provided for temporary differences between the financial reporting and tax bases of assets and liabilities. Deferred taxes are measured using provisions of currently enacted tax laws. Tax credits are accounted for as a reduction of +income taxes in the year the credit is utilized. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized. The effect of changes in tax rates is recognized in +the period in which the rate change occurs. +Earnings Per Share +Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of +common and common equivalent shares outstanding during the period using the treasury stock method. The computation assumes the proceeds from the exercise of stock options were used to repurchase common shares at the average market price during the +period. The computation of diluted earnings per share does not assume conversion, exercise, or contingent issuance of common stock equivalent shares that would have an anti-dilutive effect on earnings per share. +Foreign Currency Transactions +The functional currency of the +Company’s subsidiaries in Mexico, China and its former operating subsidiary in Ireland is the U.S. dollar. Realized foreign currency transaction gains and losses are included in general and administrative expenses. +Fair Value of Financial Instruments +The carrying values of financial +instruments reflected on the balance sheets at June 27, 2009 and June 28, 2008, reasonably approximate their fair value. Based on the borrowing rates currently available to the Company for loans with similar terms and average maturities, +the fair value of long-term debt is estimated to be $2.6 million and $12.8 million, respectively, as of June 27, 2009 and June 28, 2008, which approximates the carrying values. +Stock-based Compensation +Effective July 3, 2005, the Company adopted the provisions of SFAS No. 123R, +Share-Based Payment , for its share-based compensation plans. The Company previously accounted for these plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock +Issued to Employees. Under APB 25, prior to 2005 no compensation expense was recorded in earnings for the Company’s stock options. The pro forma effects on net income and earnings per share for stock options were instead disclosed in a +footnote to the financial statements. The Company has not granted any stock options since fiscal year 2005. As of June 27, 2009, there were no unrecognized compensation costs related to remaining unvested stock options. +Goodwill +In accordance with SFAS No. 142, Goodwill and Other +Intangible Assets , the Company recorded goodwill in the amount of $765,000, which related to the acquisition of Honeywell’s manufacturing facilities in Juarez, Mexico in fiscal year 1994. In accordance with SFAS No. 142, goodwill is +not amortized, but must be analyzed for impairment at least annually. The Company’s goodwill impairment analysis was performed at the end of the second quarter each year using the two-step method. +As of December 27, 2008, the Company completed its annual impairment test. The Company performed the first step of its goodwill impairment test and determined that +the book value of the Company exceeded its fair value based on the quoted market price of the Company’s stock as of December 26, 2008. The result of the first step indicated that goodwill was impaired and therefore, the Company performed +the second step of the goodwill analysis in accordance with SFAS No. 142. The second step analyzes any excess or implied fair value of goodwill upon allocating the fair value of the Company to all its assets and liabilities other than goodwill +and then comparing the residual amount, if any, to the book value of the goodwill. There was no residual amount of goodwill to allocate upon completing this step. As the deteriorating global economy adversely affected the Company’s common stock +price, the Company concluded that 100% of the goodwill was impaired due to the significant and sustained decline in the Company’s market capitalization to below the book value. The Company recorded an impairment charge of $765,000 for the +quarter ended December 27, 2008. As of June 27, 2009, there was no goodwill recorded in the Company’s Consolidated Balance Sheet. +32 +Table of Contents +Evaluation of Subsequent Events +The Company has evaluated subsequent events and transactions through September 11, 2009, which is the date that these financial statements were issued. On August 19, 2009, the Company entered into a credit +agreement with Wells Fargo Bank, N.A. providing for a revolving line credit facility for up to $20 million and paid off the CIT Group/Business Credit, inc. (CIT) revolving loan (See Note 4 to Consolidated Financial Statements). +Newly Adopted and Recent Accounting Pronouncements +In +June 2009, the Financial Accounting Standards Board (FASB) issued SFAS No. 168, The FASB Accounting Standards Codification TM and the Hierarchy of Generally Accepted Accounting Principles . SFAS No. 168 +establishes the FASB Accounting Standards Codification TM (Codification) as the single source of authoritative U.S. generally accepted accounting principles (U.S. GAAP) recognized by the FASB to be applied by nongovernmental +entities. Rules and interpretive releases of the United States Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. SFAS No. 168 is +effective for interim and annual periods ending after September 15, 2009 and will be adopted by the Company in the first quarter of its fiscal year 2010. The Company does not expect the adoption of SFAS No. 168 to have a material impact on +the consolidated financial statements. +In May 2009, the FASB issued SFAS No. 165, Subsequent Events. SFAS No. 165 establishes general +standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. SFAS No. 165 updates previous guidance under GAAP by replacing “type 1” and +“type 2” with “recognized” and “unrecognized.” Additionally, it requires disclosure in financial statements of the date through which subsequent events have been evaluated. SFAS No. 165 is effective for +interim or annual financial periods ending after June 15, 2009. The Company adopted SFAS No. 165 in June 2009 and it did not have a material impact on the Company’s consolidated results of operations, financial position and cash +flows. +In April 2009, the FASB issued FASB Staff Position (FSP) No. FAS 107-1, APB 28-1, Interim Disclosures about Fair Value of Financial +Instruments . FSP No. 107-1, 28-1 requires disclosure about fair value of financial instruments in interim financial statements in order to provide more timely information about the effects of current market conditions on financial +instruments. The adoption of this disclosure only guidance is not expected to have a material impact on the Company’s consolidated financial statements and will be effective beginning the Company’s first interim period of fiscal 2010. +In April 2009, the FASB issued FSP No. FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from +Contingencies . FSP No. 141(R)-1 requires that assets acquired and liabilities assumed in a business combination that arise from contingencies be recognized at fair value if fair value can be reasonably determined. If the fair value of such +assets or liabilities cannot be reasonably determined, then they would generally be recognized in accordance with SFAS No. 5, Accounting for Contingencies and FASB Interpretation No. 14, Reasonable Estimation of the Amount of a +Loss – an interpretation of FASB Statement No. 5 . This FSP also amends the subsequent accounting for assets and liabilities arising from contingencies in a business combination and certain other disclosure requirements. FSP +No. 141(R)-1 is effective for the Company as of June 28, 2009. The Company does not expect the adoption of this standard to have a material impact on our consolidated financial statements. +In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities . SFAS No. 161 changes the disclosure +requirements for derivative instruments and hedging activities. The Company will be required to provide enhanced disclosures about how and why derivative instruments are used, how derivative instruments and related hedged items are accounted for +under SFAS No. 133, Accounting for Derivative Instruments and Certain Hedging Activities , and its related interpretations, and how derivative instruments and related hedged items affect the Company’s financial position, financial +performance, and cash flows. This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company adopted SFAS No. 161 as of March 28, 2009. The adoption of +this standard did not have a material impact on our consolidated financial statements. +In February 2007, the FASB issued SFAS No. 159, Fair Value +Option for Financial Assets and Financial Liabilities, including an amendment of SFAS No. 115 . SFAS No. 159 permits entities to choose to measure certain financial instruments and certain other items at fair value at specified election +dates. The fair value option may be applied instrument by instrument with certain exceptions and is applied generally on an irrevocable basis to the entire instrument. SFAS No. 159 is effective in fiscal years beginning after November 15, +2007 and is required to be adopted by the Company in the first quarter of fiscal year 2009. SFAS No. 159 was effective for the Company as of June 29, 2008. The Company did not elect the fair value option for our financial instruments. The +adoption of this standard did not have a material impact on our consolidated financial statements. +33 +Table of Contents +In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements , which defines fair value, +establishes a framework for measuring fair value under generally accepted accounting principles, and expands the requisite disclosure for fair value measurements. SFAS No. 157 is effective in fiscal years beginning after November 15, 2007 +and is required to be adopted by the Company in the first quarter of fiscal year 2009. The Company adopted SFAS No. 157 as of September 27, 2008. The adoption of this standard did not have a material impact on our consolidated financial +statements. +Fiscal Year +The Company operates on a +52/53 week fiscal year. Fiscal years end on the Saturday nearest June 30. As such, fiscal years 2009, 2008, and 2007 ended on June 27, 2009, June 28, 2008, and June 30, 2007, respectively. Fiscal year 2010 will end on +July 3, 2010, which is a 53 week year. Fiscal years 2009, 2008 and 2007 were 52 week years. +2. INVENTORIES +Components of inventories were as follows: +June 27, 2009 +June 28, 2008 +(in thousands) +Finished goods +$ +7,898 +$ +8,774 +Work-in-process +3,968 +3,521 +Raw materials +20,425 +25,632 +$ +32,291 +$ +37,927 +3. PROPERTY, PLANT AND EQUIPMENT +Life +June 27, 2009 +June 28, 2008 +(in years) +(in thousands) +Land +— +$ +970 +$ +970 +Buildings and improvements +3 to 30 +13,602 +13,096 +Equipment +1 to 10 +33,346 +32,709 +Furniture and fixtures +3 to 5 +1,761 +1,722 +49,679 +48,497 +Accumulated depreciation +(38,480 +) +(37,699 +) +$ +11,199 +$ +10,798 +During the fourth quarter of fiscal year 2007, the Company sold its under-utilized Las Cruces, New Mexico +facility. The total sales price for the facility and adjacent vacant land was $4.3 million. Sales proceeds were in the form of $2.8 million in cash and an additional $1.5 million note from the buyer. The cash received was for the purchase of the +building and approximately 9 acres of land while the note was to pay for the adjacent 14 acres of additional land. The note was payable within 45 days of the flood plain designation being removed from the adjacent vacant land. Due to the contingent +nature of the note, the Company recognized a $1.5 million gain on real estate held for the sale of the building and 9 acres of land in fiscal year 2007 and deferred the gain on sale of the adjacent land. During the second quarter of fiscal year +2008, the flood plain designation was removed on the adjacent 14 acres of land resulting in the recognition of a gain on sale of real estate of $951,000 with the cash proceeds being received in January 2008. +In December 2000, the Company sold its headquarters building, located in Spokane, Washington. In conjunction with the sale, the Company entered into a ten year leaseback +agreement for a portion of the building. The gain on the sale of the building was deferred under other long-term obligations and is amortized to offset lease expenses over the remaining lease term, which expires in December 2010. +4. LONG-TERM DEBT +In 2001, the Company entered into a financing +agreement CIT which provides a revolving credit facility up to $25 million. The interest rate provisions allow for a variable rate based on either the prime rate or a set LIBOR rate on specific short term traunches. The agreement specifies four +alternative levels of margin to be added to these base rates depending on achieving a defined financial ratio. The range of interest being paid to CIT on outstanding balances was 1.82% -3.25% as of June 27, 2009 and 4.38% – 6.71% as of +June 28, 2008. The decrease in interest rates was a result of lower published prime and LIBOR rates. +34 +Table of Contents +The Company negotiated a decrease in the level of margin added in a loan agreement amendment signed in August 2006. The +agreement contains financial covenants that related to total equity, earnings before interest, taxes, depreciation and amortization, and a minimum fixed charge ratio. All but one of the financial covenants, the minimum fixed charge ratio, were +removed by subsequent amendments to the financing agreement as of August 2006. As of June 27, 2009, the Company was in compliance with the remaining financial covenant. At June 27, 2009, the outstanding revolving loan balance was $2.4 +million compared to $12.3 million at fiscal year end June 28, 2008. Based on eligible collateral, approximately $15.3 million was available to draw from the revolving line of credit as of June 27, 2009. +The revolving credit facility with CIT was set to mature on August 22, 2009. On August 19, 2009, the Company entered into a credit agreement with Wells Fargo +Bank, N.A. providing for a revolving line credit facility for up to $20 million and paid off the CIT revolving loan of $2.1 million. The agreement specifies that the proceeds of the revolving line of credit be used primarily for working capital and +general corporate purposes of the Company and its subsidiaries. Borrowings under this revolving line of credit bear interest at either a “Base Rate” or a “Fixed Rate”, as elected by the Company. The base rate is the higher of the +prime rate, daily one month LIBOR plus 1.5%, or the Federal Funds rate plus 1.5% and the fixed rate is LIBOR plus 2.1% or LIBOR plus 2.5% depending on the level of trailing four quarters EBITDA. +The new line of credit is secured by substantially all of the assets of the Company. Based on the trailing four quarters EBITDA as of June 27, 2009, the Company +could borrow up to $14.4 million under the new line of credit. The agreement is for a term of two years beginning on August 19, 2009 and ending on August 18, 2011. The Company must comply with certain financial covenants, including a cash +flow leverage ratio and a trading ratio. The credit agreement requires the Company to maintain a minimum profit threshold, limits the maximum lease expenditures and restricts the Company from declaring or paying dividends in cash or stock. +5. INCOME TAXES +Income tax expense (benefit) consists +of the following: +June 27, 2009 +Year Ended +June 28, 2008 +June 30, 2007 +(in thousands) +Current income tax expense: +United States +$ +15 +$ +45 +$ +154 +Foreign +219 +216 +52 +234 +261 +206 +Deferred income tax (benefit): +United States +(104 +) +— +— +Foreign +— +— +— +(104 +) +— +— +Total income tax expense +$ +130 +$ +261 +$ +206 +The Company had an income tax provision of $130,000, $261,000 and $206,000 in fiscal years 2009, 2008, and 2007, +respectively. The tax provision in fiscal years 2009 and 2008 is primarily related to income taxes in China and Mexico. The income tax provision in 2007 was primarily related to income taxes in the United States which was caused by a one-time +repatriation of earnings from our Mexico operations. +In addition to its domestic operations, the Company has subsidiaries in Mexico and China. The Company +is currently applying certain tax credits to offset the income tax liabilities of its Mexican subsidiaries. However, as of January 1, 2008, the Company is subject to a recently enacted Mexican business flat tax called Impuesto Empresarial a +Tasa Unica (IETU). The effect of IETU and an associated presidential decree on fiscal year 2009 has been included in the effective tax rate as of June 27, 2009 and was approximately $199,000. The Company continues to pay income tax in China. +The Company has domestic tax net operating loss carryforwards (NOLs) of approximately $33.2 million at June 27, 2009. In accordance with SFAS +No. 109, management assessed the Company’s recent operating levels and the sources of future taxable income to estimate a valuation allowance. A valuation allowance against deferred tax assets is required if it is more likely than not that +some of the deferred tax assets will not be realized. Management has determined that the $8.3 million valuation allowance is appropriate. +35 +Table of Contents +The Company does not provide for domestic income taxes on the undistributed earnings of its foreign subsidiaries, due to +the fact that unremitted earnings are not intended by management to be repatriated in the foreseeable future. If such earnings were subsequently recognized in the United States, the Company would be subject to U.S. federal and state income taxes and +potential withholding taxes in foreign jurisdictions. +FASB Interpretation No. 48 requires the Company to recognize in its financial statements +uncertainties in tax positions taken that may not be sustained upon examination by the taxing authorities. If interest or penalties are assessed, the Company would recognize these charges as income tax expense. Upon adoption of FIN 48 and +subsequently, the Company determined that no adjustments were necessary in implementing FIN 48. Unrecognized tax benefits are not anticipated to increase or decrease over the next 12 months. +The Company’s effective tax rate differs from the federal tax rate as follows: +June 27, 2009 +Year Ended +June 28, 2008 +June 30, 2007 +(in thousands) +Federal income tax expense at statutory rates +$ +406 +$ +1,987 +$ +1,848 +Effect of foreign vs. domestic taxes +(248 +) +(899 +) +(636 +) +Expired NOLs and permanent differences +2,345 +977 +447 +Repatriation of accumulated foreign subsidiary income +— +— +2,048 +Other +76 +158 +194 +Change in valuation allowance +(2,449 +) +(1,962 +) +(3,695 +) +Income tax provision +$ +130 +$ +261 +$ +206 +The domestic and foreign components of income before income taxes were: +June 27, 2009 +Year Ended +June 28, 2008 +June 30, 2007 +(in thousands) +Domestic +$ +475 +$ +2,710 +$ +3,420 +Foreign +718 +3,135 +2,016 +Income before income taxes +$ +1,193 +$ +5,845 +$ +5,436 +36 +Table of Contents +Deferred income taxes result from temporary differences in the timing of recognition of revenue and expenses. Deferred +income tax assets and liabilities consist of the following at: +June 27, 2009 +June 28, 2008 +(in thousands) +Inventory +$ +536 +$ +621 +Vacation accrual +337 +329 +Other +141 +229 +Net operating loss carryforwards +272 +1,020 +Current deferred income tax assets +1,286 +2,199 +Current portion of valuation allowance +(793 +) +(1,409 +) +Current deferred income tax assets, net of valuation allowance +$ +493 +$ +790 +Depreciation and amortization +$ +(97 +) +$ +(1,009 +) +State deferred taxes +336 +377 +Net operating loss carryforwards +11,010 +13,581 +Tax credit carryforwards +384 +389 +Other +529 +256 +Noncurrent deferred income tax assets +12,162 +13,594 +Valuation allowance, net of current portion +(7,551 +) +(9,384 +) +Noncurrent deferred income tax assets, net of valuation allowance +$ +4,611 +$ +4,210 +Total deferred income tax assets +$ +5,104 +$ +5,000 +At June 27, 2009 the Company had NOLs of approximately $33.2 million. The remaining net operating loss +carryforwards expire in varying amounts through 2025. Utilization of NOLs would be limited in the event the Company’s ownership changes more than 50% in a three-year period. The Company also has general business credits and alternative minimum +tax credits approximating $147,000 and $114,000, respectively. The general business credits expire in varying amounts through fiscal year 2010. The alternative minimum tax credits do not expire. +6. EARNINGS PER SHARE +Basic earnings per share (EPS) is calculated +by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is computed by including both the weighted-average number of shares outstanding and any dilutive +common share equivalents in the denominator. The following table presents a reconciliation of the denominator and the number of antidilutive common share options that were not included. These antidilutive securities occur when options outstanding +have an option price greater than the average market price for the period. +June 27, 2009 +Years Ended +June 28, 2008 +June 30, 2007 +Total weighted average shares – basic +10,059,376 +9,997,431 +9,898,009 +Effect of dilutive common stock options +15,596 +269,480 +444,457 +Total weighted average shares – diluted +10,074,972 +10,266,911 +10,342,466 +Antidilutive options not included in diluted earnings per share +741,492 +515,550 +397,750 +7. STOCK OPTION AND BENEFIT PLANS +The Company has an executive stock option plan for certain key employees. Options under this plan vest over one to three years and become exercisable as they vest. Options under the plan become exercisable in full +immediately prior to the occurrence of a “Change in Control” as defined in the plan documents. As of June 27, 2009, 697,502 options were outstanding and exercisable under the Executive Stock Option Plan and other plans which have +terminated. There are 68,500 shares available for future grant under the plan. These options expire five to ten years from the date of vesting. +The +Company also has a stock option plan for “Nonemployee Directors.” Options under this plan vested over a three-year period and are exercisable. The Company reserved 300,000 shares for issuance under this plan. As of June 27, 2009, +87,325 options were outstanding. The plan has terminated and no more options can be granted under this plan. Outstanding options expire five to ten years from the date of vesting. +37 +Table of Contents +Compensation expense for vested options totaled approximately $6,000 in fiscal year 2007. There was no compensation +expense incurred in conjunction with options vesting in fiscal year 2008 and 2009. +The intrinsic value for options exercised in fiscal year 2008 and 2007 +was $226,000 and $398,000, respectively. +The following table summarizes option activity of both plans from June 28, 2008 through June 27, 2009: +Shares +Available +For Grant +Options +Outstanding +Aggregate +Intrinsic Value +(in thousands) +Weighted +Average +Exercise +Price +Weighted +Average +Remaining +Contractual +Life +Balance at June 28, 2008 +68,500 +1,268,375 +$ +755 +$ +3.58 +1.9 +Options canceled and expired +— +(441,882 +) +$ +3.96 +Options exercised +— +(41,666 +) +77 +$ +1.38 +Balance at June 27, 2009 +68,500 +784,827 +$ +21 +$ +3.48 +1.5 +Exercisable at June 27, 2009 +784,827 +$ +21 +$ +3.48 +1.5 +The following is a summary of plan activity: +Price Range +Number +Of Options +Weighted Average +Exercise Price +Outstanding, July 1, 2006 +$ 1.15 to $ 16.25 +1,925,450 +$ +4.28 +Exercised during 2007 +$ 1.20 to $ 3.94 +(170,632 +) +$ +2.70 +Canceled +$ 3.40 to $ 16.25 +(103,980 +) +$ +10.08 +Outstanding, June 30, 2007 +$ 1.15 to $ 16.25 +1,650,838 +$ +4.08 +Exercised during 2008 +$ 1.20 to $ 4.19 +(103,263 +) +$ +2.45 +Canceled +$ 2.75 to $ 16.25 +(279,200 +) +$ +6.96 +Outstanding June 28, 2008 +$ 1.15 to $ 6.50 +1,268,375 +$ +3.58 +Exercised during 2009 +$ 1.15 to $ 2.09 +(41,666 +) +$ +1.38 +Canceled +$ 1.15 to $ 6.50 +(441,882 +) +$ +3.96 +Outstanding, June 27, 2009 +$ 1.15 to $ 6.50 +784,827 +$ +3.48 +Additional information regarding options outstanding as of June 27, 2009, is as follows: +Options +Outstanding +Options +Exercisable +Range of +Exercise Prices +Number +Outstanding +Weighted Avg. +Remaining +Contractual +Life +(yrs.) +Weighted +Avg. Exercise +Price +Number +Exercisable +Weighted +Avg. Exercise +Price +$ 1.15 - $ 1.73 +43,335 +1.7 +$ 1.17 +43,335 +$ 1.17 +1.74 - 2.60 +46,667 +2.3 +2.10 +46,667 +2.10 +2.61 - 3.92 +407,325 +1.8 +2.81 +407,325 +2.81 +3.93 - 5.89 +250,000 +0.7 +4.77 +250,000 +4.77 +5.90 - 6.50 +37,500 +1.6 +6.50 +37,500 +6.50 +$ 1.15 - $ 6.50 +784,827 +1.5 +$ 3.48 +784,827 +$ 3.48 +The Company also has a defined contribution plan (401(k)) available to U.S. employees who have attained age +21. The Company contributes an amount equal to 100% of the employee’s contribution on the first 3% of the employee’s compensation and an additional 50% of the employee’s contribution on the following 2% of the employee’s +compensation. Company contributions to the plan were $412,000, $416,000, and $427,000 in fiscal years 2009, 2008, and 2007, respectively. +38 +Table of Contents +8. COMMITMENTS AND CONTINGENCIES +Leases : As of June 27, 2009, the Company had $740,000 of property and equipment financed under capital leases. The related accumulated depreciation for these capital leases amounted to $362,000 as of +June 27, 2009. The Company also has operating leases for certain equipment and production facilities, which expire at various dates during the next five years. Future minimum payments under non-cancelable operating and capital leases with +initial or remaining terms of one year or more at June 27, 2009, are summarized as follows (in thousands): +Fiscal Years Ending +Operating +Leases +Capital +Leases +2010 +$ +3,473 +$ +179 +2011 +2,585 +— +2012 +496 +— +2013 +7 +— +2014 +— +— +Total minimum lease payments +$ +6,561 +$ +179 +* +* +Includes $7,000 of interest. +Rental expenses under operating leases were +approximately $3.4 million, $3.7 million, and $4.4 million in 2009, 2008, and 2007, respectively. +Warranty Costs : The Company provides warranties +on certain product sales, and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires the Company to make estimates of product return rates and expected costs to repair or to +replace the products under warranty. The Company establishes warranty reserves based on historical warranty costs for each product line combined with liability estimates based on the prior twelve months’ sales activities. +If actual return rates and/or repair and replacement costs differ significantly from estimates, adjustments to recognize additional cost of sales may be required in +future periods. +Components of the reserve for warranty costs during 2009, 2008, and 2007 were as follows: +Balance at July 1, 2006 +$ +90,000 +Additions +30,680 +Warranty costs incurred +(80,680 +) +Balance at June 30, 2007 +40,000 +Additions +196,200 +Warranty costs incurred +(69,085 +) +Balance at June 28, 2008 +167,115 +Recovery related to current period sales +(92,500 +) +Warranty costs incurred +(49,722 +) +Balance at June 27, 2009 +$ +24,893 +The recovery in fiscal year 2009 related to the release of a warranty claim for a specific product that was +identified in fiscal year 2008. Warranty expense for fiscal years 2008 and 2007 is related to workmanship claims on keyboards and certain EMS products. +Litigation : The Company may be party to certain lawsuits or claims in the ordinary course of business. The Company does not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on the +financial position, results of operations or cash flow of the Company. +Indemnification Rights : Under the Company’s Bylaws, the Company’s +directors and officers have certain rights to indemnification by the Company against certain liabilities that may arise by reason of their status or service as directors or officers. The Company maintains director and officer insurance, which may +cover certain liabilities arising from its obligation to indemnify its directors and officers and former directors in certain circumstances. +39 +Table of Contents +9. GOODWILL +In +accordance with SFAS No. 142, Goodwill and Other Intangible Assets , the Company recorded goodwill in the amount of $765,000, which related to the acquisition of Honeywell’s manufacturing facilities in Juarez, Mexico in fiscal year +1994. In accordance with SFAS No. 142, goodwill is not amortized, but must be analyzed for impairment at least annually. The Company’s goodwill impairment analysis was performed at the end of the second quarter each year using the two-step +method. +As of December 27, 2008, the Company completed its annual impairment test. The Company performed the first step of its goodwill impairment +test and determined that the book value of the Company exceeded its fair value based on the quoted market price of the Company’s stock as of December 26, 2008. The result of the first step indicated that goodwill was impaired and +therefore, the Company performed the second step of the goodwill analysis in accordance with SFAS No. 142. The second step analyzes any excess or implied fair value of goodwill upon allocating the fair value of the Company to all its assets and +liabilities other than goodwill and then comparing the residual amount, if any, to the book value of the goodwill. +There was no residual amount of +goodwill to allocate upon completing this step. As the deteriorating global economy adversely affected the Company’s common stock price, the Company concluded that 100% of the goodwill was impaired due to the significant and sustained decline +in the Company’s market capitalization to below the book value. The Company recorded an impairment charge of $765,000 for the quarter ended December 27, 2008. As of June 27, 2009, there was no goodwill recorded in the Company’s +Consolidated Balance Sheet. +10. FAIR VALUE MEASUREMENTS +The Company has adopted SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for assets and liabilities being measured and reported at fair value and expands disclosures about fair value +measurements. There was not a material impact on the Company’s consolidated financial statements as the result of adopting this new standard. There are three levels of fair value hierarchy inputs used to value assets and liabilities which +include: Level 1 – inputs are quoted market prices for identical assets or liabilities; Level 2 – inputs other than quoted market prices included in Level 1 that are observable for the asset or liability, either directly or indirectly; and +Level 3 – inputs are unobservable inputs for the asset or liability. +The following table summarizes the Company’s financial assets and +liabilities (only those required to be measured at fair value on a recurring basis) at fair value as of June 27, 2009 (in thousands): +Level 1 +Level 2 +Level 3 +Total +Financial Assets: +Foreign currency forward contracts +$ +— +$ +912 +$ +— +$ +912 +The Company currently has forward contracts to lock in known future cash outflows for expenses denominated in the +Mexican peso. These contracts are measured on a recurring basis based on the foreign currency spot rates and forward rates quoted by banks or foreign currency dealers. These contracts are marked to market using level 2 input criteria every period +with the unrealized gain or loss reported as a component of shareholders’ equity in accumulated other comprehensive income, as they qualify for hedge accounting. +11. DERIVATIVE FINANCIAL INSTRUMENTS +In accordance with SFAS No. 161, Disclosures about Derivative +Instruments and Hedging Activities – an amendment to SFAS No. 133, the Company has expanded the quarterly and annual disclosures on its derivative instruments and hedging activities. The Company has entered into foreign currency +forward contracts and those contracts are accounted for as cash flow hedges under SFAS No. 133. The effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive (loss) income (AOCI) and +is reclassified into earnings in the same period which the underlying hedged transaction affects earnings. The derivative’s effectiveness represents the change in fair value of the hedge that offsets the change in fair value of the hedged item. +The Company transacts business in Mexico and is subject to the risk of foreign currency exchange rate fluctuations. The Company enters into foreign +currency forward contracts to manage the foreign currency fluctuations for Mexican peso denominated payroll, utility, tax, and accounts payable expenses. The foreign currency forward contracts have terms that are matched to the underlying +transactions being hedged. As a result they are expected to fully offset the hedged risk and no ineffectiveness has been recorded. +40 +Table of Contents +As of June 27, 2009, the Company had outstanding foreign currency forward contracts of $17.8 million. These contract +maturity dates do not exceed 12 months. As of June 27, 2009, the net amount of existing gains expected to be reclassified into earnings within the next twelve months was $912,000. The Company determined the ineffectiveness associated with +its cash flow hedges to be immaterial. +The Company does not enter into derivative instruments for trading or speculative purposes. The Company’s +counterparties to the foreign currency forward contracts are major banking institutions. These institutions do not require collateral for the contracts and the Company believes that the risk of the counterparties failing to meet their contractual +obligations is remote. +The following table summarizes the fair value of derivative instruments in the Consolidated Balance Sheets as of June 27, 2009 +(in thousands): +Derivatives Designated as Hedging +Instruments Under SFAS No. 133 +Balance Sheet Location +June 27, 2009 +Fair Value +June 28, 2008 +Fair Value +Foreign currency forward contracts +Other current assets +$ +912 +$ +— +As of June 27, 2009, the Company does not have any foreign exchange contracts with credit-risk-related +contingent features. The Company entered into $26.6 million, and settled $8.8 million, foreign currency forward contracts during fiscal year 2009. There were no significant foreign currency forward contracts entered into during fiscal years 2008 and +2007. The following table summarizes the gain (loss) of derivative instruments on the Consolidated Statement of Operations for the fiscal year 2009 (in thousands): +Derivatives Designated as Hedging +Instruments under SFAS No. 133 +AOCI Balance +as of +June 28, 2008 +Effective +Portion +Recorded In +AOCI +Effective Portion +Reclassified From +AOCI Into +Cost +of Sales +AOCI Balance +as of +June 27, 2009 +Settled foreign currency forward contracts +$ +— +$ +(439 +) +$ +439 +$ +— +Unsettled foreign currency forward contracts +— +912 +— +912 +Total +$ +— +$ +473 +$ +439 +$ +912 +12. ENTERPRISE-WIDE DISCLOSURES +Products and Services +Of the revenues for the years ended June 27, 2009, June 28, 2008, and +June 30, 2007, EMS sales were $180.7 million, $198.3 million, and $196.1 million, respectively. Keyboard sales for the years ended June 27, 2009, June 28, 2008, and June 30, 2007 were $4.2 million, $5.8 million, and $5.6 +million, respectively. +Geographic Areas +Net sales and +long-lived assets (property, plant, and equipment) by geographic area as of and for the years ended June 27, 2009, June 28, 2008, and June 30, 2007 are summarized in the following table. Net sales set forth below are based on the +shipping destination. +41 +Table of Contents +Domestic (U.S.) +Foreign +Total +(in thousands) +2009 +Net sales +$ +164,032 +$ +20,892 +$ +184,924 +Long-lived assets +$ +4,909 +$ +6,290 +$ +11,199 +2008 +Net sales +$ +192,748 +$ +11,374 +$ +204,122 +Long-lived assets +$ +3,936 +$ +6,862 +$ +10,798 +2007 +Net sales +$ +183,261 +$ +18,451 +$ +201,712 +Long-lived assets +$ +5,433 +$ +5,815 +$ +11,248 +For the year ended June 27, 2009, 52.3% of the Company’s foreign net sales were to customers in Canada, +24.7% were to Switzerland, 15.8% were to Asia, and the remaining 7.2% were spread among customers in other parts of Europe and Australia. +For the year +ended June 28, 2008, 65.8% of the Company’s foreign net sales were to customers in Switzerland, 11.7% were to Canada, 10.2 % were to Asia, and the remaining 12.3% were spread among customers in other parts of Europe and Australia. +For the year ended June 30, 2007, 43.4% of the Company’s foreign net sales were to customers in Switzerland, 9.2% were to Canada, 46.3% were to +Asia, and the remaining 1.1% were spread among customers in other parts of Europe and Australia. +Significant Customers +The percentage of net sales and trade account receivables to customers were as follows: +Percentage of +Net Sales +Fiscal Year +Percentage of +Trade Accounts Receivable +Fiscal Year +2009 +2008 +2007 +2009 +2008 +Customer A +14 +% +15 +% +18 +% +14 +% +17 +% +Customer B +13 +% +18 +% +17 +% +* +14 +% +Customer C +10 +% +* +* +* +* +Customer D +* +18 +% +22 +% +* +* +* +Amount was less than 10% of total. +There can be no assurance that the +Company’s principal customers will continue to purchase products from the Company at current levels. Moreover, the Company typically does not enter into long-term volume purchase contracts with its customers, and the Company’s customers +have certain rights to extend or delay the shipment of their orders. The loss of one or more of the Company’s major customers, or the reduction, delay or cancellation of orders from such customers, could materially and adversely affect the +Company’s business, operating results and financial condition. +42 +Table of Contents +13. QUARTERLY FINANCIAL DATA +(Unaudited) +Year Ended June 27, 2009 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +Net sales +$ +48,237 +$ +46,990 +$ +44,233 +$ +45,464 +Gross profit +3,407 +3,816 +3,312 +2,645 +Income before income taxes +462 +223 +308 +200 +Net income +408 +106 +262 +287 +Earnings per common share-basic +$ +0.04 +$ +0.01 +$ +0.03 +$ +0.03 +Earnings per common share-diluted +$ +0.04 +$ +0.01 +$ +0.03 +$ +0.03 +Weighted average shares outstanding +Basic +10,040 +10,065 +10,066 +10,066 +Diluted +10,212 +10,073 +10,066 +10,074 +Year Ended June 28, 2008 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +Net sales +$ +44,550 +$ +50,824 +$ +51,461 +$ +57,287 +Gross profit +3,062 +3,507 +4,227 +6,024 +Income before income taxes +218 +1,704 +1,213 +2,710 +Net income +183 +1,636 +1,167 +2,598 +Earnings per common share-basic +$ +0.02 +$ +0.16 +$ +0.12 +$ +0.26 +Earnings per common share-diluted +$ +0.02 +$ +0.16 +$ +0.11 +$ +0.25 +Weighted average shares outstanding +Basic +9,928 +10,013 +10,024 +10,024 +Diluted +10,328 +10,341 +10,207 +10,187 +Item 9: +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES +None +Item 9A (T): CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and +Procedures +It is the responsibility of our management to establish, maintain, and monitor disclosure controls and procedures that are designed to +ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange +Commission rules and forms. Additionally, these disclosure controls include controls and procedures that are designed to accumulate and communicate the information required to be disclosed to our company’s Chief Executive Officer and Chief +Financial Officer, allowing for timely decisions regarding required disclosures. As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and with the participation of the Chief Executive +Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(f). Based on our assessment, we believe that as of June 27, 2009, the +Company’s disclosure controls and procedures are effective based on that criteria. +Management’s Report on Internal Control over Financial +Reporting +Our management has the responsibility to establish and maintain adequate internal controls over our financial reporting, as defined in +Rule 13a-15(f) under the Securities and Exchange Act of 1934. Our internal controls are designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our external financial statements in +accordance with generally accepted accounting principles (GAAP). +43 +Table of Contents +Due to inherent limitations of any internal control system, management acknowledges that there are limitations as to the +effectiveness of internal controls over financial reporting and therefore recognize that only reasonable assurance can be gained from any internal control system. Accordingly, our internal control system may not detect or prevent material +misstatements in our financial statements and projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the +policies or procedures may deteriorate. +Under the supervision and participation of management, including the Chief Executive Officer and Chief Financial +Officer, we have performed an assessment of the effectiveness of our internal controls over financial reporting as of June 27, 2009. This assessment was based on the criteria established in Internal Control-Integrated Framework, issued by the +Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we believe that as of June 27, 2009, the Company’s internal control over financial reporting is effective based on that criteria. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s +report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this annual report. +Changes in Internal Control over Financial Reporting +There +have been no significant changes in our internal controls over financial reporting during our fourth fiscal quarter ended June 27, 2009 that have materially affected, or are reasonable likely to materially affect, the Company’s internal +control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)). +Item 9B: +OTHER INFORMATION +None +44 +Table of Contents +PART III +Item 10: +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +Directors of the Registrant +Information on the nominees for election as Directors of the Company is incorporated by reference from the +Company’s definitive proxy statement for the 2008 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A under the Exchange Act no later than 120 days after the end of the Company’s 2009 fiscal year. +Executive Officers of the Registrant +This information is included in +a separate item captioned “Executive Officers of the Registrant” in Part 1 of this report pursuant to Instruction G(3) of Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K. +Compliance with Section 16(a) of the Exchange Act: +Incorporated +by reference to Key Tronic Corporation’s 2009 Proxy Statement to Shareholders. +Code of Conduct +The Board of Directors has adopted a written Code of Conduct which applies to its directors and employees, including its executive officers. The Code of Conduct is +available on the Company’s website at www.keytronic.com . The Company intends to disclose on its website any amendments to or waivers of the Code of Conduct. +Item 11: +EXECUTIVE COMPENSATION +Information appearing under the caption +“Executive Compensation” in the Company’s 2009 Proxy Statement is incorporated herein by this reference. +Item 12: +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The following table sets forth the aggregate information for the Company’s equity compensation plans in effect as of June 27, 2009. +EQUITY COMPENSATION PLAN INFORMATION +Plan category +Number of securities to +be issued upon exercise +of outstanding options, +warrants, and +rights +(a) +Weighted-average +exercise price +of +outstanding options, +warrants, and rights +(b) +Number of securities +remaining available for +future issuance under +equity compensation +plans +(excluding +securities reflected in +column (a)) +(c) +Equity compensation plans approved by security holders +671,159 +$ +3.65 +0 +Equity compensation plans not approved by security holders (1) +113,668 +$ +2.50 +68,500 +Total +784,827 +$ +3.48 +68,500 +(1) +Consists of the Key Tronic Corporation 2000 Employee Stock Option Plan +Information under the caption “Beneficial Ownership of Securities” in the Company’s 2009 Proxy Statement is incorporated herein by this reference. +45 +Table of Contents +Item 13: +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Information appearing under the caption “Related Person Transactions”, “Compensation Committee Interlocks and Insider Participation”, and “Directors’ Independence” in the Company’s 2009 Proxy +Statement is incorporated herein by this reference. +Item 14: +PRINCIPAL ACCOUNTING FEES AND SERVICES +Information appearing under +the caption “Principal Accountant Fees and Services” in the Company’s 2009 Proxy Statement is incorporated herein by this reference. +46 +Table of Contents +PART IV +Item 15: +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a) 1. FINANCIAL +STATEMENTS +Page in +Form 10-K +FINANCIAL STATEMENTS +Report of Independent Registered Public Accounting Firm +24 +Consolidated Balance Sheets, as of June 27, 2009, and June 28, 2008 +25 +Consolidated Statements of Earnings for the years ended June 27, 2009, June 28, 2008, and June +30, 2007 +26 +Consolidated Statements of Comprehensive Income for the years ended June 27, 2009, June +28, 2008, and June 30, 2007 +27 +Consolidated Statements of Shareholders’ Equity for the years ended June 27, 2009, June +28, 2008, and June 30, 2007 +28 +Consolidated Statements of Cash Flows for the years ended June 27, 2009, June 28, 2008, and June +30, 2007 +29 +Notes to Consolidated Financial Statements +30-43 +2. SCHEDULES +Report of Independent Registered Public Accounting Firm on Financial Statement Schedule +24 +II. Consolidated Valuation and Qualifying Accounts +49 +Other schedules are omitted because of the absence of conditions under which they are required, or because +required information is given in the financial statements or notes thereto. +3. EXHIBITS +Exhibit No. +Description +3.1 +Articles of Incorporation, incorporated by reference to the Exhibits to the Company’s form 10-K for the year ended June 30, 1986 +3.2 +Bylaws, as amended, incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended June 30, 1986 +10.1* +Executive Stock Option Plan, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended June 30, 1986 +10.2* +Amended and Restated 1990 Stock Option Plan for Non-Employee Directors, as amended, incorporated by reference to the Company’s 1997 Proxy Statement (dated October 10, 1997), pages 14-17 +10.3* +1995 Executive Stock Option Plan, incorporated by reference to the Company’s 1995 Proxy Statement, pages 19-22 +10.4* +2000 Employee Stock Option Plan, incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended January 1, 2000 +10.5* +Officers’ Employment Contracts, incorporated by reference to the Company’s 1998 Proxy Statement, pages 10 and 11 +10.6* +Employment Contract with Michael D. Chard, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended July 1, 2000 +10.7* +Addenda to Officers’ Employment Contracts, incorporated by reference to Exhibits to the Company’s Form 10-Q for the quarter ended January 1, 2000 +10.8* +Description of Retention Bonus Plan, incorporated by reference to the Exhibits to the Company’s 10-Q for the quarter ended December 28, 2002 +10.9* +Addenda to Officers’ Employment Contracts, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended June 29, 2002 +10.10 +Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended September 29, 2001 +47 +Table of Contents +10.11 +First and Second Amendments to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended +June 29, 2002 +10.12 +Third Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended December 29, 2002 +10.13 +Fourth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended June 28, +2003 +10.14 +Fifth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended December 27, 2003 +10.15 +Sixth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended April 3, +2004 +10.16 +Seventh Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended July 3, +2004 +10.17 +Eighth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended July 3, +2004 +10.18 +Ninth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended October 2, 2004 +10.19 +Tenth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibit to the Company’s Form 8-K filed April 4, 2005 +10.20 +Promise to execute a Purchase and Sale Agreement with Key Safety Systems de Mexico, S.A. de C.V., incorporated by reference to the Exhibit to the Company’s Form 8-K filed April 26, 2005 +10.21 +Summary of material terms and conditions of the Purchase and Sale Agreement with Key Safety Systems de Mexico, S.A. de C.V., incorporated by reference to the Exhibit to the Company’s +Form 8-K filed June 6, 2005 +10.22* +Summary of Key Tronic Corporation Incentive Compensation Plan, incorporated by reference to Exhibit 10.23* the Company’s Form 10-K for the year ended July 2, 2005 +10.23* +Employment Contract between Key Tronic Corporation and George Robert Alford, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed July 26, 2006 +10.24* +Summary of Incentive Compensation Plan Performance goals and Target Payments for fiscal year 2007, incorporated by reference to the Company’s Form 8-K filed July 28, +2006 +10.25* +Summary of Fiscal Years 2007 – 2009 Long Term Incentive Plan Performance Measures and Awards, incorporated by reference to the Company’s From 8-K filed July 28, +2006 +10.26* +Summary of Key Tronic Corporation Long Term Incentive Compensation Plan, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed September 27, 2005 +10.27 +Twelfth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibit to the Company’s Form 8-K filed September 7, 2006 +10.28 +Summary of material terms and conditions of the Purchase and Sale Agreement with Todenko Mexico S.A. de C.V., incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed +October 12, 2006 +10.29 +Summary of material terms and conditions of the Purchase and Sale Agreement with Todenko Mexico S.A. de C.V., incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed +November 20, 2006 +10.30 +Summary of material terms and conditions of the Sale and Purchase Agreement with Adevco Corporation, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed January 5, +2007 +10.31 +Summary of Second Amendment to Agreement of Sale and Purchase Agreement with Adevco Corporation, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed April 11, 2007 +10.32* +Summary of Incentive Compensation Plan Performance Goals and Target Payments for Fiscal Year 2008 and Fiscal Years 2008-2010 Long Term Incentive Plan Performance Measures and Awards +incorporated by reference to the Company’s Form 8-K filed July 27, 2007 +10.33* +Summary of Incentive Compensation Plan Performance Goals and Target payments for Fiscal Year 2009 and Fiscal Years 2009 – 2011 Long Term Incentive Plan Performance Measures and Awards +incorporated by reference to the Company’s Form 8-K filed July 24, 2008 +10.34* +Summary of Incentive Compensation Plan Performance Goals and Target payments for Fiscal Year 2010 and Fiscal Years 2010 – 2012 Long Term Incentive Plan Performance Measures and Awards +incorporated by reference to the Company’s Form 8-K filed July 23, 2009 +10.35 +Financing Agreement with Wells Fargo Bank, N.A., incorporated by reference to the Exhibits to the Company’s Form 8-K filed on August 24, 2009 +21. +Subsidiaries of Registrant, submitted herewith +23.1 +Consent of Independent Registered Public Accounting Firm, submitted herewith +31.1 +Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer, submitted herewith +31.2 +Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer, submitted herewith +32.1 +Section 1350 Certification of Chief Executive Officer, submitted herewith +32.2 +Section 1350 Certification of Chief Financial Officer, submitted herewith +* +Management contract or compensatory plan or arrangement +48 +Table of Contents +PART IV +SCHEDULE II +KEY TRONIC CORPORATION AND SUBSIDIARIES +CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS +FISCAL YEARS ENDED JUNE 27, 2009, JUNE 28, 2008, AND +JUNE 30, 2007 +2009 +2008 +2007 +(in thousands) +Allowance for Obsolete Inventory +Balance at beginning of year +$ +236 +$ +211 +$ +1,669 +Provisions +303 +159 +544 +Dispositions +(130 +) +(134 +) +(2,002 +) +Balance at end of year +$ +409 +$ +236 +$ +211 +Allowance for Doubtful Accounts +Balance at beginning of year +$ +110 +$ +20 +$ +0 +Provisions +604 +122 +555 +Write-offs +(603 +) +(32 +) +(535 +) +Balance at end of year +$ +111 +$ +110 +$ +20 +49 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed +on its behalf by the undersigned, thereunto duly authorized. +Dated: September 11, 2009 +KEY TRONIC CORPORATION +By: +/s/ Craig D. Gates +Craig D. Gates, President and Chief Executive Officer +50 +Table of Contents +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by +the following persons on behalf of the registrant and in the capacities and on the dates indicated: +/s/ Craig D. Gates +September 11, 2009 +Craig D. Gates +Date +(President and Chief Executive Officer) +/s/ Ronald F. Klawitter +September 11, 2009 +Ronald F. Klawitter +Date +(Principal Financial Officer and +Principal Accounting +Officer) +/s/ James R. Bean +September 11, 2009 +James R. Bean +Date +(Director) +/s/ Dale F. Pilz +September 11, 2009 +Dale F. Pilz +Date +(Director, Chairman of the Board) +/s/ Jack W. Oehlke +September 11, 2009 +(Director, Former President and +Chief Executive Officer) +Date +/s/ Yacov A. Shamash +September 11, 2009 +Yacov A. Shamash +Date +(Director) +/s/ Patrick Sweeney +September 11, 2009 +Patrick Sweeney +Date +(Director) +51 \ No newline at end of file diff --git a/raw/filings/0000719733/2009/0001193125-09-190584/filing_metadata.csv b/raw/filings/0000719733/2009/0001193125-09-190584/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..b87b2a010bd24cdce311dafe6ff086deb790b859 --- /dev/null +++ b/raw/filings/0000719733/2009/0001193125-09-190584/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000719733,KTCC,KEY TRONIC CORP,10-K,2009-09-11,2009-06-27,2009-09-11T19:35:04.000Z,0001193125-09-190584,d10k.htm,FORM 10-K,814626,0,0,https://www.sec.gov/Archives/edgar/data/719733/000119312509190584/d10k.htm,https://www.sec.gov/Archives/edgar/data/719733/000119312509190584/,2009,2009,1 diff --git a/raw/filings/0000719733/2009/0001193125-09-190584/item1.txt b/raw/filings/0000719733/2009/0001193125-09-190584/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..61505b14cb394c3ba3b5b255ad349ba1fccb63b0 --- /dev/null +++ b/raw/filings/0000719733/2009/0001193125-09-190584/item1.txt @@ -0,0 +1,99 @@ +Item 1. +BUSINESS +Overview +Key Tronic Corporation (dba: KeyTronicEMS Co.), was organized in 1969 as a Washington corporation that locally manufactured computer keyboards. Our goal was to become the +world’s largest manufacturer of input devices for terminals, word processors and personal computers. The ability to design, build and deliver a quality product led to a reputation in the industry, allowing us to be a leading independent +manufacturer of keyboards for computers in the United States. Our fully integrated design, tooling, and automated manufacturing capabilities enabled us to rapidly respond to customers’ needs for keyboards in production quantities worldwide. We +supported our sales growth through the development and purchase of international manufacturing facilities. As the computer keyboard market matured with increasing competition from other international providers, we determined that our business could +no longer solely rely on keyboard sales. +After assessing market conditions and our strengths and capabilities in 1999, we shifted focus from keyboard +manufacturing to contract manufacturing for a wide range of products. Our new strategy was based on our original core strengths of innovative design and engineering expertise in electronics, mechanical engineering, and precision plastics combined +with high-quality, low cost production, and assembly on a global basis. These strengths have made our company a strong competitor in the electronic manufacturing services (EMS) market. As we fully transitioned into an EMS provider, our new customer +base became comprised of world-class customers from a wide range of industries. +The EMS industry experienced growth over the past several years as more +original equipment manufacturers (OEMs) chose to outsource manufacturing. This expansion of the EMS industry allowed us to continue to expand our customer base and the industries that we serve. However, the challenging global economic environment +has had a negative impact on our results of operations as the demand from our customers has declined. We successfully confronted the challenging global economic environment in fiscal year 2009 by reducing our costs while ramping up new customer +programs, which allowed us to maintain profitability and strengthen our balance sheet. The ramp up for our new programs was slowed by the recession, but these new programs continue to represent a growing portion of our revenue and a promising +foundation for our future. In keeping with our long-term strategic objectives, we have been successfully building a more diversified customer portfolio and a less concentrated revenue base, spanning a wider range of industries. We currently offer +our customers the following services: integrated electronic and mechanical engineering, precision plastic molding, assembly, component selection, sourcing and procurement, worldwide logistics, and new product testing and production all at +competitive pricing due to our global footprint. +We believe that we are well positioned in the EMS industry to continue the expansion of our customer base +and achieve long term growth. Our core strengths continue to support our growth and our customers’ needs. We continue to focus on controlling operating expenses and leveraging the synergistic capabilities of our world-class facilities in the +United States, Mexico, and China. This global production capability provides our customers with the benefits of improved supply-chain management, reduced inventory, lower labor costs, lower transportation costs, and reduced product fulfillment time. +Given our competitive advantages and the growing need for some potential customers to move forward with their outsourcing strategies, we are strongly positioned to win new business in coming periods and grow our revenue and profits as the global +economic environment improves. +3 +Table of Contents +The EMS industry is intensely competitive. We have less than 1% of the potential global market and our revenue can +fluctuate significantly due to reliance on a concentrated base of customers. We are planning for new customer growth in the coming quarters by securing new programs, increasing our worldwide manufacturing capacity, and continuing to improve our +manufacturing processes. Ongoing challenges that we face include the following: continuing to win programs from new and existing customers, balancing production capacity and key personnel in each of our manufacturing locations, improving operating +efficiencies, controlling costs while developing competitive pricing strategies, and successfully transitioning new program wins to full production. +Our +principal executive offices are located at N. 4424 Sullivan Road, Spokane Valley, Washington 99216, and our telephone number is (509) 928-8000. Our website is located at http://www.keytronicems.com where filings of our Annual Report on Form +10-K, Quarterly Reports on Form 10-Q or current reports on Form 8-K are available after they have been filed with the Securities and Exchange Commission. The information presented on our website currently and in the future is not considered to be +part of this document or any document incorporated by reference in this document. +Marketing +We provide a mix of manufacturing services for outsourced OEM products. We provide the following EMS services: product design, surface mount technologies (SMT) for +printed circuit board assembly, tool making, precision plastic molding, liquid injection molding, automated tape winding, prototype design and full product builds. +Sales of the majority of our products have historically not been seasonal in nature, but may be seasonal in the future if there are changes in the types of products manufactured. Sales can, however, fluctuate significantly between quarters +from changes in customer demand due to our revenue concentration in a few specific customers. +For the fiscal years ended June 27, +2009, June 28, 2008, and June 30, 2007, the five largest customers in each year accounted for 52%, 68%, and 73% of total sales, respectively. The following customers represented 10 percent or more of total net sales over the last +three fiscal years: Lexmark International, Inc. (14%, 15%, 18%), International Game Technology, Inc. (13%, 18%, 17%), Zebra Technologies Corporation (less than 10%, 18%, 22%), and Imation Corporation (10%, less than 10%, less than 10%). It is +anticipated that our new customer program wins will dilute our concentration of revenue in our current top five customers in the future. +Although keyboard +manufacturing is still included in our product offerings, we expect annual keyboard sales to decline over time. We realized revenues of approximately $4.2 million, $5.8 million, and $5.6 million in fiscal years 2009, 2008, and 2007, respectively, +from the sale of keyboards. In order to accommodate the demand for standard keyboard layouts, we maintain a purchase-from-stock program. The more popular standard layouts are built and stocked for immediate availability. +We market our products and services primarily through our direct sales department aided by strategically located field sales people and distributors. Although we +maintain relationships with several independent sales organizations to assist in marketing our EMS product lines, commissions earned and paid are not material to the consolidated financial statements. +Manufacturing +Since inception, we have made substantial investments +in developing and expanding a capital equipment base to achieve vertical integration and efficiencies in our manufacturing processes. We have invested significant capital into SMT for volume manufacturing of complex printed circuit board assemblies. +We also design and develop tooling for injection molding and manufacture the majority of plastic parts used in the products we manufacture. Additionally, we have equipment to maintain a controlled clean environment for manufacturing processes that +require a high level of precise control. +We use a variety of manual and highly automated assembly processes in our facilities, depending upon product +complexity and degree of customization. Some examples of automated processes include component insertion, SMT, flexible robotic assembly, automated storage tape winding, computerized vision system quality inspection, automated switch and key top +installation, and automated functional testing. +Our engineering expertise and automated manufacturing processes enable us to work closely with our +customers during the design and prototype stages of production and to jointly increase productivity and reduce response time to the marketplace. We use computer-aided design techniques and software to assist in preparation of the tool design layout +and component placement, to reduce tooling and production costs, improve component and product quality, and enhance turnaround time during product development. +4 +Table of Contents +We purchase materials and components for our products from many different suppliers, including both domestic and +international sources. We develop close working relationships with our suppliers, many of whom have been supplying products to us for several years. +Research, Development, and Engineering +Research, development, and engineering (RD&E) expenses consist principally of employee related +costs, third party development costs, program materials costs, depreciation, and allocated information technology and facilities costs. Our RD&E expenses were $2.3 million, $2.7 million, and $3.2 million in fiscal years 2009, 2008, and 2007 +respectively. In each of these years, we focused most of our RD&E efforts on current customer EMS programs. The decrease in RD&E in fiscal year 2009 compared to fiscal year 2008 is the result of cost reduction efforts and lower incentive and +bonus expenses. The decrease in RD&E in fiscal year 2008 compared to fiscal year 2007 is related to transferring engineers and support personnel from RD&E to manufacturing costs of sales as their job roles changed to support the new SMT line +in Spokane Valley, Washington. +Competition +The market +for the products and services we provide is highly competitive. There are numerous competitors in the EMS industry, many of which have substantially more resources and are more geographically diverse than we are. Some of our competitors have similar +international production capabilities, large financial resources and some have substantially greater manufacturing, research and development, and marketing resources. There is also competition from the manufacturing operations of our current and +potential customers, who are continually evaluating the merits of manufacturing their products internally versus the advantages of outsourcing. We believe that we can currently compete favorably to these factors primarily on the basis of our global +footprint, responsiveness, creativity, vertical production capability, quality, and cost. +Trademarks and Patents +Our name and logo are federally registered trademarks, and we believe they are valuable assets of our business. During 2001, we began operating under the trade name +“KeyTronicEMS Co.” to better identify our primary business concentration. We also own several keyboard patents; however, since our focus is EMS, management believes that these patents will not have a significant impact on future revenues. +Employees +We consider our employees to be our primary +strength and we make considerable efforts to maintain a well-qualified workforce. Our employee benefits include bonus programs involving periodic payments to all employees based on meeting quarterly or fiscal year performance targets. We regularly +provide transportation, medical services, and meals to all of our employees in foreign locations. We maintain a 401(k) plan for U.S. employees, which provides a discretionary matching company contribution of up to 4% of an employee’s salary. We +provide group health, life, and disability insurance plans. We also maintain stock option plans and other long term incentive plans for certain employees and outside directors. +As of June 27, 2009, we had 1,963 employees compared to 2,502 on June 28, 2008, and 2,227 on June 30, 2007. Since we can have significant fluctuations in product demand, we seek to maintain flexibility +in our workforce by utilizing skilled temporary and short-term contract labor in our manufacturing facilities in addition to full-time employees. The change in the number of employees was a result of a change in product mix. Certain products require +more hand assembly than others. Our employees in Reynosa, Mexico, which represent approximately 13% of the Company’s employees, are represented by a local union. We have no history of any material interruption of production due to labor +disputes. +Backlog +On July 25, 2009, our order +backlog was valued at approximately $29.9 million, compared to approximately $42.2 million on July 27, 2008. Even though our order backlog is comprised of firm purchase orders, the amount of backlog is not necessarily indicative of future sales +but can be indicative of trends in expected future sales revenue. Due to the relationships with our customers, we will occasionally allow orders to be canceled or rescheduled and as a result is not a meaningful indicator of future financial results. +If there are canceled or rescheduled orders, we will attempt to negotiate fees to cover the costs we have incurred. The change in backlog at July 25, 2009, when compared to July 27, 2008, is due to a decrease in demand from our customers +as the result of the unfavorable global economic environment. Order backlog consists of purchase orders received for products expected to be shipped approximately within the next twelve months, although shipment dates are subject to change due to +design modifications, customer forecast changes, or other customer requirements. +5 +Table of Contents +Foreign Markets +Information concerning net sales and long-lived assets (property, plant, and equipment) by geographic areas is set forth in footnote 12 of the consolidated financial statements of this Annual Report on Form 10-K, under the caption +“Enterprise-Wide Disclosures”, and that information is incorporated herein. \ No newline at end of file diff --git a/raw/filings/0000719733/2009/0001193125-09-190584/item13.txt b/raw/filings/0000719733/2009/0001193125-09-190584/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..54909510f07371b0b8618b37d74985289d5a97f3 --- /dev/null +++ b/raw/filings/0000719733/2009/0001193125-09-190584/item13.txt @@ -0,0 +1,4 @@ +Item 13: +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Information appearing under the caption “Related Person Transactions”, “Compensation Committee Interlocks and Insider Participation”, and “Directors’ Independence” in the Company’s 2009 Proxy +Statement is incorporated herein by this reference. \ No newline at end of file diff --git a/raw/filings/0000719733/2009/0001193125-09-190584/item9a.txt b/raw/filings/0000719733/2009/0001193125-09-190584/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..c688c61a24434ea268974e256a0deedc230c81c6 --- /dev/null +++ b/raw/filings/0000719733/2009/0001193125-09-190584/item9a.txt @@ -0,0 +1,29 @@ +Item 9A (T): CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and +Procedures +It is the responsibility of our management to establish, maintain, and monitor disclosure controls and procedures that are designed to +ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange +Commission rules and forms. Additionally, these disclosure controls include controls and procedures that are designed to accumulate and communicate the information required to be disclosed to our company’s Chief Executive Officer and Chief +Financial Officer, allowing for timely decisions regarding required disclosures. As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and with the participation of the Chief Executive +Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(f). Based on our assessment, we believe that as of June 27, 2009, the +Company’s disclosure controls and procedures are effective based on that criteria. +Management’s Report on Internal Control over Financial +Reporting +Our management has the responsibility to establish and maintain adequate internal controls over our financial reporting, as defined in +Rule 13a-15(f) under the Securities and Exchange Act of 1934. Our internal controls are designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our external financial statements in +accordance with generally accepted accounting principles (GAAP). +43 +Table of Contents +Due to inherent limitations of any internal control system, management acknowledges that there are limitations as to the +effectiveness of internal controls over financial reporting and therefore recognize that only reasonable assurance can be gained from any internal control system. Accordingly, our internal control system may not detect or prevent material +misstatements in our financial statements and projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the +policies or procedures may deteriorate. +Under the supervision and participation of management, including the Chief Executive Officer and Chief Financial +Officer, we have performed an assessment of the effectiveness of our internal controls over financial reporting as of June 27, 2009. This assessment was based on the criteria established in Internal Control-Integrated Framework, issued by the +Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we believe that as of June 27, 2009, the Company’s internal control over financial reporting is effective based on that criteria. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s +report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this annual report. +Changes in Internal Control over Financial Reporting +There +have been no significant changes in our internal controls over financial reporting during our fourth fiscal quarter ended June 27, 2009 that have materially affected, or are reasonable likely to materially affect, the Company’s internal +control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)). \ No newline at end of file diff --git a/raw/filings/0000719733/2009/0001193125-09-190584/rp_note.txt b/raw/filings/0000719733/2009/0001193125-09-190584/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000719733/2009/0001193125-09-190584/rpt_disclosure.txt b/raw/filings/0000719733/2009/0001193125-09-190584/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..54084ae8e86f7dcc50adfbc6bca5782e7e7214c0 --- /dev/null +++ b/raw/filings/0000719733/2009/0001193125-09-190584/rpt_disclosure.txt @@ -0,0 +1,16 @@ +Related Person Transactions +In April 2007, the Board of Directors adopted a written policy and procedures for the approval or ratification of Interested Transactions with Related Parties. The policy and procedures supplement the Company’s Code of Conduct. The +policy defines an “Interested Transaction” as any transaction, arrangement or relationship or series of similar transactions, arrangements or relationships (including any indebtedness or guarantee of indebtedness) in which (1) the +aggregate amount involved will or may be expected to exceed $120,000 in any calendar year, (2) the Company is a participant, and (3) any Related Party has or will have a direct or indirect interest (other than solely as a result of being a +director or a less than 10 percent beneficial owner of another entity). +The policy defines a “Related Party” as any (a) person who is or +was (since the beginning of the last fiscal year for which the Company has filed a Form 10-K and proxy statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director, +(b) greater than 5 percent beneficial owner of the Company’s common stock, or (c) immediate family member of any of the foregoing. Immediate family member includes a person’s spouse, parents, stepparents, children, stepchildren, +siblings, mothers- and fathers-in-law, sons- and daughters-in-law, and brothers- and sisters-in-law and anyone residing in such person’s home (other than a tenant or employee). +The Audit Committee is responsible for review, approval, ratification or disapproval of Interested Transactions. In determining whether to approve or ratify an Interested Transaction, the Committee will take into +account, among other factors it deems appropriate, whether the Interested Transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the Related +Party’s interest in the Transaction. With the exception of the Transition Agreement with Mr. Oehlke (see “Employment Contracts”, pages 11-12), the Company had no related Party Transactions during fiscal year 2009. +Compensation Committee Interlocks and Insider Participation in Compensation Decisions +The Board of Directors has a Compensation Committee presently consisting of Messrs. Shamash and Pilz. No member of the Compensation Committee was an officer or employee of the Company or any of its subsidiaries during +fiscal year 2009. None of the executive officers of the Company has served on the Board of Directors or on the Compensation Committee of any other entity, any of whose officers served either on the Board of Directors or on the Compensation Committee +of the Company. \ No newline at end of file diff --git a/raw/filings/0000719733/2010/0001193125-10-209062/filing.txt b/raw/filings/0000719733/2010/0001193125-10-209062/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..3bed7ae99ecbab8094bd921815017eabbde8f2ce --- /dev/null +++ b/raw/filings/0000719733/2010/0001193125-10-209062/filing.txt @@ -0,0 +1,3360 @@ +10-K +1 +d10k.htm +FORM 10-K +FORM 10-K +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended July 3, 2010 +OR +¨ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File Number 0-11559 +KEY TRONIC CORPORATION +(Exact name of registrant as specified in its charter) +Washington +91-0849125 +(State or other jurisdiction of +Incorporation or organization) +(I.R.S. Employer +Identification No.) +N. 4424 Sullivan Road, Spokane Valley, +Washington +99216 +(Address of principal executive offices) +(Zip Code) +(509) +928-8000 +(Registrant’s telephone number, including area code) +N/A +(Former name, former address and former fiscal year, if changed since last report) +Securities Registered Pursuant to Section 12(b) of the Act: None +Title of each class +Name of each exchange on which registered +Common stock, no par value +The NASDAQ Stock Market LLC +Securities Registered Pursuant to Section 12(g) of the Act: None +Table of Contents +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the +Securities Act. Yes ¨ No x +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange +Act. Yes ¨ No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange +Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 +days. Yes x No ¨ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File +required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such +files). Yes ¨ No ¨ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, +to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller +reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +(Check one): +Large accelerated filer +¨ +Accelerated filer +¨ +Non-accelerated filer +¨ (Do not check if a smaller reporting company) +Smaller reporting company +x +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange +Act). Yes ¨ No x +State the aggregate market value of the voting and non-voting common equity held by non affiliates computed by reference to the price at which the common +equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. +As of December 26, 2009, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $34.9 million +based on the closing price as reported on the NASDAQ. +Indicate the number of shares outstanding of each of the issuer’s classes of +common stock, as of the latest practicable date: 10,326,855 shares of common stock were outstanding as of September 2, 2010. +Documents +Incorporated by Reference: +The following documents are incorporated by reference to the extent specified herein: +Document Description +Part of Form 10-K +Proxy Statement dated September 17, 2010 +Part III +Table of Contents +KEY TRONIC CORPORATION +2010 FORM 10-K +TABLE OF CONTENTS +Page +Part I +Item 1. +Business +4 – 9 +Item 1A. +Risk Factors +9 – 12 +Item 1B. +Unresolved Staff Comments +12 +Item 2. +Properties +12 – 13 +Item 3. +Legal Proceedings +13 +Item 4. +Reserved +13 +Part II +Item 5. +Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity +Securities +13 – 15 +Item 6. +Selected Financial Data +15 – 16 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +17 – 25 +Item 7A. +Quantitative and Qualitative Disclosures about Market Risk +25 – 26 +Item 8. +Financial Statements and Supplementary Data +26 – 46 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +46 +Item 9A(T). +Controls and Procedures +46 – 47 +Item 9B. +Other Information +47 +Part III +Item 10. +Directors, Executive Officers and Corporate Governance +47 – 48 +Item 11. +Executive Compensation +48 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +48 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +49 +Item 14. +Principal Accounting Fees and Services +49 +Part IV +Item 15. +Exhibits and Financial Statement Schedule +49 – 53 +Signatures +54 – 55 +FORWARD-LOOKING +STATEMENTS +References in this report to “the Company”, “Key Tronic”, “we”, “our”, or +“us” mean Key Tronic Corporation together with its subsidiaries, except where the context otherwise requires. +This Annual +Report on Form 10-K contains forward-looking statements in addition to historical information. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the +forward-looking statements. Risks and uncertainties that might cause such differences include, but are not limited to those outlined in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risks and +Uncertainties that May Affect Future Results.” Readers are cautioned not to place undue reliance on forward-looking statements, which reflect management’s opinions only as of the date hereof. The Company undertakes no obligation to update +forward-looking statements to reflect developments or information obtained after the date hereof and disclaims any obligation to do so. Readers should carefully review the +3 +Table of Contents +risk factors described in periodic reports the Company files from time to time with the Securities and Exchange Commission, including Quarterly Reports on Form 10-Q and Current Reports on Form +8-K. +PART I +Item 1. +BUSINESS +Background +Key +Tronic Corporation (dba: KeyTronicEMS Co.), was organized in 1969 as a Washington corporation that locally manufactured computer keyboards. The ability to design, build and deliver a quality product led to a reputation in the industry, allowing us +to be a leading independent manufacturer of keyboards for computers in the United States. Our fully integrated design, tooling, and automated manufacturing capabilities enabled us to rapidly respond to customers’ needs for keyboards in +production quantities worldwide. We supported our sales growth through the development and purchase of international manufacturing facilities. As the computer keyboard market matured with increasing competition from other international providers, we +determined that our business could no longer solely rely on keyboard sales. After assessing market conditions and our strengths and capabilities, we shifted focus from keyboard manufacturing to contract manufacturing for a wide range of products. +This strategy was based on our core strengths of innovative design and engineering expertise in electronics, mechanical engineering, and precision plastics combined with high-quality, low cost production, and assembly on an international basis. +These strengths have made our company a strong competitor in the electronic manufacturing services (EMS) market. +Our +Industry and Strategy +The expansion of the EMS industry during the last decade allowed us to continue to expand our customer base and +the industries that we serve. The recent challenging global macroeconomic environment has had a negative impact on previously held customer programs. However, we successfully confronted the challenging global macroeconomic environment by reducing +our costs while winning new customer programs, which allowed us to increase our profitability and strengthen our balance sheet during the global economic downturn. The increase in new programs represents a growing portion of our revenue and a +promising foundation for our future. In keeping with our long-term strategic objectives, we have been successfully building a more diversified customer portfolio and a less concentrated revenue base, spanning a wider range of industries. We +currently offer our customers the following services: integrated electronic and mechanical engineering, precision plastic molding, assembly, component selection, sourcing and procurement, worldwide logistics, and new product testing and production +all at competitive pricing due to our global footprint. +We believe that we are well positioned in the EMS industry to continue the expansion +of our customer base and achieve long term growth. Our core strengths continue to support our growth and our customers’ needs. We continue to focus on controlling operating expenses and leveraging the synergistic capabilities of our world-class +facilities in the United States, Mexico, and China. This international production capability provides our customers with the benefits of improved supply-chain management, reduced inventory, lower labor costs, lower transportation costs, and reduced +product fulfillment time. Given our competitive advantages and the growing need for some potential customers to move forward with their outsourcing strategies, we are strongly positioned to win new business in coming periods and grow our revenue and +profits. +The EMS industry is intensely competitive. Although our customer base is growing we still have less than 1% of the potential global +market and our revenue can fluctuate significantly due to reliance on a concentrated base of customers. We are planning for new customer growth in the coming quarters by securing new programs, increasing our worldwide manufacturing capacity, and +continuing to improve our manufacturing and procurement processes. Ongoing challenges that we face include the following: Continuing to win programs from new and existing customers, balancing production capacity and key personnel in support of new +customer programs, improving operating efficiencies, controlling costs while +4 +Table of Contents +developing competitive pricing strategies, successfully transitioning new program wins to full production and successfully addressing industry-wide shortages in the global supply chain. +Customers and Marketing +We provide a mix of manufacturing services for outsourced Original Equipment Manufacturing (OEM) products. We provide the following EMS services: Product +design, surface mount technologies (SMT) and pin through hole capability for printed circuit board assembly, tool making, precision plastic molding, liquid injection molding, automated tape winding, prototype design and full product builds. +Sales of the majority of our products have historically not been seasonal in nature, but may be seasonal in the future if there are changes +in the types of products manufactured. Sales can, however, fluctuate significantly between quarters from changes in customers and customer demand due to our concentrated customer base. +For the fiscal years ended July 3, 2010, June 27, 2009, and June 28, 2008, the five largest customers in each year accounted for 57%, +52%, and 68% of total sales, respectively. The following customers represented 10% or more of total net sales over the last three fiscal years: KAZ Inc. (18%, less than 10%, less than 10%) International Game Technology, Inc. (12%, 13%, 18%), and +Lexmark International, Inc. (less than 10%, 14%, 15%). It is anticipated that our new customer program wins will dilute our concentration of revenue in the future. +Although keyboard manufacturing is still included in our product offerings, we do not expect annual keyboard sales to be a material component of our +business. We realized revenues of approximately $4.5 million, $4.2 million, and $5.8 million in fiscal years 2010, 2009, and 2008, respectively, from the sale of keyboards. In order to accommodate the demand for standard keyboard layouts, we +maintain a purchase-from-stock program. The more popular standard layouts are built and stocked for immediate availability. Although we are recognized as a reputable contract manufacturer we still market our products and services primarily through +our direct sales department aided by strategically located field sales people and distributors. Although we maintain relationships with several independent sales organizations to assist in marketing our EMS product lines, commissions earned and paid +are not material to the consolidated financial statements. +Manufacturing +We have continually made investments in developing and expanding a capital equipment base to achieve vertical integration and efficiencies in our +manufacturing processes. We have invested significant capital into SMT for volume manufacturing of complex printed circuit board assemblies. We also design and develop tooling for injection molding and manufacture the majority of plastic parts used +in the products we manufacture. Additionally, we have equipment to maintain a controlled clean environment for manufacturing processes that require a high level of precise control. +We use a variety of manual and automated assembly processes in our facilities, depending upon product complexity and degree of customization. Some +examples of automated processes include component insertion, SMT, flexible robotic assembly, automated storage tape winding, computerized vision system quality inspection, automated switch and key top installation, and automated functional testing. +Our engineering expertise and automated manufacturing processes enable us to work closely with our customers during the design and prototype +stages of production and to jointly increase productivity and reduce response time to the marketplace. We use computer-aided design techniques and software to assist in preparation of the tool design layout and component placement, to reduce tooling +and production costs, improve component and product quality, and enhance turnaround time during product development. +We purchase materials +and components for our products from many different suppliers, including both domestic and international sources. We develop close working relationships with our suppliers, many of whom have been supplying products to us for several years. +5 +Table of Contents +Research, Development, and Engineering +Research, development, and engineering (RD&E) expenses consist principally of employee related costs, third party development costs, program materials +costs, depreciation, and allocated information technology and facilities costs. Our RD&E expenses were $2.8 million, $2.3 million, and $2.7 million in fiscal years 2010, 2009, and 2008 respectively. In each of these years, we focused most of our +RD&E efforts on current customer EMS programs. The increase in RD&E in fiscal year 2010 compared to fiscal year 2009 is primarily the result of higher incentive compensation and increased headcount. The decrease in RD&E in fiscal year +2009 compared to fiscal year 2008 is the result of cost reduction efforts and lower incentive and bonus expenses. +Competition +The +market for the products and services we provide is highly competitive. There are numerous competitors in the EMS industry, many of which have substantially more resources and are more geographically diverse than we are. Some of our competitors have +similar international production capabilities, large financial resources and some have substantially greater manufacturing, research and development, and marketing resources. There is also competition from the manufacturing operations of our current +and potential customers, who are continually evaluating the merits of manufacturing their products internally versus the advantages of outsourcing. We believe that we can currently compete favorably to these factors primarily on the basis of our +international footprint, responsiveness, creativity, vertical production capability, quality, and cost. +Trademarks and +Patents +Our name and logo are federally registered trademarks, and we believe they are valuable assets of our business. During 2001, +we began operating under the trade name “KeyTronicEMS Co.” to better identify our primary business concentration. We also own several keyboard patents; however, since our focus is EMS, management believes that these patents will not have a +significant impact on future revenues. +Employees +We consider our employees to be our primary strength and we make considerable efforts to maintain a well-qualified workforce. Our employee benefits +include bonus programs involving periodic payments to all employees based on meeting quarterly or fiscal year performance targets. We regularly provide transportation, medical services, and meals to all of our employees in foreign locations. We +maintain a 401(k) plan for U.S. employees, which provides a discretionary matching company contribution of up to 4% of an employee’s salary. We provide group health, life, and disability insurance plans. We also maintain stock option plans and +other long term incentive plans for certain employees and outside directors. As of July 3, 2010 we had 2,036 employees compared to 1,963 on June 27, 2009, and 2,502 on June 28, 2008. Since we can have significant fluctuations in +product demand, we seek to maintain flexibility in our workforce by utilizing skilled temporary and short-term contract labor in our manufacturing facilities in addition to full-time employees. Our employees in Reynosa, Mexico, are represented by a +local union. We have no history of any material interruption of production due to labor disputes. We anticipate that this particular subsidiary will cease its operations during fiscal year 2011. As a result, we will no longer retain employees in +Reynosa, Mexico. +Backlog +On July 31, 2010 our order backlog was valued at approximately $56.9 million, compared to approximately $29.9 million on July 25, 2009, which +reflects an increase in expected revenue during fiscal year 2011. Even though our order backlog is comprised of firm purchase orders, the amount of backlog is not necessarily indicative of future sales but can be indicative of trends in expected +future sales revenue. Due to the relationships with our customers, we will occasionally allow orders to be canceled or rescheduled and as a result is not a meaningful indicator of future financial results. If there are canceled or rescheduled +orders, we will attempt to negotiate fees to cover the costs we have incurred. Order backlog consists of +6 +Table of Contents +purchase orders received for products expected to be shipped approximately within the next twelve months, although shipment dates are subject to change due to design modifications, customer +forecast changes, or other customer requirements. +Foreign Markets +Information concerning net sales and long-lived assets (property, plant, and equipment) by geographic areas is set forth in footnote 12 of the +consolidated financial statements of this Annual Report on Form 10-K, under the caption “Enterprise-Wide Disclosures”, and that information is incorporated herein. +Executive Officers of the Registrant +The table below sets forth the name, current age and current position of our executive officers and other significant employees as of July 3, 2010: +Name +Age +Positions Held +Executive Officers +Craig D. Gates +51 +President and Chief Executive Officer +Ronald F. Klawitter +58 +Executive Vice President of Administration, Chief Financial Officer and Treasurer +Douglas G. Burkhardt +52 +Executive Vice President of Worldwide Operations +Lawrence J. Bostwick +58 +Vice President of Engineering and Quality +Phil Hochberg +48 +Vice President of Business Development +Brett R. Larsen +37 +Vice President of Finance, and Controller +Don Sinclair* +57 +Vice President of Materials +* +Subsequent to July 3, 2010, Mr. Sinclair announced his resignation with the Company effective August 31, 2010. +Executive Officers +CRAIG D. GATES – President and Chief Executive Officer +Mr. Gates, age 51, has been President and Chief Executive officer of the Company since April 2009. Previously he was Executive Vice President and +General Manager from August 2002 to April 2009. He served as Executive Vice President of Marketing, Engineering and Sales from July 1997 to August 2002 and served as Vice President and General Manager of New Business Development from October 1995 to +July 1997. He joined the Company as Vice President of Engineering in October of 1994. From 1982 he held various engineering and management positions within the Microswitch Division of Honeywell, Inc., in Freeport, Illinois, and from 1991 to October +1994 he served as Director of Operations, Electronics for Microswitch. Mr. Gates has a Bachelor of Science Degree in Mechanical Engineering and a Masters in Business Administration from the University of Illinois, Urbana. +RONALD F. KLAWITTER – Executive Vice President of Administration, Chief Financial Officer, and Treasurer +Mr. Klawitter, age 58, has been Executive Vice President of Administration, CFO, and Treasurer since July 1997. Previously he was Vice President of +Finance, Secretary, and Treasurer of the Company from October 1995 to July 1997. He was Acting Secretary from November 1994 to October 1995 and Vice President of Finance and Treasurer from 1992 to October 1995. From 1987 to 1992, Mr. Klawitter +was Vice President of Finance at Baker Hughes Tubular Service, a subsidiary of Baker Hughes, Inc. Mr. Klawitter has a BA degree from Wittenberg University and is a Certified Public Accountant. +7 +Table of Contents +DOUGLAS G. BURKHARDT – Executive Vice President of Worldwide Operations +Mr. Burkhardt, age 52, has been Executive Vice President of Worldwide Operations of the company since July 22, 2010. Previously +Mr. Burkhardt was Vice President of Worldwide Operations from July 2008 to July 2010 and Director of China Operations and Program Management from January 2006 to July 2008. Mr. Burkhardt also served as Director of Northwest and China +Operations from November of 1998 to January of 2006. Mr. Burkhardt also served as Director of Customer Satisfaction from March 1997 to November 1998 and Director of Molding from September of 1995 to March of 1997. Prior to this, +Mr. Burkhardt served in other various senior management positions within the company. Mr. Burkhardt has been with the company since May of 1989. Prior to joining Key Tronic, Mr. Burkhardt worked for House of Aluminum and Glass for 12 +years where he was the plant manager. +LAWRENCE J. BOSTWICK – Vice President of Engineering and Quality +Mr. Bostwick, age 58, has been Vice President of Engineering and Quality since July 2008. Previously he was Director of Engineering and Quality from +February 2007 to July 2008 and served as Corporate Director of Quality from February 2006 to February 2007. From 2003 to 2006 he was Director of Supply Chain Management and Quality for the Lancer Corporation and from 1998 to 2003 he was Vice +President of Operations for Thermacore International. He is a graduate of the Westinghouse and General Electric – Engineering and Manufacturing Professional Development Programs. He is certified in both Quality and Industrial Engineering and is +a Lean – Six Sigma Master Black Belt. Mr. Bostwick has a combined B.S. degree in Production and Operation and Industrial Engineering from Bowling Green State University and a Masters degree in Industrial Engineering and Business +Administration from Syracuse University. +PHIL HOCHBERG – Vice President of Business Development +Mr. Hochberg, age 48, has been Vice President of Business Development since October 2009. Previously he was Director of Business Development and +Program Management from July 2008 to October 2009. Mr. Hochberg served as Director of Business Development from October 2004 to July 2008 and as Director of EMS Sales and Marketing from July 2000 to October 2004. Prior to joining Key Tronic, +Mr. Hochberg worked for Quinton Instrument Company as their Director of Marketing and Product Management from 1992 to 2000. From 1988 to 1992, he was employed by SpaceLabs Medical as their Business Development Marketing Manager. +Mr. Hochberg has an MBA from the University of British Columbia, a BA Psychology, with a minor in Business from Washington University in St. Louis. +BRETT R. LARSEN – Vice President of Finance, and Controller +Mr. Larsen, age 37, has served as Vice President of Finance and Controller since February 2010. He was Chief Financial Officer of FLSmidth Spokane, +Inc. from December 2008 to February 22, 2010. From October 2005 through November 2008, Mr. Larsen served as Controller of Key Tronic Corporation. From May 2004 to October 2005, Mr. Larsen served as Manager of Financial Reporting of +Key Tronic Corporation. From 2002 to May 2004, Mr. Larsen was an audit manager for the public accounting firm BDO Seidman, LLP. He also held various auditing and supervisory positions with Grant Thornton LLP from 1997 to 2002. Mr. Larsen +has a Bachelor of Science degree in Accounting and a Masters degree in Accounting from Brigham Young University and is a Certified Public Accountant. +DON SINCLAIR – Vice President of Material +Mr. Sinclair, age 57, has served as the Vice President of Materials since January 2010. Prior to joining Key Tronic, Mr. Sinclair was employed +by Advanced Input Systems Division of Esterline Corporation, where he held various positions such as: Director of Materials, Managing Director – Offshore Operations, and Vice President of Business Development from 1998 to 2009. Prior to 1998, +Mr. Sinclair held management positions at companies including Intermec Technologies, Honeywell and Westinghouse. Mr. Sinclair has a Bachelor of Science Degree in Business from Washington State University. +8 +Table of Contents +Available Information +Our principal executive offices are located at N. 4424 Sullivan Road, Spokane Valley, Washington 99216, and our telephone number is (509) 928-8000. +Our website is located at http://www.keytronicems.com where filings of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q or current reports on Form 8-K are available after they have been filed with the Securities and Exchange +Commission. The information presented on our website currently and in the future is not considered to be part of this document or any document incorporated by reference in this document. +Item 1A. +RISK FACTORS +There are risks and +uncertainties that could affect our business. These risks and uncertainties include but are not limited to, the risk factors described below, in Item 7A: “Quantitative and Qualitative Disclosures about Market Risk” and elsewhere in +this Form 10-K. +RISKS AND UNCERTAINTIES THAT COULD AFFECT FUTURE RESULTS +The following risks and uncertainties could affect our actual results and could cause results to differ materially from past results or those +contemplated by our forward-looking statements. When used herein, the words “expects”, “believes”, “anticipates” and similar expressions are intended to identify forward-looking statements. +Potential Fluctuations in Quarterly Results +Our quarterly operating results have varied in the past and may vary in the future due to a variety of factors, including adverse changes in the U.S. and +global macroeconomic environment, volatility in overall demand for our customers’ products, success of customers’ programs, timing of new programs, new product introductions or technological advances by us, our customers and our +competitors, and changes in pricing policies by us, our customers, our suppliers, and our competitors. Our customer base is diverse in the markets they serve, however, decreases in demand, particularly from customers that supply the banking, +consumer products, and gambling industries, could affect future quarterly results. Additionally, our customers could be impacted by the illiquidity of the credit markets which could directly impact our operating results. +Component procurement, production schedules, personnel and other resource requirements are based on estimates of customer requirements. Occasionally, our +customers may request accelerated production that can stress resources and reduce operating margins. In addition, because many of our operating expenses are relatively fixed, a reduction in customer demand can harm our gross profit and operating +results. The products which we manufacture for our customers have relatively short product lifecycles. Therefore, our business, operating results and financial condition are dependent in significant way on our ability to obtain orders from new +customers and new product programs from existing customers. +Operating results can also fluctuate if changes are made to significant estimates +and assumptions. Significant estimates and assumptions include the allowance for doubtful receivables, provision for obsolete and non-saleable inventory, the valuation allowance on deferred tax assets, impairment of long-lived assets, long-term +incentive compensation accrual, and the provision for warranty costs. +Economic Conditions +Recently there have been adverse conditions and uncertainty in the global economy as the result of unstable global financial and credit markets, +inflation, and recession. These unfavorable economic conditions and the weakness of the credit market could affect the demand for our customers’ products. The current global macroeconomic environment may affect some of our customers that could +reduce orders and change forecasts which could adversely affect our sales in future periods. Additionally, the financial strength of our customers and suppliers and their ability to obtain and rely on credit financing may affect their ability to +fulfill their obligations to us and have an adverse affect on our financial results. +9 +Table of Contents +Credit Markets +The current illiquidity and financial instability in the credit markets could adversely impact lenders and potentially limit the ability of our suppliers +and customers to borrow. This may affect their ability to fulfill their obligations to us and have an adverse effect on our financial results. +Dependence on Suppliers +We are dependent on many suppliers, including sole source suppliers, to provide key components and raw materials used in manufacturing customers’ +products. Over the past few quarters we have seen supply shortages in certain electronic components. This has resulted in longer lead times and the inability to meet our customers request for flexible production and we have missed or +extended shipment dates. If demand for these components continues to outpace supply capacity these delays could further affect future operations. Delays in deliveries from suppliers or the inability to obtain sufficient quantities of +components and raw materials could cause delays or reductions in shipment of products to our customers which could adversely affect our operating results and damage customer relationships. +Concentration of Credit Risk +Cash and cash equivalents are exposed to concentrations of credit risk. We place our cash with high credit quality institutions. At times, such balances +may be in excess of the federal depository insurance limit or may be on deposit at institutions which are not covered by insurance. If such institutions were to become insolvent during which time it held our cash and cash equivalents in excess of +the insurance limit, it could be necessary to obtain other credit financing to operate our facilities. +Competition +The EMS industry is intensely competitive. Competitors may offer customers lower prices on certain high volume programs. This could +result in price reductions, reduced margins and loss of market share, all of which would materially and adversely affect our business, operating results, and financial condition. If we were unable to provide comparable or better manufacturing +services at a lower cost than our competitors, it could cause sales to decline. In addition, competitors can copy our non-proprietary designs after we have invested in development of products for customers, thereby enabling such competitors to offer +lower prices on such products due to savings in development costs. +Concentration of Major Customers +At present, our customer base is highly concentrated and could become more or less concentrated. Our largest EMS customer accounted for 18% of net sales +in fiscal year 2010. This same customer accounted for 6% of sales in 2009 and 0% in 2008. For the fiscal years ended 2010, 2009, and 2008, the five largest customers accounted for 57%, 52%, and 68% of total sales, respectively. There can be no +assurance that our principal customers will continue to purchase products from us at current levels. Moreover, we typically do not enter into long-term volume purchase contracts with our customers, and our customers have certain rights to extend or +delay the shipment of their orders. We, however, require that our customers contractually agree to buy back inventory purchased within specified lead times to build their products if not used. +The loss of one or more of our major customers, or the reduction, delay or cancellation of orders from such customers, due to economic conditions or +other forces, could materially and adversely affect our business, operating results and financial condition. Specifically, some of our major customers provide products to the banking and gambling industries which have been adversely affected by the +unfavorable economic environment. The contraction in demand from our customers in these industries could continue to impact our customer orders and continue to have a negative impact on our operations over the next several fiscal quarters. +Additionally, if one or more of our customers were to become insolvent or otherwise unable to pay for the manufacturing services provided by us, our operating results and financial condition would be adversely affected. +Foreign Manufacturing Operations +Most of the products manufactured by us are produced at our facilities located in Mexico and China. These international operations may be subject to a +number of risks, including: +10 +Table of Contents +• +difficulties in staffing and managing foreign operations; +• +political and economic instability (including acts of terrorism, civil unrest, forms of violence and outbreaks of war), which could impact our ability +to ship and/or receive product; +• +unexpected changes in regulatory requirements and laws; +• +longer customer payment cycles and difficulty collecting accounts receivable; +• +export duties, import controls and trade barriers (including quotas); +• +governmental restrictions on the transfer of funds; +• +burdens of complying with a wide variety of foreign laws and labor practices; +• +fluctuations in currency exchange rates, which could affect component costs, local payroll, utility and other expenses; and +• +inability to utilize net operating losses incurred by our foreign operations to reduce our U.S. income taxes; +• +our foreign locations may be impacted by hurricanes, earthquakes, water shortages, tsunamis, floods, typhoons, fires, extreme weather conditions and +other natural or manmade disasters. +Our operations in certain foreign locations receive favorable income tax treatment in +the form of tax credits or other incentives. In the event that such tax holidays or other incentives are not extended, are repealed, or we no longer qualify for such programs, our taxes may increase, which would reduce our net income. +Additionally, certain foreign jurisdictions restrict the amount of cash that can be transferred to the U.S or impose taxes and penalties on such +transfers of cash. To the extent we have excess cash in foreign locations that could be used in, or is needed by, our operations in the United States, we may incur significant penalties and/or taxes to repatriate these funds. +Dependence on Key Personnel +Our future success depends in large part on the continued service of our key technical, marketing and management personnel and on our ability to continue +to attract and retain qualified employees. There can be no assurance that we will be successful in attracting and retaining such personnel. The loss of key employees could have a material adverse effect on our business, operating results and +financial condition. +Technological Change and New Product Risk +The markets for our customers’ products is characterized by rapidly changing technology, evolving industry standards, frequent new product +introductions and relatively short product life cycles. The introduction of products embodying new technologies or the emergence of new industry standards can render existing products obsolete or unmarketable. Our success will depend upon our +customers’ ability to enhance existing products and to develop and introduce, on a timely and cost-effective basis, new products that keep pace with technological developments and emerging industry standards and address evolving and +increasingly sophisticated customer requirements. Failure of our customers to do so could substantially harm our customers’ competitive positions. There can be no assurance that our customers will be successful in identifying, developing and +marketing products that respond to technological change, emerging industry standards or evolving customer requirements. +Interest Rate Risk +We are exposed to interest rate risk under our revolving credit facility with interest rates based on various levels of margin added to published prime +rate and LIBOR rates depending on the calculation of a certain financial covenant. +Compliance with Current and Future +Environmental Regulation +We are subject to a variety of domestic and foreign environmental regulations relating to the use, storage, +and disposal of materials used in our manufacturing processes. If we fail to comply with any present or future regulations, we could be subject to future liabilities or the suspension of current manufacturing operations. In addition, such +regulations could restrict our ability to expand our operations or could require us to acquire costly equipment, substitute materials, or incur other significant expenses to comply with government regulations. +11 +Table of Contents +Foreign Currency Fluctuations +A significant portion of our operations are in foreign locations. As a result, transactions occur in currencies other than the U.S. dollar. Exchange rate +fluctuations among other currencies used by us could directly or indirectly affect our financial results. Future currency fluctuations are dependent upon a number of factors and cannot be easily predicted. We currently use Mexican peso forward +contracts to hedge foreign currency fluctuations for a portion of our Mexican peso denominated expenses. However, unexpected expenses could occur from future fluctuations in exchange rates. +Dilution and Stock Price Volatility +Holders of the common stock will suffer immediate dilution to the extent outstanding options to purchase the common stock are exercised. Our stock price +may be subject to wide fluctuations and possible rapid increases or declines over a short time period. These fluctuations may be due to factors specific to us such as variations in quarterly operating results or changes in earnings estimates, or to +factors relating to the EMS industry or to the securities markets in general, which, in recent years, have experienced significant price fluctuations. These fluctuations often have been unrelated to the operating performance of the specific +companies whose stocks are traded. +Disclosure and Internal Controls +Management does not expect that our disclosure controls and internal controls and procedures will prevent all errors or fraud. A control system is +designed to give reasonable, but not absolute, assurance that the objectives of the control system are met. In addition, any control system reflects resource constraints and the benefits of controls must be considered relative to their costs. +Inherent limitations of a control system may include: judgments in decision making may be faulty, breakdowns can occur simply because of error or mistake and controls can be circumvented by collusion or management override. Due to the inherent +limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected. +Item 1B. +UNRESOLVED STAFF COMMENTS +None +Item 2. +PROPERTIES +We have manufacturing and +sales operations located in the United States, Mexico, and China. The table below lists the locations and square footage of our operating facilities: +Location +Approx. +Sq. Ft. +Type of Interest +(Leased/Owned) +Description of Use +Spokane Valley, Washington +(1) +61,000 +Leased +Sales, research, administration and manufacturing +Spokane Valley, Washington +36,000 +Leased +Manufacturing +El Paso, Texas +80,000 +Leased +Shipping and warehouse +Total USA +177,000 +Juarez, Mexico +174,000 +Owned +Manufacturing +Juarez, Mexico +60,000 +Owned +Manufacturing and warehouse +Juarez, Mexico +66,000 +Owned +Manufacturing and warehouse +Juarez, +Mexico (2) +115,000 +Owned +Manufacturing and warehouse +Juarez, +Mexico (3) +72,000 +Leased +Manufacturing and warehouse +Reynosa, +Mexico (4) +140,000 +Leased +Manufacturing +Reynosa, +Mexico (4) +100,000 +Leased +Warehouse +12 +Table of Contents +Total Mexico +727,000 +Shanghai, China +(5) +83,000 +Leased +Manufacturing +Total China +83,000 +Grand Total +987,000 +(1) +On June 15, 2010, the company amended its lease with Royal Hills Associates (RHA) to extend the lease for an additional ten years, which we +continue to occupy as our headquarters (see Note 3 to Consolidated Financial Statements) +(2) +During fiscal year 2010, we purchased a 115, 000 square foot manufacturing facility in Juarez, Mexico for additional assembly space. In addition, as +part of the purchase transaction we obtained an option to purchase an additional adjacent manufacturing facility. +(3) +In fiscal year 2009, we leased a new facility in Juarez, Mexico for more storage capacity and additional assembly space. +( +4 +) +These facilities are used exclusively to manufacture products for one EMS customer. We anticipate that this particular subsidiary will cease its +operations during fiscal year 2011. +( +5 +) +In fiscal year 2010, we increased our leased space in China to 83,000 sq. ft. to accommodate an additional SMT line and for additional assembly space. +Subsequent to fiscal year 2010, we entered into an agreement to lease an additional 36,000 square feet of manufacturing space. +The geographic diversity of these locations allows us to offer services near certain of our customers and major electronics markets with the additional +benefit of reduced labor costs. We consider the productive capacity of our current facilities sufficient to carry on our current business. In addition, in Juarez, Mexico one of our buildings includes adjacent vacant land that could be developed into +additional manufacturing and warehouse space and we have a purchase option on another facility. All of our facilities are ISO certified to ISO 9001:2008 standards, ISO-14001 environmental standards, and ISO-13485:2003 medical devices standards. The +Spokane, Washington facilities are additionally registered to AS9100B, ITAR and ISO/TS 16949. Our China facilities are also registered to AS9100B and ISO/TS. +Item 3. +LEGAL PROCEEDINGS +We are a party to +certain lawsuits or claims in the ordinary course of business. We do not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on our financial position, results of operations or cash flow. +Item 4. +RESERVED +PART II +Item 5: +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Our common stock is traded on the NASDAQ Global Market, formerly the NASDAQ National Market System under the symbol “KTCC”. Quarterly high and +low closing sales prices for our common stock for fiscal years 2010 and 2009 were as follows: +13 +Table of Contents +2010 +2009 +High +Low +High +Low +First Quarter +$ +2.40 +$ +1.60 +$ +3.84 +$ +2.47 +Second Quarter +3.60 +2.26 +2.56 +0.97 +Third Quarter +6.02 +3.69 +1.22 +0.86 +Fourth Quarter +6.61 +4.88 +1.94 +0.91 +High and low stock prices are based on +the daily closing price reported by the NASDAQ Stock Market. These quotations represent prices between dealers without adjustment for markups, markdowns, and commissions, and may not represent actual transactions. +Holders and Dividends +As of July 3, 2010, we had 804 shareholders of common stock on record. As a result of our credit agreement with Wells Fargo, N.A. we are restricted +from declaring or paying dividends in cash and stock. We have not paid a cash dividend and do not anticipate payment of dividends in the foreseeable future. +Equity Compensation Plan Information +Information concerning securities authorized for issuance under our equity compensation plans is set forth in Part III, Item 12 of this Annual +Report, under the caption “Securities Authorized for Issuance under Equity Compensation Plans”, and that information is incorporated herein by reference. +Performance Graph +Set forth below is a line graph comparing the cumulative total shareholder return on our common stock with the cumulative total return of the NASDAQ Stock +Market (U.S. & Foreign) Index and the NASDAQ Electronic Components Index in fiscal 2010. +14 +Table of Contents +7/2/05 +6/30/06 +6/30/07 +6/28/08 +6/27/09 +7/3/10 +Key Tronic Corporation +100.00 +113.66 +147.97 +102.91 +47.97 +141.86 +NASDAQ Composite +100.00 +107.08 +130.99 +114.02 +90.79 +105.54 +NASDAQ Electronic Components +100.00 +94.09 +110.15 +100.35 +72.87 +88.63 +Item 6: +SELECTED FINANCIAL DATA +The following +selected data is derived from our audited consolidated financial statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial +statements and related notes, and other information included in this report. +15 +Table of Contents +Financial Highlights +(In thousands, except for Supplemental Data and Book Value per Share) +Fiscal Years +July 3, +2010 +June 27, +2009 +June 28, +2008 +June 30, +2007 +July 1, +2006 +Consolidated Statements of Operations Data : +Net sales +$ +199,620 +$ +184,924 +$ +204,122 +$ +201,712 +$ +187,699 +Gross profit +19,250 +13,180 +16,820 +17,670 +17,304 +Gross margin percentage +9.6 +% +7.1 +% +8.2 +% +8.8 +% +9.2 +% +Operating income +7,388 +1,783 +6,834 +6,810 +5,861 +Operating margin percentage +3.7 +% +1.0 +% +3.3 +% +3.4 +% +3.1 +% +Net income +8,690 +1,063 +5,584 +5,230 +9,753 +Earnings per share – diluted +0.85 +0.11 +0.54 +0.51 +0.97 +Consolidated Cash Flow Data : +Cash flows provided by (used in) operations +3,697 +10,038 +(718 +) +(1,857 +) +(34 +) +Capital expenditures +3,378 +1,891 +1,180 +3,137 +1,638 +Consolidated Balance Sheet Data : +Net working capital +(1) +44,708 +37,444 +45,695 +41,222 +31,703 +Total assets +101,642 +77,755 +98,344 +89,388 +88,695 +Long-term liabilities +4,236 +3,030 +13,241 +14,719 +11,665 +Shareholders’ equity +59,417 +51,114 +49,081 +43,244 +37,548 +Book value per share +(2) +5.79 +5.08 +4.90 +4.36 +3.85 +Supplemental Data : +Number of shares outstanding at year-end +10,264,390 +10,065,974 +10,024,308 +9,921,045 +9,750,413 +Number of employees at year-end +2,036 +1,963 +2,502 +2,227 +2,840 +Approximate square footage of operational facilities +987,000 +849,000 +777,000 +784,000 +723,000 +(1) +Net working +capital is defined as total current assets less total current liabilities. Net working capital measures the portion of current assets that are financed by long term funds and is an indicator of short term financial management. +(2) +Book value per +share is defined as total shareholders’ equity divided by the number of shares outstanding at the end of the fiscal year. +16 +Table of Contents +Item 7: +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +Overview +KeyTronicEMS is a leader in electronic manufacturing services and solutions to original equipment manufacturers of a broad range of products. We provide +engineering services, worldwide procurement and distribution, materials management, world-class manufacturing and assembly services, in-house testing, and unparalleled customer service. Our international production capability provides our customers +with benefits of improved supply-chain management, reduced inventories, lower transportation costs, and reduced product fulfillment time. We continue to make investments in all of our operating facilities to give us the production capacity and +logistical advantages to continue to win new business. The following information should be read in conjunction with the consolidated financial statements included herein and with Item 1A, Risk Factors. +Our mission is to provide our customers with superior manufacturing and engineering services at the lowest total cost for the highest quality products, +and create long-term mutually beneficial business relationships. +Executive Summary +Our sales of $199.6 million in fiscal year 2010 increased by 8.0% as compared to sales of $184.9 million in fiscal year 2009. This increase in sales was +primarily driven by new customer programs for both longstanding and new customers, partially offset by a continuance of an unfavorable macroeconomic environment and industry-wide shortages in the global supply chain. Sales for the first quarter of +fiscal year 2011 are expected to be within the range of $58 million to $61 million. Results will depend on actual levels of customers’ orders and the timing of the start up of production of new product programs. We believe that we are well +positioned in the EMS industry to win new business in coming periods and profitably grow our revenue as the economy recovers. +The +concentration of our largest customers increased during fiscal year 2010 with the top five customers’ sales increasing to 57% of total sales in 2010 from 52% in 2009, and 68% in 2008. Our current customer relationships involve a variety of +products, including consumer electronics, electronic storage devices, plastics, household products, gaming devices, specialty printers, telecommunications, industrial equipment, and computer accessories. The total number of our customers continued +to increase during fiscal year 2010. These new customers have programs that represent small annual sales while others have multi-million-dollar potential. +Gross profit as a percent of sales was 9.6% in fiscal year 2010 compared to 7.1% for the prior fiscal year. The increase in gross profit as a percentage +of net sales was primarily due to higher sales, increased leverage of fixed costs, a decrease in manufacturing facility costs due to favorable foreign exchange changes, a decrease in headcount of overhead employees and severance costs incurred in +fiscal year 2009 that did not recur in fiscal year 2010. +Operating income as a percentage of sales for fiscal year 2010 was 3.7% compared to +1.0% for fiscal year 2009. The increase in operating income as a percentage of sales was due to an improved gross margin, combined with our continued success in controlling operating expenses and improving efficiencies during fiscal year 2010. +Net income for fiscal year 2010 was $8.7 million or $0.85 per diluted share, up from $1.1 million or $0.11 per diluted share for fiscal year +2009. The increase in net income for fiscal year 2010 as compared to fiscal year 2009 was primarily due to an approximate 2.5% improvement in our gross margin. Also, our fiscal year 2010 results include an income tax benefit of $1.4 million, +resulting in part from the release of our valuation allowance on deferred tax assets related to our domestic net operating loss carryforwards that occurred in the third quarter of fiscal 2010. +17 +Table of Contents +We maintain a strong balance sheet with a current ratio of 2.18 and a long-term debt to equity ratio of .03. +Total cash provided by operating activities as defined on our cash flow statement was $3.7 million during fiscal year 2010. We maintain sufficient liquidity for our expected future operations and had $1.6 million in borrowings on our revolving line +of credit with Wells Fargo, N.A. of which $18.4 million remained available at July 3, 2010. We believe cash flow generated from operations, our borrowing capacity, and equipment lease financing should provide adequate capital for planned growth +over the long term. +Results of Operations +The following table sets forth for the periods indicated certain items of the consolidated statements of income expressed as a percentage of net sales. +The financial information and discussion below should be read in conjunction with the consolidated financial statements and notes contained in this Annual Report. +Years Ended +July 3, 2010 +June 27, 2009 +June 28, 2008 +Net sales +100.0 +% +100.0 +% +100.0 +% +Cost of sales +90.4 +92.9 +91.8 +Gross profit +9.6 +7.1 +8.2 +Operating expenses (income) +Research, development and engineering +1.4 +1.2 +1.3 +Selling, general and administrative +4.5 +4.5 +4.0 +Goodwill impairment +— +0.4 +— +Gain on sale of real estate held for sale +— +— +(0.4 +) +Total operating expenses +5.9 +6.1 +4.9 +Operating income +3.7 +1.0 +3.3 +Interest expense +— +0.3 +0.5 +Income before income taxes +3.7 +0.7 +2.8 +Income tax provision (benefit) +(0.7 +) +0.1 +0.1 +Net income +4.4 +% +0.6 +% +2.7 +% +Net Sales +Net sales were $199.6 million, $184.9 million, and $204.1 million in fiscal years 2010, 2009, and 2008, respectively. +Net sales increased $14.7 million during fiscal year 2010 as compared with fiscal year 2009. This increase in sales was primarily driven by new +customer programs for both longstanding and new customers, partially offset by a continuance of an unfavorable macroeconomic environment and industry-wide shortages in the global supply chain. The $19.2 million decrease in net sales during fiscal +year 2009 reflects the expected lower demand from established customers due to the unfavorable global macroeconomic environment. We anticipate that several more new customer programs will enter production in fiscal year 2011 and begin contributing +to revenue. +The table below shows the revenue by industry sectors as a percentage of revenue for the following fiscal years: +18 +Table of Contents +Years Ended +July 3, 2010 +June 27, 2009 +June 28, 2008 +Commercial Printer +9 +% +15 +% +16 +% +Communication +5 +% +10 +% +9 +% +Computer and Peripheral +15 +% +17 +% +8 +% +Consumer +32 +% +19 +% +9 +% +Gaming +13 +% +13 +% +19 +% +Industrial +4 +% +4 +% +3 +% +Transaction Printer +22 +% +22 +% +36 +% +Total +100 +% +100 +% +100 +% +We provide services to customers in a number of industries and produce a variety of products for our customers in each +industry. As we continue to diversify our customer base and win new customers we may continue to see a change in the industry concentrations of our revenue. +Sales to foreign locations represented 17.9%, 11.3%, and 5.6% of our total net sales in fiscal years 2010, 2009, and 2008, respectively. +Cost of Sales +Total +cost of sales as a percentage of net sales was 90.4%, 92.9%, and 91.8% in fiscal years 2010, 2009, and 2008, respectively. +Total cost of +materials as a percentage of net sales was approximately 68.6%, 69.2%, and 66.9% in fiscal years 2010, 2009, and 2008, respectively. The change from year-to-year is directly related to changes in product mix. +Production and support costs as a percentage of net sales were 21.8%, 23.7%, and 24.9% in fiscal years 2010, 2009, and 2008, respectively. The decrease +in fiscal year 2010 as compared to fiscal year 2009 is related to higher fixed cost absorption due to a $14.7 million increase in net sales, while production and support costs decreased $0.3 million due to favorable foreign exchange rates and a +reduction of manufacturing facility payroll. These savings were partially offset by an increase in the provision for obsolete inventory. The decrease in fiscal year 2009 as compared to fiscal year 2008 was due to a $6.9 million decrease in +production and support costs related to headcount reductions, favorable foreign exchange rates and cost saving initiatives. This was partially offset by a $19.2 million decrease in net sales. +We provide for obsolete and non-saleable inventories based on specific identification of inventory against current demand and recent usage. The amounts +charged to expense for these inventories were approximately $2.2 million, $0.3 million, and $0.2 million in fiscal years 2010, 2009, and 2008, respectively. The increased provision in fiscal year 2010 was primarily due to no longer manufacturing for +certain customers that were no longer viable. +We provide warranties on certain products we sell and estimate warranty costs based on +historical experience and anticipated product returns. The amounts charged to expense are determined based on an estimate of warranty exposure. The net warranty expense (recovery) was approximately $45,000, $(93,000), and $196,000 in fiscal years +2010, 2009, and 2008, respectively. Warranty expense for fiscal year 2010 is related to workmanship claims on keyboards and EMS products. The recovery in fiscal year 2009 was related to the release of a warranty claim for a specific product that was +identified in fiscal year 2008. Warranty expense for fiscal year 2008 was primarily related to workmanship claims on a specific EMS product. +Gross Profit +Gross +profit as a percentage of net sales was 9.6%, 7.1%, and 8.2% in fiscal years 2010, 2009, and 2008, respectively. +The 2.5 percentage point +increase in gross profit as a percentage of net sales from fiscal year 2009 to 2010 was primarily the result of a $14.7 million increase in net sales, while production and support cost +19 +Table of Contents +decreased by $0.3 million due to favorable foreign exchange changes, a decrease in headcount of overhead employees and severance costs incurred in fiscal year 2009 that did not recur in fiscal +year 2010. This was partially offset by a $8.9 million increase in material costs. The 1.1 percentage point decrease in gross profit as a percentage of net sales from fiscal year 2008 to 2009 was the result of lower fixed cost absorption due to net +sales decreasing $19.2 million. Additionally we incurred charges of approximately $1.3 million for severance charges related to cost reduction efforts during fiscal year 2009. +We took early pay discounts to suppliers that totaled approximately $364,000, $142,000, and $51,000 in fiscal years 2010, 2009, and 2008, respectively. +Early pay discounts will fluctuate based on our liquidity and changes in the discounts and terms offered by our suppliers. +Changes in gross +profit margins reflect the impact of a number of factors that can vary from period to period, including product mix, start-up costs and efficiencies associated with new programs, product life cycles, sales volumes, capacity utilization of our +resources, management of inventories, component pricing and shortages, end market demand for customers’ products, fluctuations in and timing of customer orders, and competition within the EMS industry. These and other factors can cause +variations in operating results. There can be no assurance that gross margins will not decrease in future periods. +Research, Development and Engineering +Research, development and engineering expenses (RD&E) consists principally of employee related costs, third party development costs, program +materials, depreciation and allocated information technology and facilities costs. Total RD&E was $2.8 million, $2.3 million, and $2.7 million in fiscal years 2010, 2009, and 2008, respectively. As a percentage of net sales, RD&E was 1.4%, +1.2% and 1.3% in fiscal years 2010, 2009 and 2008, respectively. +The increase in RD&E expenses in fiscal year 2010 compared to fiscal +year 2009 is primarily the result of higher incentive compensation expense and increased headcount. The decrease in RD&E expenses in fiscal year 2009 compared to fiscal year 2008 is the result of reduced headcount and lower incentive and bonus +expenses. +Selling, General and Administrative +Selling, general and administrative expenses (SG&A) consist principally of salaries and benefits, advertising and marketing programs, sales +commissions, travel expenses, provision for doubtful accounts, facilities costs, and professional services. Total SG&A expenses were $9.1 million, $8.4 million, and $8.3 million in fiscal years 2010, 2009, and 2008, respectively. As a percentage +of net sales SG&A was 4.5%, 4.5%, and 4.0% in fiscal years 2010, 2009, and 2008, respectively. Approximately half of our SG&A expenses relates to salary costs of our employees. +The $0.7 million increase in SG&A expenses in fiscal year 2010 as compared to fiscal year 2009 is primarily due to a $1.6 million increase in +incentive compensation expense. This was partially offset by an approximate $0.3 million decrease in salaries in addition to an approximate $0.6 million decrease in expense related to the write off of a receivable in the prior year. The increase in +SG&A expenses in fiscal year 2009 compared to fiscal year 2008 is mainly attributable to foreign exchange losses on Mexican peso denominated financial assets and the addition of a sales representative which were partially offset by cost +reduction efforts. Additionally, in fiscal year 2009 there was a charge of $0.6 million to provide for doubtful collection of receivables, of which $0.5 million was related to the write off of a foreign receivable. +Goodwill Impairment +We +recorded an impairment charge of $765,000 during fiscal year 2009. We did not record an impairment charge during fiscal year 2010. As of July 3, 2010 and June 27, 2009, there was no goodwill recorded in the Company’s Consolidated +Balance Sheet. +Interest Expense +We had net interest expense of $0.1 million, $0.6 million and $1.0 million in fiscal years 2010, 2009, and 2008, respectively. Interest expense decreased +in fiscal year 2010 when compared to fiscal years 2009 and 2008 as the average balance of the revolving line of credit was lower along with a decrease in variable +20 +Table of Contents +interest rates. We do not currently use derivatives to hedge interest rate risk. We often utilize short-term fixed LIBOR rates on portions of our revolving line of credit to limit the affect of +interest rate volatilities. +Income Tax Provision +We had an income tax benefit of $1.4 million during fiscal year 2010 as compared to $130,000 and $261,000 tax expense in fiscal years 2009, and 2008, +respectively. The income tax benefit of fiscal year 2010 is primarily related the release of the valuation allowance on our deferred tax assets related to domestic tax net operating loss carryforwards (NOLs) and foreign tax credits, partially offset +by the recognition of domestic deferred tax liabilities for an unremitted portion of foreign and the change of applicable tax regimes in Mexico. +Due to increased profitability, revenue growth, and new customer programs, we have determined that a valuation allowance against our domestic NOLs is not +longer required. We anticipate that we will fully utilize our domestic NOLs prior to their expiration. In addition, we reviewed our requirements for liquidity domestically to fund our revenue growth and to look for potential future acquisitions. We +have changed our previous assessments of being indefinitely reinvested and now anticipate repatriating a portion of our unremitted foreign earnings. The associated taxes and potential foreign tax credits are included in the income tax benefit that +was realized during fiscal year 2010. The tax provision in fiscal years 2009 and 2008 is primarily related to income taxes in China and Mexico. For further information on taxes please review footnote 7 of the “Notes to Consolidated Financial +Statements”. +International Subsidiaries +We offer customers a complete global manufacturing solution. Our facilities provide our customers the opportunity to have their products manufactured in +the facility that best serves specific cost, product manufacturing, and distribution needs. The locations of active foreign subsidiaries are as follows: +• +Key Tronic Juarez, SA de CV owns an SMT, assembly and molding facility, and three assembly and storage facilities in Juarez, Mexico. This subsidiary is +primarily used to support our U.S. operations. +• +Key Tronic Reynosa, SA de CV leases manufacturing and warehouse facilities in Reynosa, Mexico. This subsidiary is used exclusively to manufacture +products for one EMS customer. We anticipate that this particular subsidiary will cease its operations during fiscal year 2011, as its one EMS customer will no longer be needing manufacturing services. +• +Key Tronic Computer Peripherals (Shanghai) Co., Ltd. leases a facility with SMT and assembly capabilities in Shanghai, China, which began operations in +1999. Its primary function is to provide EMS services for export; however, it is also currently manufacturing certain electronic keyboards. +Foreign sales (based on shipping instructions) from our worldwide operations, including domestic exports, were $35.7 million, $20.9 million, and $11.4 +million in fiscal years 2010, 2009, and 2008, respectively. Products and manufacturing services provided by our subsidiary operations are sold to customers directly by the parent company. Key Tronic Computer Peripherals (Shanghai) Co., Ltd., our +subsidiary in Shanghai, China, had only minimal sales to customers in China during the past three fiscal years. +Capital +Resources and Liquidity +Cash flows provided by operating activities were $3.7 million in fiscal year 2010 as compared to $10.0 million +provided by operating activities in fiscal year 2009 and $(0.7) million used in fiscal year 2008. +The $6.3 million decrease in cash provided +by operating activities in fiscal year 2010 as compared with fiscal year 2009 was primarily due to an increase in trade receivables and inventory, partially offset by an increase in accounts payable. Trade receivables increased by $10.1 million as a +result of the increase in sales that occurred during the fourth quarter of fiscal year 2010. The $7.5 million increase in inventory was attributable to new customer programs and increasing lead times on certain components which led to some scheduled +shipments not being shipped by the end of the fiscal year. We purchase inventory based on customer forecasts and orders and expected lead times, and when those forecasts cannot be met or changes are made to lead times, inventory can increase. The +$10.5 million increase in accounts payable was primarily driven by the increase in inventory and extending payment terms during fiscal year 2010. +21 +Table of Contents +Accounts payable fluctuates with changes in inventory levels, volume of purchases, and negotiated supplier +terms. +The $10.7 million increase in cash provided by operating activities in fiscal year 2009 as compared to fiscal year 2008 was primarily +due to a decrease in trade receivables and inventory. Trade receivables and inventory decreased by $10.5 million and $5.3 million, respectively, during fiscal year 2009, partially offset by a $10.8 million decrease in accounts payable. These +decreases are the result of lower sales in the fourth quarter of fiscal year 2009 as compared to fiscal year 2008 and a concerted effort to reduce our inventory and align it with our current level of business. +Cash used in investing activities includes capital expenditures and proceeds from the sale of property and equipment. Capital expenditures were $3.4 +million, $1.9 million, and $1.2 million in fiscal years 2010, 2009, and 2008, respectively. Our capital expenditures are primarily for purchases of manufacturing assets to support our operations in Spokane Valley, Washington, Mexico and China. The +increase in capital expenditures for fiscal year 2010 as compared to fiscal year 2009 was primarily related to the purchase of a manufacturing facility and to a lesser extent the increased investment in manufacturing equipment to support the +requirements of our growing customer base and sales. Capital expenditures increased for fiscal year 2009 as compared to fiscal year 2008 as we invested in manufacturing equipment to support the requirements of new customers. +Our primary financing activity in fiscal years 2010, 2009, and 2008 was borrowing and repayment under our revolving line of our credit facility. Our +credit agreement with Wells Fargo Bank N.A. provides a revolving line of credit facility of up to $20 million, subject to availability. The agreement specifies that the proceeds of the revolving line of credit be used primarily for working capital +and general corporate purposes of the Company and its subsidiaries. The outstanding balance under the credit facility was $1.6 million as of July 3, 2010. We had availability to borrow an additional $18.4 million under the Wells Fargo line of +credit and we were in compliance with our loan covenants. +Our cash requirements are affected by the level of current operations and new EMS +programs. We believe that projected cash from operations, funds available under the revolving credit facility and leasing capabilities will be sufficient to meet our working and fixed capital requirements for the foreseeable future. +Contractual Obligations and Commitments +In the normal course of business, we enter into contracts which obligate us to make payments in the future. +The table below sets forth our significant future obligations by fiscal year: +Payments Due by Fiscal Year (in thousands) +Total +2011 +2012 +2013 +2014 +2015 +Thereafter +Wells Fargo Bank N.A. revolving loan +(1) +$ +1,554 +$ +1,554 +$ +— +$ +— +$ +— +$ +— +$ +— +Operating leases +(2) +9,831 +2,819 +1,251 +772 +763 +762 +3,464 +Short-term note +(3) +671 +671 +Purchase orders +(4) +(1) +The terms of the +Wells Fargo Bank N.A. revolving loan are discussed in the consolidated financial statements at Note 4, “Long-Term Debt”. As of July 3, 2010 we were in compliance with our loan covenants. Breaching these covenants could have resulted +in a material impact on our operations or financial condition. +(2) +We maintain vertically integrated manufacturing operations in Mexico and Shanghai, China. Such operations are heavily dependent upon technically +superior manufacturing equipment including molding machines in various tonnages, SMT lines, clean rooms, and automated insertion, and test equipment for the various products we are capable of producing. In addition, +22 +Table of Contents +we lease some of our administrative and manufacturing facilities. A complete discussion of properties can be found in Part 1, Item 2 at “Properties”. Leases have proven to be an +acceptable method for us to acquire new or replacement equipment and to maintain facilities with a minimum impact on our short term cash flows for operations. Amounts presented above include interest and principal, if applicable. +(3) +See Note 3 to +Consolidated Financial Statements for additional discussion related to building and land purchase during the fourth quarter of fiscal year 2010. +(4) +As of July 3, +2010, we had open purchase order commitments for materials and other supplies of approximately $86.5 million. Included in the open purchase orders are various blanket orders for annual requirements. Actual needs under these blanket purchase orders +fluctuate with our manufacturing levels. In addition, we have contracts with our customers that minimize our exposure to losses for material purchased within lead-times necessary to meet customer forecasts. Purchase orders generally can be cancelled +without penalty within specified ranges that are determined in negotiations with our suppliers. These agreements depend in part on the type of materials purchased as well as the circumstances surrounding any requested cancellations. +In addition to the cash requirements presented above, we have various other accruals which are not included in the table +above. We owe our suppliers approximately $24.1 million for accounts payable and shipments in transit at the end of the fiscal year. We generally pay our suppliers in a range from 30 to 120 days depending on terms offered. These payments are +financed by operating cash flows and our revolving line of credit. +We believe that cash flows generated from operations, leasing facilities, +and funds available under the revolving credit facility will satisfy cash requirements for a period in excess of 12 months and into the foreseeable future. +Critical Accounting Policies and Estimates +Preparation of our consolidated financial statements requires management to make estimates and assumptions that affect the reported amount of assets, +liabilities, revenues and expenses. Note 1 to our consolidated financial statements describes the significant accounting policies used in the preparation of our consolidated financial statements. Management believes the most complex and +sensitive judgments, because of their significance to our consolidated financial statements, result primarily from the need to make estimates about effects of matters that are inherently uncertain. The most significant areas involving management +judgments are described below. Actual results in these areas could differ from management’s estimates. +Inactive, +Obsolete, and Surplus Inventory Reserve +We reserve for inventories that we deem inactive, obsolete or surplus. This reserve is calculated +based upon the demand for the products that we produce. Demand is determined by expected sales or customer forecasts. If expected sales do not materialize, then we would have inventory in excess of our reserves and would have to charge the excess +against future earnings. In the case where we have purchased material based upon a customer’s forecast, we are usually covered by lead-time assurance agreements with each customer. These contracts state that the financial liability for material +purchased within agreed upon lead-time and based upon the customer’s forecasts, lies with the customer. If we purchase material outside the lead-time assurance agreement and the customer’s forecasts do not materialize or if we have no +lead-time assurance agreement for a specific program, we would have the financial liability and may have to charge inactive, obsolete or surplus inventory against earnings. +Allowance for Doubtful Accounts +We value our accounts receivable net of an allowance for doubtful accounts of $111,000 at July 3, 2010 and June 27, 2009. This allowance is +based on estimates of the portion of accounts receivable that may not be collected in the future. The estimates used are based primarily on specific identification of potentially uncollectible accounts. Such accounts are identified using publicly +available information in +23 +Table of Contents +conjunction with evaluations of current payment activity. However, if any of our customers were to develop unexpected and immediate financial problems that would prevent payment of open invoices, +we could incur additional and possibly material expenses that would negatively impact earnings. +Accrued Warranty +An accrual is made for expected warranty costs, with the related expense recognized in cost of goods sold. We review the adequacy of this +accrual quarterly based on historical analysis and anticipated product returns and rework costs. As we have made the transition from manufacturing primarily keyboards to primarily EMS products, our exposure to warranty claims has declined +significantly. Our warranty period for keyboards is generally longer than that for EMS products. We only warrant materials and workmanship on EMS products, and we do not warrant design defects for EMS customers. +Income Taxes +The +Company had domestic income tax loss carryforwards (NOLs) of approximately $25.1 million at July 3, 2010. In accordance with ASC 740, Income Taxes, a valuation allowance is required if it is more likely than not that some or +all of the deferred tax assets will not be realized in the future. Based on recent sustained profitability, revenue growth, new customer programs and updated forecasting that occurred during fiscal year 2010; management determined that an +allowance was no longer necessary on the domestic income tax loss carryforwards. +The Company also changed its estimates of future +repatriation of its undistributed earnings of its foreign subsidiaries during fiscal year 2010. Management expects to repatriate approximately $14.5 million based on increased sales growth driving additional capital requirements domestically, cash +requirements for potential acquisitions and to implement certain tax strategies. As such earnings are recognized in the United States, the Company would be subject to U.S. federal and state income taxes and potential withholding taxes in foreign +jurisdictions. A corresponding foreign tax credit for taxes paid on the repatriated amount can be used domestically to reduce the federal tax liability. The domestic tax, foreign tax credits and estimated withholding tax have been accrued as part of +deferred taxes as of July 3, 2010. +Stock-Based Compensation +Stock-based compensation is accounted for according to Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 718, +Compensation—Stock Compensation . ASC 718 requires us to expense the fair value of employee stock options, stock appreciation rights and other forms of stock-based compensation. Under the fair value recognition provisions of ASC 718, +share-based compensation cost is estimated at the grant date based upon the value of the stock option and at each reporting period for stock appreciation rights classified as liability awards and is recognized as expense ratably over the requisite +service period of the award (generally the vesting). Determining the appropriate fair value model and calculating the fair value of share-based awards requires judgment, including estimating the expected life of the share-based award, the expected +stock price volatility over the expected life of the share-based award and forfeitures. +To determine the fair value of stock options on the +date of grant and at each reporting period for stock appreciation rights classified as liability awards, we use the Black-Scholes option-pricing model. Inherent in this model are assumptions related to expected stock price volatility, option life, +risk-free interest rate and dividend yield. The risk-free interest rate is a less-subjective assumption as it is based on factual data derived from public sources. We use a dividend yield of zero as we have never paid cash dividends and have no +intention to pay cash dividends in the foreseeable future. The expected stock price volatility and option life assumptions require a greater level of judgment. Our expected stock-price volatility assumption is based upon the historical volatility of +our stock which is obtained from public data sources. The expected life represents either the weighted average period of time that share-based awards are expected to be outstanding (stock options), giving consideration to vesting schedules and +historical exercise patterns or using the simplified method by utilizing the midpoint between the remaining vesting period and the remaining contractual life (SARs). We determine the expected life assumption based upon the exercise and post-vesting +behavior that has been exhibited historically, adjusted for specific factors that may influence future exercise patterns. If expected volatility or expected life were to increase, that would result in an increase in the fair value of our stock +options which would result in higher compensation charges, while a +24 +Table of Contents +decrease in volatility or the expected life would result in a lower fair value of our stock option awards resulting in lower compensation charges. +We estimate forfeitures for all of our awards based upon historical experience of stock-based pre-vesting forfeitures. We believe that our estimates are +based upon outcomes that are reasonably likely to occur. If actual forfeitures are higher than our estimates it would result in lower compensation expense and to the extent the actual forfeitures are lower than our estimate we would record higher +compensation expense. +Impairment of Long-Lived Assets +Long-lived assets, such as property, plant, and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the +carrying amount of an asset may not be recoverable. The recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the +asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge would be recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. +In accordance with ASC 350, Intangibles – Goodwill and Other , goodwill is tested annually for impairment, and is tested for impairment more +frequently if events and circumstances indicate that the asset might be impaired. An impairment loss would be recognized to the extent that the carrying amount exceeds the asset’s fair value. +Upon the completion of the Company’s annual impairment test during fiscal year 2009 and as a result of the deteriorating global economy adversely +affecting the Company’s common stock price. The Company concluded that 100% of the goodwill was impaired due to the significant and sustained decline in the Company’s market capitalization to below the book value. The Company recorded an +impairment charge of $765,000 during the second quarter of fiscal year 2009. As of July 3, 2010 and June 27, 2009, respectively, there was no goodwill recorded in the Company’s Consolidated Balance Sheet. +Derivatives and Hedging Activity +Derivatives are recognized on the balance sheet at their estimated fair value. On the date a derivative contract is entered into, the Company designates +the derivative as a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (a “cash flow” hedge). The Company does not enter into derivatives for speculative +purposes. Changes in the fair value of a derivative that qualifies as a cash flow hedge are recorded in “Accumulated other comprehensive income”, until earnings are affected by the variability of cash flows. See Note 11 of the +Company’s consolidated financial statements for additional information. +Accounting Pronouncements +See Note 1 to our consolidated financial statements. +Item 7A: +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Interest Rate Risk +We are subject to the risk of fluctuating interest rates in the normal course of business. Our major market risk relates to our secured debt. Our +revolving credit facility is secured by substantially all of our assets. The interest rates applicable to our revolving credit facility fluctuate with the JP Morgan Chase Bank prime rate and LIBOR rates. There was outstanding $1.6 million in +borrowings under our revolving credit facility as of July 3, 2010, and the rate of interest being paid on the outstanding balance was 3.25%. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations +– Capital Resources and Liquidity” and Note 4 – “Long-Term Debt” to the Consolidated Financial Statements for additional information regarding our revolving credit facility. +25 +Table of Contents +Foreign Currency Exchange Risk +A significant portion of our operations are in foreign locations. As a result, transactions occur in currencies other than the U.S. dollar. Exchange rate +fluctuations among other currencies used by us would directly or indirectly affect our financial results. We currently use Mexican peso forward contracts to hedge foreign currency fluctuations for a portion of our Mexican peso denominated expenses. +There was $30.9 million of foreign currency forward contracts outstanding as of July 3, 2010. The fair value of these contracts was approximately $(361,000). See Note 11 – “Derivative Financial Instruments” to the Consolidated +Financial Statements for additional information regarding our derivative instruments. +Item 8: +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Report of Independent Registered Public Accounting Firm +The Board of Directors and Shareholders +Key +Tronic Corporation +Spokane Valley, Washington +We have audited the accompanying consolidated balance sheets of Key Tronic Corporation (the Company) as of July 3, 2010 and June 27, 2009 and +the related consolidated statements of income, shareholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended July 3, 2010. These financial statements are the responsibility of the +Company’s management. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. Our responsibility is to express an opinion on these financial statements +and schedule based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board +(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, +an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of +expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures +in the financial statements, 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 Key Tronic Corporation at July 3, 2010 and June 27, 2009, and the results of its operations and its cash flows for each of the three years in the period ended July 3, 2010, in conformity with accounting principles +generally accepted in the United States of America. +Also, in our opinion, the 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. +/s/ BDO USA, LLP +Spokane, Washington +September 13, 2010 +26 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED BALANCE SHEETS +(In thousands) +July 3, 2010 +June 27, 2009 +ASSETS +Current assets: +Cash and cash equivalents +$ +770 +$ +729 +Trade receivables, net of allowance for doubtful accounts of $111 and $111 +34,617 +24,867 +Inventories +39,775 +32,291 +Deferred income tax asset +4,420 +493 +Other +3,115 +2,675 +Total current assets +82,697 +61,055 +Property, plant and equipment, net +13,898 +11,199 +Other assets: +Restricted cash +— +124 +Deferred income tax asset +4,394 +4,611 +Other, net of accumulated amortization of $106 and $118 +653 +766 +Total assets +$ +101,642 +$ +77,755 +LIABILITIES AND SHAREHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +29,158 +$ +18,703 +Accrued compensation and vacation +5,097 +3,198 +Current portion of other long-term obligations +146 +359 +Other +3,588 +1,351 +Total current liabilities +37,989 +23,611 +Long-term liabilities: +Revolving loan +1,554 +2,412 +Other long-term obligations +2,682 +618 +Total long-term liabilities +4,236 +3,030 +Commitments and contingencies (Notes 4 and 8) +Shareholders’ equity +Common stock, no par value, authorized 25,000 shares; issued and outstanding 10,264 and 10,066 shares, +respectively +40,126 +39,359 +Retained earnings +19,533 +10,843 +Accumulated other comprehensive (loss) income +(242 +) +912 +Total shareholders’ equity +59,417 +51,114 +Total liabilities and shareholders’ equity +$ +101,642 +$ +77,755 +See accompanying notes to consolidated financial +statements. +27 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF INCOME +(In thousands, except per share amounts) +Years Ended +July 3, 2010 +June 27, 2009 +June 28, 2008 +Net sales +$ +199,620 +$ +184,924 +$ +204,122 +Cost of sales +180,370 +171,744 +187,302 +Gross margin +19,250 +13,180 +16,820 +Operating expenses (income): +Research, development and engineering +2,783 +2,266 +2,676 +Selling, general and administrative +9,079 +8,366 +8,261 +Goodwill impairment +— +765 +— +Gain on sale of real estate +— +— +(951 +) +Total operating expense +11,862 +11,397 +9,986 +Operating income +7,388 +1,783 +6,834 +Interest expense, net +102 +590 +989 +Income before income taxes +7,286 +1,193 +5,845 +Income tax (benefit) provision +(1,404 +) +130 +261 +Net income +$ +8,690 +$ +1,063 +$ +5,584 +Earnings per share: +Earnings per common share – basic +$ +0.86 +$ +0.11 +$ +0.56 +Weighted average shares outstanding – basic +10,124 +10,059 +9,997 +Earnings per common share – diluted +$ +0.85 +$ +0.11 +$ +0.54 +Weighted average shares outstanding – diluted +10,191 +10,075 +10,267 +See accompanying notes +to consolidated financial statements. +28 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME +(In thousands) +Common Stock +Accumulated +Other +Comprehensive +Income +(Loss) +Shares +Amount +Retained Earnings +Total +Balances, June 30, 2007 +9,921 +$ +39,048 +$ +4,196 +— +$ +43,244 +Net income +— +— +5,584 +— +5,584 +Exercise of stock options +103 +253 +— +— +253 +Balances, June 28, 2008 +10,024 +39,301 +9,780 +49,081 +Net income +— +— +1,063 +— +1,063 +Unrealized gain on foreign exchange contracts +— +— +— +912 +912 +Comprehensive income, net +1,975 +Exercise of stock options +42 +58 +— +— +58 +Balances, June 27, 2009 +10,066 +39,359 +10,843 +912 +51,114 +Net income +— +— +8,690 +— +8,690 +Unrealized loss on foreign exchange contracts +— +— +— +(1,154 +) +(1,154 +) +Comprehensive income, net +7,536 +Exercise of stock options +198 +604 +— +— +604 +Tax benefit from exercise of stock options +— +163 +— +— +163 +Balances, July 3, 2010 +10,264 +$ +40,126 +$ +19,533 +(242 +) +$ +59,417 +Other comprehensive income for fiscal year 2010 is reflected net of tax $(119,000). +See accompanying notes to consolidated financial statements. +29 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended +July 3, 2010 +June 27, 2009 +June 28, 2008 +Cash flows from operating activities: +Net income +$ +8,690 +$ +1,063 +$ +5,584 +Adjustments to reconcile net income to cash provided by (used in) operating activities: +Depreciation and amortization +1,794 +1,595 +1,768 +Goodwill impairment charge +— +765 +— +Excess tax benefit from exercise of stock options +163 +— +— +Accretion of deferred gain on sale of building +(78 +) +(78 +) +(78 +) +Provision for obsolete inventory +2,182 +303 +159 +Provision for doubtful receivables +— +604 +122 +Provision for (recovery of) warranty +(45 +) +(93 +) +196 +Loss (gain) on sale of assets +(58 +) +14 +(949 +) +SARs expense +57 +— +— +Deferred income taxes +(2,062 +) +(104 +) +— +Changes in operating assets and liabilities: +Trade receivables +(10,104 +) +10,547 +(5,757 +) +Inventories +(9,666 +) +5,333 +(5,740 +) +Other assets +(1,659 +) +2,320 +(742 +) +Accounts payable +10,455 +(10,794 +) +5,393 +Accrued compensation and vacation +1,899 +(1,190 +) +675 +Other liabilities +2,129 +(247 +) +(1,349 +) +Cash provided by (used in) operating activities +3,697 +10,038 +(718 +) +Cash flows from investing activities: +Purchase of property and equipment +(3,378 +) +(1,891 +) +(1,180 +) +Proceeds from sale of property and equipment +74 +— +1,485 +Cash provided by (used in) investing activities +(3,304 +) +(1,891 +) +305 +Cash flows from financing activities: +Payment of financing costs +(50 +) +(50 +) +(50 +) +Proceeds from exercise of stock options +604 +58 +253 +Proceeds from long-term debt +— +— +215 +Repayment of long-term debt +(172 +) +(284 +) +(249 +) +Borrowing under revolving credit agreement +24,931 +194,066 +204,940 +Repayment of revolving credit agreement +(25,789 +) +(204,002 +) +(205,673 +) +Decrease (increase) in restricted cash +124 +(85 +) +470 +Cash used in financing activities +(352 +) +(10,297 +) +(94 +) +Increase (decrease) in cash and cash equivalents +41 +(2,150 +) +(507 +) +Cash and cash equivalents, beginning of year +729 +2,879 +3,386 +Cash and cash equivalents, end of year +$ +770 +$ +729 +$ +2,879 +30 +Table of Contents +Supplemental cash flow information: +Interest payments +$ +85 +$ +621 +$ +1,013 +Income tax payments, net of refunds +$ +415 +$ +327 +$ +301 +See accompanying notes +to consolidated financial statements. +31 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. SIGNIFICANT ACCOUNTING POLICIES +Business +Key +Tronic Corporation and subsidiaries (the Company) is engaged in electronic manufacturing services (EMS) for original equipment manufacturers (OEMs), and also manufactures keyboards and other input devices. The Company’s headquarters are located +in Spokane Valley, Washington with manufacturing operations in Spokane Valley; Juarez and Reynosa, Mexico; and Shanghai, China. +Principles of Consolidation +The consolidated financial statements include the Company and its wholly owned subsidiaries in Mexico and China. Intercompany balances and transactions +have been eliminated in consolidation. +Use of Estimates +The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to +make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the +reporting period. Estimates include the allowance for doubtful receivables, the provision for obsolete and non-saleable inventories, deferred tax assets and liabilities, impairment of long-lived assets, medical self insurance liability, long-term +incentive compensation accrual, the provision for warranty costs, and the fair values of options granted under the Company’s stock-based compensation plans. Due to uncertainties with respect to the assumptions and estimates actual results could +differ from those estimates. +Cash and Cash Equivalents +The Company considers investments with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost, which +approximates fair value. +Allowance for Doubtful Accounts +The Company evaluates the collectibility of accounts receivable and records an allowance for doubtful accounts, which reduces the receivables to an amount +that management reasonably estimates will be collected. A specific allowance is recorded against receivables considered to be impaired based on the Company’s knowledge of the financial condition of the customer. In determining the amount of the +allowance, the Company considers several factors including the aging of the receivables, the current business environment, and historical experience. After all attempts to collect a receivable have failed, the receivable is written off against the +allowance. +Inventories +Inventories are stated at the lower of cost or market. Cost is determined principally using the first-in, first-out (FIFO) method. The Company provides +for obsolete and non-saleable inventories based on specific identification of inventory against current demand forecasts and recent usage. +Property, Plant and Equipment +Property, plant and equipment are carried at cost and depreciated using straight-line methods over the expected useful lives of the assets. Internally +constructed molds and dies are depreciated over the expected useful lives of one to two years. Repairs and maintenance costs are expensed as incurred. +32 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +Impairment of Long-lived Assets +The Company, using its best estimates based on reasonable and supportable assumptions and projections, reviews assets for impairment whenever events or +changes in circumstances have indicated that the carrying amount of its assets might not be recoverable. Impaired assets are reported at the lower of cost or fair value. +Deferred Loan Fees +Deferred loan fees included in other assets are amortized over the term of the related loan agreement. +Accrued Warranty +An accrual is made for expected warranty costs, with the related expense recognized in cost of goods sold. Management reviews the adequacy of this accrual +quarterly based on historical analyses and anticipated product returns. +Self-funded Insurance +The Company self-funds its domestic employee health plan. The Company contracted with a separate administrative service company to supervise and +administer the program and act as its representative. The Company reduces its risk under this self-funded platform by purchasing stop-loss insurance coverage for claims. In addition, if the aggregate annual claims amount to more than 125% of +expected claims for the plan year this insurance will also pay those claims amounts exceeding that level. +The Company estimates its exposure +for claims incurred but not paid at the end of each reporting period and uses historical claims data supplied by the Company’s broker to estimate its self-funded insurance liability. This liability is subject to a total limitation that varies +based on employee enrollment and factors that are established at each annual contract renewal. Actual claims experience may differ from the Company’s estimates. Costs related to the administration of the plan and related claims are expensed as +incurred. +Revenue Recognition +Sales revenue from manufacturing is recognized upon shipment of the manufactured product per contractual terms. Upon shipment, title transfers and the +customer assumes risks and rewards of ownership of the product. Unless specifically stated in contractual terms, there are no formal customer acceptance requirements or further obligations related to the manufacturing services; if any such +requirements exist, then sales revenue is recognized at the time when such requirements are completed and such obligations are fulfilled. Revenue is recorded net of estimated returns of manufactured product based on management’s analysis of +historical returns. +Revenues and associated costs from engineering design, development services and tooling, which are performed under +contract of short term durations, are recognized only after the completed performance of the service. Revenue from engineering design, development services and tooling represented approximately 2%, 3%, and 3% of total revenue in fiscal years 2010, +2009, and 2008, respectively. +Shipping and Handling Fees +The Company classifies costs associated with shipping and handling fees as a component of cost of goods sold. Customer billings related to shipping and +handling fees are reported as revenue. +Research, Development and Engineering +Research, development and engineering expenses include unreimbursed EMS costs as well as design and engineering costs associated with the production of +EMS programs. Such costs are charged to expense as incurred. +33 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +Income Taxes +Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences +attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using +enacted tax rates expected to apply to taxable income in the years in which temporary differences and carryforwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities for a change in tax rates is recognized in +the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized. +Earnings Per Common Share +Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted +earnings per common share is computed by dividing net income by the combination of other potentially dilutive weighted average common shares and the weighted average number of common shares outstanding during the period using the treasury stock +method. The computation assumes the proceeds from the exercise of stock options were used to repurchase common shares at the average market price during the period. The computation of diluted earnings per common share does not assume conversion, +exercise, or contingent issuance of common stock equivalent shares that would have an anti-dilutive effect on earnings per share. +Foreign Currency Transactions +The functional currency of the Company’s subsidiaries in Mexico and China is the U.S. dollar. Realized foreign currency transaction gains and losses +are included in cost of goods sold. +Fair Value of Financial Instruments +The carrying values of financial instruments reflected on the balance sheets at July 3, 2010 and June 27, 2009, reasonably approximate their +fair value. Based on the borrowing rates currently available to the Company for loans with similar terms and average maturities, the fair value of long-term debt is estimated to be $1.6 million and $2.6 million, respectively, as of July 3, 2010 +and June 27, 2009, which approximates the carrying values. +Stock -based Compensation +The Company’s incentive plan provides for equity and liability awards to employees in the form of stock options, stock appreciation rights, +restricted stock, restricted stock units, stock awards, stock units, performance shares, performance units, and other stock–based or cash-based awards. Compensation cost is recognized on a straight-line basis over the requisite employee service +period, which is generally the vesting period, and is included in selling, general and administrative expenses. +Newly +Adopted and Recent Accounting Pronouncements +In June 2009, the Financial Accounting Standards Board (FASB) +issued Statement of Financial Accounting Standard (SFAS) No. 168, The FASB Accounting Standards +Codification TM and the Hierarchy of Generally Accepted +Accounting Principles . This statement establishes the FASB Accounting Standards +Codification TM (ASC) as the single source of +authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. This statement was codified into FASB ASC Topic 105, Generally Accepted Accounting Principles . The +Codification structure was created to organize GAAP pronouncements using numerical designation by topic, subtopic, section, and paragraph so users can more easily access the authoritative accounting guidance. This guidance is effective for interim +and annual periods ending after September 15, 2009. The Company adopted this statement in the first quarter of fiscal year 2010 and all SFAS references have been replaced with ASC references. +34 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +ASC 825 , Financial Instruments, requires disclosure about fair value of financial instruments in +interim financial statements in order to provide more timely information about the effects of current market conditions on financial instruments. The Company adopted this statement in the first quarter of fiscal year 2010 and it did not have a +material impact on the Company’s Consolidated Financial Statements. +In August 2009, the FASB issued Accounting Standard Update (ASU) +2009-05, Measuring Liabilities at Fair Value, concerning measuring liabilities at fair value. The new guidance provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not +available, a reporting entity is required to measure fair value using certain valuation techniques. Additionally, it clarifies that a reporting entity is not required to adjust the fair value of a liability for the existence of a restriction that +prevents the transfer of the liability. We have adopted the provisions of ASU 2009-05, which did not have a material impact on our consolidated financial statements. +In January 2010, the FASB issued ASU 2010-06, Improving Disclosures About Fair Value Measurements , which requires reporting entities to make new +disclosures about recurring or nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair-value measurements and information on purchases, sales, issuances, and settlements on a gross basis in the +reconciliation of Level 3 fair-value measurements. ASU 2010-06 is effective for annual reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for annual periods beginning after +December 15, 2010. The adoption of ASU 2010-06 did not have a material impact on our consolidated financial statements. +In February +2010, the FASB issued ASU 2010-09, Subsequent Events – Amendments to Certain Recognition and Disclosure Requirements (ASU 2010-09), that amends ASC Subtopic 855-10, Subsequent Events – Overall (ASC 855-10). ASU 2010-09 +requires an SEC filer to evaluate subsequent events through the date that the financial statements are issued but removed the requirement to disclose this date in the notes to the entity’s financial statements. The amendments are effective upon +issuance of the final update and accordingly, we have adopted the provisions of ASU 2010-09. The adoption of this provision did not have a material impact on our consolidated financial statements. +Fiscal Year +The +Company operates on a 52/53 week fiscal year. Fiscal years end on the Saturday nearest June 30. As such, fiscal years 2010, 2009, and 2008, ended on July 3, 2010, June 27, 2009, and June 28, 2008, respectively. Fiscal year +2010 was a 53 week year, whereas fiscal years 2009, and 2008 were 52 week years. +2. INVENTORIES +Components of inventories were as follows: +July 3, 2010 +June 27, 2009 +(in thousands) +Finished goods +$ +4,492 +$ +7,898 +Work-in-process +4,095 +3,968 +Raw materials +31,188 +20,425 +$ +39,775 +$ +32,291 +35 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +3. PROPERTY, PLANT AND EQUIPMENT +Life +July 3, 2010 +June 27, 2009 +(in years) +(in thousands) +Land +— +$ +2,089 +$ +970 +Buildings and improvements +3 to 30 +15,067 +13,602 +Equipment +1 to 10 +33,884 +33,346 +Furniture and fixtures +3 to 5 +2,108 +1,761 +53,148 +49,679 +Accumulated depreciation +(39,250 +) +(38,480 +) +$ +13,898 +$ +11,199 +During the fourth quarter of fiscal year 2010, the Company purchased a building and land in Juarez, Mexico at a total +purchase price of $2.2 million. Of the total $2.2 million, 70% or $1.6 million was paid in cash and the remaining 30% or $0.6 million is payable prior to January 6, 2011. +During the fourth quarter of fiscal year 2007, the Company sold its Las Cruces, New Mexico facility. The total sales price for the facility and adjacent +vacant land was $4.3 million. Due to the contingent nature of a portion of the sale, the Company recognized a $1.5 million gain on real estate held and a gain on sale of real estate of $951,000 in fiscal year 2008. +In December 2000, the Company sold its headquarters building, located in Spokane, Washington. In conjunction with the sale, the Company entered into a +ten year leaseback agreement for a portion of the building. The gain on the sale of the building was deferred under other long-term obligations and is amortized to offset lease expenses over the remaining original lease term, which expires in +December 2010. On June 15, 2010, the company amended the agreement to extend the lease for an additional ten years. +4. LONG-TERM DEBT +On August 19, 2009, the Company entered into a credit agreement with Wells Fargo Bank, N.A. providing for a revolving line of credit +facility for up to $20 million and paid off its previously outstanding CIT Group/Business Credit, Inc. (CIT) revolving loan. The agreement specifies that the proceeds of the revolving line of credit be used primarily for working capital and general +corporate purposes of the Company and its subsidiaries. Borrowings under this revolving line of credit bear interest at either a “Base Rate” or a “Fixed Rate”, as elected by the Company. The base rate is the higher of the JP +Morgan Chase prime rate, daily one month London Interbank Offered Rate (LIBOR) plus 1.5%, or the Federal Funds rate plus 1.5%. The fixed rate is LIBOR plus 2.1% or LIBOR plus 2.5% depending on the level of trailing four quarters Earnings Before +Interest, Taxes, Depreciation and Amortization (EBITDA). The new line of credit is secured by substantially all of the assets of the Company. +The agreement is for a term of two years beginning on August 19, 2009 and ending on August 18, 2011. The Company must comply with certain +financial covenants, including a cash flow leverage ratio and a trading ratio. The credit agreement requires the Company to maintain a minimum profit threshold, limits the maximum lease expenditures and restricts the Company from declaring or paying +dividends in cash or stock. +As of July 3, 2010, the Company had availability to borrow an additional $18.4 million under the Wells Fargo +line of credit. The outstanding balance under the credit facility was $1.6 million as of July 3, 2010 and the rate of interest being paid on the outstanding balance was 3.25%. As of June 27, 2009, the outstanding revolving loan balance +related to CIT was $2.4 million and the range of interest being paid to CIT on the outstanding balances was 1.82% to 3.25%. +36 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +5. INCOME TAXES +Income tax expense (benefit) consists of the following: +Year Ended +July 3, 2010 +June 27, 2009 +June 28, 2008 +(in thousands) +Current income tax expense: +United States +$ +162 +$ +15 +$ +45 +Foreign +496 +219 +216 +658 +234 +261 +Deferred income tax(benefit) expense: +United States +(3,588 +) +(104 +) +— +Foreign +1,526 +— +— +(2,062 +) +(104 +) +— +Total income tax(benefit) expense +$ +(1,404 +) +$ +130 +$ +261 +The Company has domestic NOLs of approximately $25.1 million at +July 3, 2010. In accordance with ASC 740, management assessed the Company’s recent operating levels and estimated future taxable income and determined there was not a need for a valuation allowance. A valuation allowance against deferred +tax assets is required if it is more likely than not that some of the deferred tax assets will not be realized. Management determined during fiscal year 2010, based on the Company’s increased profitability and estimated repatriation from +foreign subsidiaries that it was likely that the NOLs will be fully utilized prior to their expiration. +Management also updated its estimates +of future repatriation of its undistributed earnings of its foreign subsidiaries during fiscal year 2010. Management expects to repatriate a portion of its foreign undistributed earnings based on increased sales growth driving additional capital +requirements domestically, cash requirements for potential acquisitions and to implement certain tax strategies. The Company expects to repatriate approximately $14.5 million in the future. As such, as earnings are recognized in the United States, +the Company would be subject to U.S. federal and state income taxes and potential withholding taxes in foreign jurisdictions. Both the domestic tax and estimated withholding tax have been recorded as part of deferred taxes as of July 3, 2010. +All other unremitted foreign earnings are expected to remain permanently reinvested in planned fixed assets purchases in foreign locations. +The Company has wholly owned foreign subsidiaries in Mexico that apply certain tax credits related to production assets that currently offset all of the +income tax liabilities under general Mexican income tax law. However, the Company is subject to a Mexican business flat tax called Impuesto Empresarial a Tasa Unica (IETU). Based on certain events that occurred during fiscal year 2010, the Company +now anticipates that it will be taxable under IETU for the foreseeable future based on projected assets used in its operations. The effect of IETU and an associated presidential decree on fiscal year 2010 has been included in the effective tax rate +as of July 3, 2010. +The Company is required to pay taxes in China on its statutory foreign profits. Its subsidiary in China did not have +statutory profits during fiscal year 2010. The Company has a full valuation allowance on its Chinese tax net operating loss carryforwards until a consistent statutory profit can be maintained and it becomes likely that they will be utilized before +expiration. +ASC 740 requires the Company to recognize in its financial statements uncertainties in tax positions taken that may not be +sustained upon examination by the taxing authorities. If interest or penalties are assessed, the Company would recognize these charges as income tax expense. The Company does not have any uncertain tax positions as of July 3, 2010. Unrecognized +tax benefits are not anticipated to increase or decrease over the next 12 months. +37 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +The Company’s effective tax rate differs from the federal tax rate as follows: +Year Ended +July 3, 2010 +June 27, 2009 +June 28, 2008 +(in thousands) +Federal income tax expense at statutory rates +$ +2,477 +$ +406 +$ +1,987 +Effect of foreign vs. domestic taxes +99 +(248 +) +(899 +) +Expired NOLs, tax credits and permanent differences +— +2,345 +977 +Effect of repatriation of foreign earnings income, net +2,158 +— +— +Effect of change in applied Mexican tax regime +1,526 +— +— +Other +211 +76 +158 +Change in valuation allowance +(7,875 +) +(2,449 +) +(1,962 +) +Income tax (benefit) provision +$ +(1,404 +) +130 +261 +The domestic and foreign components of income before income taxes were: +Year Ended +July 3, 2010 +June 27, 2009 +June 28, 2008 +(in thousands) +Domestic +$ +6,117 +$ +475 +$ +2,710 +Foreign +1,169 +718 +3,135 +Income before income taxes +$ +7,286 +$ +1,193 +$ +5,845 +Deferred income tax assets and liabilities consist of the following +at: +July 3, 2010 +June 27, 2009 +(in thousands) +Deferred tax assets: +Net operating loss carryforwards +$ +9,001 +$ +11,282 +Tax credit carryforwards +1,028 +384 +Inventory +839 +536 +Accruals +1,244 +1,343 +Deferred income tax assets +12,112 +13,545 +Valuation allowance +(469 +) +(8,344 +) +Deferred income tax assets, net of valuation allowance +$ +11,643 +$ +5,201 +Deferred tax liabilities: +Repatriated earnings of foreign subsidiary, net of foreign tax credits +(2,158 +) +— +Accruals +(979 +) +— +Fixed assets +(850 +) +— +Other +(368 +) +(97 +) +Deferred income tax liabilities +$ +(4,355 +) +$ +(97 +) +Total, net deferred income tax assets +$ +7,288 +$ +5,104 +Balance sheet caption reported in: +Current deferred tax asset +$ +4,420 +$ +493 +Long-term deferred tax asset +4,394 +4,611 +Other current liabilities +(918 +) +— +Other long-term obligations +(608 +) +— +Total, net deferred income tax asset +$ +7,288 +$ +5,104 +At July 3, 2010 the Company had NOLs of approximately $25.1 million. The remaining net operating loss carryforwards +expire in varying amounts through 2025. Utilization of NOLs would be limited in the event the Company’s ownership changes more than 50% in a three-year period. The Company also has +38 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +alternative minimum tax credits approximating $575,000. The alternative minimum tax credits do not expire. +6. EARNINGS PER SHARE +Basic earnings +per share (EPS) is calculated by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is computed by including both the weighted-average number of shares +outstanding and any dilutive common share equivalents in the denominator. The following table presents a reconciliation of the denominator and the number of antidilutive common share options that were not included. These antidilutive securities +occur when options outstanding have an option price greater than the average market price for the period. +Years Ended +July 3, 2010 +June 27, 2009 +June 28, 2008 +Total weighted average shares – basic +10,124,320 +10,059,376 +9,997,431 +Effect of dilutive common stock options +66,626 +15,596 +269,480 +Total weighted average shares – diluted +10,190,946 +10,074,972 +10,266,911 +Antidilutive options not included in diluted earnings per share +112,500 +741,492 +515,550 +7. STOCK OPTION AND BENEFIT +PLANS +The Company has an executive stock option plan for certain key employees. Options under this plan vest over one to three years and +become exercisable as they vest. Options under the plan become exercisable in full immediately prior to the occurrence of a “Change in Control” as defined in the plan documents. As of July 3, 2010, 266,169 options were outstanding and +exercisable under the Executive Stock Option Plan and other plans which have terminated. The plan has terminated and no more options can be granted under this plan. These options expire five to ten years from the date of vesting. +The Company also has a stock option plan for “Nonemployee Directors.” Options under this plan vested over a three-year period and are +exercisable. The Company reserved 300,000 shares for issuance under this plan. As of July 3, 2010, 57,325 options were outstanding. The plan has terminated and no more options can be granted under this plan. Outstanding options expire five to +ten years from the date of vesting. +In May 2010, the Company established a new Stock Incentive Plan (the “2010 Incentive +Plan”). The 2010 Incentive Plan was adopted by the Board of Directors in May 2010, and certain aspects are subject to approval by the shareholders at the 2010 Annual Meeting. The 2010 Incentive Plan provides for the granting of +nonqualified stock options within the meaning of Section 422 Internal Revenue Code, as well as stock appreciation rights (SARs), restricted stock, restricted stock units, stock awards, stock units, performance shares, performance units, and +other stock –based or cash-based awards. Stock appreciation rights may be settled in stock or cash. Because stock-based awards cannot be issued under the plan until it is approved by shareholders, the Company can only grant stock appreciation +rights under the plan as cash-settled SARs. Once the plan has been approved by the shareholders, the Company can then convert the awards into stock-settled SARs at its discretion. Options and SARs under the plan become exercisable in full +immediately prior to the occurrence of a “Change in Control” as defined in the plan documents. The 2010 Incentive Plan has a total of 1,200,000 shares authorized for grant. As of July 3, 2010, 555,000 SARs were outstanding. +Outstanding options and SARs expire five to ten years from the date of vesting. +39 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +The Company granted 555,000 cash-settled SARs under the 2010 Incentive Plan to certain key employees and +outside directors at a strike price of $5.89 and a grant date weighted average fair market value of $3.04 as of May 14, 2010. In addition to service conditions, these SARs contain a performance condition. The additional performance condition is +based upon the achievement of Return on Invested Capital (ROIC) goals relative to a peer group. All awards with performance conditions are measured over the vesting period and are charged to compensation expense over the requisite service period +based on the number of shares expected to vest. The SARs cliff vest over a three-year period from date of grant and expire in five years from date of grant. ASC 718 requires that the Company classify cash settled awards as liabilities in the +Company’s Consolidated Balance Sheets and measure these awards at fair value at each reporting date until the award is ultimately settled (i.e. until the SAR is exercised or canceled). All changes in fair value are recorded in the +Company’s Consolidated Statements of Income. As of July 3, 2010, approximately $57,000 related to cash settled awards was recorded as a liability in the Company’s Consolidated Balance Sheets with a related charge to compensation +expense in the income statement. +The fair value for SARs was estimated using the Black-Scholes option valuation model with the following +weighted average assumptions as of July 3, 2010: +Fiscal Year 2010 +Expected dividend yield +0.00 +% +Risk-free interest rate +1.45 +% +Expected volatility +67.8 +% +Expected life +3.87 years +Fair value +$ +2.25 +Stock-based compensation expense is +recognized only for those awards that are expected to vest, with forfeitures estimated at the date of grant based on the Company’s historical experience and future expectations. This forfeiture rate will be revised, if necessary, in subsequent +periods if actual forfeitures differ from the amount estimated. +The Black-Scholes option valuation model was developed for use in estimating +the fair value of traded options, which differ significantly from the SARs, as traded options have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, +particularly for the expected term and expected stock price volatility. Changes in these assumptions can materially affect the fair value estimates. +The intrinsic value for options exercised in fiscal years 2010, 2009 and 2008 was $0.5 million, $0.1 million and $0.2 million, respectively. +As of July 3, 2010, total unrecognized compensation expense related to nonvested share-based compensation arrangements was approximately +$1.2 million. This expense is expected to be recognized over a weighted-average period of 2.9 years. +40 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +The following table summarizes option activity of all plans from June 27, 2009 through July 3, +2010: +Shares +Available +For Grant +Options +Outstanding +Aggregate +Intrinsic +Value +(in +thousands) +Weighted +Average +Exercise +Price +Weighted +Average +Remaining +Contractual +Life (in +years) +Balance at June 27, 2009 +68,500 +784,827 +21 +$ +3.48 +1.5 +Options authorized +Options granted +Options canceled and expired +(68,500 +) +(262,917 +) +Options exercised +— +(198,416 +) +Balance at July 3, 2010 +— +323,494 +483 +3.57 +1.4 +Exercisable at July 3, 2010 +323,494 +483 +3.57 +1.4 +The following is a summary of plan activity: +Price Range +Number of +Options +Weighted Average +Exercise Price +Outstanding, June 30, 2007 +$ +1.15 +to +$ +16.25 +1,650,838 +$ +4.08 +Exercised during 2008 +$ +1.20 +to +$ +4.19 +(103,263 +) +$ +2.45 +Canceled +$ +2.75 +to +$ +16.25 +(279,200 +) +$ +6.96 +Outstanding, June 28, 2008 +$ +1.15 +to +$ +6.50 +1,268,375 +$ +3.58 +Exercised during 2009 +$ +1.15 +to +$ +2.09 +(41,666 +) +$ +1.38 +Canceled +$ +1.15 +to +$ +6.50 +(441,882 +) +$ +3.96 +Outstanding June 27, 2009 +$ +1.15 +to +$ +6.50 +784,827 +$ +3.48 +Exercised +$ +1.15 +to +$ +4.81 +(198,416 +) +$ +3.05 +Canceled +$ +2.61 +to +$ +5.89 +(262,917 +) +$ +3.69 +Outstanding, July 3, 2010 +$ +1.15 +to +$ +6.50 +323,494 +$ +3.57 +Additional information regarding options outstanding as of July 3, 2010, is as follows: +Options +Outstanding +Options +Exercisable +Range of +Exercise Prices +Number +Outstanding +Weighted Avg. +Remaining +Contractual +Life (yrs.) +Weighted +Avg. Exercise +Price +Number +Exercisable +Weighted +Avg. +Exercise +Price +$1.15 –$1.73 +21,669 +1.0 +$ +1.17 +21,669 +$ +1.17 +1.74 – 2.60 +22,500 +2.7 +2.13 +22,500 +2.13 +2.61 – 3.92 +166,825 +2.0 +2.87 +166,825 +2.87 +3.93 – 5.89 +75,000 +0.2 +4.80 +75,000 +4.80 +5.90 – 6.50 +37,500 +0.6 +6.50 +37,500 +6.50 +$1.15 to $6.50 +323,494 +1.4 +$ +3.57 +323,494 +$ +3.57 +The Company also has a defined contribution plan +(401(k)) available to U.S. employees who have attained age 21. The Company contributes an amount equal to 100% of the employee’s contribution on the first 3% +41 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +of the employee’s compensation and an additional 50% of the employee’s contribution on the following 2% of the employee’s compensation. Company contributions to the plan were +approximately $0.4 million in fiscal years 2010, 2009, and 2008, respectively. +8. COMMITMENTS AND CONTINGENCIES +Leases : The Company has operating leases for certain equipment and production facilities, which expire at various dates during the next ten years. +As of July 3, 2010, the Company did not have any property and equipment financed under capital leases. Future minimum payments under non-cancelable operating leases with initial or remaining terms of one year or more at July 3, 2010, are +summarized as follows (in thousands): +Fiscal Years Ending +Operating +Leases +2011 +$ +2,819 +2012 +1,251 +2013 +772 +2014 +763 +2015 +762 +Thereafter +3,464 +Total minimum lease payments +$ +9,831 +Rental expense under operating leases was approximately $3.3 million, +$3.4 million, and $3.7 million in fiscal years 2010, 2009, and 2008, respectively. +Warranty Costs : The Company provides warranties on +certain product sales, and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires the Company to make estimates of product return rates and expected costs to repair or to replace +the products under warranty. The Company establishes warranty reserves based on historical warranty costs for each product line combined with liability estimates based on the prior twelve months’ sales activities. +If actual return rates and/or repair and replacement costs differ significantly from estimates, adjustments to recognize additional cost of sales may be +required in future periods. +Components of the reserve for warranty costs during fiscal years 2010, 2009, and 2008 were as follows: +Balance at June 30, 2007 +$ +40,000 +Additions +196,200 +Warranty costs incurred +(69,085 +) +Balance at June 28, 2008 +167,115 +Recovery related to current period sales +(92,500 +) +Warranty costs incurred +(49,722 +) +Balance at June 27, 2009 +24,893 +Additions +44,529 +Warranty costs incurred +(44,959 +) +Balance at July 3, 2010 +$ +24,463 +Warranty expense for fiscal years 2010 and 2008 is related to workmanship claims on keyboards and certain EMS products. The +recovery in fiscal year 2009 is related to the release of a warranty claim for a specific product that was identified in fiscal year 2008. +42 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +Litigation : The Company is party to certain lawsuits or claims in the ordinary course of +business. The Company does not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on the financial position, results of operations or cash flow of the Company. +Indemnification Rights : Under the Company’s bylaws, the Company’s directors and officers have certain rights to indemnification by the +Company against certain liabilities that may arise by reason of their status or service as directors or officers. The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its +directors and officers and former directors in certain circumstances. +9. GOODWILL +In accordance with ASC 350 Intangibles – Goodwill and Other , goodwill is not amortized, but must be analyzed for impairment at least annually. +On December 27, 2008, the Company completed its annual impairment test. As the deteriorating global macroeconomic environment adversely affected the Company’s common stock price, the Company concluded that 100% of the goodwill was impaired +due to the significant and sustained decline in the Company’s market capitalization to below the book value. The Company recorded an impairment charge of $765,000 during fiscal year 2009. As of July 3, 2010, and June 27, 2009, +respectively, there was no goodwill recorded in the Company’s Consolidated Balance Sheet. +10. FAIR VALUE MEASUREMENTS +The Company has adopted ASC 820, Fair Value Measurements, which defines fair value, establishes a framework for assets and liabilities being +measured and reported at fair value and expands disclosures about fair value measurements. There are three levels of fair value hierarchy inputs used to value assets and liabilities which include: Level 1 – inputs are quoted market prices for +identical assets or liabilities; Level 2 – inputs other than quoted market prices included in Level 1 that are observable for the asset or liability, either directly or indirectly; and Level 3 – inputs are unobservable inputs for the asset +or liability. +The following table summarizes the Company’s financial assets and liabilities (only those required to be measured at fair +value on a recurring basis) at fair value as of July 3, 2010 and June 27, 2009 (in thousands): +July 3, 2010 +Level 1 +Level 2 +Level 3 +Total Fair Value +Financial Assets +Foreign currency forward contracts +$ +— +$ +416 +$ +— +$ +416 +Financial Liabilities +Foreign currency forward contracts +$ +— +$ +(777 +) +$ +— +$ +(777 +) +Total +$ +— +$ +(361 +) +$ +— +$ +(361 +) +June 27, 2009 +Level 1 +Level 2 +Level 3 +Total Fair Value +Financial Assets +Foreign currency forward contracts +$ +— +$ +912 +$ +— +$ +912 +The Company currently has forward +contracts to hedge known future cash outflows for expenses denominated in the Mexican peso. These contracts are measured on a recurring basis based on the foreign currency spot rates and forward rates quoted by banks or foreign currency dealers. +These contracts are marked to market using level 2 input criteria every period with the unrealized gain or loss, net of tax, reported as a component of shareholders’ equity in accumulated other comprehensive income, as they qualify for hedge +accounting. +43 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +11. DERIVATIVE FINANCIAL INSTRUMENTS +In accordance with ASC 815 , Derivatives and Hedging, the Company has expanded the quarterly and annual disclosures on its derivative instruments +and hedging activities. The Company has entered into foreign currency forward contracts and those contracts are accounted for as cash flow hedges. The effective portion of the gain or loss on the derivative is reported as a component of accumulated +other comprehensive income (AOCI) and is reclassified into earnings in the same period in which the underlying hedged transaction affects earnings. The derivative’s effectiveness represents the change in fair value of the hedge that offsets the +change in fair value of the hedged item. +The Company transacts business in Mexico and is subject to the risk of foreign currency exchange +rate fluctuations. The Company enters into foreign currency forward contracts to manage the foreign currency fluctuations for Mexican peso denominated payroll, utility, tax, and accounts payable expenses. The foreign currency forward contracts have +terms that are matched to the underlying transactions being hedged. As a result these transactions fully offset the hedged risk and no ineffectiveness has been recorded. +As of July 3, 2010, the Company had outstanding foreign currency forward contracts of $30.9 million. These contract maturity dates extend through +June 27, 2012. As of July 3, 2010, the net amount of existing gains (losses) expected to be reclassified into earnings within the next 24 months was $(361,000). During the fiscal year ended July 3, 2010, the Company entered into $30.9 +million of foreign currency forward contracts and settled $17.8 million of such contracts. During the fiscal year ended June 27, 2009 the Company entered into $26.6 million and settled $8.8 million of foreign currency forward contracts. There +were no significant foreign currency forward contracts entered into during fiscal year 2008. Subsequent to July 3, 2010, the Company entered into an additional $3.9 million of foreign currency forward contracts that extended the hedge position +through September 2012. +The following table summarizes the fair value of derivative instruments in the Consolidated Balance Sheets as of +July 3, 2010 (in thousands): +Derivatives Designated as Hedging Instruments +Balance +Sheet Location +July 3 , 2010 +Fair Value +June 27, 2009 +Fair Value +Foreign currency forward contracts +Other current assets +$ +416 +$ +912 +Foreign currency forward contracts +Other long term +liabilities +$ +(777 +) +$ +— +The following table +summarizes the gain (loss) of derivative instruments on the Consolidated Statement of Operations for the fiscal year 2010 (in thousands): +Derivatives Designated as Hedging +Instruments +AOCI Balance +as of +June 27, 2009 +Effective +Portion +Recorded In +AOCI +Effective Portion +Reclassified From +AOCI +Into +Cost of Sales +AOCI Balance +as of +July 3, +2010 +Settled foreign currency forward contracts +$ +912 +$ +912 +$ +(1,824 +) +$ +— +Unsettled foreign currency forward contracts +— +(242 +) +— +(242 +) +Total +$ +912 +$ +670 +$ +(1,824 +) +$ +(242 +) +The Company does not enter into derivative instruments for trading or speculative purposes. The Company’s +counterparties to the foreign currency forward contracts are major banking institutions. These institutions do not require collateral for the contracts and the Company believes that the risk of the counterparties failing to meet their contractual +obligations is remote. +As of July 3, 2010, the Company does not have any foreign exchange contracts with credit-risk-related contingent +features. +44 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +12. ENTERPRISE-WIDE DISCLOSURES +Products and Services +Of the revenues for the years ended July 3, 2010, June 27, 2009, and June 28, 2008, EMS sales were $195.1 million, $180.7 million, and +$198.3 million, respectively. Keyboard sales for the years ended July 3, 2010, June 27, 2009, and June 28, 2008 were $4.5 million, $4.2 million, and $5.8 million, respectively. +Geographic Areas +Net sales and long-lived assets (property, plant, and equipment) by geographic area as of July 3, 2010, June 27, 2009, and June 28, +2008, respectively are summarized in the following table. Net sales set forth below are based on the shipping destination. +Domestic (U.S.) +Foreign +Total +(in thousands) +2010 +Net sales +$ +163,915 +$ +35,705 +$ +199,620 +Long-lived assets +$ +931 +$ +12,967 +$ +13,898 +2009 +Net sales +$ +164,032 +$ +20,892 +$ +184,924 +Long-lived assets +$ +755 +$ +10,444 +$ +11,199 +2008 +Net sales +$ +192,748 +$ +11,374 +$ +204,122 +Long-lived assets +$ +802 +$ +9,996 +$ +10,798 +For the year ended July 3, +2010, 48.8% of the Company’s foreign net sales were to customers in Canada, 16.9% were to Australia, 13.9% were to China , and the remaining 20.4% were spread among customers in other parts of Europe and Asia. +For the year ended June 27, 2009, 52.3% of the Company’s foreign net sales were to customers in Canada, 24.7% were to Switzerland, 15.8% were +to Asia, and the remaining 7.2% were spread among customers in other parts of Europe and Australia. +For the year ended June 28, 2008, +65.8% of the Company’s foreign net sales were to customers in Switzerland, 11.7% were to Canada, 10.2 % were to Asia, and the remaining 12.3% were spread among customers in other parts of Europe and Australia. +Significant Customers +The percentage of net sales to and trade accounts receivables from significant customers were as follows: +Percentage of +Net +Sales +Fiscal Year +Percentage of +Trade Accounts Receivable +Fiscal Year +2010 +2009 +2008 +2010 +2009 +Customer A +18 +% +* +* +22 +% +14 +% +Customer B +12 +% +13 +% +18 +% +18 +% +* +Customer C +* +14 +% +15 +% +* +14 +% +Customer D +* +* +* +10 +% +* +* +Amount was less than 10% of total. +45 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) +There can be no assurance that the Company’s principal customers will continue to purchase products +from the Company at current levels. Moreover, the Company typically does not enter into long-term volume purchase contracts with its customers, and the Company’s customers have certain rights to extend or delay the shipment of their orders. The +loss of one or more of the Company’s major customers, or the reduction, delay or cancellation of orders from such customers, could materially and adversely affect the Company’s business, operating results and financial condition. +13. QUARTERLY FINANCIAL DATA +(Unaudited) +Year Ended July 3, 2010 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +Net sales +$ +41,309 +$ +44,750 +$ +51,697 +$ +61,864 +Gross profit +2,675 +4,710 +5,242 +6,623 +Income before income taxes +331 +1,714 +2,217 +3,024 +Net income +295 +1,670 +4,414 +2,311 +Earnings per common share-basic +$ +0.03 +$ +0.17 +$ +0.44 +$ +0.23 +Earnings per common share-diluted +$ +0.03 +$ +0.17 +$ +0.43 +$ +0.22 +Weighted average shares outstanding +Basic +10,066 +10,087 +10,126 +10,219 +Diluted +10,082 +10,110 +10,254 +10,342 +Year Ended June 27, 2009 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +Net sales +$ +48,237 +$ +46,990 +$ +44,233 +$ +45,464 +Gross profit +3,407 +3,816 +3,312 +2,645 +Income before income taxes +462 +223 +308 +200 +Net income +408 +106 +262 +287 +Earnings per common share-basic +$ +0.04 +$ +0.01 +$ +0.03 +$ +0.03 +Earnings per common share-diluted +$ +0.04 +$ +0.01 +$ +0.03 +$ +0.03 +Weighted average shares outstanding +Basic +10,040 +10,065 +10,066 +10,066 +Diluted +10,212 +10,073 +10,066 +10,074 +Item 9: +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES +None +Item 9A (T): CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +It is the responsibility of our management to establish, maintain, and monitor disclosure controls and procedures that are designed to ensure that +information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission rules and +forms. Additionally, these disclosure controls include controls and procedures that are designed to accumulate and communicate the information required to be disclosed to our company’s Chief Executive Officer and Chief +46 +Table of Contents +Financial Officer, allowing for timely decisions regarding required disclosures. As of the end of the period covered by this report, our management carried out an evaluation, under the +supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(f). Based on our +assessment, we believe that as of July 3, 2010, the Company’s disclosure controls and procedures are effective based on that criteria. +Management’s Report on Internal Control over Financial Reporting +Our management has the responsibility to establish and maintain adequate internal controls over our financial reporting, as defined in Rule 13a-15(f) +under the Securities and Exchange Act of 1934. Our internal controls are designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our external financial statements in accordance with +generally accepted accounting principles (GAAP). +Due to inherent limitations of any internal control system, management acknowledges that +there are limitations as to the effectiveness of internal controls over financial reporting and therefore recognize that only reasonable assurance can be gained from any internal control system. Accordingly, our internal control system may not +detect or prevent material misstatements in our financial statements and projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the +degree of compliance with the policies or procedures may deteriorate. +Under the supervision and participation of management, including the +Chief Executive Officer and Chief Financial Officer, we have performed an assessment of the effectiveness of our internal controls over financial reporting as of July 3, 2010. This assessment was based on the criteria established in Internal +Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we believe that as of July 3, 2010, the Company’s internal control over financial reporting is effective +based on that criteria. +This annual report does not include an attestation report of our registered public accounting firm regarding internal +control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this annual report. +Changes in Internal Control over Financial Reporting +There have been no significant changes in our internal controls over financial reporting during our fourth fiscal quarter ended July 3, 2010 that +have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)). +Item 9B: +OTHER INFORMATION +None +PART III +Item 10: +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +Directors of the Registrant +Information on the nominees for election as Directors of the Company is incorporated by reference from the Company’s definitive proxy statement for +the 2010 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A under the Exchange Act no later than 120 days after the end of the Company’s 2010 fiscal year. +47 +Table of Contents +Executive Officers of the Registrant +This information is included in a separate item captioned “Executive Officers of the Registrant” in Item 1 of Part 1 of this report +pursuant to Instruction G(3) of Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K. +Compliance with +Section 16(a) of the Exchange Act: +Incorporated by reference to Key Tronic Corporation’s 2010 Proxy Statement to +Shareholders. +Code of Conduct +The Board of Directors has adopted a written Code of Conduct which applies to its directors and employees, including its executive officers. The Code of +Conduct is available on the Company’s website at www.keytronic.com . The Company intends to disclose on its website any amendments to or waivers of the Code of Conduct. +Item 11: +EXECUTIVE COMPENSATION +Information +appearing under the caption “Executive Compensation” in the Company’s 2010 Proxy Statement is incorporated herein by this reference. +Item 12: +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The following table sets forth the aggregate information for the Company’s equity compensation plans in effect as of July 3, 2010. +EQUITY COMPENSATION PLAN INFORMATION +Plan category +Number of securities to +be +issued upon exercise +of outstanding +options, +warrants, and rights +(a) +Weighted-average +exercise price of +outstanding options, +warrants, and +rights +(b) +Number of securities +remaining +available for +future issuance under +equity +compensation +plans (excluding +securities reflected +in +column (a) +(c) +Equity compensation plans approved by security holders +243,993 +$ +3.87 +— +Equity compensation plans not approved by security +holders (1) +79,501 +$ +2.67 +— +Total +323,494 +$ +3.57 +— +(1) +Consists of the Key Tronic Corporation 2000 Employee Stock Option Plan. Not included are the 1,200,000 shares subject to the 2010 Plan, the issuance of +which is subject to shareholder approval of the 2010 Plan at the Annual Meeting, or the cash-settled SARs issued under the 2010 Plan that may be settled in shares of Common Stock, subject to shareholder approval of the 2010 Plan. See “Proposal +3: Approval of the Key Tronic Corporation 2010 Incentive Plan” for further information about the 2010 Plan. +Information under the caption “Beneficial Ownership of Securities” in the Company’s 2010 Proxy Statement is incorporated herein by this +reference. +48 +Table of Contents +Item 13: +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Information appearing under the caption “Related Person Transactions”, “Compensation Committee Interlocks and Insider Participation”, +and “Directors’ Independence” in the Company’s 2010 Proxy Statement is incorporated herein by this reference. +Item 14: +PRINCIPAL ACCOUNTING FEES AND SERVICES +Information appearing under the caption “Principal Accountant Fees and Services” in the Company’s 2010 Proxy Statement is incorporated +herein by this reference. +PART IV +Item 15: +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a) 1. FINANCIAL STATEMENTS +Page in +Form +10-K +FINANCIAL STATEMENTS +Report of Independent Registered Public Accounting Firm +26 +Consolidated Balance Sheets, as of July 3, 2010, and June 27, 2009 +27 +Consolidated Statements of Income for the years ended July 3, 2010, June 27, 2009, and June 28, +2008 +28 +Consolidated Statements of Shareholders’ Equity and Comprehensive Income for the years ended July 3, +2010, June 27, 2009, and June 28, 2008 +29 +Consolidated Statements of Cash Flows for the years ended July 3, 2010, June 27, 2009, and June 28, +2008 +30 - 31 +Notes to Consolidated Financial Statements +32 - 46 +2. SCHEDULES +II. Consolidated Valuation and Qualifying Accounts +53 +Other schedules are omitted because of +the absence of conditions under which they are required, or because required information is given in the financial statements or notes thereto. +3. EXHIBITS +Exhibit +No. +Description +3.1 +Articles of Incorporation, incorporated by reference to the Exhibits to the Company’s form 10-K for the year ended June 30, 1986 +3.2 +Bylaws, as amended, incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended June 30, 1986 +10.1* +Executive Stock Option Plan, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended June 30, 1986 +10.2* +Amended and Restated 1990 Stock Option Plan for Non-Employee Directors, as amended, incorporated by reference to the Company’s 1997 Proxy Statement (dated October 10, 1997), +pages 14-17 +49 +Table of Contents +10.3* +1995 Executive Stock Option Plan, incorporated by reference to the Company’s 1995 Proxy Statement, pages 19-22 +10.4* +2000 Employee Stock Option Plan, incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended January 1, 2000 +10.5* +Officers’ Employment Contracts, incorporated by reference to the Company’s 1998 Proxy Statement, pages 10 and 11 +10.6* +Employment Contract with Michael D. Chard, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended July 1, 2000 +10.7* +Addenda to Officers’ Employment Contracts, incorporated by reference to Exhibits to the Company’s Form 10-Q for the quarter ended January 1, 2000 +10.8* +Description of Retention Bonus Plan, incorporated by reference to the Exhibits to the Company’s 10-Q for the quarter ended December 28, 2002 +10.9* +Addenda to Officers’ Employment Contracts, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended June 29, 2002 +10.10 +Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended September 29, +2001 +10.11 +First and Second Amendments to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended +June 29, 2002 +10.12 +Third Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended December +29, 2002 +10.13 +Fourth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended June 28, +2003 +10.14 +Fifth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended December +27, 2003 +10.15 +Sixth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended April 3, +2004 +10.16 +Seventh Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended July 3, +2004 +10.17 +Eighth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended July 3, +2004 +10.18 +Ninth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended October +2, 2004 +10.19 +Tenth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibit to the Company’s Form 8-K filed April 4, +2005 +10.20 +Promise to execute a Purchase and Sale Agreement with Key Safety Systems de Mexico, S.A. de C.V., incorporated by reference to the Exhibit to the +Company’s +50 +Table of Contents +Form 8-K filed April 26, 2005 +10.21 +Summary of material terms and conditions of the Purchase and Sale Agreement with Key Safety Systems de Mexico, S.A. de C.V., incorporated by reference to the Exhibit to the +Company’s Form 8-K filed June 6, 2005 +10.22* +Summary of Key Tronic Corporation Incentive Compensation Plan, incorporated by reference to Exhibit 10.23* the Company’s Form 10-K for the year ended July 2, +2005 +10.23* +Employment Contract between Key Tronic Corporation and George Robert Alford, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed July 26, +2006 +10.24* +Summary of Incentive Compensation Plan Performance goals and Target Payments for fiscal year 2007, incorporated by reference to the Company’s Form 8-K filed July 28, +2006 +10.25* +Summary of Fiscal Years 2007 – 2009 Long Term Incentive Plan Performance Measures and Awards, incorporated by reference to the Company’s From 8-K filed July 28, +2006 +10.26* +Summary of Key Tronic Corporation Long Term Incentive Compensation Plan, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed September 27, +2005 +10.27 +Twelfth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibit to the Company’s Form 8-K filed September 7, +2006 +10.28 +Summary of material terms and conditions of the Purchase and Sale Agreement with Todenko Mexico S.A. de C.V., incorporated by reference to Exhibit 10.1 to the Company’s Form +8-K filed October 12, 2006 +10.29 +Summary of material terms and conditions of the Purchase and Sale Agreement with Todenko Mexico S.A. de C.V., incorporated by reference to Exhibit 10.1 to the Company’s Form +8-K filed November 20, 2006 +10.30 +Summary of material terms and conditions of the Sale and Purchase Agreement with Adevco Corporation, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed +January 5, 2007 +10.31 +Summary of Second Amendment to Agreement of Sale and Purchase Agreement with Adevco Corporation, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed April +11, 2007 +10.32* +Summary of Incentive Compensation Plan Performance Goals and Target Payments for Fiscal Year 2008 and Fiscal Years 2008-2010 Long Term Incentive Plan Performance Measures and Awards +incorporated by reference to the Company’s Form 8-K filed July 27, 2007 +10.33* +Summary of Incentive Compensation Plan Performance Goals and Target payments for Fiscal Year 2009 and Fiscal Years 2009 – 2011 Long Term Incentive Plan Performance Measures and +Awards incorporated by reference to the Company’s Form 8-K filed July 24, 2008 +10.34* +Summary of Incentive Compensation Plan Performance Goals and Target payments for Fiscal Year 2010 and Fiscal Years 2010 – 2012 Long Term Incentive Plan Performance Measures and +Awards incorporated by reference to the Company’s Form 8-K filed July 23, 2009 +10.35 +Financing Agreement with Wells Fargo Bank, N.A., incorporated by reference to the +51 +Table of Contents +Exhibits to the Company’s Form 8-K filed on August 24, 2009 +10.36* +2010 Incentive Plan, submitted here with the Company’s Form 10-K for the year ended July 3, 2010 +10.37* +Employment Contract with Douglas G. Burkhardt, submitted here with the Company’s Form 10-K for the year ended July 3,2010 +10.38 +Summary of material terms and conditions of the Purchase and Sale Agreement with Autopartes Y Arneses de Mexico S.A. de C.V., submitted here with the Company’s Form 10-K for +the year ended July 3,2010 +21. +Subsidiaries of Registrant, submitted herewith +23.1 +Consent of Independent Registered Public Accounting Firm, submitted herewith +31.1 +Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer, submitted herewith +31.2 +Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer, submitted herewith +32.1 +Section 1350 Certification of Chief Executive Officer, submitted herewith +32.2 +Section 1350 Certification of Chief Financial Officer, submitted herewith +* +Management contract or compensatory plan or arrangement +52 +Table of Contents +PART IV +SCHEDULE II +KEY +TRONIC CORPORATION AND SUBSIDIARIES +CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS +FISCAL YEARS ENDED JULY 3, 2010, JUNE 27, 2009, AND +JUNE 28, 2008 +2010 +2009 +2008 +(in thousands) +Allowance for Obsolete Inventory +Balance at beginning of year +$ +409 +$ +236 +$ +211 +Provisions +2,182 +303 +159 +Dispositions +(1,288 +) +(130 +) +(134 +) +Balance at end of year +$ +1,303 +$ +409 +$ +236 +Allowance for Doubtful Accounts +Balance at beginning of year +$ +111 +$ +110 +$ +20 +Provisions +— +604 +122 +Write-offs +— +(603 +) +(32 +) +Balance at end of year +$ +111 +$ +111 +$ +110 +53 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed +on its behalf by the undersigned, thereunto duly authorized. +Dated: September 13, 2010 +KEY TRONIC CORPORATION +By: +/ S / C RAIG D. +G ATES +Craig D. Gates, +President and Chief Executive Officer +(Principal Executive Officer) +54 +Table of Contents +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by +the following persons on behalf of the registrant and in the capacities and on the dates indicated: +/ S / C RAIG D. +G ATES +September 13, 2010 +Craig D. Gates +Date +Director and President and Chief Executive Officer +(Principal Executive Officer) +/ S / R ONALD F. +K LAWITTER +September 13, 2010 +Ronald F. Klawitter +Date +Director and Executive Vice President of Administration, Chief Financial Officer and Treasurer +(Principal Financial Officer) +/ S / B RETT R. +L ARSEN +September 13, 2010 +Brett R. Larsen +Date +Vice President of Finance and Controller +(Principal Accounting Officer) +/ S / J AMES R. +B EAN +September 13, 2010 +James R. Bean, +Date +Director +/ S / D ALE F. +P ILZ +September 13, 2010 +Dale F. Pilz, +Date +Director and Chairman of the Board +/ S / Y ACOV A. +S HAMASH +September 13, 2010 +Yacov A. Shamash, +Date +Director +/ S / P ATRICK +S WEENEY +September 13, 2010 +Patrick Sweeney, +Date +Director +55 \ No newline at end of file diff --git a/raw/filings/0000719733/2010/0001193125-10-209062/filing_metadata.csv b/raw/filings/0000719733/2010/0001193125-10-209062/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..8e3219ca1143ca5a4ef59e5e2e89b9b7113f22dd --- /dev/null +++ b/raw/filings/0000719733/2010/0001193125-10-209062/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000719733,KTCC,KEY TRONIC CORP,10-K,2010-09-13,2010-07-03,2010-09-13T21:16:13.000Z,0001193125-10-209062,d10k.htm,FORM 10-K,1057006,0,0,https://www.sec.gov/Archives/edgar/data/719733/000119312510209062/d10k.htm,https://www.sec.gov/Archives/edgar/data/719733/000119312510209062/,2010,2010,1 diff --git a/raw/filings/0000719733/2010/0001193125-10-209062/item1.txt b/raw/filings/0000719733/2010/0001193125-10-209062/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..c57a8b34ac361036359707f1711deec771be814a --- /dev/null +++ b/raw/filings/0000719733/2010/0001193125-10-209062/item1.txt @@ -0,0 +1,165 @@ +Item 1. +BUSINESS +Background +Key +Tronic Corporation (dba: KeyTronicEMS Co.), was organized in 1969 as a Washington corporation that locally manufactured computer keyboards. The ability to design, build and deliver a quality product led to a reputation in the industry, allowing us +to be a leading independent manufacturer of keyboards for computers in the United States. Our fully integrated design, tooling, and automated manufacturing capabilities enabled us to rapidly respond to customers’ needs for keyboards in +production quantities worldwide. We supported our sales growth through the development and purchase of international manufacturing facilities. As the computer keyboard market matured with increasing competition from other international providers, we +determined that our business could no longer solely rely on keyboard sales. After assessing market conditions and our strengths and capabilities, we shifted focus from keyboard manufacturing to contract manufacturing for a wide range of products. +This strategy was based on our core strengths of innovative design and engineering expertise in electronics, mechanical engineering, and precision plastics combined with high-quality, low cost production, and assembly on an international basis. +These strengths have made our company a strong competitor in the electronic manufacturing services (EMS) market. +Our +Industry and Strategy +The expansion of the EMS industry during the last decade allowed us to continue to expand our customer base and +the industries that we serve. The recent challenging global macroeconomic environment has had a negative impact on previously held customer programs. However, we successfully confronted the challenging global macroeconomic environment by reducing +our costs while winning new customer programs, which allowed us to increase our profitability and strengthen our balance sheet during the global economic downturn. The increase in new programs represents a growing portion of our revenue and a +promising foundation for our future. In keeping with our long-term strategic objectives, we have been successfully building a more diversified customer portfolio and a less concentrated revenue base, spanning a wider range of industries. We +currently offer our customers the following services: integrated electronic and mechanical engineering, precision plastic molding, assembly, component selection, sourcing and procurement, worldwide logistics, and new product testing and production +all at competitive pricing due to our global footprint. +We believe that we are well positioned in the EMS industry to continue the expansion +of our customer base and achieve long term growth. Our core strengths continue to support our growth and our customers’ needs. We continue to focus on controlling operating expenses and leveraging the synergistic capabilities of our world-class +facilities in the United States, Mexico, and China. This international production capability provides our customers with the benefits of improved supply-chain management, reduced inventory, lower labor costs, lower transportation costs, and reduced +product fulfillment time. Given our competitive advantages and the growing need for some potential customers to move forward with their outsourcing strategies, we are strongly positioned to win new business in coming periods and grow our revenue and +profits. +The EMS industry is intensely competitive. Although our customer base is growing we still have less than 1% of the potential global +market and our revenue can fluctuate significantly due to reliance on a concentrated base of customers. We are planning for new customer growth in the coming quarters by securing new programs, increasing our worldwide manufacturing capacity, and +continuing to improve our manufacturing and procurement processes. Ongoing challenges that we face include the following: Continuing to win programs from new and existing customers, balancing production capacity and key personnel in support of new +customer programs, improving operating efficiencies, controlling costs while +4 +Table of Contents +developing competitive pricing strategies, successfully transitioning new program wins to full production and successfully addressing industry-wide shortages in the global supply chain. +Customers and Marketing +We provide a mix of manufacturing services for outsourced Original Equipment Manufacturing (OEM) products. We provide the following EMS services: Product +design, surface mount technologies (SMT) and pin through hole capability for printed circuit board assembly, tool making, precision plastic molding, liquid injection molding, automated tape winding, prototype design and full product builds. +Sales of the majority of our products have historically not been seasonal in nature, but may be seasonal in the future if there are changes +in the types of products manufactured. Sales can, however, fluctuate significantly between quarters from changes in customers and customer demand due to our concentrated customer base. +For the fiscal years ended July 3, 2010, June 27, 2009, and June 28, 2008, the five largest customers in each year accounted for 57%, +52%, and 68% of total sales, respectively. The following customers represented 10% or more of total net sales over the last three fiscal years: KAZ Inc. (18%, less than 10%, less than 10%) International Game Technology, Inc. (12%, 13%, 18%), and +Lexmark International, Inc. (less than 10%, 14%, 15%). It is anticipated that our new customer program wins will dilute our concentration of revenue in the future. +Although keyboard manufacturing is still included in our product offerings, we do not expect annual keyboard sales to be a material component of our +business. We realized revenues of approximately $4.5 million, $4.2 million, and $5.8 million in fiscal years 2010, 2009, and 2008, respectively, from the sale of keyboards. In order to accommodate the demand for standard keyboard layouts, we +maintain a purchase-from-stock program. The more popular standard layouts are built and stocked for immediate availability. Although we are recognized as a reputable contract manufacturer we still market our products and services primarily through +our direct sales department aided by strategically located field sales people and distributors. Although we maintain relationships with several independent sales organizations to assist in marketing our EMS product lines, commissions earned and paid +are not material to the consolidated financial statements. +Manufacturing +We have continually made investments in developing and expanding a capital equipment base to achieve vertical integration and efficiencies in our +manufacturing processes. We have invested significant capital into SMT for volume manufacturing of complex printed circuit board assemblies. We also design and develop tooling for injection molding and manufacture the majority of plastic parts used +in the products we manufacture. Additionally, we have equipment to maintain a controlled clean environment for manufacturing processes that require a high level of precise control. +We use a variety of manual and automated assembly processes in our facilities, depending upon product complexity and degree of customization. Some +examples of automated processes include component insertion, SMT, flexible robotic assembly, automated storage tape winding, computerized vision system quality inspection, automated switch and key top installation, and automated functional testing. +Our engineering expertise and automated manufacturing processes enable us to work closely with our customers during the design and prototype +stages of production and to jointly increase productivity and reduce response time to the marketplace. We use computer-aided design techniques and software to assist in preparation of the tool design layout and component placement, to reduce tooling +and production costs, improve component and product quality, and enhance turnaround time during product development. +We purchase materials +and components for our products from many different suppliers, including both domestic and international sources. We develop close working relationships with our suppliers, many of whom have been supplying products to us for several years. +5 +Table of Contents +Research, Development, and Engineering +Research, development, and engineering (RD&E) expenses consist principally of employee related costs, third party development costs, program materials +costs, depreciation, and allocated information technology and facilities costs. Our RD&E expenses were $2.8 million, $2.3 million, and $2.7 million in fiscal years 2010, 2009, and 2008 respectively. In each of these years, we focused most of our +RD&E efforts on current customer EMS programs. The increase in RD&E in fiscal year 2010 compared to fiscal year 2009 is primarily the result of higher incentive compensation and increased headcount. The decrease in RD&E in fiscal year +2009 compared to fiscal year 2008 is the result of cost reduction efforts and lower incentive and bonus expenses. +Competition +The +market for the products and services we provide is highly competitive. There are numerous competitors in the EMS industry, many of which have substantially more resources and are more geographically diverse than we are. Some of our competitors have +similar international production capabilities, large financial resources and some have substantially greater manufacturing, research and development, and marketing resources. There is also competition from the manufacturing operations of our current +and potential customers, who are continually evaluating the merits of manufacturing their products internally versus the advantages of outsourcing. We believe that we can currently compete favorably to these factors primarily on the basis of our +international footprint, responsiveness, creativity, vertical production capability, quality, and cost. +Trademarks and +Patents +Our name and logo are federally registered trademarks, and we believe they are valuable assets of our business. During 2001, +we began operating under the trade name “KeyTronicEMS Co.” to better identify our primary business concentration. We also own several keyboard patents; however, since our focus is EMS, management believes that these patents will not have a +significant impact on future revenues. +Employees +We consider our employees to be our primary strength and we make considerable efforts to maintain a well-qualified workforce. Our employee benefits +include bonus programs involving periodic payments to all employees based on meeting quarterly or fiscal year performance targets. We regularly provide transportation, medical services, and meals to all of our employees in foreign locations. We +maintain a 401(k) plan for U.S. employees, which provides a discretionary matching company contribution of up to 4% of an employee’s salary. We provide group health, life, and disability insurance plans. We also maintain stock option plans and +other long term incentive plans for certain employees and outside directors. As of July 3, 2010 we had 2,036 employees compared to 1,963 on June 27, 2009, and 2,502 on June 28, 2008. Since we can have significant fluctuations in +product demand, we seek to maintain flexibility in our workforce by utilizing skilled temporary and short-term contract labor in our manufacturing facilities in addition to full-time employees. Our employees in Reynosa, Mexico, are represented by a +local union. We have no history of any material interruption of production due to labor disputes. We anticipate that this particular subsidiary will cease its operations during fiscal year 2011. As a result, we will no longer retain employees in +Reynosa, Mexico. +Backlog +On July 31, 2010 our order backlog was valued at approximately $56.9 million, compared to approximately $29.9 million on July 25, 2009, which +reflects an increase in expected revenue during fiscal year 2011. Even though our order backlog is comprised of firm purchase orders, the amount of backlog is not necessarily indicative of future sales but can be indicative of trends in expected +future sales revenue. Due to the relationships with our customers, we will occasionally allow orders to be canceled or rescheduled and as a result is not a meaningful indicator of future financial results. If there are canceled or rescheduled +orders, we will attempt to negotiate fees to cover the costs we have incurred. Order backlog consists of +6 +Table of Contents +purchase orders received for products expected to be shipped approximately within the next twelve months, although shipment dates are subject to change due to design modifications, customer +forecast changes, or other customer requirements. +Foreign Markets +Information concerning net sales and long-lived assets (property, plant, and equipment) by geographic areas is set forth in footnote 12 of the +consolidated financial statements of this Annual Report on Form 10-K, under the caption “Enterprise-Wide Disclosures”, and that information is incorporated herein. +Executive Officers of the Registrant +The table below sets forth the name, current age and current position of our executive officers and other significant employees as of July 3, 2010: +Name +Age +Positions Held +Executive Officers +Craig D. Gates +51 +President and Chief Executive Officer +Ronald F. Klawitter +58 +Executive Vice President of Administration, Chief Financial Officer and Treasurer +Douglas G. Burkhardt +52 +Executive Vice President of Worldwide Operations +Lawrence J. Bostwick +58 +Vice President of Engineering and Quality +Phil Hochberg +48 +Vice President of Business Development +Brett R. Larsen +37 +Vice President of Finance, and Controller +Don Sinclair* +57 +Vice President of Materials +* +Subsequent to July 3, 2010, Mr. Sinclair announced his resignation with the Company effective August 31, 2010. +Executive Officers +CRAIG D. GATES – President and Chief Executive Officer +Mr. Gates, age 51, has been President and Chief Executive officer of the Company since April 2009. Previously he was Executive Vice President and +General Manager from August 2002 to April 2009. He served as Executive Vice President of Marketing, Engineering and Sales from July 1997 to August 2002 and served as Vice President and General Manager of New Business Development from October 1995 to +July 1997. He joined the Company as Vice President of Engineering in October of 1994. From 1982 he held various engineering and management positions within the Microswitch Division of Honeywell, Inc., in Freeport, Illinois, and from 1991 to October +1994 he served as Director of Operations, Electronics for Microswitch. Mr. Gates has a Bachelor of Science Degree in Mechanical Engineering and a Masters in Business Administration from the University of Illinois, Urbana. +RONALD F. KLAWITTER – Executive Vice President of Administration, Chief Financial Officer, and Treasurer +Mr. Klawitter, age 58, has been Executive Vice President of Administration, CFO, and Treasurer since July 1997. Previously he was Vice President of +Finance, Secretary, and Treasurer of the Company from October 1995 to July 1997. He was Acting Secretary from November 1994 to October 1995 and Vice President of Finance and Treasurer from 1992 to October 1995. From 1987 to 1992, Mr. Klawitter +was Vice President of Finance at Baker Hughes Tubular Service, a subsidiary of Baker Hughes, Inc. Mr. Klawitter has a BA degree from Wittenberg University and is a Certified Public Accountant. +7 +Table of Contents +DOUGLAS G. BURKHARDT – Executive Vice President of Worldwide Operations +Mr. Burkhardt, age 52, has been Executive Vice President of Worldwide Operations of the company since July 22, 2010. Previously +Mr. Burkhardt was Vice President of Worldwide Operations from July 2008 to July 2010 and Director of China Operations and Program Management from January 2006 to July 2008. Mr. Burkhardt also served as Director of Northwest and China +Operations from November of 1998 to January of 2006. Mr. Burkhardt also served as Director of Customer Satisfaction from March 1997 to November 1998 and Director of Molding from September of 1995 to March of 1997. Prior to this, +Mr. Burkhardt served in other various senior management positions within the company. Mr. Burkhardt has been with the company since May of 1989. Prior to joining Key Tronic, Mr. Burkhardt worked for House of Aluminum and Glass for 12 +years where he was the plant manager. +LAWRENCE J. BOSTWICK – Vice President of Engineering and Quality +Mr. Bostwick, age 58, has been Vice President of Engineering and Quality since July 2008. Previously he was Director of Engineering and Quality from +February 2007 to July 2008 and served as Corporate Director of Quality from February 2006 to February 2007. From 2003 to 2006 he was Director of Supply Chain Management and Quality for the Lancer Corporation and from 1998 to 2003 he was Vice +President of Operations for Thermacore International. He is a graduate of the Westinghouse and General Electric – Engineering and Manufacturing Professional Development Programs. He is certified in both Quality and Industrial Engineering and is +a Lean – Six Sigma Master Black Belt. Mr. Bostwick has a combined B.S. degree in Production and Operation and Industrial Engineering from Bowling Green State University and a Masters degree in Industrial Engineering and Business +Administration from Syracuse University. +PHIL HOCHBERG – Vice President of Business Development +Mr. Hochberg, age 48, has been Vice President of Business Development since October 2009. Previously he was Director of Business Development and +Program Management from July 2008 to October 2009. Mr. Hochberg served as Director of Business Development from October 2004 to July 2008 and as Director of EMS Sales and Marketing from July 2000 to October 2004. Prior to joining Key Tronic, +Mr. Hochberg worked for Quinton Instrument Company as their Director of Marketing and Product Management from 1992 to 2000. From 1988 to 1992, he was employed by SpaceLabs Medical as their Business Development Marketing Manager. +Mr. Hochberg has an MBA from the University of British Columbia, a BA Psychology, with a minor in Business from Washington University in St. Louis. +BRETT R. LARSEN – Vice President of Finance, and Controller +Mr. Larsen, age 37, has served as Vice President of Finance and Controller since February 2010. He was Chief Financial Officer of FLSmidth Spokane, +Inc. from December 2008 to February 22, 2010. From October 2005 through November 2008, Mr. Larsen served as Controller of Key Tronic Corporation. From May 2004 to October 2005, Mr. Larsen served as Manager of Financial Reporting of +Key Tronic Corporation. From 2002 to May 2004, Mr. Larsen was an audit manager for the public accounting firm BDO Seidman, LLP. He also held various auditing and supervisory positions with Grant Thornton LLP from 1997 to 2002. Mr. Larsen +has a Bachelor of Science degree in Accounting and a Masters degree in Accounting from Brigham Young University and is a Certified Public Accountant. +DON SINCLAIR – Vice President of Material +Mr. Sinclair, age 57, has served as the Vice President of Materials since January 2010. Prior to joining Key Tronic, Mr. Sinclair was employed +by Advanced Input Systems Division of Esterline Corporation, where he held various positions such as: Director of Materials, Managing Director – Offshore Operations, and Vice President of Business Development from 1998 to 2009. Prior to 1998, +Mr. Sinclair held management positions at companies including Intermec Technologies, Honeywell and Westinghouse. Mr. Sinclair has a Bachelor of Science Degree in Business from Washington State University. +8 +Table of Contents +Available Information +Our principal executive offices are located at N. 4424 Sullivan Road, Spokane Valley, Washington 99216, and our telephone number is (509) 928-8000. +Our website is located at http://www.keytronicems.com where filings of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q or current reports on Form 8-K are available after they have been filed with the Securities and Exchange +Commission. The information presented on our website currently and in the future is not considered to be part of this document or any document incorporated by reference in this document. \ No newline at end of file diff --git a/raw/filings/0000719733/2010/0001193125-10-209062/item13.txt b/raw/filings/0000719733/2010/0001193125-10-209062/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..72fe5e88513157319f206eaa919ed7a834a09ad3 --- /dev/null +++ b/raw/filings/0000719733/2010/0001193125-10-209062/item13.txt @@ -0,0 +1,4 @@ +Item 13: +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Information appearing under the caption “Related Person Transactions”, “Compensation Committee Interlocks and Insider Participation”, +and “Directors’ Independence” in the Company’s 2010 Proxy Statement is incorporated herein by this reference. \ No newline at end of file diff --git a/raw/filings/0000719733/2010/0001193125-10-209062/item9a.txt b/raw/filings/0000719733/2010/0001193125-10-209062/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..3bfe835477fb9fb28e0349cbd6205f809ebf990e --- /dev/null +++ b/raw/filings/0000719733/2010/0001193125-10-209062/item9a.txt @@ -0,0 +1,27 @@ +Item 9A (T): CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +It is the responsibility of our management to establish, maintain, and monitor disclosure controls and procedures that are designed to ensure that +information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission rules and +forms. Additionally, these disclosure controls include controls and procedures that are designed to accumulate and communicate the information required to be disclosed to our company’s Chief Executive Officer and Chief +46 +Table of Contents +Financial Officer, allowing for timely decisions regarding required disclosures. As of the end of the period covered by this report, our management carried out an evaluation, under the +supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(f). Based on our +assessment, we believe that as of July 3, 2010, the Company’s disclosure controls and procedures are effective based on that criteria. +Management’s Report on Internal Control over Financial Reporting +Our management has the responsibility to establish and maintain adequate internal controls over our financial reporting, as defined in Rule 13a-15(f) +under the Securities and Exchange Act of 1934. Our internal controls are designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our external financial statements in accordance with +generally accepted accounting principles (GAAP). +Due to inherent limitations of any internal control system, management acknowledges that +there are limitations as to the effectiveness of internal controls over financial reporting and therefore recognize that only reasonable assurance can be gained from any internal control system. Accordingly, our internal control system may not +detect or prevent material misstatements in our financial statements and projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the +degree of compliance with the policies or procedures may deteriorate. +Under the supervision and participation of management, including the +Chief Executive Officer and Chief Financial Officer, we have performed an assessment of the effectiveness of our internal controls over financial reporting as of July 3, 2010. This assessment was based on the criteria established in Internal +Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we believe that as of July 3, 2010, the Company’s internal control over financial reporting is effective +based on that criteria. +This annual report does not include an attestation report of our registered public accounting firm regarding internal +control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this annual report. +Changes in Internal Control over Financial Reporting +There have been no significant changes in our internal controls over financial reporting during our fourth fiscal quarter ended July 3, 2010 that +have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)). \ No newline at end of file diff --git a/raw/filings/0000719733/2010/0001193125-10-209062/rp_note.txt b/raw/filings/0000719733/2010/0001193125-10-209062/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000719733/2010/0001193125-10-209062/rpt_disclosure.txt b/raw/filings/0000719733/2010/0001193125-10-209062/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..185707fef51fee3375c6504c46088d4ef0f2d091 --- /dev/null +++ b/raw/filings/0000719733/2010/0001193125-10-209062/rpt_disclosure.txt @@ -0,0 +1,13 @@ +Related Person Transactions +In April 2007, the Board of Directors adopted a written policy and procedures for the approval or ratification of Interested Transactions with Related +Parties. The policy and procedures supplement the Company’s Code of Conduct. The policy defines an “Interested Transaction” as any transaction, arrangement or relationship or series of similar transactions, arrangements or +relationships (including any indebtedness or guarantee of indebtedness) in which (1) the aggregate amount involved will or may be expected to exceed $120,000 in any calendar year, (2) the Company is a participant, and (3) any Related +Party has or will have a direct or indirect interest (other than solely as a result of being a director or a less than 10 percent beneficial owner of another entity). +The policy defines a “Related Party” as any (a) person who is or was (since the beginning of the last fiscal year for which the Company +has filed a Form 10-K and proxy statement, even if they do not presently serve in that role) an executive officer, director or nominee for election as a director, (b) greater than 5 percent beneficial owner of the Company’s common stock, +or (c) immediate family member of any of the foregoing. Immediate family member includes a person’s spouse, parents, stepparents, children, stepchildren, siblings, mothers- and fathers-in-law, sons- and daughters-in-law, and brothers- and +sisters-in-law and anyone residing in such person’s home (other than a tenant or employee). +The Audit Committee is responsible for +review, approval, ratification or disapproval of Interested Transactions. In determining whether to approve or ratify an Interested Transaction, the Committee will take into account, among other factors it deems appropriate, whether the Interested +Transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the Related Party’s interest in the Transaction. +6 \ No newline at end of file diff --git a/raw/filings/0000719733/2011/0001193125-11-245992/filing.txt b/raw/filings/0000719733/2011/0001193125-11-245992/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..1df3e0bf15a83dc1cbb54ea889511a6ca9640225 --- /dev/null +++ b/raw/filings/0000719733/2011/0001193125-11-245992/filing.txt @@ -0,0 +1,3770 @@ +10-K +1 +d224529d10k.htm +FORM 10-K +Form 10-K +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended July 2, 2011 +OR +¨ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission File Number 0-11559 +KEY TRONIC +CORPORATION +(Exact name of registrant as specified in its charter) +Washington +91-0849125 +(State or other jurisdiction of +Incorporation or organization) +(I.R.S. Employer +Identification No.) +N. 4424 Sullivan Road, Spokane Valley, +Washington +99216 +(Address of principal executive offices) +(Zip Code) +(509) 928-8000 +(Registrant’s telephone number, including area code) +N/A +(Former name, former address and former fiscal year, if changed since last report) +Securities Registered Pursuant to Section 12(b) of the Act: None +Title of each class +Name of each exchange on which registered +Common stock, no par value +The NASDAQ Stock Market LLC +Securities Registered Pursuant to Section 12(g) of the Act: +None +Indicate by +check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x +Indicate by check mark if the registrant is not required to file reports pursuant +to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the +Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 +days. Yes x No ¨ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every +Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such +files). Yes ¨ No ¨ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will +not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form +10-K. x +Indicate by check mark whether the registrant is a large +accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the +Exchange Act. +(Check one): +Large accelerated filer +¨ +Accelerated filer +¨ +Non-accelerated filer +¨ (Do not check if a smaller reporting company) +Smaller reporting company +x +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the +Exchange Act). Yes ¨ No x +State the aggregate market value of the voting and non-voting common equity held by non affiliates computed by reference to the price at +which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. +As of January 1, 2011, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was +$52.6 million based on the closing price as reported on the NASDAQ. +Indicate the number of shares outstanding of each of the +issuer’s classes of common stock, as of the latest practicable date: 10,439,187 shares of common stock were outstanding as of September 7, 2011. +Documents +Incorporated by Reference: +The following documents are incorporated by reference to the extent specified herein: +Document Description +Part of Form 10-K +Proxy Statement dated September 23, 2011 +Part III +Table of Contents +KEY TRONIC CORPORATION +2011 FORM 10-K +TABLE OF CONTENTS +Page +Part I +Item 1. +Business +3 - 7 +Item 1A. +Risk Factors +7 - 11 +Item 1B. +Unresolved Staff Comments +12 +Item 2. +Properties +12 +Item 3. +Legal Proceedings +13 +Item 4. +Reserved +13 +Part II +Item 5. +Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities +13 - 14 +Item 6. +Selected Financial Data +15 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +16 - 27 +Item 7A. +Quantitative and Qualitative Disclosures about Market Risk +27 +Item 8. +Financial Statements and Supplementary Data +28 - 50 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +50 +Item 9A. +Controls and Procedures +50 - 51 +Item 9B. +Other Information +51 +Part III +Item 10. +Directors, Executive Officers and Corporate Governance +51 +Item 11. +Executive Compensation +51 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +52 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +52 +Item 14. +Principal Accounting Fees and Services +52 +Part IV +Item 15. +Exhibits and Financial Statement Schedule +53 - 57 +Signatures +58 - 59 +FORWARD-LOOKING STATEMENTS +References in this report to “the Company”, “Key Tronic”, “we”, “our”, or “us” mean Key Tronic Corporation together with its subsidiaries, except where +the context otherwise requires. +This Annual Report on Form 10-K contains forward-looking statements in addition to historical +information. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Risks and uncertainties that might cause such +differences include, but are not limited to those outlined in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risks and Uncertainties that May Affect Future Results.” Readers are cautioned +not to place undue reliance on forward-looking statements, which reflect management’s opinions only as of the date hereof. The Company undertakes no obligation to update forward-looking statements to reflect developments or information obtained +after the date hereof and disclaims any obligation to do so. Readers should carefully review the risk factors described in periodic reports the Company files from time to time with the Securities and Exchange Commission, including Quarterly Reports +on Form 10-Q and Current Reports on Form 8-K. +2 +Table of Contents +PART I +Item 1. +BUSINESS +Background +Key Tronic Corporation (dba: KeyTronicEMS Co.), was organized in 1969 as a Washington corporation that locally manufactured computer keyboards. The +ability to design, build and deliver a quality product led us to become a leading independent manufacturer of keyboards for computers in the United States. Our fully integrated design, tooling, and automated manufacturing capabilities enabled us to +rapidly respond to customers’ needs for keyboards in production quantities worldwide. We supported our sales growth through the development and purchase of international manufacturing facilities. As the computer keyboard market matured with +increasing competition from other international providers, we determined that our business could no longer solely rely on keyboard sales. +After assessing market conditions and our strengths and capabilities, we shifted focus from keyboard manufacturing to contract manufacturing for a wide +range of products. Our unique strategic attributes are based on our core strengths of innovative design and engineering expertise in electronics, mechanical engineering, and precision plastics combined with high-quality, low cost production, and +assembly on an international basis while providing exceptional customer service. These strengths have made our company a strong competitor in the electronic manufacturing services (EMS) market. +Our Industry and Strategy +The expansion +of the EMS industry during the last decade allowed us to continue to expand our customer base and the industries that we serve. The challenging global macroeconomic environment has had a negative impact on previously held customer programs. However, +we successfully confronted the challenging global macroeconomic environment by controlling our costs while winning new customer programs, which allowed us to maintain our profitability and maintain a strong balance sheet during the global economic +downturn. The increase in new programs represents a growing portion of our revenue and a promising foundation for our future. In keeping with our long-term strategic objectives, we have been successfully building a more diversified customer +portfolio, spanning a wider range of industries. We currently offer our customers the following services: integrated electronic and mechanical engineering, precision plastic molding, assembly, component selection, sourcing and procurement, worldwide +logistics, and new product testing and production all at competitive pricing due to our global footprint. +We believe that we are well +positioned in the EMS industry to continue the expansion of our customer base and achieve long term growth. Our unique blend of multinational facilities, centralized management, and core strengths continue to support our growth and our +customers’ needs. We continue to focus on controlling operating expenses and leveraging the synergistic capabilities of our world-class facilities in the United States, Mexico, and China. This international production capability provides our +customers with the benefits of improved supply-chain management, reduced inventory, lower labor costs, lower transportation costs, and reduced product fulfillment time. Given our competitive advantages and the growing need for some potential +customers to move forward with their outsourcing strategies, we are strongly positioned to win new business in coming periods and grow our revenue and profits. +The EMS industry is intensely competitive. Although our customer base is growing we still have less than 1% of the potential global market and our revenue can fluctuate significantly due to reliance on a +concentrated base of customers. We are planning for new customer growth in the coming quarters by securing new programs, increasing our worldwide manufacturing capacity, and continuing to improve our manufacturing and procurement processes. Ongoing +challenges that we face include the following: Continuing to win programs from new and existing customers, balancing production capacity and key personnel in support of new customer programs, improving operating efficiencies, controlling costs while +developing competitive pricing strategies, and successfully transitioning new program wins to full production during a time of macroeconomic uncertainty. +3 +Table of Contents +Customers and Marketing +We provide a mix of manufacturing services for outsourced Original Equipment Manufacturing (OEM) products. We provide the following EMS services: Product design, surface mount technologies (SMT) and pin +through hole capability for printed circuit board assembly, tool making, precision plastic molding, liquid injection molding, automated tape winding, prototype design and full product assembly. +Sales of the majority of our products have historically not been seasonal in nature, but may be seasonal in the future if there are changes in the types +of products manufactured. Sales can, however, fluctuate significantly between quarters from changes in customers and customer demand due to our concentrated customer base. +For the fiscal years ended July 2, 2011, July 3, 2010, and June 27, 2009, the five largest customers in each year accounted for 62%, 57%, and 52% of total net sales, respectively. At the +end of fiscal year 2011, we were generating revenue from 30 EMS customers as compared with 20 at the end of fiscal year 2010. New customer program wins would dilute our concentration of revenue in the future. +The following table represents all customers that represented 10% or more of total net sales during the last three fiscal years: +Percentage of Net Sales by +Fiscal Year +2011 +2010 +2009 +Customer A +16 +% +12 +% +13 +% +Customer B +16 +% +18 +% +* +Customer C +15 +% +* +* +Customer D +* +10 +% +* +Customer E +* +* +14 +% +* +Amount was less than 10% of total. +Although +keyboard manufacturing is still included in our product offerings, we do not expect annual keyboard sales to be a material component of our business. We realized revenues of approximately $3.9 million, $4.5 million, and $4.2 million in fiscal years +2011, 2010, and 2009, respectively, from the sale of keyboards. In order to accommodate the demand for standard keyboard layouts, we maintain a purchase-from-stock program. The more popular standard layouts are built and stocked for immediate +availability. +We market our products and services primarily through our direct sales department aided by strategically located field sales +people and distributors. Although we maintain relationships with several independent sales organizations to assist in marketing our EMS product lines, commissions earned and paid are not material to the consolidated financial statements. +Manufacturing +We have continually made +investments in developing and expanding a capital equipment base to achieve vertical integration and efficiencies in our manufacturing processes. We have invested significant capital into SMT for volume manufacturing of complex printed circuit board +assemblies. We also design and develop tooling for injection molding and manufacture the majority of plastic parts used in the products we manufacture. Additionally, we have equipment to maintain a controlled clean environment for manufacturing +processes that require a high level of precise control. +We use a variety of manual and automated assembly processes in our facilities, +depending upon product complexity and degree of customization. Some examples of automated processes include component insertion, SMT, flexible robotic assembly, automated storage tape winding, computerized vision system quality inspection, automated +switch and key top installation, and automated functional testing. +Our engineering expertise and automated manufacturing processes enable us +to work closely with our customers during the design and prototype stages of production and to jointly increase productivity and reduce response time to the marketplace. We use computer-aided design techniques and software to assist +4 +Table of Contents +in preparation of the tool design layout and component placement, to reduce tooling and production costs, improve component and product quality, and enhance turnaround time during product +development. +We purchase materials and components for our products from many different suppliers, including both domestic and international +sources. We develop close working relationships with our suppliers, many of whom have been supplying products to us for several years. +Research, Development, and Engineering +As part of our long-term strategy, we are committed to supporting our customers by providing research, development, and engineering services. These +services allow us to facilitate in optimizing new product designs, and the production processes of our customers programs. +Research, +development, and engineering (RD&E) expenses consist principally of employee related costs, third party development costs, program materials costs, depreciation, and allocated information technology and facilities costs. Our RD&E expenses +were $3.8 million, $2.8 million, and $2.3 million in fiscal years 2011, 2010, and 2009, respectively. In each of these years, we focused most of our RD&E efforts on current customer EMS programs. The increase in RD&E in fiscal years 2011 and +2010 as compared to their respective prior fiscal year periods is primarily the result of increased headcount and to a lesser extent higher incentive compensation. +Competition +The market for the products and services we provide is highly competitive. +There are numerous competitors in the EMS industry, many of which have substantially more resources and are more geographically diverse than we are. Some of our competitors have similar international production capabilities, large financial +resources and some have substantially greater manufacturing, research and development, and marketing resources. There is also competition from the manufacturing operations of our current and potential customers, who are continually evaluating the +merits of manufacturing their products internally versus the advantages of outsourcing. We believe that we can currently compete favorably in these areas primarily on the basis of our international footprint, responsiveness, creativity, vertical +production capability, quality, and cost. +Trademarks and Patents +Our name and logo are federally registered trademarks, and we believe they are valuable assets of our business. During 2001, we began operating under the trade name “KeyTronicEMS Co.” to better +identify our primary business concentration. We also own several keyboard patents; however, since our focus is EMS, management believes that these patents will not have a significant impact on future revenues. +Employees +We consider our employees to +be our primary strength and we make considerable efforts to maintain a well-qualified workforce. Our employee benefits include bonus programs involving periodic payments to all employees based on meeting quarterly or fiscal year performance targets. +We regularly provide transportation, medical services, and meals to all of our employees in foreign locations. We maintain a 401(k) plan for U.S. employees, which provides a discretionary matching company contribution of up to 4% of an +employee’s salary. We provide group health, life, and disability insurance plans. We also maintain stock option plans and other long term incentive plans for certain employees and outside directors. +As of July 2, 2011 we had 1,997 employees compared to 2,036 on July 3, 2010, and 1,963 on June 27, 2009. Since we can have significant +fluctuations in product demand, we seek to maintain flexibility in our workforce by utilizing skilled temporary and short-term contract labor in our manufacturing facilities in addition to full-time employees. +Backlog +On July 30, 2011 our order +backlog was valued at approximately $54.9 million, compared to approximately $56.9 million on July 31, 2010. Even though our order backlog is comprised of firm purchase orders, the amount of backlog is not necessarily indicative of future sales +but can be indicative of trends in expected future sales revenue. Due to the relationships with our customers, we will occasionally allow orders to be canceled or rescheduled and as a result it is not a meaningful indicator of future financial +results. If there +5 +Table of Contents +are canceled or rescheduled orders, we will attempt to negotiate fees to cover the costs we have incurred. Order backlog consists of purchase orders received for products expected to be shipped +approximately within the next twelve months, although shipment dates are subject to change due to design modifications, customer forecast changes, or other customer requirements. +Foreign Markets +Information concerning net sales and long-lived assets (property, plant, +and equipment) by geographic areas is set forth in Note 12, “Enterprise-Wide Disclosures” of the consolidated financial statements of this Annual Report on Form 10-K and that information is incorporated herein. +Executive Officers of the Registrant +The table below sets forth the name, current age and current position of our executive officers and other significant employees as of July 2, 2011: +Name +Age +Positions Held +Executive Officers +Craig D. Gates +52 +President and Chief Executive Officer +Ronald F. Klawitter +59 +Executive Vice President of Administration, Chief Financial +Officer and Treasurer +Douglas G. Burkhardt +53 +Executive Vice President of Worldwide Operations +Lawrence J. Bostwick +59 +Vice President of Engineering and Quality +Phil S. Hochberg +49 +Vice President of Business Development +Brett R. Larsen +38 +Vice President of Finance, and Controller +Executive Officers +CRAIG D. GATES – President and Chief Executive Officer +Mr. Gates, age 52, has +been President and Chief Executive officer of the Company since April 2009. Previously he was Executive Vice President and General Manager from August 2002 to April 2009. He served as Executive Vice President of Marketing, Engineering and Sales from +July 1997 to August 2002 and served as Vice President and General Manager of New Business Development from October 1995 to July 1997. He joined the Company as Vice President of Engineering in October of 1994. From 1982 he held various engineering +and management positions within the Microswitch Division of Honeywell, Inc., in Freeport, Illinois, and from 1991 to October 1994 he served as Director of Operations, Electronics for Microswitch. Mr. Gates has a Bachelor of Science Degree in +Mechanical Engineering and a Masters in Business Administration from the University of Illinois, Urbana. +RONALD F. KLAWITTER – +Executive Vice President of Administration, Chief Financial Officer, and Treasurer +Mr. Klawitter, age 59, has been Executive Vice +President of Administration, CFO, and Treasurer since July 1997. Previously he was Vice President of Finance, Secretary, and Treasurer of the Company from October 1995 to July 1997. He was Acting Secretary from November 1994 to October 1995 and Vice +President of Finance and Treasurer from 1992 to October 1995. From 1987 to 1992, Mr. Klawitter was Vice President of Finance at Baker Hughes Tubular Service, a subsidiary of Baker Hughes, Inc. Mr. Klawitter has a BA degree from Wittenberg +University and is a Certified Public Accountant. +6 +Table of Contents +DOUGLAS G. BURKHARDT – Executive Vice President of Worldwide Operations +Mr. Burkhardt, age 53, has been Executive Vice President of Worldwide Operations of the Company since +July 22, 2010. Previously Mr. Burkhardt was Vice President of Worldwide Operations from July 2008 to July 2010 and Director of China Operations +and Program Management from January 2006 to July 2008. Mr. Burkhardt also served as Director of Northwest and China Operations from November of 1998 to January of 2006. Mr. Burkhardt also served as Director of Customer Satisfaction from +March 1997 to November 1998 and Director of Molding from September of 1995 to March of 1997. Prior to this, Mr. Burkhardt served in other various senior management positions within the Company. Mr. Burkhardt has been with the Company since +May of 1989. Prior to joining Key Tronic, Mr. Burkhardt worked for House of Aluminum and Glass for 12 years where he was the plant manager. +LAWRENCE J. BOSTWICK – Vice President of Engineering and Quality +Mr. Bostwick, +age 59, has been Vice President of Engineering and Quality since July 2008. Previously he was Director of Engineering and Quality from February 2007 to July 2008 and served as Corporate Director of Quality from February 2006 to February 2007. From +2003 to 2006 he was Director of Supply Chain Management and Quality for the Lancer Corporation and from 1998 to 2003 he was Vice President of Operations for Thermacore International. He is a graduate of the Westinghouse and General Electric – +Engineering and Manufacturing Professional Development Programs. He is certified in both Quality and Industrial Engineering and is a Lean – Six Sigma Master Black Belt. Mr. Bostwick has a combined B.S. degree in Production and Operation +and Industrial Engineering from Bowling Green State University and a Masters degree in Industrial Engineering and Business Administration from Syracuse University. +PHIL S. HOCHBERG – Vice President of Business Development +Mr. Hochberg, age 49, +has been Vice President of Business Development since October 2009. Previously he was Director of Business Development and Program Management from July 2008 to October 2009. Mr. Hochberg served as Director of Business Development from October +2004 to July 2008 and as Director of EMS Sales and Marketing from July 2000 to October 2004. Prior to joining Key Tronic, Mr. Hochberg worked for Quinton Instrument Company as their Director of Marketing and Product Management from 1992 to +2000. From 1988 to 1992, he was employed by SpaceLabs Medical as their Business Development Marketing Manager. Mr. Hochberg has an MBA from the University of British Columbia, a BA Psychology, with a minor in Business from Washington University +in St. Louis. +BRETT R. LARSEN – Vice President of Finance, and Controller +Mr. Larsen, age 38, has served as Vice President of Finance and Controller since February 2010. He was Chief Financial Officer of FLSmidth Spokane, +Inc. from December 2008 to February 22, 2010. From October 2005 through November 2008, Mr. Larsen served as Controller of Key Tronic Corporation. From May 2004 to October 2005, Mr. Larsen served as Manager of Financial Reporting of +Key Tronic Corporation. From 2002 to May 2004, Mr. Larsen was an audit manager for the public accounting firm BDO Seidman, LLP. He also held various auditing and supervisory positions with Grant Thornton LLP from 1997 to 2002. Mr. Larsen +has a Bachelor of Science degree in Accounting and a Masters degree in Accounting from Brigham Young University and is a Certified Public Accountant. +Available Information +Our principal executive offices are located at N. 4424 Sullivan +Road, Spokane Valley, Washington 99216, and our telephone number is (509) 928-8000. Our website is located at http://www.keytronicems.com where filings of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q or current reports on Form +8-K are available after they have been filed with the Securities and Exchange Commission. The information presented on our website currently and in the future is not considered to be part of this document or any document incorporated by reference in +this document. +Item 1A. +RISK FACTORS +There are risks and +uncertainties that could affect our business. These risks and uncertainties include but are not limited to, the risk factors described below, in Item 7A: “Quantitative and Qualitative Disclosures about Market Risk” and elsewhere in +this Form 10-K. +7 +Table of Contents +RISKS AND UNCERTAINTIES THAT COULD AFFECT FUTURE RESULTS +The following risks and uncertainties could affect our actual results and could cause results to differ materially from past results or those +contemplated by our forward-looking statements. When used herein, the words “expects”, “believes”, “anticipates” and similar expressions are intended to identify forward-looking statements. +Potential Fluctuations in Quarterly Results of Operations +Our quarterly operating results have varied in the past and may vary in the future due to a variety of factors, including adverse changes in the U.S. and global macroeconomic environment, volatility in +overall demand for our customers’ products, success of customers’ programs, timing of new programs, new product introductions or technological advances by us, our customers and our competitors, and changes in pricing policies by us, our +customers, our suppliers, and our competitors. Our customer base is diverse in the markets they serve, however, decreases in demand, particularly from customers that supply the banking, consumer products, and gambling industries, could affect future +quarterly results. Additionally, our customers could be impacted by the illiquidity of the credit markets which could directly impact our operating results. +Component procurement, production schedules, personnel and other resource requirements are based on estimates of customer requirements. Occasionally, our customers may request accelerated production that +can stress resources and reduce operating margins. In addition, because many of our operating expenses are relatively fixed, a reduction in customer demand can harm our gross profit and operating results. The products which we manufacture for our +customers have relatively short product lifecycles. Therefore, our business, operating results and financial condition are dependent in a significant way on our ability to obtain orders from new customers and new product programs from existing +customers. +Operating results can also fluctuate if changes are made to significant estimates and assumptions. Significant estimates and +assumptions include the allowance for doubtful receivables, provision for obsolete and non-saleable inventory, stock-based compensation, the valuation allowance on deferred tax assets, impairment of long-lived assets, long-term incentive +compensation accrual, and the provision for warranty costs. +Economic Conditions +Recently there have been adverse conditions and uncertainty in the global economy as the result of unstable global financial and credit markets, +inflation, and recession. These unfavorable economic conditions and the weakness of the credit market could affect the demand for our customers’ products. The current global macroeconomic environment may affect some of our customers that could +reduce orders and change forecasts which could adversely affect our sales in future periods. Additionally, the financial strength of our customers and suppliers and their ability to obtain and rely on credit financing may affect their ability to +fulfill their obligations to us and have an adverse affect on our financial results. +Credit Markets +The current illiquidity and financial instability in the credit markets could adversely impact lenders and potentially limit the ability of our suppliers +and customers to borrow. This may affect their ability to fulfill their obligations to us and have an adverse effect on our financial results. +Dependence on Suppliers +We are +dependent on many suppliers, including sole source suppliers, to provide key components and raw materials used in manufacturing customers’ products. We have seen supply shortages in certain electronic components. This can result in longer +lead times and the inability to meet our customers request for flexible production and extended shipment dates. Additionally, force majeure issues in Japan have caused supply constraints from some suppliers. If demand for components outpaces +supply, capacity delays could affect future operations. Delays in deliveries from suppliers or the inability to obtain sufficient quantities of components and raw materials could cause delays or reductions in shipment of products to our +customers which could adversely affect our operating results and damage customer relationships. +8 +Table of Contents +Concentration of Credit Risk +Cash and cash equivalents are exposed to concentrations of credit risk. We place our cash with high credit quality institutions. At times, such balances may be in excess of the federal depository +insurance limit or may be on deposit at institutions which are not covered by insurance. If such institutions were to become insolvent during which time it held our cash and cash equivalents in excess of the insurance limit, it could be necessary to +obtain other credit financing to operate our facilities. +Competition +The EMS industry is intensely competitive. Competitors may offer customers lower prices on certain high volume programs. This could result in price reductions, reduced margins and loss of market share, +all of which would materially and adversely affect our business, operating results, and financial condition. If we were unable to provide comparable or better manufacturing services at a lower cost than our competitors, it could cause sales to +decline. In addition, competitors can copy our non-proprietary designs after we have invested in development of products for customers, thereby enabling such competitors to offer lower prices on such products due to savings in development costs. +Concentration of Major Customers +At present, our customer base is concentrated and could become more or less concentrated. There can be no assurance that our principal customers will continue to purchase products from us at current +levels. Moreover, we typically do not enter into long-term volume purchase contracts with our customers, and our customers have certain rights to extend or delay the shipment of their orders. We, however, require that our customers contractually +agree to buy back inventory purchased within specified lead times to build their products if not used. +The loss of one or more of our major +customers, or the reduction, delay or cancellation of orders from such customers, due to economic conditions or other forces, could materially and adversely affect our business, operating results and financial condition. Specifically, some of our +major customers provide products to the banking and gambling industries which have been adversely affected by the unfavorable economic environment. The contraction in demand from our customers in these industries could continue to impact our +customer orders and continue to have a negative impact on our operations over the foreseeable future. Additionally, if one or more of our customers were to become insolvent or otherwise unable to pay for the manufacturing services provided by us, +our operating results and financial condition would be adversely affected. +Foreign Manufacturing Operations and Currencies +Most of the products manufactured by us are produced at our facilities located in Mexico and China. These international operations may be subject to a +number of risks, including: +• +difficulties in staffing and managing foreign operations; +• +political and economic instability (including acts of terrorism, civil unrest, forms of violence and outbreaks of war), which could impact our ability +to ship and/or receive product; +• +unexpected changes in regulatory requirements and laws; +• +longer customer payment cycles and difficulty collecting accounts receivable; +• +export duties, import controls and trade barriers (including quotas); +• +governmental restrictions on the transfer of funds; +• +burdens of complying with a wide variety of foreign laws and labor practices; +• +fluctuations in currency exchange rates, which could affect component costs, local payroll, utility and other expenses; and +• +inability to utilize net operating losses generated by our foreign operations to reduce our U.S. income taxes; +• +our foreign locations may be impacted by hurricanes, earthquakes, water shortages, tsunamis, floods, typhoons, fires, extreme weather conditions and +other natural or manmade disasters. +9 +Table of Contents +Our operations in certain foreign locations receive favorable income tax treatment in the form of tax +credits or other incentives. In the event that such tax incentives are not extended, are repealed, or we no longer qualify for such programs, our taxes may increase, which would reduce our net income. +A significant portion of our operations are in foreign locations. As a result, transactions occur in currencies other than the U.S. dollar. Exchange rate +fluctuations among other currencies used by us could directly or indirectly affect our financial results. Future currency fluctuations are dependent upon a number of factors and cannot be easily predicted. We currently use Mexican peso forward +contracts to hedge foreign currency fluctuations for a portion of our Mexican peso denominated expenses. However, unexpected losses could occur from future fluctuations in exchange rates. +Additionally, certain foreign jurisdictions restrict the amount of cash that can be transferred to the U.S or impose taxes and penalties on such transfers of cash. To the extent we have excess cash in +foreign locations that could be used in, or is needed by, our operations in the United States, we may incur significant penalties and/or taxes to repatriate these funds. +Dependence on Key Personnel +Our future success depends in large part on the continued +service of our key technical, marketing and management personnel and on our ability to continue to attract and retain qualified employees. There can be no assurance that we will be successful in attracting and retaining such personnel. The loss of +key employees could have a material adverse effect on our business, operating results and financial condition. +New Program, New Product, +and New Customer Risk +The markets for our customers’ products is characterized by rapidly changing technology, evolving industry +standards, frequent new product introductions and short product life cycles. The introduction of products embodying new technologies or the emergence of new industry standards can render existing products obsolete or unmarketable. Our success will +depend upon our customers’ ability to enhance existing products and to develop and introduce, on a timely and cost-effective basis, new products that keep pace with technological developments and emerging industry standards and address evolving +and increasingly sophisticated customer requirements. Failure of our customers to do so could substantially harm our customers’ competitive positions. There can be no assurance that our customers will be successful in identifying, developing +and marketing products that respond to technological change, emerging industry standards or evolving customer requirements. +Start-up costs, +the management of labor and equipment resources in connection with the establishment of new programs and new customer relationships, and the need to obtain required resources in advance can adversely affect our gross margins and operating results. +These factors are particularly evident in the ramping stages of new programs. These factors also affect our ability to efficiently use labor and equipment. We are currently managing a number of new programs. Consequently, our exposure to these +factors has increased. In addition, if any of these new programs or new customer relationships were terminated, our operating results could be harmed, particularly in the short term. We may not be able to recoup these start-up costs or replace +anticipated new program revenues. +Interest Rate Risk +We are exposed to interest rate risk under our revolving line of credit with interest rates based on various levels of margin added to published prime rate and LIBOR rates depending on the calculation of +a certain financial covenant. +Compliance with Current and Future Environmental Regulation +We are subject to a variety of domestic and foreign environmental regulations relating to the use, storage, and disposal of materials used in our +manufacturing processes. If we fail to comply with any present or future regulations, we could be subject to future liabilities or the suspension of current manufacturing operations. In addition, such regulations could restrict our ability to expand +our operations or could require us to acquire costly equipment, substitute materials, or incur other significant expenses to comply with government regulations. +10 +Table of Contents +Dilution and Stock Price Volatility +Holders of the common stock will suffer immediate dilution to the extent outstanding options to purchase the common stock are exercised. Our stock price may be subject to wide fluctuations and possible +rapid increases or declines over a short time period. These fluctuations may be due to factors specific to us such as variations in quarterly operating results or changes in earnings estimates, or to factors relating to the EMS industry or to the +securities markets in general, which, in recent years, have experienced significant price fluctuations. These fluctuations often have been unrelated to the operating performance of the specific companies whose stocks are traded. +Disclosure and Internal Controls +Management does not expect that our disclosure controls and internal controls and procedures will prevent all errors or fraud. A control system is +designed to give reasonable, but not absolute, assurance that the objectives of the control system are met. In addition, any control system reflects resource constraints and the benefits of controls must be considered relative to their costs. +Inherent limitations of a control system may include: judgments in decision making may be faulty, breakdowns can occur simply because of error or mistake and controls can be circumvented by collusion or management override. Due to the inherent +limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected. +Managing Growth +Our business is experiencing rapid growth which can place considerable additional demands upon our management team and our operational, +financial and management information systems. Our ability to manage growth effectively requires us to continue to implement and improve these systems; avoid cost overruns; maintain customer, supplier and other favorable business relationships during +possible transition periods; continue to develop the management skills of our managers and supervisors; and continue to train, motivate and manage our employees. Our failure to effectively manage growth could have a material adverse effect on our +results of operations. +Manufacturing Process +We manufacture and design products to our customers’ specifications, and, in some cases, our manufacturing processes and facilities may need to comply with applicable statutory and regulatory +requirements. For example, medical devices that we manufacture or design, as well as the facilities and manufacturing processes that we use to produce them, are regulated by the Food and Drug Administration and non-U.S. counterparts of this +agency. In addition, our customers’ products and the manufacturing processes that we use to produce them often are highly complex. As a result, products that we manufacture may at times contain manufacturing or design defects, and our +manufacturing processes may be subject to errors or not be in compliance with applicable statutory and regulatory requirements. Defects in the products we manufacture or design, whether caused by a design, manufacturing or component failure or +error, or deficiencies in our manufacturing processes, may result in delayed shipments to customers or reduced or cancelled customer orders. If these defects or deficiencies are significant, our business reputation may also be damaged. The failure +of the products that we manufacture or our manufacturing processes and facilities to comply with applicable statutory and regulatory requirements may subject us to legal fines or penalties and, in some cases, require us to shut down or incur +considerable expense to correct a manufacturing process or facility. In addition, these defects may result in liability claims against us or expose us to liability to pay for the recall of a product. Even if our customers are responsible for the +defects, they may not, or may not have resources to, assume responsibility for any costs or liabilities arising from these defects, which could expose us to additional liability claims. +Energy Prices +Certain components that we use in our manufacturing process are +petroleum-based. In addition, we, along with our suppliers and customers, rely on various energy sources in our transportation activities. While significant uncertainty currently exists about the future levels of energy prices, a significant +increase is possible. Increased energy prices could cause an increase to our raw material costs and transportation costs. In addition, increased transportation costs of certain of our suppliers and customers could be passed along to us. We may not +be able to increase our product prices enough to offset these increased costs. In addition, any increase in our product prices may reduce our future customer orders and profitability. +11 +Table of Contents +Item 1B. +UNRESOLVED STAFF COMMENTS +None +Item 2. +PROPERTIES +We have manufacturing and +sales operations located in the United States, Mexico, and China. The table below lists the locations and square footage of our operating facilities: +Location +Approx. +Sq. Ft. +Type of Interest +(Leased/Owned) +Description of Use +Spokane Valley, Washington (1) +62,000 +Leased +Sales, research, administration and manufacturing +Spokane Valley, Washington +36,000 +Leased +Manufacturing +El Paso, Texas +80,000 +Leased +Shipping and warehouse +Total USA +178,000 +Juarez, Mexico +174,000 +Owned +Manufacturing +Juarez, Mexico +60,000 +Owned +Manufacturing and warehouse +Juarez, Mexico +66,000 +Owned +Manufacturing and warehouse +Juarez, Mexico (2) +115,000 +Owned +Manufacturing and warehouse +Juarez, Mexico (3) +72,000 +Leased +Manufacturing and warehouse +Total Mexico +487,000 +Shanghai, China (4) +95,000 +Leased +Manufacturing +Shanghai, China (5) +36,000 +Leased +Manufacturing +Total China +131,000 +Grand Total +796,000 +(1) +On June 15, 2010, the company amended its lease with Royal Hills Associates (RHA) to extend the lease for an additional ten years, which we +continue to occupy as our headquarters +(2) +During fiscal year 2010, we purchased a 115, 000 square foot manufacturing facility in Juarez, Mexico for additional assembly space. (see Note 3 to +Consolidated Financial Statements) +(3) +In fiscal year 2009, we leased a new facility in Juarez, Mexico for more storage capacity and additional assembly space. +( 4 ) +During fiscal year 2011, we amended the lease of our China facility whereby extending the term to December 2015 and increasing our leased space to +95,000 square feet to accommodate an additional SMT line and for additional assembly space. +( 5 ) +During fiscal year 2011, we entered into an agreement to lease an additional 36,000 square feet of manufacturing space. +The geographic diversity of these locations allows us to offer services near certain of our customers and major electronics markets with the additional +benefit of reduced labor costs. We consider the productive capacity of our current facilities sufficient to carry on our current business. In addition, in Juarez, Mexico one of our buildings includes adjacent vacant land that could be developed into +additional manufacturing and warehouse space. +All of our facilities are ISO certified to ISO 9001:2008 standards, ISO-14001 environmental +standards, ISO-13485:2003 medical devices standards, AS9001 aviation, space and defense standards, and ISO/TS 16949 automotive standards. The Spokane, Washington facilities are additionally registered to AS9100B, and ITAR. Our China facilities are +also registered to AS9100B and ISO/TS. +12 +Table of Contents +Item 3. +LEGAL PROCEEDINGS +We are a party to +certain lawsuits or claims in the ordinary course of business. We do not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on our financial position, results of operations or cash flow. +Item 4. +RESERVED +PART II +Item 5: +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Our common stock is +traded on the NASDAQ Global Market, formerly the NASDAQ National Market System under the symbol “KTCC”. Quarterly high and low closing sales prices for our common stock for fiscal years 2011 and 2010 were as follows: +2011 +2010 +High +Low +High +Low +First Quarter +$ +6.03 +$ +4.69 +$ +2.40 +$ +1.60 +Second Quarter +6.50 +5.06 +3.60 +2.26 +Third Quarter +6.01 +4.40 +6.02 +3.69 +Fourth Quarter +5.37 +4.16 +6.61 +4.88 +High and low stock prices are based on the daily closing price reported by the NASDAQ Stock Market. These quotations +represent prices between dealers without adjustment for markups, markdowns, and commissions, and may not represent actual transactions. +Holders and Dividends +As of +July 2, 2011, we had 788 shareholders of common stock on record. As a result of our credit agreement with Wells Fargo, N.A. we are restricted from declaring or paying dividends in cash or stock. We have not paid a cash dividend and do not +anticipate payment of dividends in the foreseeable future. +Equity Compensation Plan Information +Information concerning securities authorized for issuance under our equity compensation plans is set forth in Part III, Item 12 of this Annual +Report, under the caption “Securities Authorized for Issuance under Equity Compensation Plans”, and that information is incorporated herein by reference. +13 +Table of Contents +Performance Graph +Set forth below is a line graph comparing the cumulative total shareholder return on our common stock with the cumulative total return of the NASDAQ Stock Market (U.S. & Foreign) Index and the +NASDAQ Electronic Components Index in fiscal 2011. +6/30/06 +6/30/07 +6/28/08 +6/27/09 +7/3/10 +7/2/11 +Key Tronic Corporation +100.00 +130.18 +90.54 +42.20 +124.81 +115.60 +NASDAQ Composite +100.00 +122.33 +108.31 +86.75 +100.42 +132.75 +NASDAQ Electronic Components +100.00 +116.80 +106.44 +77.55 +93.33 +116.37 +14 +Table of Contents +Item 6: +SELECTED FINANCIAL DATA +The following +selected data is derived from our audited consolidated financial statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial +statements and related notes, and other information included in this report. +Financial Highlights +(In thousands, except for Supplemental Data and Book Value per Share) +Fiscal Years +July 2, 2011 +July 3, 2010 +June 27, 2009 +June 28, 2008 +June 30, 2007 +Consolidated Statements of Operations Data: +Net sales +$ +253,846 +$ +199,620 +$ +184,924 +$ +204,122 +$ +201,712 +Gross profit +20,648 +19,250 +13,180 +16,820 +17,670 +Gross margin percentage +8.1 +% +9.6 +% +7.1 +% +8.2 +% +8.8 +% +Operating income +6,939 +7,388 +1,783 +6,834 +6,810 +Operating margin percentage +2.7 +% +3.7 +% +1.0 +% +3.3 +% +3.4 +% +Net income +5,736 +8,690 +1,063 +5,584 +5,230 +Earnings per share – diluted +0.55 +0.85 +0.11 +0.54 +0.51 +Consolidated Cash Flow Data: +Cash flows (used in) provided by operations +(2,569 +) +3,697 +10,038 +(718 +) +(1,857 +) +Capital expenditures +3,818 +3,378 +1,891 +1,180 +3,137 +Consolidated Balance Sheet Data: +Net working capital (1) +58,307 +44,708 +37,444 +45,695 +41,222 +Total assets +116,539 +101,642 +77,755 +98,344 +89,388 +Long-term liabilities +14,673 +4,236 +3,030 +13,241 +14,719 +Shareholders’ equity +68,023 +59,417 +51,114 +49,081 +43,244 +Book value per share (2) +$ +6.54 +$ +5.79 +$ +5.08 +$ +4.90 +$ +4.36 +Supplemental Data: +Number of shares outstanding at year-end +10,399,187 +10,264,390 +10,065,974 +10,024,308 +9,921,045 +Number of employees at year-end +1,997 +2,036 +1,963 +2,502 +2,227 +Approximate square footage of operational facilities +796,000 +987,000 +849,000 +777,000 +784,000 +(1) +Net working capital is defined as total current assets less total current liabilities. Net working capital measures the portion of current assets that +are financed by long term funds and is an indicator of short term financial management. +(2) +Book value per share is defined as total shareholders’ equity divided by the number of shares outstanding at the end of the fiscal year. +15 +Table of Contents +Item 7: +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +Overview +KeyTronicEMS is a leader in electronic manufacturing services and solutions to +original equipment manufacturers of a broad range of products. We provide engineering services, worldwide procurement and distribution, materials management, world-class manufacturing and assembly services, in-house testing, and unparalleled +customer service. Our international production capability provides our customers with benefits of improved supply-chain management, reduced inventories, lower transportation costs, and reduced product fulfillment time. We continue to make +investments in all of our operating facilities to give us the production capacity and logistical advantages to continue to win new business. The following information should be read in conjunction with the consolidated financial statements included +herein and with Item 1A, Risk Factors. +Our mission is to provide our customers with superior manufacturing and engineering services at +the lowest total cost for the highest quality products, and create long-term mutually beneficial business relationships by employing our “Trust, Commitment, Results” philosophy. +Executive Summary +Our sales of $253.8 million in fiscal year 2011 increased by 27.2 +percent as compared to sales of $199.6 million in fiscal year 2010. This increase in sales was primarily driven by new customer programs for both longstanding and new customers, partially offset by an unfavorable macroeconomic environment and +industry-wide shortages in the global supply chain that occurred through most of fiscal year 2011. Sales for the first quarter of fiscal year 2012 are expected to be within the range of $65 million to $69 million. Future results will depend on +actual levels of customers’ orders, the timing of the start up of production of new product programs and the potential impact of the macroeconomic uncertainty. We believe that we are well positioned in the EMS industry to continue expansion of +our customer base and continue long-term growth. +The concentration of our largest customers increased during fiscal year 2011 with the top +five customers’ sales increasing to 62 percent of total sales in 2011 from 57 percent in 2010, and 52 percent in 2009. Our current customer relationships involve a variety of products, including consumer electronics, electronic storage devices, +plastics, household products, gaming devices, specialty printers, telecommunications, industrial equipment, computer accessories, and electronic whiteboards. At the end of fiscal year 2011, we were generating revenue from 30 EMS customers as +compared with 20 at the end of fiscal year 2010. These new customers have programs that represent small annual sales while others have multi-million-dollar potential. +Gross profit as a percent of sales was 8.1 percent in fiscal year 2011 compared to 9.6 percent for the prior fiscal year. This 1.5 percentage point decrease is primarily related to a 6.4 percentage point +increase in material costs as a percent of sales, resulting from higher material content in certain new customer programs, partially offset by a 4.9 percentage point improvement in leveraging of certain overhead costs. The level of gross margin is +impacted by product mix, timing of the start up of new programs, facility utilization, pricing within the electronics industry and material costs, which can fluctuate significantly from quarter to quarter. +Operating income as a percentage of sales for fiscal year 2011 was 2.7 percent compared to 3.7 percent for fiscal year 2010. The decrease in operating +income as a percentage of sales was due to a decline in gross margin, partially offset by the leveraging of certain operating expenses and by improving efficiencies during fiscal year 2011. +Net income for fiscal year 2011 was $5.7 million or $0.55 per diluted share, as compared to net income of $8.7 million or $0.85 per diluted share for fiscal year 2010. The decrease in net income for +fiscal year 2011 as compared to fiscal year 2010 was primarily due to an approximate 1.5 percentage point decline in our gross margin. Also, our fiscal year 2010 results include an income tax benefit of $1.4 million, resulting in part from the +release of our valuation allowance on deferred tax assets related to our domestic net operating loss carryforwards that occurred in the third quarter of fiscal 2010. +16 +Table of Contents +We maintain a strong balance sheet with a current ratio of 2.7 and a long-term debt to equity ratio of 0.11. +Total cash used in operating activities as defined on our cash flow statement was $2.6 million during fiscal year 2011. However, we maintain sufficient liquidity for our expected future operations and had $6.0 million in borrowings on our revolving +line of credit with Wells Fargo, N.A. of which $24.0 million remained available at July 2, 2011. We believe cash flow from operations, our borrowing capacity, and equipment lease financing should provide adequate capital for planned growth over +the long term. +RESULTS OF OPERATIONS +Comparison of the Fiscal Year Ended July 2, 2011 with the Fiscal Year Ended July 3, 2010 +The following table sets forth for the periods indicated certain items of the consolidated statements of income expressed as a percentage of net sales. The financial information and discussion below +should be read in conjunction with the consolidated financial statements and notes contained in this Annual Report. +Fiscal Year Ended +July 2, +2011 +% of +net sales +July 3, +2010 +% of +net sales +$ change +% change +Net sales +$ +253,846 +100.0 +% +$ +199,620 +100.0 +% +$ +54,226 +27.2 +% +Cost of sales +233,198 +91.9 +180,370 +90.4 +52,828 +29.3 +Gross profit +20,648 +8.1 +19,250 +9.6 +1,398 +7.3 +Operating expenses: +Research, development and engineering +3,782 +1.5 +2,783 +1.4 +999 +35.9 +Selling, general and administrative +9,927 +3.9 +9,079 +4.5 +848 +9.3 +Total operating expenses +13,709 +5.4 +11,862 +5.9 +1,847 +15.6 +Operating income +6,939 +2.7 +7,388 +3.7 +(449 +) +(6.1 +) +Interest expense, net +457 +0.2 +102 +0.1 +355 +348.0 +Income before income taxes +6,482 +2.6 +7,286 +3.6 +(804 +) +(11.0 +) +Income tax provision (benefit) +746 +0.3 +(1,404 +) +0.7 +(2,150 +) +* +Net income +$ +5,736 +2.3 +% +$ +8,690 +4.4 +% +$ +(2,954 +) +(34.0 +)% +Effective income tax rate +11.5 +% +(19.3 +)% +* +Percent change from negative to positive is not considered meaningful. +Net Sales +Net sales were $253.8 million, and $199.6 million in fiscal years 2011 +and 2010, respectively. +Net sales increased $54.2 million during fiscal year 2011 as compared with fiscal year 2010. This increase in net +sales was primarily driven by an approximate $77.9 million increase in revenues related to new programs for both new and longstanding customers. This was partially offset by a $18.5 million decline related to decreased demand from certain current +customer programs. In addition, during fiscal year 2011 we experienced an approximately $5.2 million decline related to the negative impact of end-of-life customer programs and to a lesser extent customer program losses. The negative impact +resulting from industry-wide shortages in the global supply chain that occurred throughout most of the year and the uncertain macroeconomic environment are reflected in the analysis of our new and longstanding customers programs as discussed above. +17 +Table of Contents +The following table shows the revenue by industry sectors as a percentage of revenue for fiscal years 2011 +and 2010: +Years Ended +July 2, 2011 +July 3, 2010 +Commercial Printer +5 +% +9 +% +Communication +22 +11 +Computer and Peripheral +13 +15 +Consumer +20 +26 +Gaming +16 +13 +Industrial +6 +4 +Transaction Printer +18 +22 +Total +100 +% +100 +% +We provide services to customers in a number of industries and produce a variety of products for our customers in each +industry. As we continue to diversify our customer base and win new customers we may continue to see a change in the industry concentrations of our revenue. +Sales to foreign locations represented 31.9 percent, and 17.9 percent of our total net sales in fiscal years 2011, and 2010, respectively. +Cost of Sales +Total cost of sales as a percentage of net sales was 91.9 percent, +and 90.4 percent in fiscal years 2011, and 2010, respectively. +Total cost of materials as a percentage of net sales was approximately 73.9 +percent, and 68.6 percent in fiscal years 2011, and 2010, respectively. The change from year-to-year is primarily the result of higher material content in certain new customer programs and changes in product mix. +Production and support costs as a percentage of net sales were 18.0 percent, and 21.8 percent in fiscal years 2011, and 2010, respectively. The decrease +in fiscal year 2011 is primarily related to the leveraging of our fixed costs as a percentage of sales during the fiscal year. +We provide for +obsolete and non-saleable inventories based on specific identification of inventory against current demand and recent usage. The amounts charged to expense for these inventories were approximately $0.3 million, and $2.2 million in fiscal years 2011, +and 2010, respectively. The large provision in fiscal year 2010 was primarily due to a discontinuance of manufacturing for certain customers that became no longer viable. +We provide warranties on certain products we sell and estimate warranty costs based on historical experience and anticipated product returns. The amounts charged to expense are determined based on an +estimate of warranty exposure. The net warranty expense was approximately $158,000 and $45,000 in fiscal years 2011, and 2010, respectively. Warranty expense for fiscal years 2011 and 2010 is related to workmanship claims on keyboards and EMS +products. +Gross Profit +Gross profit as a percentage of net sales was 8.1 percent, and 9.6 percent in fiscal years 2011, and 2010, respectively. +The 1.5 percentage point decrease in gross profit as a percentage of net sales during fiscal year 2011as compared to fiscal year 2010 is primarily +related to a 6.4 percentage point increase in material costs, as a percent of sales, resulting from higher material content in certain new customer programs, partially offset by a 4.9 percentage point improvement in leveraging of certain overhead +costs. +We took early pay discounts to suppliers that totaled approximately $678,000, and $364,000, in fiscal years 2011, and 2010, +respectively. Early pay discounts will fluctuate based on our liquidity and changes in the discounts and terms offered by our suppliers. +18 +Table of Contents +Changes in gross profit margins reflect the impact of a number of factors that can vary from period to +period, including product mix, start-up costs and efficiencies associated with new programs, product life cycles, sales volumes, capacity utilization of our resources, management of inventories, component pricing and shortages, end market demand for +customers’ products, fluctuations in and timing of customer orders, and competition within the EMS industry. These and other factors can cause variations in operating results. There can be no assurance that gross margins will not decrease in +future periods. +Research, Development and Engineering +Research, development and engineering expenses (RD&E) consists principally of employee related costs, third party development costs, program materials, depreciation and allocated information +technology and facilities costs. Total RD&E was $3.8 million, and $2.8 million in fiscal years 2011, and 2010, respectively. As a percentage of net sales, RD&E was 1.5 percent and 1.4 percent in fiscal years 2011, and 2010, respectively. The +increase in RD&E in fiscal year 2011 is primarily the result of increased headcount and to a lesser extent higher incentive compensation. +Selling, General and Administrative +Selling, general and administrative expenses (SG&A) consist principally of salaries and benefits, advertising and marketing programs, sales commissions, travel expenses, provision for doubtful +accounts, facilities costs, and professional services. Total SG&A expenses were $9.9 million, and $9.1 million in fiscal years 2011, and 2010, respectively. As a percentage of net sales SG&A was 3.9 percent, and 4.5 percent in fiscal years +2011, and 2010, respectively. Approximately half of our SG&A expenses relates to salary costs of our employees. +The $0.8 million increase +in SG&A expenses in fiscal year 2011 as compared to fiscal year 2010 is primarily due to a $0.5 million increase in outside services and professional fees, a $0.4 million increase in salary related costs, and a $0.3 million increase related to +other overhead costs. This was partially offset by an approximate $0.4 million decrease in incentive compensation expense. +Interest +Expense +We had net interest expense of $0.5 million, and $0.1 million in fiscal years 2011, and 2010, respectively. Interest expense +increased in fiscal year 2011 when compared to fiscal year 2010 as the average balance of the revolving line of credit was higher in addition to interest expense incurred as a result of our capital lease obligations. We often utilize short-term +fixed LIBOR rates on portions of our revolving line of credit to limit the affect of interest rate volatilities. +Income Tax Provision +We had an income tax expense of $746,000 during fiscal year 2011 as compared to an income tax benefit of $1.4 million in fiscal year +2010. The income tax expense recognized during fiscal 2011 was primarily a function of U.S. and foreign taxes recognized at the statutory rates offset by the net benefit associated with federal research and development tax credits, the release of +the valuation allowance in China, and changes in potential foreign tax credits. The income tax benefit of fiscal year 2010 is primarily related to the release of the valuation allowance on our deferred tax assets related to domestic tax net +operating loss carryforwards (NOLs) and foreign tax credits, partially offset by the recognition of domestic deferred tax liabilities for an unremitted portion of foreign earnings and the change of applicable tax regimes in Mexico. +Due to increased profitability, revenue growth, and new customer programs, we have determined that a valuation allowance against our domestic NOLs is not +required. We anticipate that we will fully utilize our domestic NOLs prior to their expiration. In addition, we reviewed our requirements for liquidity domestically to fund our revenue growth and to look for potential future acquisitions. We have +changed our previous assessments of being permanently reinvested and now anticipate repatriating a portion of our unremitted foreign earnings. The associated taxes and potential foreign tax credits were first included in the income tax benefit that +was realized during fiscal year 2010 and certain changes in the estimates of foreign earnings and profits and tax pools resulted in the recognition of additional tax benefits during fiscal year 2011. For further information on taxes please review +footnote 5 of the “Notes to Consolidated Financial Statements”. +19 +Table of Contents +International Subsidiaries +We offer customers a complete global manufacturing solution. Our facilities provide our customers the opportunity to have their products manufactured in the facility that best serves specific cost, +product manufacturing, and distribution needs. Key Tronic Reynosa, SA de CV operated manufacturing and warehouse facilities in Reynosa, Mexico for a specific customer program. This subsidiary ceased its operations during fiscal year 2011. The +closure of the facility did not have a significant impact on our results of operations. The locations of active foreign subsidiaries are as follows: +• +Key Tronic Juarez, SA de CV owns an SMT, assembly and molding facility, and four assembly and storage facilities in Juarez, Mexico. This subsidiary is +primarily used to support our U.S. operations. +• +Key Tronic Computer Peripherals (Shanghai) Co., Ltd. leases a facility with SMT and assembly capabilities in Shanghai, China, which began operations in +1999. Its primary function is to provide EMS services for export; however, it is also currently manufacturing certain electronic keyboards. +Foreign sales (based on shipping instructions) from our worldwide operations, including domestic exports, were $81.1 million, and $35.7 million in fiscal years 2011, and 2010, respectively. Products and +manufacturing services provided by our subsidiary operations are sold to customers directly by the parent company. Key Tronic Computer Peripherals (Shanghai) Co., Ltd., our subsidiary in Shanghai, China, had only minimal direct sales to customers in +China during the past two fiscal years. +Comparison of the Fiscal Year Ended July 3, 2010 with the Fiscal Year Ended +June 27, 2009 +The following table sets forth for the periods indicated certain items of the consolidated statements of income +expressed as a percentage of net sales. The financial information and discussion below should be read in conjunction with the consolidated financial statements and notes contained in this Annual Report. +Fiscal Year Ended +July 3, +2010 +% of +net sales +June 27, +2009 +% of +net sales +$ change +% change +Net sales +$ +199,620 +100.0 +% +$ +184,924 +100.0 +% +$ +14,696 +7.9 +% +Cost of sales +180,370 +90.4 +171,744 +92.9 +8,626 +5.0 +Gross profit +19,250 +9.6 +13,180 +7.1 +6,070 +46.1 +Operating expenses: +Research, development and engineering +2,783 +1.4 +2,266 +1.2 +517 +22.8 +Selling, general and administrative +9,079 +4.5 +8,366 +4.5 +713 +8.5 +Goodwill impairment +— +0.0 +765 +0.4 +(765 +) +(100 +) +Total operating expenses +11,862 +5.9 +11,397 +6.2 +465 +4.1 +Operating income +7,388 +3.7 +1,783 +1.0 +5,605 +314.4 +Interest expense, net +102 +0.1 +590 +0.3 +(488 +) +(82.7 +) +Income before income taxes +7,286 +3.6 +1,193 +0.6 +6,093 +510.7 +Income tax provision (benefit) +(1,404 +) +0.7 +130 +0.1 +(1,534 +) +* +Net income +$ +8,690 +4.4 +% +$ +1,063 +0.6 +% +$ +7,627 +717.5 +% +Effective income tax rate +(19.3 +)% +10.9 +% +* +Percent change from negative to positive is not considered meaningful. +Net Sales +Net sales were $199.6 million and $184.9 million in fiscal years 2010, +and 2009, respectively. +Net sales increased $14.7 million during fiscal year 2010 as compared with fiscal year 2009. This increase in sales +was primarily driven by new customer programs for both longstanding and new customers, partially offset by a continuance of an unfavorable macroeconomic environment and industry-wide shortages in the global supply chain. +20 +Table of Contents +The table below shows the revenue by industry sectors as a percentage of revenue for the following fiscal +years: +Years Ended +July 3, 2010 +June 27, 2009 +Commercial Printer +9 +% +15 +% +Communication +11 +14 +Computer and Peripheral +15 +17 +Consumer +26 +15 +Gaming +13 +13 +Industrial +4 +4 +Transaction Printer +22 +22 +Total +100 +% +100 +% +We provide services to customers in a number of industries and produce a variety of products for our customers in each +industry. As we continue to diversify our customer base and win new customers we may continue to see a change in the industry concentrations of our revenue. +Sales to foreign locations represented 17.9 percent and 11.3 percent of our total net sales in fiscal years 2010, and 2009, respectively. +Cost of Sales +Total cost of sales as a percentage of net sales was 90.4 percent and +92.9 percent in fiscal years 2010, and 2009, respectively. +Total cost of materials as a percentage of net sales was approximately 68.6 +percent and 69.2 percent in fiscal years 2010, and 2009, respectively. The change from year-to-year was directly related to changes in product mix. +Production and support costs as a percentage of net sales were 21.8 percent and 23.7 percent in fiscal years 2010, and 2009, respectively. The decrease in fiscal year 2010 as compared to fiscal year 2009 +was related to higher fixed cost absorption due to a $14.7 million increase in net sales, while production and support costs decreased $0.3 million due to favorable foreign exchange rates and a reduction of manufacturing facility payroll. These +savings were partially offset by an increase in the provision for obsolete inventory. +We provide for obsolete and non-saleable inventories +based on specific identification of inventory against current demand and recent usage. The amounts charged to expense for these inventories were approximately $2.2 million, and $0.3 million in fiscal years 2010, and 2009, respectively. The increased +provision in fiscal year 2010 was primarily due to no longer manufacturing for certain customers that were no longer viable. +We provide +warranties on certain products we sell and estimate warranty costs based on historical experience and anticipated product returns. The amounts charged to expense were determined based on an estimate of warranty exposure. The net warranty expense +(recovery) was approximately $45,000, and $(93,000) in fiscal years 2010, and 2009, respectively. Warranty expense for fiscal year 2010 is related to workmanship claims on keyboards and EMS products. The recovery in fiscal year 2009 was related to +the release of a warranty claim for a specific product that was identified in fiscal year 2008. +Gross Profit +Gross profit as a percentage of net sales was 9.6 percent and 7.1 percent in fiscal years 2010, and 2009, respectively. +The 2.5 percentage point increase in gross profit as a percentage of net sales during fiscal year 2010 as compared to fiscal year 2009 was primarily the +result of a $14.7 million increase in net sales, while production and support cost decreased by $0.3 million due to favorable foreign exchange changes, a +21 +Table of Contents +decrease in headcount of overhead employees and severance costs incurred in fiscal year 2009 that did not recur in fiscal year 2010. This was partially offset by a $8.9 million increase in +material costs. +We took early pay discounts to suppliers that totaled approximately $364,000, and $142,000 in fiscal years 2010, and 2009, +respectively. Early pay discounts will fluctuate based on our liquidity and changes in the discounts and terms offered by our suppliers. +Changes in gross profit margins reflect the impact of a number of factors that can vary from period to period, including product mix, start-up costs and +efficiencies associated with new programs, product life cycles, sales volumes, capacity utilization of our resources, management of inventories, component pricing and shortages, end market demand for customers’ products, fluctuations in and +timing of customer orders, and competition within the EMS industry. These and other factors can cause variations in operating results. There can be no assurance that gross margins will not decrease in future periods. +Research, Development and Engineering +Research, development and engineering expenses (RD&E) consists principally of employee related costs, third party development costs, program materials, depreciation and allocated information +technology and facilities costs. Total RD&E was $2.8 million, and $2.3 million in fiscal years 2010, and 2009, respectively. As a percentage of net sales, RD&E was 1.4 percent, and 1.2 percent in fiscal years 2010, and 2009, respectively. +The increase in RD&E expenses in fiscal year 2010 compared to fiscal year 2009 was primarily the result of higher incentive compensation expense and increased headcount. +Selling, General and Administrative +Selling, general and administrative expenses +(SG&A) consist principally of salaries and benefits, advertising and marketing programs, sales commissions, travel expenses, provision for doubtful accounts, facilities costs, and professional services. Total SG&A expenses were $9.1 million, +and $8.4 million in fiscal years 2010, and 2009, respectively. As a percentage of net sales SG&A was 4.5 percent, and 4.5 percent in fiscal years 2010, and 2009, respectively. Approximately half of our SG&A expenses relates to salary costs +of our employees. +The $0.7 million increase in SG&A expenses in fiscal year 2010 as compared to fiscal year 2009 was primarily due to a +$1.6 million increase in incentive compensation expense. This was partially offset by an approximate $0.3 million decrease in salaries in addition to an approximate $0.6 million decrease in expense related to the write off of a receivable in the +prior year. +Goodwill Impairment +We recorded an impairment charge of $765,000 during fiscal year 2009. We did not record an impairment charge during fiscal year 2010. As of July 3, 2010, there was no goodwill recorded in the +Company’s Consolidated Balance Sheet. +Interest Expense +We had net interest expense of $0.1 million, and $0.6 million in fiscal years 2010, and 2009, respectively. Interest expense decreased in fiscal year 2010 when compared to fiscal year 2009 as the average +balance of the revolving line of credit was lower along with a decrease in variable interest rates. We do not currently use derivatives to hedge interest rate risk. We often utilize short-term fixed LIBOR rates on portions of our revolving line of +credit to limit the affect of interest rate volatilities. +Income Tax Provision +We had an income tax benefit of $1.4 million during fiscal year 2010 as compared to $130,000 of tax expense in fiscal year 2009. The income tax benefit of +fiscal year 2010 was primarily related the release of the valuation allowance on our deferred tax assets related to domestic tax net operating loss carryforwards (NOLs) and foreign tax credits, partially offset by the recognition of domestic +deferred tax liabilities for an unremitted portion of foreign earnings and the change of applicable tax regimes in Mexico. +Due to increased +profitability, revenue growth, and new customer programs, we determined that a valuation allowance against our domestic NOLs was not longer required. We anticipate that we will fully utilize our domestic NOLs prior to their expiration. In addition, +we reviewed our requirements for liquidity +22 +Table of Contents +domestically to fund our revenue growth and to look for potential future acquisitions. We changed our previous assessments of being indefinitely reinvested and anticipated repatriating a portion +of our unremitted foreign earnings. The associated taxes and potential foreign tax credits are included in the income tax benefit that was realized during fiscal year 2010. The tax provision in fiscal year 2009 was primarily related to income taxes +in China and Mexico. For further information on taxes please review footnote 7 of the “Notes to Consolidated Financial Statements”. +International Subsidiaries +Foreign sales (based on shipping instructions) from our worldwide operations, including domestic exports, were $35.7 million, and $20.9 million in fiscal +years 2010, and 2009, respectively. Products and manufacturing services provided by our subsidiary operations are sold to customers directly by the parent company. Key Tronic Computer Peripherals (Shanghai) Co., Ltd., our subsidiary in Shanghai, +China, had only minimal sales to customers in China during the past two fiscal years. +Capital Resources and Liquidity +Cash flows used in operating activities were $2.6 million in fiscal year 2011 as compared to cash provided by operating activities of $3.7 million and +$10.0 million in fiscal years 2010 and 2009, respectively. +The $6.3 million decrease in cash provided by operating activities in fiscal year +2011 as compared with fiscal year 2010 was primarily due to an increase in trade receivables, inventory, and a decrease in accounts payable. Trade receivables increased by $5.7 million as a result of the increase in sales that occurred during the +fourth quarter of fiscal year 2011. The $2.1 million increase in inventory was attributable to our recent and expected growth in production levels for a number of new programs. We purchase inventory based on customer forecasts and orders and +expected lead times, and when those forecasts cannot be met or changes are made to lead times, inventory can increase. The $3.0 million decrease in accounts payable was primarily driven by the timing of payments and terms of the supply chain related +to new programs. Accounts payable fluctuates with changes in inventory levels, volume of purchases, and negotiated supplier terms. The $6.3 million decrease in cash provided by operating activities in fiscal year 2010 as compared with fiscal year +2009 was primarily due to an increase in trade receivables and inventory, partially offset by an increase in accounts payable. Trade receivables increased by $10.1 million as a result of the increase in sales that occurred during the fourth quarter +of fiscal year 2010. The $9.7 million increase in inventory was attributable to new customer programs and increasing lead times on certain components which led to some scheduled shipments not being shipped by the end of the fiscal year. We purchase +inventory based on customer forecasts and orders and expected lead times, and when those forecasts cannot be met or changes are made to lead times, inventory can increase. The $10.5 million increase in accounts payable was primarily driven by the +increase in inventory and extending payment terms during fiscal year 2010. Accounts payable fluctuates with changes in inventory levels, volume of purchases, and negotiated supplier terms. +Cash flows used in investing activities were $3.7 million, $3.3 million, and $1.9 million in fiscal years 2011, 2010 and 2009, respectively. Cash used in investing activities includes capital expenditures +and proceeds from the sale of property and equipment. Capital expenditures were $3.8 million, $3.4 million, and $1.9 million in fiscal years 2011, 2010, and 2009, respectively. Our capital expenditures are primarily for purchases of manufacturing +assets to support our operations in Spokane Valley, Washington, Mexico and China. The increase in capital expenditures for fiscal year 2011 as compared to fiscal year 2010 is primarily related to the increased investment in manufacturing equipment +to support the requirements of our growing customer programs and sales. The increase in capital expenditures for fiscal year 2010 as compared to fiscal year 2009 was primarily related to the purchase of a manufacturing facility and to a lesser +extent the increased investment in manufacturing equipment to support the requirements of our growing customer programs and sales. +Cash flows +provided by financing activities were $6.7 million in fiscal year 2011 as compared to cash used in financing activities of $0.4 million and $10.3 million in fiscal years 2010 and 2009, respectively. Our primary financing activity in fiscal years +2011, 2010, and 2009 was borrowing and repayment under our revolving line of our credit facility. Our credit agreement with Wells Fargo Bank N.A. provides a revolving line of credit facility of up to $30 million. The agreement specifies that +the proceeds of the revolving line of credit be used primarily for working capital and general corporate purposes of the Company and its +23 +Table of Contents +subsidiaries. The outstanding balance under the credit facility was $6.0 million as of July 2, 2011. We had availability to borrow an additional $24.0 million under the Wells Fargo line of +credit and we were in compliance with our loan covenants. During fiscal year 2011, cash provided by financing activities reflected an additional $2.2 million of proceeds to finance capital leases and we made payments of $0.3 million on such capital +leases. +Our cash requirements are affected by the level of current operations and new EMS programs. We believe that projected cash from +operations, funds available under the revolving credit facility and leasing capabilities will be sufficient to meet our working and fixed capital requirements for the foreseeable future. +Contractual Obligations and Commitments +In the normal course of business, we enter into +contracts which obligate us to make payments in the future. +The table below sets forth our significant future obligations by fiscal year: +Payments Due by Fiscal Year (in thousands) +Total +2012 +2013 +2014 +2015 +2016 +Thereafter +Wells Fargo Bank N.A. revolving loan (1) +$ +6,000 +$ +— +$ +— +$ +6,000 +$ +— +$ +— +$ +— +Operating leases (2) +7,342 +1,284 +911 +857 +788 +205 +3,297 +Capital leases (3) +2,152 +782 +782 +588 +— +— +— +Purchase orders (4) +(1) +The terms of the Wells Fargo Bank N.A. revolving loan are discussed in the consolidated financial statements at Note 4, “Long-Term Debt”. As +of July 2, 2011 we were in compliance with our loan covenants. Breaching these covenants could have resulted in a material impact on our operations or financial condition. +(2) +We maintain vertically integrated manufacturing operations in Mexico and Shanghai, China. Such operations are heavily dependent upon technically +superior manufacturing equipment including molding machines in various tonnages, SMT lines, clean rooms, and automated insertion, and test equipment for the various products we are capable of producing. In addition, we lease some of our +administrative and manufacturing facilities. A complete discussion of properties can be found in Part 1, Item 2 at “Properties”. Leases have proven to be an acceptable method for us to acquire new or replacement equipment and to +maintain facilities with a minimum impact on our short term cash flows for operations. Amounts presented above include interest and principal, if applicable. +(3) +During fiscal year 2011, we entered into capital leases for the purchase of certain equipment and leasehold improvements. See Note 4, “Long-Term +Debt” for additional discussion of capital lease obligations. +(4) +As of July 2, 2011, we had open purchase order commitments for materials and other supplies of approximately $118.7 million. Included in the open +purchase orders are various blanket orders for annual requirements. Actual needs under these blanket purchase orders fluctuate with our manufacturing levels. In addition, we have contracts with our customers that minimize our exposure to losses for +material purchased within lead-times necessary to meet customer forecasts. Purchase orders generally can be cancelled without penalty within specified ranges that are determined in negotiations with our suppliers. These agreements depend in part on +the type of materials purchased as well as the circumstances surrounding any requested cancellations. +In addition to the +cash requirements presented above, we have various other accruals which are not included in the table above. We owe our suppliers approximately $21.4 million for accounts payable and shipments in transit at the end of the fiscal year. We generally +pay our suppliers in a range from 30 to 120 +24 +Table of Contents +days depending on terms offered. These payments are financed by operating cash flows and our revolving line of credit. +We believe that cash flows generated from operations, leasing facilities, and funds available under the revolving credit facility will satisfy cash requirements for a period in excess of 12 months and +into the foreseeable future. +Critical Accounting Policies and Estimates +Preparation of our consolidated financial statements requires management to make estimates and assumptions that affect the reported amount of assets, liabilities, revenues and expenses. Note 1 to our +consolidated financial statements describes the significant accounting policies used in the preparation of our consolidated financial statements. Management believes the most complex and sensitive judgments, because of their significance to our +consolidated financial statements, result primarily from the need to make estimates about effects of matters that are inherently uncertain. The most significant areas involving management judgments are described below. Actual results in these areas +could differ from management’s estimates. +Inactive, Obsolete, and Surplus Inventory Reserve +We reserve for inventories that we deem inactive, obsolete or surplus. This reserve is calculated based upon the demand for the products that we produce. +Demand is determined by expected sales or customer forecasts. If expected sales do not materialize, then we would have inventory in excess of our reserves and would have to charge the excess against future earnings. In the case where we have +purchased material based upon a customer’s forecast, we are usually covered by lead-time assurance agreements with each customer. These contracts state that the financial liability for material purchased within agreed upon lead-time and based +upon the customer’s forecasts, lies with the customer. If we purchase material outside the lead-time assurance agreement and the customer’s forecasts do not materialize or if we have no lead-time assurance agreement for a specific program, +we would have the financial liability and may have to charge inactive, obsolete or surplus inventory against earnings. +Allowance for +Doubtful Accounts +We value our accounts receivable net of an allowance for doubtful accounts of $111,000 at July 2, 2011 and +July 3, 2010. This allowance is based on estimates of the portion of accounts receivable that may not be collected in the future. The estimates used are based primarily on specific identification of potentially uncollectible accounts. Such +accounts are identified using publicly available information in conjunction with evaluations of current payment activity. However, if any of our customers were to develop unexpected and immediate financial problems that would prevent payment of open +invoices, we could incur additional and possibly material expenses that would negatively impact earnings. +Accrued Warranty +An accrual is made for expected warranty costs, with the related expense recognized in cost of goods sold. We review the adequacy of this accrual +quarterly based on historical analysis and anticipated product returns and rework costs. As we have made the transition from manufacturing primarily keyboards to primarily EMS products, our exposure to warranty claims has declined significantly. Our +warranty period for keyboards is generally longer than that for EMS products. We only warrant materials and workmanship on EMS products, and we do not warrant design defects for EMS customers. +Income Taxes +Income tax expense +includes U.S. and international income taxes and the provision for U.S. taxes on undistributed earnings of international subsidiaries not deemed to be permanently invested. Certain income and expenses are not reported in tax returns and financial +statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. The deferred income taxes are classified as current or long-term based on the classification of the related asset or liability. The most +significant areas involving management judgments include deferred income tax assets and liabilities, uncertain tax positions, and research and development tax credits. Our estimates of the realization of the deferred tax assets related to our net +operating loss carryforwards and tax credits is based upon our estimates of future taxable income which may change. +25 +Table of Contents +Stock-Based Compensation +Stock-based compensation is accounted for according to Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 718, Compensation – Stock Compensation . ASC 718 +requires us to expense the fair value of employee stock options, stock appreciation rights and other forms of stock-based compensation. Under the fair value recognition provisions of ASC 718, share-based compensation cost is estimated at the grant +date based upon the value of the stock option and at each reporting period for stock appreciation rights classified as liability awards and is recognized as expense ratably over the requisite service period of the award (generally the vesting). +Determining the appropriate fair value model and calculating the fair value of share-based awards requires judgment, including estimating the expected life of the share-based award, the expected stock price volatility over the expected life of the +share-based award and forfeitures. +To determine the fair value of stock based awards on the date of grant and at each reporting period for +any stock appreciation rights that may be classified as liability awards, we use the Black-Scholes option-pricing model. Inherent in this model are assumptions related to expected stock price volatility, option life, risk-free interest rate and +dividend yield. The risk-free interest rate is a less-subjective assumption as it is based on factual data derived from public sources. We use a dividend yield of zero as we have never paid cash dividends and have no intention to pay cash dividends +in the foreseeable future. The expected stock price volatility and option life assumptions require a greater level of judgment. Our expected stock-price volatility assumption is based upon the historical volatility of our stock which is obtained +from public data sources. The expected life represents either the weighted average period of time that share-based awards are expected to be outstanding (stock options), giving consideration to vesting schedules and historical exercise patterns. We +determine the expected life assumption based upon the exercise and post-vesting behavior that has been exhibited historically, adjusted for specific factors that may influence future exercise patterns. If expected volatility or expected life were to +increase, that would result in an increase in the fair value of our stock options which would result in higher compensation charges, while a decrease in volatility or the expected life would result in a lower fair value of our stock option awards +resulting in lower compensation charges. +We estimate forfeitures for all of our awards based upon historical experience of stock-based +pre-vesting forfeitures. We believe that our estimates are based upon outcomes that are reasonably likely to occur. If actual forfeitures are higher than our estimates it would result in lower compensation expense and to the extent the actual +forfeitures are lower than our estimate we would record higher compensation expense. +Impairment of Long-Lived Assets +Long-lived assets, such as property, plant, and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the +carrying amount of an asset may not be recoverable. The recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the +asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge would be recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. +In accordance with ASC 350, Intangibles – Goodwill and Other , goodwill is tested annually for impairment, and is tested for impairment more +frequently if events and circumstances indicate that the asset might be impaired. An impairment loss would be recognized to the extent that the carrying amount exceeds the asset’s fair value. +Upon the completion of the Company’s annual impairment test during fiscal year 2009 and as a result of the deteriorating global economy adversely +affecting the Company’s common stock price. The Company concluded that 100% of the goodwill was impaired due to the significant and sustained decline in the Company’s market capitalization to below the book value. The Company recorded an +impairment charge of $765,000 during the second quarter of fiscal year 2009. As of July 2, 2011 and July 3, 2010, respectively, there was no goodwill recorded in the Company’s Consolidated Balance Sheet. +26 +Table of Contents +Derivatives and Hedging Activity +Derivatives are recognized on the balance sheet at their estimated fair value. On the date a derivative contract is entered into, the Company designates the derivative as a hedge of a forecasted +transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (a “cash flow” hedge). The Company does not enter into derivatives for speculative purposes. Changes in the fair value of a +derivative that qualifies as a cash flow hedge are recorded in “Accumulated Other Comprehensive Income”, until earnings are affected by the variability of cash flows. See Note 11 of the Company’s consolidated financial statements for +additional information. +Accounting Pronouncements +See Note 1 to our consolidated financial statements. +Item 7A: +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Interest Rate Risk +We are subject to the risk of fluctuating interest rates in the normal +course of business. Our major market risk relates to our secured debt. Our revolving credit facility is secured by substantially all of our assets. The interest rates applicable to our revolving credit facility fluctuate with the JP Morgan Chase +Bank prime rate and LIBOR rates. There was outstanding $6.0 million in borrowings under our revolving credit facility as of July 2, 2011, and the rate of interest being paid on the outstanding balance was 2.48%. See “Management’s +Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources and Liquidity” and Note 4 – “Long-Term Debt” to the Consolidated Financial Statements for additional information regarding our +revolving credit facility. +Foreign Currency Exchange Risk +A significant portion of our operations are in foreign locations. As a result, transactions occur in currencies other than the U.S. dollar. Exchange rate fluctuations among other currencies used by us +would directly or indirectly affect our financial results. We currently use Mexican peso forward contracts to hedge foreign currency fluctuations for a portion of our Mexican peso denominated expenses. There was $37.9 million of foreign currency +forward contracts outstanding as of July 2, 2011. The fair value of these contracts was approximately $2.6 million. See Note 11 – “Derivative Financial Instruments” to the Consolidated Financial Statements for additional +information regarding our derivative instruments. +27 +Table of Contents +Item 8: +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Report of Independent Registered Public Accounting Firm +The +Board of Directors and Shareholders +Key Tronic Corporation +Spokane Valley, Washington +We have audited the accompanying consolidated balance sheets of Key +Tronic Corporation (the Company) as of July 2, 2011 and July 3, 2010 and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended +July 2, 2011. These financial statements are the responsibility of the Company’s management. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. +Our responsibility is to express an opinion on these financial statements and schedule based on our audits. +We conducted our audits in +accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material +misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing +audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also +includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 Key Tronic Corporation at July 2, 2011 and July 3, 2010, and the results of its operations and its cash flows for each of the three years in +the period ended July 2, 2011, in conformity with accounting principles generally accepted in the United States of America. +Also, in our +opinion, the 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. +/s/ BDO USA, LLP +Spokane, Washington +September 12, 2011 +28 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED BALANCE SHEETS +(In thousands) +July 2, 2011 +July 3, 2010 +ASSETS +Current assets: +Cash and cash equivalents +$ +1,232 +$ +770 +Trade receivables, net of allowance for doubtful accounts of $111 and $111 +40,350 +34,617 +Inventories +41,554 +39,775 +Deferred income tax asset +4,465 +4,420 +Other +4,549 +3,115 +Total current assets +92,150 +82,697 +Property, plant and equipment, net +14,917 +13,898 +Other assets: +Deferred income tax asset +7,829 +4,394 +Other, net of accumulated amortization of $93 and $106 +1,643 +653 +Total assets +$ +116,539 +$ +101,642 +LIABILITIES AND SHAREHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +26,149 +$ +29,158 +Accrued compensation and vacation +4,436 +5,097 +Current portion of other long-term obligations +761 +146 +Other +2,497 +3,588 +Total current liabilities +33,843 +37,989 +Long-term liabilities: +Revolving loan +6,000 +1,554 +Deferred income tax liability +5,152 +608 +Other long-term obligations +3,521 +2,074 +Total long-term liabilities +14,673 +4,236 +Commitments and contingencies (Notes 4 and 8) +Shareholders’ equity +Common stock, no par value, authorized 25,000 shares; issued and outstanding 10,399 and 10,264 shares, +respectively +41,014 +40,126 +Retained earnings +25,269 +19,533 +Accumulated other comprehensive income (loss) +1,740 +(242 +) +Total shareholders’ equity +68,023 +59,417 +Total liabilities and shareholders’ equity +$ +116,539 +$ +101,642 +See accompanying notes to consolidated financial statements. +29 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF INCOME +(In thousands) +Years Ended +July 2, 2011 +July 3, 2010 +June 27, 2009 +Net sales +$ +253,846 +$ +199,620 +$ +184,924 +Cost of sales +233,198 +180,370 +171,744 +Gross margin +20,648 +19,250 +13,180 +Operating expenses: +Research, development and engineering +3,782 +2,783 +2,266 +Selling, general and administrative +9,927 +9,079 +8,366 +Goodwill impairment +— +— +765 +Total operating expenses +13,709 +11,862 +11,397 +Operating income +6,939 +7,388 +1,783 +Interest expense, net +457 +102 +590 +Income before income taxes +6,482 +7,286 +1,193 +Income tax provision (benefit) +746 +(1,404 +) +130 +Net income +$ +5,736 +$ +8,690 +$ +1,063 +Earnings per share: +Earnings per common share – basic +$ +0.55 +$ +0.86 +$ +0.11 +Weighted average shares outstanding – basic +10,344 +10,124 +10,059 +Earnings per common share – diluted +$ +0.55 +$ +0.85 +$ +0.11 +Weighted average shares outstanding – diluted +10,407 +10,191 +10,075 +See accompanying notes to consolidated financial statements. +30 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(In thousands) +Years Ended +July 2, 2011 +July 3, 2010 +June 27, 2009 +Comprehensive income: +Net Income +$ +5,736 +$ +8,690 +$ +1,063 +Other comprehensive income (loss): +Unrealized gain (loss) on foreign exchange contracts +1,982 +(1,154 +) +912 +Comprehensive income +$ +7,718 +$ +7,536 +$ +1,975 +Other comprehensive income for fiscal years 2011 and 2010 are reflected net of tax of approximately $1.0 million and +$(0.1) million, respectively. +See accompanying notes to consolidated financial statements. +31 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY +(In thousands) +Common Stock +Retained +Earnings +Accumulated +Other +Comprehensive +Income (Loss) +Total +Shares +Amount +Balances, June 28, 2008 +10,024 +$ +39,301 +$ +9,780 +$ +— +$ +49,081 +Net income +— +— +1,063 +— +1,063 +Unrealized gain on foreign exchange contracts +— +— +— +912 +912 +Exercise of stock options +42 +58 +— +— +58 +Balances, June 27, 2009 +10,066 +39,359 +10,843 +912 +51,114 +Net income +— +— +8,690 +— +8,690 +Unrealized loss on foreign exchange contracts +— +— +— +(1,154 +) +(1,154 +) +Exercise of stock options +198 +604 +— +— +604 +Tax benefit from exercise of stock options +— +163 +— +— +163 +Balances, July 3, 2010 +10,264 +40,126 +19,533 +$ +(242 +) +59,417 +Net income +— +— +5,736 +— +5,736 +Unrealized gain on foreign exchange contracts +— +— +— +1,982 +1,982 +Exercise of stock options +135 +332 +— +— +332 +Stock-based compensation +— +556 +— +— +556 +Balances, July 2, 2011 +10,399 +$ +41,014 +$ +25,269 +$ +1,740 +$ +68,023 +See accompanying notes to consolidated financial statements. +32 +Table of Contents +KEY TRONIC CORPORATION +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +July 2, 2011 +Year Ended +July 3, 2010 +June 27, 2009 +Cash flows from operating activities: +Net income +$ +5,736 +$ +8,690 +$ +1,063 +Adjustments to reconcile net income to cash provided by (used in) operating activities: +Depreciation and amortization +2,212 +1,794 +1,595 +Goodwill impairment charge +— +— +765 +Excess tax benefit from exercise of stock options +— +163 +— +Accretion of deferred gain on sale of building +(39 +) +(78 +) +(78 +) +Provision for obsolete inventory +299 +2,182 +303 +Provision for doubtful receivables +15 +— +604 +Provision for (recovery of) warranty +158 +(45 +) +(93 +) +Loss (gain) on sale of assets +(6 +) +(58 +) +14 +SARs expense +500 +57 +— +Deferred income taxes +470 +(2,062 +) +(104 +) +Changes in operating assets and liabilities: +Trade receivables +(5,748 +) +(10,104 +) +10,547 +Inventories +(2,078 +) +(9,666 +) +5,333 +Other assets +(274 +) +(1,659 +) +2,320 +Accounts payable +(3,009 +) +10,455 +(10,794 +) +Accrued compensation and vacation +(661 +) +1,899 +(1,190 +) +Other liabilities +(144 +) +2,129 +(247 +) +Cash (used in) provided by operating activities +(2,569 +) +3,697 +10,038 +Cash flows from investing activities: +Purchase of property and equipment +(3,818 +) +(3,378 +) +(1,891 +) +Proceeds from sale of property and equipment +15 +74 +— +Proceeds from life insurance +113 +— +— +Cash used in investing activities +(3,690 +) +(3,304 +) +(1,891 +) +Cash flows from financing activities: +Payment of financing costs +(50 +) +(50 +) +(50 +) +Proceeds from exercise of stock options +332 +604 +58 +Proceeds from capital lease financings +2,244 +— +— +Capital lease payments +(251 +) +(172 +) +(284 +) +Borrowing under revolving credit agreement +98,985 +24,931 +194,066 +Repayment of revolving credit agreement +(94,539 +) +(25,789 +) +(204,002 +) +Decrease (increase) in restricted cash +— +124 +(85 +) +Cash provided by (used in) financing activities +6,721 +(352 +) +(10,297 +) +Increase (decrease) in cash and cash equivalents +462 +41 +(2,150 +) +Cash and cash equivalents, beginning of year +770 +729 +2,879 +Cash and cash equivalents, end of year +$ +1,232 +$ +770 +$ +729 +Supplemental cash flow information: +Interest payments +$ +463 +$ +85 +$ +621 +Income tax payments, net of refunds +$ +533 +$ +415 +$ +327 +See accompanying notes to consolidated financial statements. +33 +Table of Contents +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. SIGNIFICANT ACCOUNTING POLICIES +Business +Key Tronic Corporation and +subsidiaries (the Company) is engaged in electronic manufacturing services (EMS) for original equipment manufacturers (OEMs), and also manufactures keyboards and other input devices. The Company’s headquarters are located in Spokane Valley, +Washington with manufacturing operations in Spokane Valley; Juarez, Mexico; and Shanghai, China. +Principles of Consolidation +The consolidated financial statements include the Company and its wholly owned subsidiaries in Mexico and China. Intercompany balances and +transactions have been eliminated in consolidation. +Use of Estimates +The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the +reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates include the allowance for +doubtful receivables, the provision for obsolete and non-saleable inventories, deferred tax assets and liabilities, uncertain tax positions, impairment of long-lived assets, medical self insurance liability, long-term incentive compensation accrual, +the provision for warranty costs, and the fair values of options granted under the Company’s stock-based compensation plans. Due to uncertainties with respect to the assumptions and estimates actual results could differ from those estimates. +Cash and Cash Equivalents +The Company considers investments with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost, which +approximates fair value. +Allowance for Doubtful Accounts +The Company evaluates the collectibility of accounts receivable and records an allowance for doubtful accounts, which reduces the receivables to an amount that management reasonably estimates will be +collected. A specific allowance is recorded against receivables considered to be impaired based on the Company’s knowledge of the financial condition of the customer. In determining the amount of the allowance, the Company considers several +factors including the aging of the receivables, the current business environment, and historical experience. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. +Inventories +Inventories are stated at +the lower of cost or market. Cost is determined principally using the first-in, first-out (FIFO) method. The Company provides for obsolete and non-saleable inventories based on specific identification of inventory against current demand forecasts +and recent usage. +Property, Plant and Equipment +Property, plant and equipment are carried at cost and depreciated using straight-line methods over the expected useful lives of the assets. Internally constructed molds and dies are depreciated over the +expected useful lives of one to two years. Repairs and maintenance costs are expensed as incurred. +34 +Table of Contents +Impairment of Long-lived Assets +The Company, using its best estimates based on reasonable and supportable assumptions and projections, reviews assets for impairment whenever events or changes in circumstances have indicated that the +carrying amount of its assets might not be recoverable. Impaired assets are reported at the lower of cost or fair value. +Deferred Loan +Fees +Deferred loan fees included in other assets are amortized over the term of the related loan agreement. +Accrued Warranty +An accrual is made for +expected warranty costs, with the related expense recognized in cost of goods sold. Management reviews the adequacy of this accrual quarterly based on historical analyses and anticipated product returns. +Self-funded Insurance +The Company +self-funds its domestic employee health plan. The Company contracted with a separate administrative service company to supervise and administer the program and act as its representative. The Company reduces its risk under this self-funded platform +by purchasing stop-loss insurance coverage for claims. In addition, if the aggregate annual claims amount to more than 125 percent of expected claims for the plan year this insurance will also pay those claims amounts exceeding that level. +The Company estimates its exposure for claims incurred but not paid at the end of each reporting period and uses historical claims data +supplied by the Company’s broker to estimate its self-funded insurance liability. This liability is subject to a total limitation that varies based on employee enrollment and factors that are established at each annual contract renewal. Actual +claims experience may differ from the Company’s estimates. Costs related to the administration of the plan and related claims are expensed as incurred. +Revenue Recognition +Sales revenue from manufacturing is recognized upon shipment of the +manufactured product per contractual terms. Upon shipment, title transfers and the customer assumes risks and rewards of ownership of the product. Unless specifically stated in contractual terms, there are no formal customer acceptance requirements +or further obligations related to the manufacturing services; if any such requirements exist, then sales revenue is recognized at the time when such requirements are completed and such obligations are fulfilled. Revenue is recorded net of estimated +returns of manufactured product based on management’s analysis of historical returns. +Revenues and associated costs from engineering +design, development services and tooling, which are performed under contract of short term durations, are recognized only after the completed performance of the service. Revenue from engineering design, development services and tooling represented +approximately 3.3 percent, 2.4 percent, and 3.3 percent of total revenue in fiscal years 2011, 2010, and 2009, respectively. +Shipping and +Handling Fees +The Company classifies costs associated with shipping and handling fees as a component of cost of goods sold. Customer +billings related to shipping and handling fees are reported as revenue. +Research, Development and Engineering +Research, development and engineering expenses include unreimbursed EMS costs as well as design and engineering costs associated with the production of +EMS programs. Research, development and engineering costs are expensed as incurred. +35 +Table of Contents +Income Taxes +Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences and benefits attributable to differences +between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, as well as operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates +expected to apply to taxable income in the years in which temporary differences and carryforwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities for a change in tax rates is recognized in the period that +includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized. +We utilize a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence +indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% +likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and which may not accurately forecast actual outcomes. We did not +have any unrecognized tax benefits. Our policy is to recognize interest and penalties related to the underpayment of income taxes as a component of income tax expense. To date, we have not incurred charges for interest or penalties in relation to +the underpayment of income taxes. The tax years 1993 through the present remain open to examination by the major taxing jurisdictions to which we are subject. +Earnings Per Common Share +Basic earnings per common share is computed by dividing net +income by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed by dividing net income by the combination of other potentially dilutive weighted average common shares and the +weighted average number of common shares outstanding during the period using the treasury stock method. The computation assumes the proceeds from the exercise of stock options were used to repurchase common shares at the average market price during +the period. The computation of diluted earnings per common share does not assume conversion, exercise, or contingent issuance of common stock equivalent shares that would have an anti-dilutive effect on earnings per share. +Foreign Currency Transactions +The +functional currency of the Company’s subsidiaries in Mexico and China is the U.S. dollar. Realized foreign currency transaction gains and losses for local currency denominated assets and liabilities are included in cost of goods sold. +Fair Value of Financial Instruments +The carrying values of financial instruments reflected on the balance sheets at July 2, 2011 and July 3, 2010, reasonably approximate their fair value. Based on the borrowing rates currently +available to the Company for loans with similar terms and average maturities, the fair value of long-term debt is estimated to be $6.0 million and $1.6 million, respectively, as of July 2, 2011 and July 3, 2010. +Stock-based Compensation +The +Company’s incentive plan provides for equity and liability awards to employees in the form of stock options, stock appreciation rights, restricted stock, restricted stock units, stock awards, stock units, performance shares, performance units, +and other stock –based or cash-based awards. Compensation cost is recognized on a straight-line basis over the requisite employee service period, which is generally the vesting period, and is included in cost of goods sold and selling, general, +and administrative expenses. +Newly Adopted and Recent Accounting Pronouncements +In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-06, Improving Disclosures About Fair +Value Measurements , which requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair-value measurements and information on +purchases, sales, +36 +Table of Contents +issuances, and settlements on a gross basis in the reconciliation of Level 3 fair-value measurements. ASU 2010-06 is effective for annual reporting periods beginning after December 15, 2009, +except for Level 3 reconciliation disclosures which are effective for annual periods beginning after December 15, 2010. The adoption of ASU 2010-06 did not have a material impact on the Company’s consolidated financial statements. +In May 2011, the FASB issued Accounting Standards Update 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure +Requirements in U.S. GAAP and IFRSs (ASU 2011-04). ASU 2011-04 amends Accounting Standards Codification (ASC)Topic 820, Fair Value Measurements (ASC 820) by: (1) clarifying that the highest-and-best-use and valuation-premise concepts +only apply to measuring the fair value of non-financial assets; (2) allowing a reporting entity to measure the fair value of the net asset or net liability position in a manner consistent with how market participants would price the net risk +position, if certain criteria are met; (3) providing a framework for considering whether a premium or discount can be applied in a fair value measurement; (4) providing that the fair value of an instrument classified in a reporting +entity’s shareholders’ equity is estimated from the perspective of a market participant that holds the identical item as an asset; and (5) expanding the qualitative and quantitative fair value disclosure requirements. The expanded +disclosures include, for Level 3 items, a description of the valuation process and a narrative description of the sensitivity of the fair value to changes in unobservable inputs and interrelationships between those inputs if a change in those inputs +would result in a significantly different fair value measurement. ASU 2011-04 also requires disclosures about the highest-and-best-use of a non-financial asset when this use differs from the asset’s current use and the reasons for such a +difference. In addition, this ASU amends Accounting Standards Codification 820, Fair Value Measurements , to require disclosures to include any transfers between Level 1 and Level 2 of the fair value hierarchy. These amendments are effective +for fiscal years beginning after December 15, 2011 and for interim periods within those fiscal years. The amendments of ASU 2011-04, when adopted, are not expected to have a material impact on the Company’s consolidated financial +statements. +In June 2011, the FASB issued Accounting Standards Update 2011-05, Presentation of Comprehensive Income (ASU 2011-05). ASU +2011-05 requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. Under the two-statement approach, the first statement would +include components of net income, and the second statement would include components of other comprehensive income. This ASU does not change the items that must be reported in other comprehensive income. These provisions are effective for fiscal +years beginning after December 15, 2011 and for interim periods within those fiscal years; however, early adoption is permitted. The provisions of ASU 2011-05, when adopted, are not expected to have a material impact on the Company’s +consolidated financial statements. +Fiscal Year +The Company operates on a 52/53 week fiscal year. Fiscal years end on the Saturday nearest June 30. As such, fiscal years 2011, 2010, and 2009, ended on July 2, 2011, July 3, 2010, +and June 27, 2009, respectively. Fiscal year 2010 was a 53 week year, whereas fiscal years 2011, and 2009 were 52 week years. +2. +INVENTORIES +Components of inventories were as follows: +July 2, 2011 +July 3, 2010 +(in thousands) +Finished goods +$ +5,660 +$ +4,492 +Work-in-process +4,821 +4,095 +Raw materials +31,073 +31,188 +$ +41,554 +$ +39,775 +37 +Table of Contents +3. PROPERTY, PLANT AND EQUIPMENT +Life +July 2, 2011 +July 3, 2010 +(in years) +(in thousands) +Land +— +$ +2,089 +$ +2,089 +Buildings and improvements +3 to 30 +16,855 +15,067 +Equipment +1 to 10 +34,686 +33,884 +Furniture and fixtures +3 to 5 +2,530 +2,108 +56,160 +53,148 +Accumulated depreciation +(41,243 +) +(39,250 +) +$ +14,917 +$ +13,898 +During fiscal year 2010, the Company purchased a building and land in Juarez, Mexico at a total purchase price of $2.2 +million of which $1.6 million was paid during fiscal year 2010 and the remainder was paid during the first quarter of fiscal year 2011. +4. +LONG-TERM DEBT +Note Payable – Bank +On October 15, 2010, the Company entered into an amended credit agreement with Wells Fargo Bank, N.A. thereby increasing its revolving line of credit for up to $30 million and extending the term of +the credit agreement to October 15, 2013. The agreement specifies that the proceeds of the revolving line of credit be used primarily for working capital and general corporate purposes of the Company and its subsidiaries. Borrowings under this +revolving line of credit bear interest at either a “Base Rate” or a “Fixed Rate”, as elected by the Company. The base rate is the higher of the Wells Fargo Bank prime rate, daily one month London Interbank Offered Rate (LIBOR) +plus 1.5%, or the Federal Funds rate plus 1.5%. The fixed rate is LIBOR plus 2.1% or LIBOR plus 2.5% depending on the level of the Company’s trailing four quarters Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). The +revolving line of credit is secured by substantially all of the assets of the Company. +The Company must comply with certain financial +covenants, including a cash flow leverage ratio and a trading ratio. The credit agreement requires the Company to maintain a minimum profit threshold, limits the maximum lease expenditures and restricts the Company from declaring or paying dividends +in cash or stock. The Company is in compliance with all financial covenants for all periods presented. +As of July 2, 2011, the Company +had availability to borrow an additional $24.0 million under the Wells Fargo line of credit. The outstanding balance under the credit facility was $6.0 million as of July 2, 2011 and the interest rate being paid on the outstanding balance was +2.48%. The outstanding balance under the credit facility was $1.6 million as of July 3, 2010 and the interest rate on the outstanding balances was 3.25%. +Capital Lease Obligations +On January 11, 2011, the Company entered into a capital +lease agreement. The term of the capital lease agreement extends to January 2014 with monthly payments of $16,760 and a fixed interest rate of 3.86%. At July 2, 2011, the outstanding principal balance was $569,212 under the capital lease +agreement and the net book value of the equipment was $618,486. +On April 1, 2011, the Company entered into two capital lease agreements. +The term of the capital lease agreements extends to March 2014 with monthly payments of $39,445 and $8,961, with fixed interest rates of 6.21%. At July 2, 2011, the outstanding principal balances were $1,160,533 and $263,664 under the capital +lease agreements. The net book value at July 2, 2011 for the equipment under the capital lease agreements was $1,217,898 and $276,208, respectively. +38 +Table of Contents +5. INCOME TAXES +Income tax expense (benefit) consists of the following: +Year Ended +July 2, 2011 +July 3, 2010 +June 27, 2009 +(in thousands) +Current income tax expense: +United States +$ +34 +$ +162 +$ +15 +Foreign +242 +496 +219 +276 +658 +234 +Deferred income tax(benefit) expense: +United States +1,250 +(3,588 +) +(104 +) +Foreign +(780 +) +1,526 +— +470 +(2,062 +) +(104 +) +Total income tax(benefit) expense +$ +746 +$ +(1,404 +) +$ +130 +The Company has domestic net operating loss ( NOLs) of approximately $14 million and tax credit carryforwards of +approximately $5.9 million at July 2, 2011. In accordance with ASC 740, Income Taxes (ASC 740), management assessed the Company’s recent operating levels and estimated future taxable income and determined there was no need for a +valuation allowance other than for certain tax credits related to research and development activities. A valuation allowance against deferred tax assets is required if it is more likely than not that some of the deferred tax assets will not be +realized. Management determined during fiscal year 2010, based on the Company’s increased profitability and estimated repatriation from foreign subsidiaries, that it was more likely than not that the NOLs and a majority of the tax credits would +be fully utilized prior to their expiration. +During the fourth quarter of the year ended July 2, 2011, management determined it had a +gross potential research and development (R&D) tax credit of approximately $2.7 million. Approximately $1.6 million relates to tax credits which will expire during the fiscal years ending in 2012 and 2013. Currently, the Company anticipates +generating future taxable income but also anticipates utilizing the remainder of its domestic NOLs during those same years. Accordingly, the Company has recognized a partial valuation allowance of $720,000 against the expiring credits. Management +believes it is more likely than not that all other tax credits generated will be utilized in future years and therefore there is no other valuation allowance. +Management updated its estimates of future repatriation of its undistributed earnings of its foreign subsidiaries during fiscal year 2010. Management expects to repatriate only a portion of its foreign +undistributed earnings based on increased sales growth driving additional U.S. capital requirements, cash requirements for potential acquisitions and to implement certain tax strategies. A total of $4.6 million was repatriated from its Mexican +subsidiaries during fiscal 2011. The Company expects to repatriate approximately an additional $8.0 million in the future. As such, as earnings are recognized in the United States, the Company would be subject to U.S. federal and state income taxes +and potential withholding taxes in foreign jurisdictions. Both the domestic tax and estimated withholding tax have been recorded as part of deferred taxes as of July 2, 2011. Included in tax credits is $2.7 million related to foreign tax +credits that can be used to offset future domestic income tax. All other unremitted foreign earnings are expected to remain permanently reinvested in planned fixed asset purchases in foreign locations. +The Company has not provided for U.S. income taxes or foreign withholding taxes on approximately $6 million of earnings for certain non-U.S. subsidiaries +which are permanently reinvested outside the U.S. The unrecognized deferred tax liability associated with these earnings is approximately $870,000. +The Company has wholly owned foreign subsidiaries in Mexico that apply certain tax credits related to production assets that currently offset all of the income tax liabilities under general Mexican income +tax +39 +Table of Contents +law. However, the Company is subject to a Mexican business flat tax called Impuesto Empresarial a Tasa Unica (IETU). The Company now anticipates that it will be taxable under IETU for the +foreseeable future based on projected assets used in its operations. The effect of IETU and an associated presidential decree in fiscal year 2011 has been included in the effective tax rate for the year ended July 2, 2011. +The Company is required to pay taxes in China on its statutory foreign profits. As of July 3, 2010 the Company had recognized a full valuation +allowance on its Chinese tax NOL carryforwards. However, based on the statutory profits earned during fiscal 2011 and anticipated future profits in China, the entire valuation allowance was released during the second quarter of fiscal 2011. The +China subsidiary will not pay any taxes related to fiscal 2011 due to NOL carryforwards available in China. The Company recorded an adjustment in the fourth quarter of fiscal 2011 to account for China foreign tax credits related to future +repatriations of earnings. This resulted in a tax benefit of approximately $268,000 in the fourth quarter, which was not material in prior periods. +The Company’s effective tax rate differs from the federal tax rate as follows: +Year Ended +July 2, 2011 +July 3, 2010 +June 27, 2009 +(in thousands) +Federal income tax expense at statutory rates +$ +2,205 +$ +2,477 +$ +406 +Effect of foreign vs. domestic taxes +(326 +) +99 +(248 +) +Effect of income tax credits +(1,249 +) +— +— +Expired NOLs +— +— +2,345 +Effect of repatriation of foreign earnings, net +72 +2,158 +— +Effect of change in applied Mexican tax regime +— +1,526 +— +Other +(86 +) +211 +76 +Change in valuation allowance +130 +(7,875 +) +(2,449 +) +Income tax (benefit) provision +$ +746 +(1,404 +) +130 +The domestic and foreign components of income before income taxes were: +Year Ended +July 2, 2011 +July 3, 2010 +June 27, 2009 +(in thousands) +Domestic +$ +4,048 +$ +6,117 +$ +475 +Foreign +2,434 +1,169 +718 +Income before income taxes +$ +6,482 +$ +7,286 +$ +1,193 +Deferred income tax assets and liabilities consist of the following at: +July 2, 2011 +July 3, 2010 +(in thousands) +Deferred tax assets: +Net operating loss carryforwards +$ +4,565 +$ +9,001 +Tax credit carryforwards +5,933 +1,028 +Inventory +224 +839 +Accruals +1,789 +1,244 +Other +503 +— +Deferred income tax assets +13,014 +12,112 +Valuation allowance +(720 +) +(469 +) +Deferred income tax assets, net of valuation allowance +$ +12,294 +$ +11,643 +40 +Table of Contents +Deferred tax liabilities: +Repatriated earnings of foreign subsidiary +(3,173 +) +(2,158 +) +Accruals +— +(979 +) +Fixed assets +(1,542 +) +(850 +) +Other +(1,002 +) +(368 +) +Deferred income tax liabilities +$ +(5,717 +) +$ +(4,355 +) +Net deferred income tax assets +$ +6,577 +$ +7,288 +Balance sheet caption reported in: +Current deferred tax asset +$ +4,465 +$ +4,420 +Long-term deferred tax asset +7,829 +4,394 +Other current liabilities +(565 +) +(918 +) +Long term deferred income tax liability +(5,152 +) +(608 +) +Net deferred income tax asset +$ +6,577 +$ +7,288 +At July 2, 2011 the Company had NOLs of approximately $14 million, which expire in varying amounts through 2027. +Utilization of NOLs would be limited in the event the Company’s ownership changes more than 50% in a three-year period. The Company also has alternative minimum tax credits approximating $768,000. The alternative minimum tax credits do not +expire. +Uncertain Tax Positions +As of July 2, 2011, the Company had unrecognized tax benefits of $781,000. The unrecognized tax benefits relate to certain R&D tax credits generated in 2011 and prior years. No unrecognized tax +benefits were recognized as of July 3, 2010. +A reconciliation of the beginning and ending amount of unrecognized tax benefits is as +follows: +Balance at July 3, 2010 +$ +— +Additions based on tax positions related to the current year +781 +Reductions for tax positions of the prior years +— +Balance at July 2, 2011 (included in other long term liabilities) +$ +781 +Since a portion of the $781,000 of unrecognized tax benefits relates to credits expiring at the end of fiscal 2012, it is +expected that this liability will be reduced by approximately $270,000 during the next 12 months if these credits are unable to be used. Management does not anticipate any other material changes. +The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses. The Company has not +recognized any interest or penalties in the fiscal years presented in these financial statements. The Company is subject to income tax in the U.S. federal jurisdiction, Mexico and China. Certain years remain subject to examination but there are +currently no ongoing exams in any taxing jurisdictions. +41 +Table of Contents +6. EARNINGS PER SHARE +Basic earnings per share (EPS) is calculated by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is computed +by including both the weighted-average number of shares outstanding and any dilutive common share equivalents in the denominator. The following table presents a reconciliation of the denominator and the number of antidilutive common share options +that were not included. These antidilutive securities occur when options outstanding have an option price greater than the average market price for the period. +Years Ended +July 2, 2011 +July 3, 2010 +June 27, 2009 +Total weighted average shares – basic +10,343,705 +10,124,320 +10,059,376 +Effect of dilutive common stock options +62,993 +66,626 +15,596 +Total weighted average shares – diluted +10,406,698 +10,190,946 +10,074,972 +Antidilutive options not included in diluted earnings per share +540,750 +112,500 +741,492 +7. STOCK OPTION AND BENEFIT PLANS +The Company has an executive stock option plan for certain key employees. Options under this plan vest over one to three years and become exercisable as they vest. Options under the plan become +exercisable in full immediately prior to the occurrence of a “Change in Control” as defined in the plan documents. As of July 2, 2011, 106,753 options were outstanding and exercisable under the Executive Stock Option Plan. The plan +has terminated and no more options can be granted under this plan. These options expire five to ten years from the date of grant. +The Company +also has a stock option plan for “Nonemployee Directors.” Options under this plan vested over a three-year period and are exercisable as they vest. As of July 2, 2011, 39,860 options were outstanding. The plan has terminated and no +more options can be granted under this plan. Outstanding options expire five to ten years from the date of grant. +In May 2010, the +Company established a new Stock Incentive Plan (the “2010 Incentive Plan”). The 2010 Incentive Plan has a total of 1,200,000 shares authorized for grant. The 2010 Incentive Plan was adopted by the Board of Directors in May 2010, and +approved by the shareholders at the 2010 Annual Meeting. The 2010 Incentive Plan provides for the granting of nonqualified stock options within the meaning of Section 422 of the Internal Revenue Code, as well as stock appreciation rights +(SARs), restricted stock, restricted stock units, stock awards, stock units, performance shares, performance units, and other stock-based or cash-based awards. Stock appreciation rights may be settled in stock or cash at the Company’s +discretion. Options and SARs under the plan become exercisable in full immediately prior to the occurrence of a “Change in Control” as defined in the plan documents. As a result of the shareholder approval, the Company made a decision to +amend the accounting of 522,000 SARs granted during the fourth quarter of fiscal 2010 by replacing the cash-settlement feature with a net-share-settlement feature. As a result of the change the awards were reclassified from liability awards to +equity awards effective October 21, 2010 at a weighted average fair value of $2.89. No incremental compensation cost resulted from the change. +As of July 2, 2011, 522,000 SARs were outstanding. In addition to service conditions, these SARs contain a performance condition. The additional performance condition is based upon the achievement of +Return on Invested Capital (ROIC) goals relative to a peer group. All awards with performance conditions are measured over the vesting period and are charged to compensation expense over the requisite service period based on the number of shares +expected to vest. The SARs cliff vest over a three-year period from date of grant and expire five years from date of grant. +42 +Table of Contents +The fair value for the liability awards amended to equity awards during fiscal year 2011 were estimated +using the Black-Scholes option valuation model with the following weighted average assumptions as of October 21, 2010: +Expected dividend yield +0.00 +% +Risk-free interest rate +0.73 +% +Expected volatility +68.3 +% +Expected life +3.56 years +Fair value +$ +2.89 +Stock-based compensation expense is recognized only for those awards that are expected to vest, with forfeitures +estimated at the date of grant based on the Company’s historical experience and future expectations. This forfeiture rate will be revised, if necessary, in subsequent periods if actual forfeitures differ from the amount estimated. Stock-based +compensation expense for fiscal years ended July 2, 2011 and July 3, 2010 was $0.5 million and $0.1 million, respectively. No stock-based compensation expense was recognized during the year ended June 29, 2009. +The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which differ significantly from the SARs, +as traded options have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, particularly for the expected term and expected stock price volatility. Changes in +these assumptions can materially affect the fair value estimates. +The intrinsic value for options exercised in fiscal years 2011, 2010 and +2009 was $0.2 million, $0.5 million and $0.1 million, respectively. +As of July 2, 2011, total unrecognized compensation expense related +to nonvested share-based compensation arrangements was approximately $0.9 million. This expense is expected to be recognized over a weighted-average period of 1.9 years. +The following table summarizes option/SARs activity of all plans from July 3, 2010 through July 2, 2011: +Shares +Available +For Grant +Options/SARs +Outstanding +Aggregate +Intrinsic +Value (in +thousands) +Weighted +Average +Exercise +Price +Weighted +Average +Remaining +Contractual +Life (in +years) +Balance at July 3, 2010 +— +323,494 +$ +483 +$ +3.57 +1.4 +Shares authorized +1,200,000 +Options granted +— +SARs amended to equity +(522,000 +) +522,000 +Options canceled and expired +— +(42,084 +) +Options exercised +— +(134,797 +) +Balance at July 2, 2011 +678,000 +668,613 +$ +240 +$ +5.29 +3.3 +Exercisable at July 2, 2011 +146,613 +$ +240 +$ +3.14 +1.4 +43 +Table of Contents +The following is a summary of plan activity: +Number of +Options/SARs +Weighted Average +Exercise Price +Outstanding, June 28, 2008 +1,268,375 +$ +3.58 +Exercised during 2009 +(41,666 +) +1.38 +Canceled +(441,882 +) +3.96 +Outstanding June 27, 2009 +784,827 +3.48 +Exercised during 2010 +(198,416 +) +3.05 +Canceled +(262,917 +) +3.69 +Outstanding July 3, 2010 +323,494 +3.57 +Amended to equity +522,000 +5.89 +Exercised +(134,797 +) +3.66 +Canceled +(42,084 +) +4.85 +Outstanding, July 2, 2011 +668,613 +$ +5.29 +Additional information regarding options outstanding as of July 2, 2011, is as follows: +Options/SARs +Outstanding +Options/SARs +Exercisable +Range of +Exercise Prices +Number +Outstanding +Weighted +Avg. +Remaining +Contractual +Life (yrs.) +Weighted +Avg. +Exercise +Price +Number +Exercisable +Weighted +Avg. +Exercise +Price +$1.15 – $1.73 +7,500 +1.3 +$ +1.20 +7,500 +$ +1.20 +1.74 – 2.60 +22,500 +1.7 +2.13 +22,500 +2.13 +2.61 – 3.92 +97,863 +1.6 +2.87 +97,863 +2.87 +5.89 +522,000 +3.9 +5.89 +— +— +5.90 – 6.50 +18,750 +0.1 +6.50 +18,750 +6.50 +$1.15 to $6.50 +668,613 +3.3 +$ +5.29 +146,613 +$ +3.14 +The Company also has a defined contribution plan (401(k)) available to U.S. employees who have attained age 21. The +Company contributes an amount equal to 100% of the employee’s contribution on the first 3% of the employee’s compensation and an additional 50% of the employee’s contribution on the following 2% of the employee’s compensation. +Company contributions to the plan were approximately $0.5 million during fiscal year 2011 and approximately $0.4 million during each of fiscal years 2010 and 2009. +8. COMMITMENTS AND CONTINGENCIES +Leases : As of July 2, 2011, the Company had +$2.2 million in equipment that is being financed through capital leases. The related depreciation expense was $0.1 million as of July 2, 2011. The Company has operating and capital leases for certain equipment and production facilities, which +expire at various dates during the next ten years. +44 +Table of Contents +Future minimum payments under non-cancelable operating and capital leases with initial or remaining terms of +one year or more at July 2, 2011, are summarized as follows (in thousands): +Fiscal Years Ending +Operating +Leases +Capital +Leases +2012 +$ +1,284 +$ +782 +2013 +911 +782 +2014 +857 +588 +2015 +788 +— +2016 +205 +— +Thereafter +3,297 +— +Total minimum lease payments +$ +7,342 +$ +2,152 +* +* +Includes $202 of interest. +Rental expense +under operating leases was approximately $2.4 million, $3.3 million, and $3.4 million during fiscal years 2011, 2010, and 2009, respectively. +Warranty Costs : The Company provides warranties on certain product sales, and allowances for estimated warranty costs are recorded during the +period of sale. The determination of such allowances requires the Company to make estimates of product return rates and expected costs to repair or to replace the products under warranty. The Company establishes warranty reserves based on historical +warranty costs for each product line combined with liability estimates based on the prior twelve months’ sales activities. +If actual +return rates and/or repair and replacement costs differ significantly from estimates, adjustments to recognize additional cost of sales may be required in future periods. +Components of the reserve for warranty costs during fiscal years 2011, 2010, and 2009 were as follows (in thousands): +Balance at June 28, 2008 +$ +167 +Recovery related to current period sales +(93 +) +Warranty costs incurred +(49 +) +Balance at June 27, 2009 +25 +Additions +45 +Warranty costs incurred +(45 +) +Balance at July 3, 2010 +25 +Additions +158 +Warranty costs incurred +(173 +) +Balance at July 2, 2011 +$ +10 +Warranty expense for fiscal years 2011 and 2010 is related to workmanship claims on keyboards and certain EMS products. +The recovery in fiscal year 2009 is related to the release of a warranty claim for a specific product that was identified in fiscal year 2008. +Litigation : The Company is party to certain lawsuits or claims in the ordinary course of business. The Company does not believe that these +proceedings, individually or in the aggregate, will have a material adverse effect on the financial position, results of operations or cash flow of the Company. +45 +Table of Contents +Indemnification Rights : Under the Company’s bylaws, the Company’s directors and officers +have certain rights to indemnification by the Company against certain liabilities that may arise by reason of their status or service as directors or officers. The Company maintains director and officer insurance, which may cover certain liabilities +arising from its obligation to indemnify its directors and officers and former directors in certain circumstances. +9. GOODWILL +In accordance with ASC 350 Intangibles – Goodwill and Other , goodwill is not amortized, but must be analyzed for impairment at +least annually. On December 27, 2008, the Company completed its annual impairment test. As the deteriorating global macroeconomic environment adversely affected the Company’s common stock price, the Company concluded that 100% of the +goodwill was impaired due to the significant and sustained decline in the Company’s market capitalization to below the book value. The Company recorded an impairment charge of $765,000 during fiscal year 2009. As of July 2, 2011, and +July 3, 2010, there was no goodwill recorded in the Company’s Consolidated Balance Sheet. +10. FAIR VALUE MEASUREMENTS +The Company has adopted ASC 820, Fair Value Measurements, which defines fair value, establishes a framework for assets and +liabilities being measured and reported at fair value and expands disclosures about fair value measurements. There are three levels of fair value hierarchy inputs used to value assets and liabilities which include: Level 1 – inputs are quoted +market prices for identical assets or liabilities; Level 2 – inputs other than quoted market prices included in Level 1 that are observable for the asset or liability, either directly or indirectly; and Level 3 – inputs are unobservable +inputs for the asset or liability. +The following table summarizes the Company’s financial assets and liabilities (only those required to +be measured at fair value on a recurring basis) at fair value as of July 2, 2011 and July 3, 2010 (in thousands): +July 2, 2011 +Level 1 +Level 2 +Level 3 +Total +Fair Value +Financial Assets: +Foreign currency forward contracts +$ +— +$ +2,723 +$ +— +$ +2,723 +Financial Liabilities: +Foreign currency forward contracts +$ +— +$ +(82 +) +$ +— +$ +(82 +) +July 3, 2010 +Level 1 +Level 2 +Level 3 +Total +Fair Value +Financial Assets: +Foreign currency forward contracts +$ +— +$ +416 +$ +— +$ +416 +Financial Liabilities: +Foreign currency forward contracts +$ +— +$ +(777 +) +$ +— +$ +(777 +) +The Company currently has forward contracts to hedge known future cash outflows for expenses denominated in the Mexican +peso. These contracts are measured on a recurring basis based on the foreign currency spot rates and forward rates quoted by banks or foreign currency dealers. These contracts are marked to market using level 2 input criteria every period with the +unrealized gain or loss, net of tax, reported as a component of shareholders’ equity in accumulated other comprehensive income, as they qualify for hedge accounting. +11. DERIVATIVE FINANCIAL INSTRUMENTS +The Company has entered into foreign currency forward +contracts and those contracts are accounted for as cash flow hedges. The effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income (AOCI) and is reclassified into earnings in the +same period in which the underlying hedged transaction affects earnings. The derivative’s effectiveness represents the change in fair value of the hedge that offsets the change in fair value of the hedged item. +46 +Table of Contents +The Company transacts business in Mexico and is subject to the risk of foreign currency exchange rate +fluctuations. The Company enters into foreign currency forward contracts to manage the foreign currency fluctuations for Mexican peso denominated payroll, utility, tax, and accounts payable expenses. The foreign currency forward contracts have terms +that are matched to the underlying transactions being hedged. As a result, these transactions fully offset the hedged risk and no ineffectiveness has been recorded. +As of July 2, 2011, the Company had outstanding foreign currency forward contracts of $37.9 million. These contract maturity dates extend through September 25, 2013. As of July 2, 2011, the +net amount of existing gains expected to be reclassified into earnings within the next 12 months was $1.6 million. During the fiscal year ended July 2, 2011, the Company entered into $21.7 million of foreign currency forward contracts and +settled $14.6 million of such contracts. During the fiscal year ended July 3, 2010, the Company entered into $30.9 million of foreign currency forward contracts and settled $17.8 million of such contracts. During the fiscal year ended +June 27, 2009, the Company entered into $26.6 million of foreign currency forward contracts and settled $8.8 million of such contracts. Subsequent to July 2, 2011, the Company entered into $4.4 million of additional foreign currency +forward contracts for October through December 2013. +The following table summarizes the fair value of derivative instruments in the +Consolidated Balance Sheets as of July 2, 2011 (in thousands): +Derivatives Designated as Hedging +Instruments +Balance Sheet Location +July 2, 2011 +Fair Value +July 3, 2010 +Fair Value +Foreign currency forward contracts +Other current assets +$ +1,645 +$ +416 +Foreign currency forward contracts +Other long term assets +$ +1,078 +$ +— +Foreign currency forward contracts +Other long term liabilities +$ +(82 +) +$ +(777 +) +The following table summarizes the gain (loss) of derivative instruments on the Consolidated Statement of Operations for +the fiscal year 2011 (in thousands): +Derivatives Designated as Hedging +Instruments +AOCI Balance +as of July 3, +2010 +Effective +Portion +Recorded In +AOCI +Effective Portion +Reclassified From +AOCI Into Cost +of Sales +AOCI Balance +as of July 2, +2011 +Settled foreign currency forward contracts +$ +279 +$ +1,253 +$ +(1,532 +) +$ +— +Unsettled foreign currency forward contracts +(521 +) +2,261 +— +1,740 +Total +$ +(242 +) +$ +3,514 +$ +(1,532 +) +$ +1,740 +The following table summarizes the gain (loss) of derivative instruments on the Consolidated Statement of Operations for +the fiscal year 2010 (in thousands): +Derivatives Designated as Hedging +Instruments +AOCI Balance +as of June 27, +2009 +Effective +Portion +Recorded In +AOCI +Effective Portion +Reclassified From +AOCI Into Cost +of Sales +AOCI Balance +as of July 3, +2010 +Settled foreign currency forward contracts +$ +912 +$ +912 +$ +(1,824 +) +$ +— +Unsettled foreign currency forward contracts +— +(242 +) +— +(242 +) +Total +$ +912 +$ +670 +$ +(1,824 +) +$ +(242 +) +47 +Table of Contents +The following table summarizes the gain (loss) of derivative instruments on the Consolidated Statement of +Operations for the fiscal year 2009 (in thousands): +Derivatives Designated as +Hedging Instruments +AOCI Balance +as of June 28, +2008 +Effective +Portion +Recorded In +AOCI +Effective Portion +Reclassified From +AOCI Into Cost +of Sales +AOCI Balance +as of June 27, +2009 +Settled foreign currency forward contracts +$ +— +$ +(439 +) +$ +439 +$ +— +Unsettled foreign currency forward contracts +— +912 +— +912 +Total +$ +— +$ +473 +$ +439 +$ +912 +The Company does not enter into derivative instruments for trading or speculative purposes. The Company’s +counterparties to the foreign currency forward contracts are major banking institutions. These institutions do not require collateral for the contracts and the Company believes that the risk of the counterparties failing to meet their contractual +obligations is remote. +As of July 2, 2011, the Company does not have any foreign exchange contracts with credit-risk-related contingent +features. The Company is subject to the risk of fluctuating interest rates from our line of credit as well foreign currency risk resulting from our China operations. The Company does not currently manage these risk exposures by using derivative +instruments. +12. ENTERPRISE-WIDE DISCLOSURES +Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making +group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is its Chief Executive Officer. As of July 2, 2011, the Company operates and internally manages a single operating +segment, Electronics Manufacturing Services. +Products and Services +Of the revenues for the years ended July 2, 2011, July 3, 2010, and June 27, 2009, EMS sales and services were $249.9 million, $195.1 million, and $180.7 million, respectively. Keyboard +sales for the years ended July 2, 2011, July 3, 2010, and June 27, 2009 were $3.9 million, $4.5 million, and $4.2 million, respectively. +Geographic Areas +Net sales and long-lived assets (property, plant, and equipment) by +geographic area for the years ended and as of July 2, 2011, July 3, 2010, and June 27, 2009 are summarized in the following table. Net sales set forth below are based on the shipping destination. +Domestic (U.S.) +Foreign +Total +(in thousands) +2011 +Net sales +$ +172,778 +$ +81,068 +$ +253,846 +Long-lived assets +$ +1,588 +$ +13,329 +$ +14,917 +2010 +Net sales +$ +163,915 +$ +35,705 +$ +199,620 +Long-lived assets +$ +931 +$ +12,967 +$ +13,898 +2009 +Net sales +$ +164,032 +$ +20,892 +$ +184,924 +Long-lived assets +$ +755 +$ +10,444 +$ +11,199 +48 +Table of Contents +For the year ended July 2, 2011, 50.7% of the Company’s foreign net sales were to customers in +Canada, 24.4% were to Australia, 6.9% were to Switzerland, 6.1% were to England, 5.1% were to New Zealand, and the remaining 6.8% were spread among customers in other parts of Europe and Asia. +For the year ended July 3, 2010, 48.8% of the Company’s foreign net sales were to customers in Canada, 16.9% were to Australia, 13.9% were to +China, and the remaining 20.4% were spread among customers in other parts of Europe and Asia. +For the year ended June 27, 2009, 52.3% of +the Company’s foreign net sales were to customers in Canada, 24.7% were to Switzerland, 15.8% were to Asia, and the remaining 7.2% were spread among customers in other parts of Europe and Australia. +Significant Customers +The percentage of +net sales to and trade accounts receivables from significant customers were as follows: +Percentage of +Net Sales +Fiscal Year +Percentage of +Trade +Accounts Receivable +Fiscal Year +2011 +2010 +2009 +2011 +2010 +Customer A +16 +% +12 +% +13 +% +14 +% +18 +% +Customer B +16 +% +18 +% +* +20 +% +22 +% +Customer C +15 +% +* +* +21 +% +10 +% +Customer D +* +10 +% +* +* +* +Customer E +* +* +14 +% +* +* +* +Amount was less than 10% of total. +There can +be no assurance that the Company’s principal customers will continue to purchase products from the Company at current levels. Moreover, the Company typically does not enter into long-term volume purchase contracts with its customers, and the +Company’s customers have certain rights to extend or delay the shipment of their orders. The loss of one or more of the Company’s major customers, or the reduction, delay or cancellation of orders from such customers, could materially and +adversely affect the Company’s business, operating results and financial condition. +13. QUARTERLY FINANCIAL DATA +Year Ended July 2, 2011 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +Net sales +$ +63,340 +$ +61,038 +$ +63,424 +$ +66,044 +Gross profit +5,970 +5,446 +4,229 +5,003 +Income before income taxes +2,552 +1,640 +765 +1,525 +Net income +1,742 +1,733 +724 +1,537 +Earnings per common share-basic +$ +0.17 +$ +0.17 +$ +0.07 +$ +0.15 +Earnings per common share-diluted +$ +0.17 +$ +0.17 +$ +0.07 +$ +0.15 +Weighted average shares outstanding +Basic +10,296 +10,345 +10,353 +10,380 +Diluted +10,403 +10,448 +10,436 +10,435 +49 +Table of Contents +Year Ended July 3, 2010 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +Net sales +$ +41,309 +$ +44,750 +$ +51,697 +$ +61,864 +Gross profit +2,675 +4,710 +5,242 +6,623 +Income before income taxes +331 +1,714 +2,217 +3,024 +Net income +295 +1,670 +4,414 +2,311 +Earnings per common share-basic +$ +0.03 +$ +0.17 +$ +0.44 +$ +0.23 +Earnings per common share-diluted +$ +0.03 +$ +0.17 +$ +0.43 +$ +0.22 +Weighted average shares outstanding +Basic +10,066 +10,087 +10,126 +10,219 +Diluted +10,082 +10,110 +10,254 +10,342 +Item 9: +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES +None +Item 9A: +CONTROLS AND PROCEDURES +Evaluation +of Disclosure Controls and Procedures +It is the responsibility of our management to establish, maintain, and monitor disclosure +controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 are recorded, processed, summarized, and reported within the time periods +specified in the Securities and Exchange Commission rules and forms. Additionally, these disclosure controls include controls and procedures that are designed to accumulate and communicate the information required to be disclosed to our +Company’s Chief Executive Officer and Chief Financial Officer, allowing for timely decisions regarding required disclosures. As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and +with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(f). Based on our assessment, we +believe that as of July 2, 2011, the Company’s disclosure controls and procedures are effective based on that criteria. +Management’s Report on Internal Control over Financial Reporting +Our management has the responsibility to establish and maintain adequate internal controls over our financial reporting, as defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934. Our +internal controls are designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our external financial statements in accordance with generally accepted accounting principles (GAAP). +Due to inherent limitations of any internal control system, management acknowledges that there are limitations as to the effectiveness of +internal controls over financial reporting and therefore recognize that only reasonable assurance can be gained from any internal control system. Accordingly, our internal control system may not detect or prevent material misstatements in our +financial statements and projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures +may deteriorate. +Under the supervision and participation of management, including the Chief Executive Officer and Chief Financial Officer, we +have performed an assessment of the effectiveness of our internal controls over financial reporting as of July 2, 2011. This assessment was based on the criteria established in Internal Control-Integrated Framework, issued by the Committee of +Sponsoring Organizations of the Treadway +50 +Table of Contents +Commission. Based on our assessment, we believe that as of July 2, 2011, the Company’s internal control over financial reporting is effective based on that criteria. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. +Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this annual report. +Changes in Internal Control over Financial Reporting +There have been no significant changes in our internal controls over financial reporting during our fourth fiscal quarter ended July 2, 2011 that have materially affected, or are reasonable likely to +materially affect, the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)). +Item 9B: +OTHER INFORMATION +None +PART III +Item 10: +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +Directors of the Registrant +Information on the nominees for election as Directors of the +Company is incorporated by reference from the Company’s definitive proxy statement for the 2011 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A under the Exchange Act no later than 120 days after the end of the +Company’s 2011 fiscal year. +Executive Officers of the Registrant +This information is included in a separate item captioned “Executive Officers of the Registrant” in Item 1 of Part 1 of this report pursuant to Instruction G(3) of Form 10-K and Instruction +3 to Item 401(b) of Regulation S-K. +Compliance with Section 16(a) of the Exchange Act: +Incorporated by reference to Key Tronic Corporation’s 2011 Proxy Statement to Shareholders. +Code of Conduct +The Board of Directors has adopted a written Code of Conduct which applies +to its directors and employees, including its executive officers. The Code of Conduct is available on the Company’s website at www.keytronic.com . The Company intends to disclose on its website any amendments to or waivers of the Code of +Conduct. +Item 11: +EXECUTIVE COMPENSATION +Information +appearing under the caption “Executive Compensation” in the Company’s 2011 Proxy Statement is incorporated herein by this reference. +51 +Table of Contents +Item 12: +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The following table sets forth the aggregate information for the Company’s equity compensation plans in effect as of July 2, 2011. +EQUITY COMPENSATION PLAN INFORMATION +Plan category +Number of securities to +be issued upon exercise +of outstanding +options, +warrants, and rights +(a) +Weighted-average +exercise price of +outstanding options, +warrants, and +rights +(b) +Number of +securities +remaining available for +future issuance under +equity compensation +plans (excluding +securities +reflected +in column +(a) (c) +Equity compensation plans approved by security holders (1) +633,944 +$ +5.42 +678,000 +Equity compensation plans not approved by security holders (2) +34,669 +$ +2.85 +— +Total +668,613 +$ +5.29 +678,000 +(1) +Included are the 1,200,000 shares subject to the 2010 Plan, the issuance of which were approved by the shareholders at the 2010 Annual Meeting. As a +result of the shareholder approval, the Company made the decision to amend the cash-settled SARs granted during fiscal year 2010 to stock-settled SARs effective October 21, 2011. +(2) +Consists of the Key Tronic Corporation 2000 Employee Stock Option Plan. +Information under the caption “Beneficial Ownership of Securities” in the Company’s 2011 Proxy Statement is incorporated herein by this reference. +Item 13: +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Information appearing under the caption “Related Person Transactions”, “Compensation Committee Interlocks and Insider Participation”, and “Directors’ Independence” in +the Company’s 2011 Proxy Statement is incorporated herein by this reference. +Item 14: +PRINCIPAL ACCOUNTING FEES AND SERVICES +Information appearing under the caption “Principal Accountant Fees and Services” in the Company’s 2011 Proxy Statement is incorporated +herein by this reference. +52 +Table of Contents +PART IV +Item 15: +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a) 1. FINANCIAL STATEMENTS +Page in +Form 10-K +FINANCIAL STATEMENTS +Report of Independent Registered Public Accounting Firm +28 +Consolidated Balance Sheets, as of July 2, 2011, and July 3, 2010 +29 +Consolidated Statements of Income for the years ended July 2, 2011, July 3, 2010 and June +27, 2009 +30 +Consolidated Statements of Comprehensive Income for the years ended July 2, 2011, +July 3, 2010 and June 27, 2009 +31 +Consolidated Statements of Shareholders’ Equity for the years ended July 2, 2011, +July 3, 2010, and June 27, 2009 +32 +Consolidated Statements of Cash Flows for the years ended July 2, 2011, +July 3, 2010, and June 27, 2009 +33 +Notes to Consolidated Financial Statements +34 - 50 +2. SCHEDULES +II. Consolidated Valuation and Qualifying Accounts +57 +Other schedules are omitted because of the absence of conditions under which they are required, or because required +information is given in the financial statements or notes thereto. +3. EXHIBITS +Exhibit No. +Description +3.1 +Articles of Incorporation, incorporated by reference to the Exhibits to the Company’s form 10-K for the year ended June 30, 1986 +3.2 +Bylaws, as amended, incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended June 30, 1986 +10.1* +Executive Stock Option Plan, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended June 30, 1986 +10.2* +Amended and Restated 1990 Stock Option Plan for Non-Employee Directors, as amended, incorporated by reference to the Company’s 1997 Proxy Statement (dated October 10, 1997), +pages 14-17 +10.3* +1995 Executive Stock Option Plan, incorporated by reference to the Company’s 1995 Proxy Statement, pages 19-22 +10.4* +2000 Employee Stock Option Plan, incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended January 1, 2000 +10.5* +Officers’ Employment Contracts, incorporated by reference to the Company’s 1998 Proxy Statement, pages 10 and 11 +10.6* +Employment Contract with Michael D. Chard, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended July 1, 2000 +10.7* +Addenda to Officers’ Employment Contracts, incorporated by reference to Exhibits to the Company’s Form 10-Q for the quarter ended January 1, 2000 +53 +Table of Contents +10.8* +Description of Retention Bonus Plan, incorporated by reference to the Exhibits to the Company’s 10-Q for the quarter ended December 28, 2002 +10.9* +Addenda to Officers’ Employment Contracts, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended June 29, 2002 +10.10 +Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended September 29, +2001 +10.11 +First and Second Amendments to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended +June 29, 2002 +10.12 +Third Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended December +29, 2002 +10.13 +Fourth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended June 28, +2003 +10.14 +Fifth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended December +27, 2003 +10.15 +Sixth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended April 3, +2004 +10.16 +Seventh Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended July 3, +2004 +10.17 +Eighth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended July 3, +2004 +10.18 +Ninth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended October +2, 2004 +10.19 +Tenth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibit to the Company’s Form 8-K filed April 4, +2005 +10.20 +Promise to execute a Purchase and Sale Agreement with Key Safety Systems de Mexico, S.A. de C.V., incorporated by reference to the Exhibit to the Company’s Form 8-K filed April +26, 2005 +10.21 +Summary of material terms and conditions of the Purchase and Sale Agreement with Key Safety Systems de Mexico, S.A. de C.V., incorporated by reference to the Exhibit to the +Company’s Form 8-K filed June 6, 2005 +10.22* +Summary of Key Tronic Corporation Incentive Compensation Plan, incorporated by reference to Exhibit 10.23* the Company’s Form 10-K for the year ended July 2, +2005 +10.23* +Employment Contract between Key Tronic Corporation and George Robert Alford, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed July 26, +2006 +54 +Table of Contents +10.24* +Summary of Incentive Compensation Plan Performance goals and Target Payments for fiscal year 2007, incorporated by reference to the Company’s Form 8-K filed July 28, +2006 +10.25* +Summary of Fiscal Years 2007 – 2009 Long Term Incentive Plan Performance Measures and Awards, incorporated by reference to the Company’s Form 8-K filed July 28, +2006 +10.26* +Summary of Key Tronic Corporation Long Term Incentive Compensation Plan, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed September 27, +2005 +10.27 +Twelfth Amendment to Financing Agreement with CIT Group Business Credit, Inc., incorporated by reference to the Exhibit to the Company’s Form 8-K filed September 7, +2006 +10.28 +Summary of material terms and conditions of the Purchase and Sale Agreement with Todenko Mexico S.A. de C.V., incorporated by reference to Exhibit 10.1 to the Company’s Form +8-K filed October 12, 2006 +10.29 +Summary of material terms and conditions of the Purchase and Sale Agreement with Todenko Mexico S.A. de C.V., incorporated by reference to Exhibit 10.1 to the Company’s Form +8-K filed November 20, 2006 +10.30 +Summary of material terms and conditions of the Sale and Purchase Agreement with Adevco Corporation, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed +January 5, 2007 +10.31 +Summary of Second Amendment to Agreement of Sale and Purchase Agreement with Adevco Corporation, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed April +11, 2007 +10.32* +Summary of Incentive Compensation Plan Performance Goals and Target Payments for Fiscal Year 2008 and Fiscal Years 2008 – 2010 Long Term Incentive Plan Performance Measures and +Awards incorporated by reference to the Company’s Form 8-K filed July 27, 2007 +10.33* +Summary of Incentive Compensation Plan Performance Goals and Target payments for Fiscal Year 2009 and Fiscal Years 2009 – 2011 Long Term Incentive Plan Performance Measures and +Awards incorporated by reference to the Company’s Form 8-K filed July 24, 2008 +10.34* +Summary of Incentive Compensation Plan Performance Goals and Target payments for Fiscal Year 2010 and Fiscal Years 2010 – 2012 Long Term Incentive Plan Performance Measures and +Awards incorporated by reference to the Company’s Form 8-K filed July 23, 2009 +10.35 +Financing Agreement with Wells Fargo Bank, N.A., incorporated by reference to the Exhibits to the Company’s Form 8-K filed on August 24, 2009 +10.36* +2010 Incentive Plan, incorporated by reference to Exhibit 10.36 to the Company’s Form 10-K for the year ended July 3, 2010 +10.37* +Employment Contract with Douglas G. Burkhardt, incorporated by reference to Exhibit 10.37 to the Company’s Form 10-K for the year ended July 3, 2010 +10.38 +Summary of material terms and conditions of the Purchase and Sale Agreement with Autopartes Y Arneses de Mexico S.A. de C.V., incorporated by reference to Exhibit 10.38 to the +Company’s Form 10-K for the year ended July 3, 2010 +10.39* +Summary of Incentive Compensation Plan Performance Goals and Target Payments for Fiscal Year 2011 and Fiscal Years 2011 – 2013 Long Term Incentive Plan Performance Measures and +Awards incorporated by reference to the Company’s Form 8-K filed July 27, 2011 +10.40* +Amendment to Employment Contract of Craig D. Gates, dated August 23, 2011; of Ronald F. Klawitter, dated August 23, 2011 and of Douglas G. Burkhardt dated September 6, 2011; +submitted here with the Company’s Form 10-K for the year ended July 2, 2011 +21. +Subsidiaries of Registrant, submitted herewith +55 +Table of Contents +23.1 +Consent of Independent Registered Public Accounting Firm, submitted herewith +31.1 +Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer, submitted herewith +31.2 +Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer, submitted herewith +32.1 +Section 1350 Certification of Chief Executive Officer, submitted herewith +32.2 +Section 1350 Certification of Chief Financial Officer, submitted herewith +* +Management contract or compensatory plan or arrangement +56 +Table of Contents +PART IV +SCHEDULE II +KEY TRONIC CORPORATION AND +SUBSIDIARIES +CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS +FISCAL YEARS ENDED JULY 2, 2011, JULY 3, 2010, AND JUNE 27, 2009 +2011 +2010 +2009 +(in thousands) +Allowance for Obsolete Inventory +Balance at beginning of year +$ +1,303 +$ +409 +$ +236 +Provisions +299 +2,182 +303 +Dispositions +(870 +) +(1,288 +) +(130 +) +Balance at end of year +$ +732 +$ +1,303 +$ +409 +Allowance for Doubtful Accounts +Balance at beginning of year +$ +111 +$ +111 +$ +110 +Provisions +15 +— +604 +Write-offs +(15 +) +— +(603 +) +Balance at end of year +$ +111 +$ +111 +$ +111 +57 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this +report to be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: September 12, 2011 +KEY TRONIC CORPORATION +By: +/s/ Craig D. Gates +Craig D. Gates, President and Chief Executive Officer +(Principal Executive Officer) +58 +Table of Contents +Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been +signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated: +/s/ Craig D. Gates +September 12, 2011 +Craig D. Gates +Date +Director and President and Chief Executive Officer +(Principal Executive Officer) +/s/ Ronald F. Klawitter +September 12, 2011 +Ronald F. Klawitter +Date +Director and Executive Vice President of Administration, Chief Financial Officer and Treasurer +(Principal Financial Officer) +/s/ Brett R. Larsen +September 12, 2011 +Brett R. Larsen +Date +Vice President of Finance and Controller +(Principal Accounting Officer) +/s/ James R. Bean +September 12, 2011 +James R. Bean, Director +Date +/s/ Dale F. Pilz +September 12, 2011 +Dale F. Pilz, Director and Chairman of the Board +Date +/s/ Yacov A. Shamash +September 12, 2011 +Yacov A. Shamash, Director +Date +/s/ Patrick Sweeney +September 12, 2011 +Patrick Sweeney, Director +Date +59 \ No newline at end of file diff --git a/raw/filings/0000719733/2011/0001193125-11-245992/filing_metadata.csv b/raw/filings/0000719733/2011/0001193125-11-245992/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..2b2c7d89d80ce5cad07b4b7480ad8c10a7af9da0 --- /dev/null +++ b/raw/filings/0000719733/2011/0001193125-11-245992/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000719733,KTCC,KEY TRONIC CORP,10-K,2011-09-12,2011-07-02,2011-09-12T21:24:18.000Z,0001193125-11-245992,d224529d10k.htm,FORM 10-K,1101504,0,0,https://www.sec.gov/Archives/edgar/data/719733/000119312511245992/d224529d10k.htm,https://www.sec.gov/Archives/edgar/data/719733/000119312511245992/,2011,2011,1 diff --git a/raw/filings/0000719733/2011/0001193125-11-245992/item1.txt b/raw/filings/0000719733/2011/0001193125-11-245992/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..bac3a22a3c60eb2a6249fe8848b379dbef299c31 --- /dev/null +++ b/raw/filings/0000719733/2011/0001193125-11-245992/item1.txt @@ -0,0 +1,196 @@ +Item 1. +BUSINESS +Background +Key Tronic Corporation (dba: KeyTronicEMS Co.), was organized in 1969 as a Washington corporation that locally manufactured computer keyboards. The +ability to design, build and deliver a quality product led us to become a leading independent manufacturer of keyboards for computers in the United States. Our fully integrated design, tooling, and automated manufacturing capabilities enabled us to +rapidly respond to customers’ needs for keyboards in production quantities worldwide. We supported our sales growth through the development and purchase of international manufacturing facilities. As the computer keyboard market matured with +increasing competition from other international providers, we determined that our business could no longer solely rely on keyboard sales. +After assessing market conditions and our strengths and capabilities, we shifted focus from keyboard manufacturing to contract manufacturing for a wide +range of products. Our unique strategic attributes are based on our core strengths of innovative design and engineering expertise in electronics, mechanical engineering, and precision plastics combined with high-quality, low cost production, and +assembly on an international basis while providing exceptional customer service. These strengths have made our company a strong competitor in the electronic manufacturing services (EMS) market. +Our Industry and Strategy +The expansion +of the EMS industry during the last decade allowed us to continue to expand our customer base and the industries that we serve. The challenging global macroeconomic environment has had a negative impact on previously held customer programs. However, +we successfully confronted the challenging global macroeconomic environment by controlling our costs while winning new customer programs, which allowed us to maintain our profitability and maintain a strong balance sheet during the global economic +downturn. The increase in new programs represents a growing portion of our revenue and a promising foundation for our future. In keeping with our long-term strategic objectives, we have been successfully building a more diversified customer +portfolio, spanning a wider range of industries. We currently offer our customers the following services: integrated electronic and mechanical engineering, precision plastic molding, assembly, component selection, sourcing and procurement, worldwide +logistics, and new product testing and production all at competitive pricing due to our global footprint. +We believe that we are well +positioned in the EMS industry to continue the expansion of our customer base and achieve long term growth. Our unique blend of multinational facilities, centralized management, and core strengths continue to support our growth and our +customers’ needs. We continue to focus on controlling operating expenses and leveraging the synergistic capabilities of our world-class facilities in the United States, Mexico, and China. This international production capability provides our +customers with the benefits of improved supply-chain management, reduced inventory, lower labor costs, lower transportation costs, and reduced product fulfillment time. Given our competitive advantages and the growing need for some potential +customers to move forward with their outsourcing strategies, we are strongly positioned to win new business in coming periods and grow our revenue and profits. +The EMS industry is intensely competitive. Although our customer base is growing we still have less than 1% of the potential global market and our revenue can fluctuate significantly due to reliance on a +concentrated base of customers. We are planning for new customer growth in the coming quarters by securing new programs, increasing our worldwide manufacturing capacity, and continuing to improve our manufacturing and procurement processes. Ongoing +challenges that we face include the following: Continuing to win programs from new and existing customers, balancing production capacity and key personnel in support of new customer programs, improving operating efficiencies, controlling costs while +developing competitive pricing strategies, and successfully transitioning new program wins to full production during a time of macroeconomic uncertainty. +3 +Table of Contents +Customers and Marketing +We provide a mix of manufacturing services for outsourced Original Equipment Manufacturing (OEM) products. We provide the following EMS services: Product design, surface mount technologies (SMT) and pin +through hole capability for printed circuit board assembly, tool making, precision plastic molding, liquid injection molding, automated tape winding, prototype design and full product assembly. +Sales of the majority of our products have historically not been seasonal in nature, but may be seasonal in the future if there are changes in the types +of products manufactured. Sales can, however, fluctuate significantly between quarters from changes in customers and customer demand due to our concentrated customer base. +For the fiscal years ended July 2, 2011, July 3, 2010, and June 27, 2009, the five largest customers in each year accounted for 62%, 57%, and 52% of total net sales, respectively. At the +end of fiscal year 2011, we were generating revenue from 30 EMS customers as compared with 20 at the end of fiscal year 2010. New customer program wins would dilute our concentration of revenue in the future. +The following table represents all customers that represented 10% or more of total net sales during the last three fiscal years: +Percentage of Net Sales by +Fiscal Year +2011 +2010 +2009 +Customer A +16 +% +12 +% +13 +% +Customer B +16 +% +18 +% +* +Customer C +15 +% +* +* +Customer D +* +10 +% +* +Customer E +* +* +14 +% +* +Amount was less than 10% of total. +Although +keyboard manufacturing is still included in our product offerings, we do not expect annual keyboard sales to be a material component of our business. We realized revenues of approximately $3.9 million, $4.5 million, and $4.2 million in fiscal years +2011, 2010, and 2009, respectively, from the sale of keyboards. In order to accommodate the demand for standard keyboard layouts, we maintain a purchase-from-stock program. The more popular standard layouts are built and stocked for immediate +availability. +We market our products and services primarily through our direct sales department aided by strategically located field sales +people and distributors. Although we maintain relationships with several independent sales organizations to assist in marketing our EMS product lines, commissions earned and paid are not material to the consolidated financial statements. +Manufacturing +We have continually made +investments in developing and expanding a capital equipment base to achieve vertical integration and efficiencies in our manufacturing processes. We have invested significant capital into SMT for volume manufacturing of complex printed circuit board +assemblies. We also design and develop tooling for injection molding and manufacture the majority of plastic parts used in the products we manufacture. Additionally, we have equipment to maintain a controlled clean environment for manufacturing +processes that require a high level of precise control. +We use a variety of manual and automated assembly processes in our facilities, +depending upon product complexity and degree of customization. Some examples of automated processes include component insertion, SMT, flexible robotic assembly, automated storage tape winding, computerized vision system quality inspection, automated +switch and key top installation, and automated functional testing. +Our engineering expertise and automated manufacturing processes enable us +to work closely with our customers during the design and prototype stages of production and to jointly increase productivity and reduce response time to the marketplace. We use computer-aided design techniques and software to assist +4 +Table of Contents +in preparation of the tool design layout and component placement, to reduce tooling and production costs, improve component and product quality, and enhance turnaround time during product +development. +We purchase materials and components for our products from many different suppliers, including both domestic and international +sources. We develop close working relationships with our suppliers, many of whom have been supplying products to us for several years. +Research, Development, and Engineering +As part of our long-term strategy, we are committed to supporting our customers by providing research, development, and engineering services. These +services allow us to facilitate in optimizing new product designs, and the production processes of our customers programs. +Research, +development, and engineering (RD&E) expenses consist principally of employee related costs, third party development costs, program materials costs, depreciation, and allocated information technology and facilities costs. Our RD&E expenses +were $3.8 million, $2.8 million, and $2.3 million in fiscal years 2011, 2010, and 2009, respectively. In each of these years, we focused most of our RD&E efforts on current customer EMS programs. The increase in RD&E in fiscal years 2011 and +2010 as compared to their respective prior fiscal year periods is primarily the result of increased headcount and to a lesser extent higher incentive compensation. +Competition +The market for the products and services we provide is highly competitive. +There are numerous competitors in the EMS industry, many of which have substantially more resources and are more geographically diverse than we are. Some of our competitors have similar international production capabilities, large financial +resources and some have substantially greater manufacturing, research and development, and marketing resources. There is also competition from the manufacturing operations of our current and potential customers, who are continually evaluating the +merits of manufacturing their products internally versus the advantages of outsourcing. We believe that we can currently compete favorably in these areas primarily on the basis of our international footprint, responsiveness, creativity, vertical +production capability, quality, and cost. +Trademarks and Patents +Our name and logo are federally registered trademarks, and we believe they are valuable assets of our business. During 2001, we began operating under the trade name “KeyTronicEMS Co.” to better +identify our primary business concentration. We also own several keyboard patents; however, since our focus is EMS, management believes that these patents will not have a significant impact on future revenues. +Employees +We consider our employees to +be our primary strength and we make considerable efforts to maintain a well-qualified workforce. Our employee benefits include bonus programs involving periodic payments to all employees based on meeting quarterly or fiscal year performance targets. +We regularly provide transportation, medical services, and meals to all of our employees in foreign locations. We maintain a 401(k) plan for U.S. employees, which provides a discretionary matching company contribution of up to 4% of an +employee’s salary. We provide group health, life, and disability insurance plans. We also maintain stock option plans and other long term incentive plans for certain employees and outside directors. +As of July 2, 2011 we had 1,997 employees compared to 2,036 on July 3, 2010, and 1,963 on June 27, 2009. Since we can have significant +fluctuations in product demand, we seek to maintain flexibility in our workforce by utilizing skilled temporary and short-term contract labor in our manufacturing facilities in addition to full-time employees. +Backlog +On July 30, 2011 our order +backlog was valued at approximately $54.9 million, compared to approximately $56.9 million on July 31, 2010. Even though our order backlog is comprised of firm purchase orders, the amount of backlog is not necessarily indicative of future sales +but can be indicative of trends in expected future sales revenue. Due to the relationships with our customers, we will occasionally allow orders to be canceled or rescheduled and as a result it is not a meaningful indicator of future financial +results. If there +5 +Table of Contents +are canceled or rescheduled orders, we will attempt to negotiate fees to cover the costs we have incurred. Order backlog consists of purchase orders received for products expected to be shipped +approximately within the next twelve months, although shipment dates are subject to change due to design modifications, customer forecast changes, or other customer requirements. +Foreign Markets +Information concerning net sales and long-lived assets (property, plant, +and equipment) by geographic areas is set forth in Note 12, “Enterprise-Wide Disclosures” of the consolidated financial statements of this Annual Report on Form 10-K and that information is incorporated herein. +Executive Officers of the Registrant +The table below sets forth the name, current age and current position of our executive officers and other significant employees as of July 2, 2011: +Name +Age +Positions Held +Executive Officers +Craig D. Gates +52 +President and Chief Executive Officer +Ronald F. Klawitter +59 +Executive Vice President of Administration, Chief Financial +Officer and Treasurer +Douglas G. Burkhardt +53 +Executive Vice President of Worldwide Operations +Lawrence J. Bostwick +59 +Vice President of Engineering and Quality +Phil S. Hochberg +49 +Vice President of Business Development +Brett R. Larsen +38 +Vice President of Finance, and Controller +Executive Officers +CRAIG D. GATES – President and Chief Executive Officer +Mr. Gates, age 52, has +been President and Chief Executive officer of the Company since April 2009. Previously he was Executive Vice President and General Manager from August 2002 to April 2009. He served as Executive Vice President of Marketing, Engineering and Sales from +July 1997 to August 2002 and served as Vice President and General Manager of New Business Development from October 1995 to July 1997. He joined the Company as Vice President of Engineering in October of 1994. From 1982 he held various engineering +and management positions within the Microswitch Division of Honeywell, Inc., in Freeport, Illinois, and from 1991 to October 1994 he served as Director of Operations, Electronics for Microswitch. Mr. Gates has a Bachelor of Science Degree in +Mechanical Engineering and a Masters in Business Administration from the University of Illinois, Urbana. +RONALD F. KLAWITTER – +Executive Vice President of Administration, Chief Financial Officer, and Treasurer +Mr. Klawitter, age 59, has been Executive Vice +President of Administration, CFO, and Treasurer since July 1997. Previously he was Vice President of Finance, Secretary, and Treasurer of the Company from October 1995 to July 1997. He was Acting Secretary from November 1994 to October 1995 and Vice +President of Finance and Treasurer from 1992 to October 1995. From 1987 to 1992, Mr. Klawitter was Vice President of Finance at Baker Hughes Tubular Service, a subsidiary of Baker Hughes, Inc. Mr. Klawitter has a BA degree from Wittenberg +University and is a Certified Public Accountant. +6 +Table of Contents +DOUGLAS G. BURKHARDT – Executive Vice President of Worldwide Operations +Mr. Burkhardt, age 53, has been Executive Vice President of Worldwide Operations of the Company since +July 22, 2010. Previously Mr. Burkhardt was Vice President of Worldwide Operations from July 2008 to July 2010 and Director of China Operations +and Program Management from January 2006 to July 2008. Mr. Burkhardt also served as Director of Northwest and China Operations from November of 1998 to January of 2006. Mr. Burkhardt also served as Director of Customer Satisfaction from +March 1997 to November 1998 and Director of Molding from September of 1995 to March of 1997. Prior to this, Mr. Burkhardt served in other various senior management positions within the Company. Mr. Burkhardt has been with the Company since +May of 1989. Prior to joining Key Tronic, Mr. Burkhardt worked for House of Aluminum and Glass for 12 years where he was the plant manager. +LAWRENCE J. BOSTWICK – Vice President of Engineering and Quality +Mr. Bostwick, +age 59, has been Vice President of Engineering and Quality since July 2008. Previously he was Director of Engineering and Quality from February 2007 to July 2008 and served as Corporate Director of Quality from February 2006 to February 2007. From +2003 to 2006 he was Director of Supply Chain Management and Quality for the Lancer Corporation and from 1998 to 2003 he was Vice President of Operations for Thermacore International. He is a graduate of the Westinghouse and General Electric – +Engineering and Manufacturing Professional Development Programs. He is certified in both Quality and Industrial Engineering and is a Lean – Six Sigma Master Black Belt. Mr. Bostwick has a combined B.S. degree in Production and Operation +and Industrial Engineering from Bowling Green State University and a Masters degree in Industrial Engineering and Business Administration from Syracuse University. +PHIL S. HOCHBERG – Vice President of Business Development +Mr. Hochberg, age 49, +has been Vice President of Business Development since October 2009. Previously he was Director of Business Development and Program Management from July 2008 to October 2009. Mr. Hochberg served as Director of Business Development from October +2004 to July 2008 and as Director of EMS Sales and Marketing from July 2000 to October 2004. Prior to joining Key Tronic, Mr. Hochberg worked for Quinton Instrument Company as their Director of Marketing and Product Management from 1992 to +2000. From 1988 to 1992, he was employed by SpaceLabs Medical as their Business Development Marketing Manager. Mr. Hochberg has an MBA from the University of British Columbia, a BA Psychology, with a minor in Business from Washington University +in St. Louis. +BRETT R. LARSEN – Vice President of Finance, and Controller +Mr. Larsen, age 38, has served as Vice President of Finance and Controller since February 2010. He was Chief Financial Officer of FLSmidth Spokane, +Inc. from December 2008 to February 22, 2010. From October 2005 through November 2008, Mr. Larsen served as Controller of Key Tronic Corporation. From May 2004 to October 2005, Mr. Larsen served as Manager of Financial Reporting of +Key Tronic Corporation. From 2002 to May 2004, Mr. Larsen was an audit manager for the public accounting firm BDO Seidman, LLP. He also held various auditing and supervisory positions with Grant Thornton LLP from 1997 to 2002. Mr. Larsen +has a Bachelor of Science degree in Accounting and a Masters degree in Accounting from Brigham Young University and is a Certified Public Accountant. +Available Information +Our principal executive offices are located at N. 4424 Sullivan +Road, Spokane Valley, Washington 99216, and our telephone number is (509) 928-8000. Our website is located at http://www.keytronicems.com where filings of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q or current reports on Form +8-K are available after they have been filed with the Securities and Exchange Commission. The information presented on our website currently and in the future is not considered to be part of this document or any document incorporated by reference in +this document. \ No newline at end of file diff --git a/raw/filings/0000719733/2011/0001193125-11-245992/item13.txt b/raw/filings/0000719733/2011/0001193125-11-245992/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..907e7f31fa3246919c58b7515f6f23438df54c5c --- /dev/null +++ b/raw/filings/0000719733/2011/0001193125-11-245992/item13.txt @@ -0,0 +1,4 @@ +Item 13: +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Information appearing under the caption “Related Person Transactions”, “Compensation Committee Interlocks and Insider Participation”, and “Directors’ Independence” in +the Company’s 2011 Proxy Statement is incorporated herein by this reference. \ No newline at end of file diff --git a/raw/filings/0000719733/2011/0001193125-11-245992/item9a.txt b/raw/filings/0000719733/2011/0001193125-11-245992/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..e548a92389854560f7ee91cb15a06ec4cf38c236 --- /dev/null +++ b/raw/filings/0000719733/2011/0001193125-11-245992/item9a.txt @@ -0,0 +1,28 @@ +Item 9A: +CONTROLS AND PROCEDURES +Evaluation +of Disclosure Controls and Procedures +It is the responsibility of our management to establish, maintain, and monitor disclosure +controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 are recorded, processed, summarized, and reported within the time periods +specified in the Securities and Exchange Commission rules and forms. Additionally, these disclosure controls include controls and procedures that are designed to accumulate and communicate the information required to be disclosed to our +Company’s Chief Executive Officer and Chief Financial Officer, allowing for timely decisions regarding required disclosures. As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and +with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(f). Based on our assessment, we +believe that as of July 2, 2011, the Company’s disclosure controls and procedures are effective based on that criteria. +Management’s Report on Internal Control over Financial Reporting +Our management has the responsibility to establish and maintain adequate internal controls over our financial reporting, as defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934. Our +internal controls are designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our external financial statements in accordance with generally accepted accounting principles (GAAP). +Due to inherent limitations of any internal control system, management acknowledges that there are limitations as to the effectiveness of +internal controls over financial reporting and therefore recognize that only reasonable assurance can be gained from any internal control system. Accordingly, our internal control system may not detect or prevent material misstatements in our +financial statements and projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures +may deteriorate. +Under the supervision and participation of management, including the Chief Executive Officer and Chief Financial Officer, we +have performed an assessment of the effectiveness of our internal controls over financial reporting as of July 2, 2011. This assessment was based on the criteria established in Internal Control-Integrated Framework, issued by the Committee of +Sponsoring Organizations of the Treadway +50 +Table of Contents +Commission. Based on our assessment, we believe that as of July 2, 2011, the Company’s internal control over financial reporting is effective based on that criteria. +This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. +Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this annual report. +Changes in Internal Control over Financial Reporting +There have been no significant changes in our internal controls over financial reporting during our fourth fiscal quarter ended July 2, 2011 that have materially affected, or are reasonable likely to +materially affect, the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)). \ No newline at end of file diff --git a/raw/filings/0000719733/2011/0001193125-11-245992/rp_note.txt b/raw/filings/0000719733/2011/0001193125-11-245992/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000719733/2011/0001193125-11-245992/rpt_disclosure.txt b/raw/filings/0000719733/2011/0001193125-11-245992/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..00e9ed21cde481b9e5cde30e743950ac88f27141 --- /dev/null +++ b/raw/filings/0000719733/2011/0001193125-11-245992/rpt_disclosure.txt @@ -0,0 +1,13 @@ +Related Person Transactions +In April 2007, the Board of Directors adopted a written policy and procedures for the approval or ratification of Interested Transactions with Related +Parties. The policy and procedures supplement the Company’s Code of Conduct. The policy defines an “Interested Transaction” as any transaction, arrangement or relationship or series of similar transactions, arrangements or +relationships (including any indebtedness or guarantee of indebtedness) in which (1) the aggregate amount involved will or may be expected to exceed $120,000 in any calendar year, (2) the Company is a participant, and (3) any Related +Party has or will have a direct or indirect interest (other than solely as a result of being a director or a less than 10 percent beneficial owner of another entity). +The policy defines a “Related Party” as any (a) person who is or was (since the beginning of the last fiscal year for which the Company has filed a Form 10-K and proxy statement, even if +they do not presently serve in that role) an executive officer, director or nominee for election as a director, (b) greater than 5 percent beneficial owner of the Company’s common stock, or (c) immediate family member of any of the +foregoing. Immediate family member includes a person’s spouse, parents, stepparents, children, stepchildren, siblings, mothers- and fathers-in-law, sons- and daughters-in-law, and brothers- and sisters-in-law and anyone residing in such +person’s home (other than a tenant or employee). +The Audit Committee is responsible for review, approval, ratification or disapproval of +Interested Transactions. In determining whether to approve or ratify an Interested Transaction, the Committee will take into account, among other factors it deems appropriate, whether the Interested Transaction is on terms no less favorable than +terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the Related Party’s interest in the Transaction. +6 \ No newline at end of file diff --git a/raw/filings/0000719733/2013/0000719733-13-000015/filing.txt b/raw/filings/0000719733/2013/0000719733-13-000015/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..f2a5bc02ff7b31cd9d7f1551d7af216d51aed000 --- /dev/null +++ b/raw/filings/0000719733/2013/0000719733-13-000015/filing.txt @@ -0,0 +1,3099 @@ +10-K +1 +ktcc-06292013x10k.htm +10-K +KTCC - 06.29.2013 - 10K +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +____________________________________________________________ +FORM 10-K +____________________________________________________________ +x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +FOR THE FISCAL YEAR ENDED JUNE 29, 2013 +OR +¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 +FOR THE PERIOD FROM TO +Commission File Number 0-11559 +____________________________________________________________ +KEY TRONIC CORPORATION +(Exact name of registrant as specified in its charter) +____________________________________________________________ +Washington +91-0849125 +(State or other jurisdiction of +Incorporation or organization) +(I.R.S. Employer +Identification No.) +N. 4424 Sullivan Road, Spokane Valley, +Washington +99216 +(Address of principal executive offices) +(Zip Code) +(509) 928-8000 +(Registrant’s telephone number, including area code) +N/A +(Former name, former address and former fiscal year, if changed since last report) +____________________________________________________________ +Securities Registered Pursuant to Section 12(b) of the Act: None +Title of each class +Name of each exchange on which registered +Common stock, no par value +The NASDAQ Stock Market LLC +Securities Registered Pursuant to Section 12(g) of the Act: None +____________________________________________________________ +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x +Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. +(Check one): +Large accelerated filer +¨ +Accelerated filer +x +Non-accelerated filer +¨ (Do not check if a smaller reporting company) +Smaller reporting company +¨ +Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x +State the aggregate market value of the voting and non-voting common equity held by non affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. +As of December 29, 2012, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $98.8 million based on the closing price as reported on the NASDAQ. +Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 10,509,688 shares of common stock were outstanding as of September 4, 2013 . +____________________________________________________________ +Documents Incorporated by Reference: +The following documents are incorporated by reference to the extent specified herein: +Document Description +Part of Form 10-K +Proxy Statement dated September 20, 2013 +Part III +KEY TRONIC CORPORATION +2013 FORM 10-K +TABLE OF CONTENTS +Page No. +PART I +Item 1. +Business +4 +Item 1A. +Risk Factors +8 +Item 1B. +Unresolved Staff Comments +13 +Item 2. +Properties +14 +Item 3. +Legal Proceedings +14 +Item 4. +Mine Safety Disclosures +14 +PART II +Item 5. +Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities +15 +Item 6. +Selected Financial Data +17 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +18 +Item 7A. +Quantitative and Qualitative Disclosures about Market Risk +27 +Item 8. +Financial Statements and Supplementary Data +28-50 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +50 +Item 9A. +Controls and Procedures +50 +Item 9B. +Other Information +51 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +52 +Item 11. +Executive Compensation +52 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +53 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +53 +Item 14. +Principal Accounting Fees and Services +53 +PART IV +Item 15. +Exhibits and Financial Statement Schedule +53 +Signatures +58 +3 +FORWARD-LOOKING STATEMENTS +References in this report to “the Company”, “Key Tronic”, “KeyTronicEMS”, “we”, “our”, or “us” mean Key Tronic Corporation together with its subsidiaries, except where the context otherwise requires. +This Annual Report on Form 10-K contains forward-looking statements in addition to historical information. Forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Risks and uncertainties that might cause such differences include, but are not limited to those outlined in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risks and Uncertainties that May Affect Future Results.” Readers are cautioned not to place undue reliance on forward-looking statements, which reflect management’s opinions only as of the date hereof. The Company undertakes no obligation to update forward-looking statements to reflect developments or information obtained after the date hereof and disclaims any obligation to do so. Readers should carefully review the risk factors described in periodic reports the Company files from time to time with the Securities and Exchange Commission, including Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. +PART I +Item 1. +BUSINESS +Background +Key Tronic Corporation (dba: KeyTronicEMS Co.), was organized in 1969 as a Washington corporation that locally manufactured computer keyboards. The ability to design, build and deliver a quality product led us to become a leading independent manufacturer of keyboards for computers in the United States. Our fully integrated design, tooling, and automated manufacturing capabilities enabled us to rapidly respond to customers’ needs for keyboards in production quantities worldwide. We supported our sales growth through the development and purchase of international manufacturing facilities. As the computer keyboard market matured with increasing competition from other international providers, we determined that our business could no longer solely rely on keyboard sales. +After assessing market conditions and our strengths and capabilities, we shifted focus from keyboard manufacturing to contract manufacturing for a wide range of products. Our unique strategic attributes are based on our core strengths of innovative design and engineering expertise in electronics, mechanical engineering, sheet metal and stamping, and precision plastics combined with high-quality, low cost production, and assembly on an international basis while providing exceptional customer service. These strengths have made our company a strong competitor in the electronic manufacturing services (EMS) market. +Our Industry and Strategy +The expansion of the EMS industry has allowed us to continue to expand our customer base and the industries that we serve. The challenging global macroeconomic environment has had a negative impact on previously held customer programs. However, we are successfully confronting the challenging global macroeconomic environment by controlling our costs and winning new customer programs, which allowed us to increase our profitability and maintain a strong balance sheet. The increase in new programs represents a growing portion of our revenue and a promising foundation for our future. In keeping with our long-term strategic objectives, we have been successfully building a more diversified customer portfolio, spanning a wider range of industries. We currently offer our customers the following services: integrated electronic and mechanical engineering, precision plastic molding, sheet metal fabrication, assembly, component selection, sourcing and procurement, worldwide logistics, and new product testing and production all at competitive pricing due to our global footprint. +We believe that we are well positioned in the EMS industry to continue the expansion of our customer base and achieve long term growth. Our unique blend of multinational facilities, centralized management, and core strengths continue to support our growth and our customers’ needs. We continue to focus on controlling operating expenses and leveraging the synergistic capabilities of our world-class facilities in the United States, Mexico, and China. This international production capability provides our customers with the benefits of improved supply-chain management, reduced inventory, lower labor costs, lower transportation costs, and reduced product fulfillment time. Given our competitive advantages and the growing pressure for new potential customers to move forward with their outsourcing strategies, we are strongly positioned to win new business in coming periods and grow our revenue and profits. +The EMS industry is intensely competitive. Although our customer base is growing we still have less than 1% of the potential global market and our revenue can fluctuate significantly due to reliance on a concentrated base of customers. We are planning for new customer growth in the coming quarters by securing new programs with new and existing customers, increasing our worldwide manufacturing capacity, and continuing to improve our manufacturing and procurement processes. Ongoing challenges that we face include the following: Continuing to win programs from new and existing customers, balancing production capacity and key personnel in support of new customer programs, improving operating efficiencies, controlling costs while developing competitive pricing strategies, and successfully transitioning new program wins to full production during a time of macroeconomic uncertainty. +4 +Customers and Marketing +We provide a mix of manufacturing services for outsourced Original Equipment Manufacturing (OEM) products. We provide the following EMS services: Product design, surface mount technologies (SMT) and pin through hole capability for printed circuit board assembly, tool making, precision plastic molding, sheet metal fabrication, liquid injection molding, complex assembly, automated tape winding, prototype design and full product assembly. +Sales of the majority of our products have historically not been seasonal in nature, but may be seasonal in the future if there are changes in the types of products manufactured. Sales can, however, fluctuate significantly between quarters from changes in customers and customer demand due to the concentration of sales generated by our largest customers. +For the fiscal years 2013 , 2012 and 2011 , the five largest customers in each year accounted for 71%, 73%, and 62% of combined total net sales, respectively. At the end of fiscal year 2013 , we were generating revenue from 183 separate programs and 56 distinct customers as compared to 165 programs and 48 customers at the end of fiscal year 2012 . As these new customers’ sales ramp up and new programs are won our concentration of revenue should decrease in the future. +The following table represents all customers that represented 10% or more of total net sales during the last three fiscal years: +Percentage of Net Sales by Fiscal Year +2013 +2012 +2011 +Customer A +23% +29% +15% +Customer B +21% +17% +16% +Customer C +19% +16% +16% +Although keyboard manufacturing is still included in our product offerings, we do not expect annual keyboard sales to be a material component of our business. We realized revenues of approximately $2.4 million , $2.8 million , and $3.9 million in fiscal years 2013 , 2012 , and 2011 , respectively, from the sale of keyboards. In order to accommodate the demand for standard keyboard layouts, we maintain a purchase-from-stock program. The more popular standard layouts are built and stocked for immediate availability. +We market our products and services primarily through our direct sales department aided by strategically located field sales people and distributors. Although we maintain relationships with several independent sales organizations to assist in marketing our EMS product lines, commissions earned and paid are not material to the consolidated financial statements. +Manufacturing +We have continually made investments in developing and expanding a capital equipment base to achieve vertical integration and efficiencies in our manufacturing processes. We have invested significant capital into SMT for volume manufacturing of complex printed circuit board assemblies. We also design and develop tooling for injection molding and manufacture the majority of plastic parts used in the products we manufacture. Additionally, we have equipment to maintain a controlled clean environment for manufacturing processes that require a high level of precise control. +We use a variety of manual and automated assembly processes in our facilities, depending upon product complexity and degree of customization. Some examples of automated processes include component insertion, SMT, flexible robotic assembly, automated storage tape winding, computerized vision system quality inspection, automated switch and key top installation, and automated functional testing. +Our engineering expertise and automated manufacturing processes enable us to work closely with our customers during the design and prototype stages of production and to jointly increase productivity and reduce response time to the marketplace. We use computer-aided design techniques and software to assist in preparation of the tool design layout and component placement, to reduce tooling and production costs, improve component and product quality, and enhance turnaround time during product development. +We purchase materials and components for our products from many different suppliers, including both domestic and international sources. We develop close working relationships with our suppliers, many of whom have been supplying products to us for several years. +5 +Research, Development, and Engineering +As part of our long-term strategy, we are committed to supporting our customers by providing research, development, and engineering services. These services allow us to facilitate in optimizing new product designs, and the production processes of our customers programs. +Research, development, and engineering (RD&E) expenses consist principally of employee related costs, third party development costs, program materials costs, depreciation, and allocated information technology and facilities costs. +Competition +The market for the products and services we provide is highly competitive. There are numerous competitors in the EMS industry, many of which have substantially more resources and are more geographically diverse than we are. Some of our competitors have similar international production capabilities, large financial resources and some have substantially greater manufacturing, research and development, and marketing resources. There is also competition from the manufacturing operations of our current and potential customers, who are continually evaluating the merits of manufacturing their products internally versus the advantages of outsourcing. We believe that we can currently compete favorably in these areas primarily on the basis of our international footprint, responsiveness, creativity, vertical production capability, quality, and cost. +Trademarks and Patents +Our name and logo are federally registered trademarks, and we believe they are valuable assets of our business. During 2001, we began operating under the trade name “KeyTronicEMS” to better identify our primary business concentration. We also own several keyboard patents; however, since our focus is EMS, management believes that these patents will not have a significant impact on future revenues. +Employees +We consider our employees to be our primary strength and we make considerable efforts to maintain a well-qualified workforce. Our employee benefits include bonus programs involving periodic payments to all employees based on meeting quarterly or fiscal year performance targets. We regularly provide transportation, medical services, and meals to all of our employees in foreign locations. We maintain a 401(k) plan for U.S. employees, which provides a discretionary matching company contribution of up to 4% of an employee’s salary. We provide group health, life, and disability insurance plans. We also maintain stock option plans and other long term incentive plans for certain employees and outside directors. +As of June 29, 2013 we had 2,584 employees compared to 2,700 on June 30, 2012 , and 1,997 on July 2, 2011 . Since we can have significant fluctuations in product demand, we seek to maintain flexibility in our workforce by utilizing skilled temporary and short-term contract labor in our manufacturing facilities in addition to full-time employees. +Backlog +On July 27, 2013 our order backlog was valued at approximately $60.0 million, compared to approximately $83.1 million on July 28, 2012. Even though our order backlog is comprised of firm purchase orders, the amount of backlog is not necessarily indicative of future sales but can be indicative of trends in expected future sales revenue. Due to the relationships with our customers, we will occasionally allow orders to be canceled or rescheduled and as a result it is not a meaningful indicator of future financial results. If there are canceled or rescheduled orders, we typically negotiate fees to cover the costs we have incurred. Order backlog consists of purchase orders received for products expected to be shipped approximately within the next twelve months, although shipment dates are subject to change due to design modifications, customer forecast changes, or other customer requirements. +Foreign Markets +Information concerning net sales and long-lived assets (property, plant, and equipment) by geographic areas is set forth in Note 11, “Enterprise-Wide Disclosures” of the consolidated financial statements of this Annual Report on Form 10-K and that information is incorporated herein. +6 +Executive Officers of the Registrant +The table below sets forth the name, current age and current position of our executive officers and other significant employees: +Name +Age +Positions Held +Executive Officers +Craig D. Gates +54 +President and Chief Executive Officer +Ronald F. Klawitter +61 +Executive Vice President of Administration, Chief Financial Officer and Treasurer +Douglas G. Burkhardt +55 +Executive Vice President of Worldwide Operations +Philip S. Hochberg +51 +Executive Vice President of Business Development +Lawrence J. Bostwick +61 +Vice President of Engineering and Quality +Brett R. Larsen +40 +Vice President of Finance and Controller +Frank Crispigna III +52 +Vice President of Materials +Duane D. Mackleit +45 +Vice President of Program Management +Executive Officers +CRAIG D. GATES – President and Chief Executive Officer +Mr. Gates, age 54 , has been President and Chief Executive officer of the Company since April 2009. Previously he was Executive Vice President and General Manager from August 2002 to April 2009. He served as Executive Vice President of Marketing, Engineering and Sales from July 1997 to August 2002 and served as Vice President and General Manager of New Business Development from October 1995 to July 1997. He joined the Company as Vice President of Engineering in October of 1994. From 1982 to 1991 he held various engineering and management positions within the Microswitch Division of Honeywell, Inc., in Freeport, Illinois, and from 1991 to October 1994 he served as Director of Operations, Electronics for Microswitch. Mr. Gates has a Bachelor of Science Degree in Mechanical Engineering and a Masters in Business Administration from the University of Illinois, Urbana. +RONALD F. KLAWITTER – Executive Vice President of Administration, Chief Financial Officer, and Treasurer +Mr. Klawitter, age 61 , has been Executive Vice President of Administration, CFO, and Treasurer since July 1997. Previously he was Vice President of Finance, Secretary, and Treasurer of the Company from October 1995 to July 1997. He was Acting Secretary from November 1994 to October 1995 and Vice President of Finance and Treasurer from 1992 to October 1995. From 1987 to 1992, Mr. Klawitter was Vice President of Finance at Baker Hughes Tubular Service, a subsidiary of Baker Hughes, Inc. Mr. Klawitter has a BA degree from Wittenberg University and is a Certified Public Accountant. +DOUGLAS G. BURKHARDT – Executive Vice President of Worldwide Operations +Mr. Burkhardt, age 55 , has been Executive Vice President of Worldwide Operations of the Company since July 22, 2010. Previously Mr. Burkhardt was Vice President of Worldwide Operations from July 2008 to July 2010 and Director of China Operations and Program Management from January 2006 to July 2008. Mr. Burkhardt also served as Director of Northwest and China Operations from November of 1998 to January of 2006. Mr. Burkhardt also served as Director of Customer Satisfaction from March 1997 to November 1998 and Director of Molding from September of 1995 to March of 1997. Prior to this, Mr. Burkhardt served in other various senior management positions within the Company. Mr. Burkhardt has been with the Company since May of 1989. Prior to joining Key Tronic, Mr. Burkhardt worked for House of Aluminum and Glass for 12 years where he was the plant manager. +PHILIP S. HOCHBERG – Executive Vice President of Business Development +Mr. Hochberg, age 51 , has been Executive Vice President of Business Development since July 2012. Prior this, Mr. Hochberg served as Vice President of Business Development from October 2009 through June 2012. He was Director of Business Development and Program Management from July 2008 to October 2009. Mr. Hochberg served as Director of Business Development from October 2004 to July 2008 and as Director of EMS Sales and Marketing from July 2000 to October 2004. Prior to joining Key Tronic, Mr. Hochberg worked for Quinton Instrument Company as their Director of Marketing and Product Management from 1992 to 2000. From 1988 to 1992, he was employed by SpaceLabs Medical as their Business Development Marketing Manager. Mr. Hochberg has an MBA from the University of British Columbia, a BA Psychology, with a minor in Business from Washington University in St. Louis. +7 +LAWRENCE J. BOSTWICK – Vice President of Engineering and Quality +Mr. Bostwick, age 61 , has been Vice President of Engineering and Quality since July 2008. Previously he was Director of Engineering and Quality from February 2007 to July 2008 and served as Corporate Director of Quality from February 2006 to February 2007. From 2003 to 2006 he was Director of Supply Chain Management and Quality for the Lancer Corporation and from 1998 to 2003 he was Vice President of Operations for Thermacore International. He is a graduate of the Westinghouse and General Electric – Engineering and Manufacturing Professional Development Programs. He is certified in both Quality and Industrial Engineering and is a Lean – Six Sigma Master Black Belt. Mr. Bostwick has a combined B.S. degree in Production and Operation and Industrial Engineering from Bowling Green State University and a Masters degree in Industrial Engineering and Business Administration from Syracuse University. +BRETT R. LARSEN – Vice President of Finance, and Controller +Mr. Larsen, age 40 , has served as Vice President of Finance and Controller since February 2010. He was Chief Financial Officer of FLSmidth Spokane, Inc. from December 2008 to February 2010. From October 2005 through November 2008, Mr. Larsen served as Controller of Key Tronic Corporation. From May 2004 to October 2005, Mr. Larsen served as Manager of Financial Reporting of Key Tronic Corporation. From 2002 to May 2004, Mr. Larsen was an audit manager for the public accounting firm BDO Seidman, LLP. He also held various auditing and supervisory positions with Grant Thornton LLP from 1997 to 2002. Mr. Larsen has a Bachelor of Science degree in Accounting and a Masters degree in Accounting from Brigham Young University and is a Certified Public Accountant. +FRANK CRISPIGNA III – Vice President of Materials +Mr. Crispigna, age 52 , has been Vice President of Materials of the company since October 2011. Prior to this, Mr. Crispigna held a variety of Materials and Supply Chain positions at Plexus Corporation since 1997, most recently serving as the Director – Supply Chain Solutions from 2005 - 2011. He has a Masters degree in Business Administration, and a Bachelor of Business Administration Degree in Marketing from the University of Wisconsin – Oshkosh. Mr. Crispigna also is a C.P.M., and received his certification in Supply Chain Leadership from the University of Wisconsin. +DUANE D. MACKLEIT – Vice President of Program Management +Mr. Mackleit, age 45 , has been Vice President of Program Management of the company since July 2012. He served as Director of Program Management from July 2008 through June 2012. From May 2006 to July 2008 he served as Principal Program Manager. Prior to that, he served as Program Manager from March 2002 to May 2006 and Associate Program Manager from August 2000 to March 2002. Mr. Mackleit has also held several other positions with Key Tronic Corporation. Mr. Mackleit has an AA in Business from Spokane Falls Community College and a BA in Business/Marketing from Eastern Washington University. He also holds a MBA from Gonzaga University. +Available Information +Our principal executive offices are located at N. 4424 Sullivan Road, Spokane Valley, Washington 99216, and our telephone number is (509) 928-8000. Our website is located at http://www.keytronicems.com where filings of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q or current reports on Form 8-K are available after they have been filed with the Securities and Exchange Commission. The information presented on our website currently and in the future is not considered to be part of this document or any document incorporated by reference in this document. +Item 1A. +RISK FACTORS +There are risks and uncertainties that could affect our business. These risks and uncertainties include but are not limited to, the risk factors described below, in Item 7A: “Quantitative and Qualitative Disclosures about Market Risk” and elsewhere in this Form 10-K. +RISKS AND UNCERTAINTIES THAT MAY AFFECT FUTURE RESULTS +The following risks and uncertainties could affect our actual results and could cause results to differ materially from past results or those contemplated by our forward-looking statements. When used herein, the words “expects”, “believes”, “anticipates” and similar expressions are intended to identify forward-looking statements. +8 +We may experience fluctuations in quarterly results of operations. +Our quarterly operating results have varied in the past and may vary in the future due to a variety of factors, including adverse changes in the U.S. and global macroeconomic environment, volatility in overall demand for our customers' products, success of customers' programs, timing of new programs, new product introductions or technological advances by us, our customers and our competitors, and changes in pricing policies by us, our customers, our suppliers, and our competitors. Our customer base is diverse in the markets they serve, however, decreases in demand, particularly from customers that supply the education, consumer products, and gambling industries, could affect future quarterly results. Additionally, our customers could be impacted by the illiquidity of the credit markets which could directly impact our operating results. +Component procurement, production schedules, personnel and other resource requirements are based on estimates of customer requirements. Occasionally, our customers may request accelerated production that can stress resources and reduce operating margins. In addition, because many of our operating expenses are relatively fixed, a reduction in customer demand can harm our gross profit and operating results. The products which we manufacture for our customers have relatively short product lifecycles. Therefore, our business, operating results and financial condition are dependent in a significant way on our ability to obtain orders from new customers and new product programs from existing customers. +Operating results can also fluctuate if changes are made to significant estimates and assumptions. Significant estimates and assumptions include the allowance for doubtful receivables, provision for obsolete and non-saleable inventory, stock-based compensation, the valuation allowance on deferred tax assets, impairment of long-lived assets, long-term incentive compensation accrual, the provision for warranty costs, and the impact of hedging activities. +We are exposed to general economic conditions, which could have a material adverse impact on our business, operating results and financial condition. +Recently there have been adverse conditions and uncertainty in the global economy as the result of unstable global financial and credit markets, inflation, and recession. These unfavorable economic conditions and the weakness of the credit market could affect the demand for our customers' products. The current global macroeconomic environment may affect some of our customers that could reduce orders and change forecasts which could adversely affect our sales in future periods. Additionally, the financial strength of our customers and suppliers and their ability to obtain and rely on credit financing may affect their ability to fulfill their obligations to us and have an adverse effect on our financial results. +The majority of our sales come from a small number of customers and a decline in sales to any of these customers could adversely affect our business. +At present, our customer base is concentrated and could become more or less concentrated. There can be no assurance that our principal customers will continue to purchase products from us at current levels. Moreover, we typically do not enter into long-term volume purchase contracts with our customers, and our customers have certain rights to extend or delay the shipment of their orders. We, however, typically require that our customers contractually agree to buy back inventory purchased within specified lead times to build their products if not used. +The loss of one or more of our major customers, or the reduction, delay or cancellation of orders from such customers, due to economic conditions or other forces, could materially and adversely affect our business, operating results and financial condition. Specifically, some of our major customers provide products to the banking and gambling industries which have been adversely affected by the unfavorable economic environment. The contraction in demand from our customers in these industries could continue to impact our customer orders and continue to have a negative impact on our operations over the foreseeable future. Additionally, if one or more of our customers were to become insolvent or otherwise unable to pay for the manufacturing services provided by us, our operating results and financial condition would be adversely affected. +We depend on a limited number of suppliers for components that are critical to our manufacturing processes. A shortage of these components or an increase in their price could interrupt our operations and result in a significant change in our results of operations. +We are dependent on many suppliers, including sole source suppliers, to provide key components and raw materials used in manufacturing customers' products. We have seen supply shortages in certain electronic components. This can result in longer lead times and the inability to meet our customers request for flexible production and extended shipment dates. If demand for components outpaces supply, capacity delays could affect future operations. Delays in deliveries from suppliers or the inability to obtain sufficient quantities of components and raw materials could cause delays or reductions in shipment of products to our customers which could adversely affect our operating results and damage customer relationships. +9 +We operate in a highly competitive industry; if we are not able to compete effectively in the EMS industry, our business could be adversely affected. +Competitors may offer customers lower prices on certain high volume programs. This could result in price reductions, reduced margins and loss of market share, all of which would materially and adversely affect our business, operating results, and financial condition. If we were unable to provide comparable or better manufacturing services at a lower cost than our competitors, it could cause sales to decline. In addition, competitors can copy our non-proprietary designs and processes after we have invested in development of products for customers, thereby enabling such competitors to offer lower prices on such products due to savings in development costs. +Cash and cash equivalents are exposed to concentrations of credit risk. +We place our cash with high credit quality institutions. At times, such balances may be in excess of the federal depository insurance limit or may be on deposit at institutions which are not covered by insurance. If such institutions were to become insolvent during which time it held our cash and cash equivalents in excess of the insurance limit, it could be necessary to obtain other credit financing to operate our facilities. +Our ability to secure and maintain sufficient credit arrangements is key to its continued operations . +There is no assurance that we will be able to retain or renew our credit agreements in the future. In the event the business grows rapidly or the uncertain macroeconomic climate continues, additional financing resources could be necessary in the current or future fiscal years. There is no assurance that we will be able to obtain equity or debt financing at acceptable terms, or at all in the future. For a summary of our banking arrangements, see Note 4, Long-Term Debt, of the “Notes to Consolidated Financial Statements” in this Annual Report on Form 10-K. +Our international operations may be subject to certain risks. +Most of the products we manufacture are in facilities located in Mexico and China. These international operations may be subject to a number of risks, including: +• +difficulties in staffing and managing foreign operations; +• +political and economic instability (including acts of terrorism, civil unrest, forms of violence and outbreaks of war), which could impact our ability to ship, manufacture, and/or receive product; +• +unexpected changes in regulatory requirements and laws; +• +longer customer payment cycles and difficulty collecting accounts receivable; +• +export duties, import controls and trade barriers (including quotas); +• +governmental restrictions on the transfer of funds; +• +burdens of complying with a wide variety of foreign laws and labor practices; +• +fluctuations in currency exchange rates, which could affect component costs, local payroll, utility and other expenses; +• +our foreign locations may be impacted by hurricanes, earthquakes, water shortages, tsunamis, floods, typhoons, fires, extreme weather conditions and other natural or man-made disasters. +Our operations in certain foreign locations receive favorable income tax treatment in the form of tax credits or other incentives. In the event that such tax incentives are not extended, are repealed, or we no longer qualify for such programs, our taxes may increase, which would reduce our net income. +A significant portion of our operations are in foreign locations. As a result, transactions occur in currencies other than the U.S. dollar. Exchange rate fluctuations among other currencies used by us could directly or indirectly affect our financial results. Future currency fluctuations are dependent upon a number of factors and cannot be easily predicted. We currently use Mexican peso forward contracts to hedge foreign currency fluctuations for a portion of our Mexican peso denominated expenses. However, unexpected losses could occur from future fluctuations in exchange rates. +Additionally, certain foreign jurisdictions restrict the amount of cash that can be transferred to the U.S or impose taxes and penalties on such transfers of cash. To the extent we have excess cash in foreign locations that could be used in, or is needed by, our operations in the United States, we may incur significant penalties and/or taxes to repatriate these funds. +10 +Our success will continue to depend to a significant extent on our key personnel. +Our future success depends in large part on the continued service of our key technical, marketing and management personnel and on our ability to continue to attract and retain qualified employees. There can be no assurance that we will be successful in attracting and retaining such personnel. The loss of key employees could have a material adverse effect on our business, operating results and financial condition. +If we are unable to maintain our technological and manufacturing process expertise, our business could be adversely affected. +The markets for our customers' products is characterized by rapidly changing technology, evolving industry standards, frequent new product introductions and short product life cycles. The introduction of products embodying new technologies or the emergence of new industry standards can render existing products obsolete or unmarketable. Our success will depend upon our customers' ability to enhance existing products and to develop and introduce, on a timely and cost-effective basis, new products that keep pace with technological developments and emerging industry standards and address evolving and increasingly sophisticated customer requirements. Failure of our customers to do so could substantially harm our customers' competitive positions. There can be no assurance that our customers will be successful in identifying, developing and marketing products that respond to technological change, emerging industry standards or evolving customer requirements. +Start-up costs and inefficiencies related to new or transferred programs can adversely affect our operating results and such costs may not be recoverable if such new programs or transferred programs are canceled. +Start-up costs, the management of labor and equipment resources in connection with the establishment of new programs and new customer relationships, and the need to obtain required resources in advance can adversely affect our gross margins and operating results. These factors are particularly evident in the ramping stages of new programs. These factors also affect our ability to efficiently use labor and equipment. We are currently managing a number of new programs. Consequently, our exposure to these factors has increased. In addition, if any of these new programs or new customer relationships were terminated, our operating results could be harmed, particularly in the short term. We may not be able to recoup these start-up costs or replace anticipated new program revenues. +An adverse change in the interest rates for our borrowings could adversely affect our financial condition. +We are exposed to interest rate risk under our revolving line of credit with interest rates based on various levels of margin added to published prime rate and LIBOR rates depending on the calculation of a certain financial covenant. We have not historically hedged the interest rate on our credit facility, therefore, significant changes in interest rates could adversely affect our results of operations. +Compliance or the failure to comply with current and future environmental laws or regulations could cause us significant expense. +We are subject to a variety of domestic and foreign environmental regulations relating to the use, storage, and disposal of materials used in our manufacturing processes. If we fail to comply with any present or future regulations, we could be subject to future liabilities or the suspension of current manufacturing operations. In addition, such regulations could restrict our ability to expand our operations or could require us to acquire costly equipment, substitute materials, or incur other significant expenses to comply with government regulations. +Our stock price is volatile. +Holders of the common stock will suffer immediate dilution to the extent outstanding equity awards are exercised to purchase common stock. Our stock price may be subject to wide fluctuations and possible rapid increases or declines over a short time period. These fluctuations may be due to factors specific to us such as variations in quarterly operating results or changes in earnings estimates, or to factors relating to the EMS industry or to the securities markets in general, which, in recent years, have experienced significant price fluctuations. These fluctuations often have been unrelated to the operating performance of the specific companies whose stocks are traded. +Due to inherent limitations, there can be no assurance that our system of disclosure and internal controls and procedures will be successful in preventing all errors, theft and fraud, or in informing management of all material information in a timely manner. +Management does not expect that our disclosure controls and internal controls and procedures will prevent all errors or fraud. A control system is designed to give reasonable, but not absolute, assurance that the objectives of the control system are met. In addition, any control system reflects resource constraints and the benefits of controls must be considered relative to their costs. Inherent limitations of a control system may include: judgments in decision making may be faulty, breakdowns can occur simply because of error or mistake and controls can be circumvented by collusion or management override. Due to the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected. +11 +If we do not manage our growth effectively, our profitability could decline. +Our business is experiencing rapid growth which can place considerable additional demands upon our management team and our operational, financial and management information systems. Our ability to manage growth effectively requires us to continue to implement and improve these systems; avoid cost overruns; maintain customer, supplier and other favorable business relationships during possible transition periods; continue to develop the management skills of our managers and supervisors; and continue to train, motivate and manage our employees. Our failure to effectively manage growth could have a material adverse effect on our results of operations. +If our manufacturing processes and services do not comply with applicable statutory and regulatory requirements, or if we manufacture products containing design or manufacturing defects, demand for our services may decline and we may be subject to liability claims. +We manufacture and design products to our customers' specifications, and, in some cases, our manufacturing processes and facilities may need to comply with applicable statutory and regulatory requirements. For example, medical devices that we manufacture or design, as well as the facilities and manufacturing processes that we use to produce them, are regulated by the Food and Drug Administration and non-U.S. counterparts of this agency. In addition, our customers' products and the manufacturing processes that we use to produce them often are highly complex. As a result, products that we manufacture may at times contain manufacturing or design defects, and our manufacturing processes may be subject to errors or not be in compliance with applicable statutory and regulatory requirements. Defects in the products we manufacture or design, whether caused by a design, manufacturing or component failure or error, or deficiencies in our manufacturing processes, may result in delayed shipments to customers or reduced or canceled customer orders. If these defects or deficiencies are significant, our business reputation may also be damaged. The failure of the products that we manufacture or our manufacturing processes and facilities to comply with applicable statutory and regulatory requirements may subject us to legal fines or penalties and, in some cases, require us to shut down or incur considerable expense to correct a manufacturing process or facility. Our customers are required to indemnify us against liability associated with designing products to meet their specifications. However, if our customers are responsible for the defects, they may not, or may not have resources to, assume responsibility for any costs or liabilities arising from these defects, which could expose us to additional liability claims. +Energy price increases may negatively impact our results of operations. +Certain components that we use in our manufacturing process are petroleum-based. In addition, we, along with our suppliers and customers, rely on various energy sources in our transportation activities. While significant uncertainty currently exists about the future levels of energy prices, a significant increase is possible. Increased energy prices could cause an increase to our raw material costs and transportation costs. In addition, increased transportation costs of certain of our suppliers and customers could be passed along to us. We may not be able to increase our product prices enough to offset these increased costs. In addition, any increase in our product prices may reduce our future customer orders and profitability. +Disruptions to our information systems, including security breaches, losses of data or outages, could adversely affect our operations. +We rely on information technology networks and systems to process, transmit and store electronic information. In particular, we depend on our information technology infrastructure for a variety of functions, including worldwide financial reporting, inventory management, procurement, invoicing and email communications. Any of these systems may be susceptible to outages due to fire, floods, power loss, telecommunications failures, terrorist attacks and similar events. Despite the implementation of network security measures, our systems and those of third parties on which we rely may also be vulnerable to computer viruses, break-ins and similar disruptions. If we or our vendors are unable to prevent such outages and breaches, our operations could be disrupted. +We are involved in various legal proceedings. +In the past, we have been notified of claims relating to various matters including contractual matters, intellectual property rights or other issues arising in the ordinary course of business. In the event of such a claim, we may be required to spend a significant amount of money to defend or otherwise address the claim. Any litigation, even where a claim is without merit, could result in substantial costs and diversion of resources. Accordingly, the resolution or adjudication of such disputes, even those encountered in the ordinary course of business, could have a material adverse effect on our business, consolidated financial conditions and results of operations. +12 +Increases in our own market capitalization and changes in securities laws and regulations will increase our costs and risk of noncompliance. +As a result of our increased market capitalization as of the end of our second quarter of fiscal year 2013, we are required to file as an accelerated filer. As such, we are subject to additional requirements contained in the Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act) and more recently the Dodd-Frank Act. The Sarbanes-Oxley and Dodd-Frank Acts required or will require changes in some of our corporate governance, securities disclosure and compliance practices. In response to the requirements of the Sarbanes-Oxley and Dodd-Frank Acts, the SEC and NASDAQ promulgated new rules and additional rulemaking is expected in the future. Compliance with these new rules and future rules has increased and may increase further our legal, financial and accounting costs as well as a potential risk of noncompliance. Absent significant changes in related rules, which we cannot assure, we anticipate some level of increased costs related to these new regulations to continue indefinitely. We also expect these developments to make it more difficult and more expensive to obtain director and officer liability insurance, and we may be forced to accept reduced coverage or incur substantially higher costs to obtain coverage. Likewise, these developments may make it more difficult for us to attract and retain qualified members of our Board of Directors or qualified management personnel. Further, the costs associated with the compliance with and implementation of procedures under these and future laws and related rules could have a material impact on our results of operations. In addition, the costs associated with noncompliance with additional securities laws and regulations could also impact our business. +We may encounter complications with acquisitions, which could potentially harm our business. +Any current or future acquisitions may require additional equity financing, which could be dilutive to our existing shareholders, or additional debt financing, which could potentially affect our credit ratings. Any downgrades in our credit ratings associated with an acquisition could adversely affect our ability to borrow by resulting in more restrictive borrowing terms. To integrate acquired businesses, we must implement our management information systems, operating systems and internal controls, and assimilate and manage the personnel of the acquired operations. The integration of acquired businesses may be further complicated by difficulties managing operations in geographically dispersed locations. The integration of acquired businesses may not be successful and could result in disruption by diverting management's attention from the core business. In addition, the integration of acquired businesses may require that we incur significant restructuring charges or other increases in our expenses and working capital requirements, which reduce our return on invested capital. +Acquisitions may involve numerous other risks and challenges including but not limited to: potential loss of key employees and customers of the acquired companies; the potential for deficiencies in internal controls at acquired companies; lack of experience operating in the geographic market or industry sector of the acquired business; and exposure to unanticipated liabilities of acquired companies. These and other factors could harm our ability to achieve anticipated levels of profitability at acquired operations or realize other anticipated benefits of an acquisition, and could adversely affect our consolidated business and operating results. +Item 1B. +UNRESOLVED STAFF COMMENTS +None +13 +Item 2. +PROPERTIES +We have manufacturing and sales operations located in the United States, Mexico, and China. The table below lists the locations and square footage of our operating facilities: +Location +Approx. +Sq. Ft. +Type of Interest +(Leased/ +Owned) +Description of Use +Spokane Valley, Washington +75,000 +Leased +Sales, research, administration and manufacturing +Spokane Valley, Washington +36,000 +Leased +Manufacturing +El Paso, Texas +80,000 +Leased +Shipping and warehouse +Total USA +191,000 +Juarez, Mexico +174,000 +Owned +Manufacturing +Juarez, Mexico +60,000 +Owned +Manufacturing and warehouse +Juarez, Mexico +66,000 +Owned +Manufacturing and warehouse +Juarez, Mexico +115,000 +Owned +Manufacturing and warehouse +Juarez, Mexico (1) +103,000 +Owned +Manufacturing and warehouse +Juarez, Mexico (2) +105,000 +Leased +Warehouse +Juarez, Mexico (3) +66,000 +Leased +Manufacturing +Total Mexico +689,000 +Shanghai, China (4) +95,000 +Leased +Manufacturing +Shanghai, China (5) +36,000 +Leased +Manufacturing +Total China +131,000 +Grand Total +1,011,000 +(1) +During fiscal year 2012, we purchased an additional 103,000 square feet of manufacturing and warehouse space. +(2) +During fiscal year 2012, we entered into an agreement to lease an additional 105,000 square feet of warehouse space to replace the 72,000 square feet leased space that expired August 30, 2012. +(3) +Subsequent to fiscal year 2013, we completed our acquisition of Sabre Manufacturing resulting in an additional 66,000 square feet of leased manufacturing space with the lease expiring on August 30, 2016. +(4) +During fiscal year 2011, we amended the lease of our China facility whereby extending the term to December 2015 and increasing our leased space to 95,000 square feet to accommodate an additional SMT line and for additional assembly space. +(5) +During fiscal year 2011, we entered into an agreement to lease an additional 36,000 square feet of manufacturing space. +The geographic diversity of these locations allows us to offer services near certain of our customers and major electronics markets with the additional benefit of reduced labor costs. We consider the productive capacity of our current facilities sufficient to carry on our current business. In addition, in Juarez, Mexico one of our buildings includes adjacent vacant land that could be developed into additional manufacturing and warehouse space. +All of our facilities are ISO certified to ISO 9001:2008 standards, ISO-14001 environmental standards, ISO-13485:2003 medical devices standards, AS9100C aviation, space and defense standards, ISO/TS 16949 automotive standards and to Customs Trade Partnership against Terrorism (CTPAT). The Spokane, Washington facilities are additionally registered by the US State Department for International Traffic in Arms Regulations (ITAR). +Item 3. +LEGAL PROCEEDINGS +We are a party to certain lawsuits or claims in the ordinary course of business. We do not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on our financial position, results of operations or cash flow. +Item 4. +MINE SAFETY DISCLOSURES +Not Applicable +14 +PART II +Item 5: +MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES +Market Information +Our common stock is traded on the NASDAQ Global Market, formerly the NASDAQ National Market System under the symbol “KTCC”. Quarterly high and low sales prices for our common stock for fiscal years 2013 and 2012 were as follows: +2013 +2012 +High +Low +High +Low +First Quarter +$ +11.35 +$ +7.15 +$ +4.70 +$ +3.21 +Second Quarter +11.62 +8.69 +5.08 +3.22 +Third Quarter +12.28 +9.36 +11.49 +4.71 +Fourth Quarter +12.12 +10.16 +13.16 +7.60 +High and low stock prices are based on the daily sales prices reported by the NASDAQ Stock Market. These quotations represent prices between dealers without adjustment for markups, markdowns, and commissions, and may not represent actual transactions. +Holders and Dividends +As of June 29, 2013 , we had 726 shareholders of common stock on record. As a result of our credit agreement with Wells Fargo Bank, N.A. we are restricted from declaring or paying dividends in cash or stock without the Bank's prior written consent. We have not paid a cash dividend and do not anticipate payment of dividends in the foreseeable future. +15 +Equity Compensation Plan Information +Information concerning securities authorized for issuance under our equity compensation plans is set forth in Part III, Item 12 of this Annual Report, under the caption “Securities Authorized for Issuance under Equity Compensation Plans”, and that information is incorporated herein by reference. +Performance Graph +Set forth below is a line graph comparing the cumulative total shareholder return on our common stock with the cumulative total return of the NASDAQ Stock Market (U.S. & Foreign) Index and the NASDAQ Electronic Components Index in fiscal 2013 . +6/28/2008 +6/27/2009 +7/3/2010 +7/2/2011 +6/30/2012 +6/29/2013 +Key Tronic Corporation +100.00 +46.61 +137.85 +127.68 +232.77 +292.37 +NASDAQ Composite +100.00 +80.56 +93.30 +124.28 +132.47 +155.74 +NASDAQ Electronic Components +100.00 +74.56 +89.10 +113.46 +107.40 +119.76 +16 +Item 6: +SELECTED FINANCIAL DATA +The following selected data is derived from our audited consolidated financial statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements and related notes, and other information included in this report. +Financial Highlights +(In thousands, except for Supplemental Data and Per Share Amounts) +Fiscal Years +June 29, 2013 +June 30, 2012 +July 2, 2011 +July 3, 2010 +June 27, 2009 +Consolidated Statements of Operations Data : +Net sales +$ +361,033 +$ +346,475 +$ +253,846 +$ +199,620 +$ +184,924 +Gross profit +34,512 +29,836 +20,648 +19,250 +13,180 +Gross margin percentage +9.6 +% +8.6 +% +8.1 +% +9.6 +% +7.1 +% +Operating income +18,126 +14,351 +6,939 +7,388 +1,783 +Operating margin percentage +5.0 +% +4.1 +% +2.7 +% +3.7 +% +1.0 +% +Net income +12,583 +11,626 +5,736 +8,690 +1,063 +Earnings per share – diluted +1.15 +1.10 +0.55 +0.85 +0.11 +Consolidated Cash Flow Data : +Cash flows provided by (used in) operations +29,282 +(5,066 +) +(2,569 +) +3,534 +10,038 +Capital expenditures +3,470 +4,654 +3,818 +3,378 +1,891 +Consolidated Balance Sheet Data : +Net working capital (1) +73,827 +76,236 +58,307 +44,708 +37,444 +Total assets +135,130 +150,912 +112,364 +101,642 +77,755 +Long-term liabilities +3,030 +19,050 +11,063 +4,236 +3,030 +Shareholders’ equity +94,160 +78,608 +68,023 +59,417 +51,114 +Book value per share (2) +$ +8.97 +$ +7.50 +$ +6.54 +$ +5.79 +$ +5.08 +Supplemental Data : +Number of shares outstanding at year-end +10,502,188 +10,481,356 +10,399,187 +10,264,390 +10,065,974 +Number of employees at year-end +2,584 +2,700 +1,997 +2,036 +1,963 +Approximate square footage of operational facilities +1,011,000 +945,000 +796,000 +987,000 +849,000 +(1) +Net working capital is defined as total current assets less total current liabilities. Net working capital measures the portion of current assets that are financed by long term funds and is an indicator of short term financial management. +(2) +Book value per share is defined as total shareholders’ equity divided by the number of shares outstanding at the end of the fiscal year. +17 +Item 7: +MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS +Overview +KeyTronicEMS is a leader in electronic manufacturing services and solutions to original equipment manufacturers of a broad range of products. We provide engineering services, worldwide procurement and distribution, materials management, world-class manufacturing and assembly services, in-house testing, and unparalleled customer service. Our international production capability provides our customers with benefits of improved supply-chain management, reduced inventories, lower transportation costs, and reduced product fulfillment time. We continue to make investments in all of our operating facilities to give us the production capacity and logistical advantages to continue to win new business. The following information should be read in conjunction with the consolidated financial statements included herein and with Item 1A, Risk Factors. +Our mission is to provide our customers with superior manufacturing and engineering services at the lowest total cost for the highest quality products, and create long-term mutually beneficial business relationships by employing our “Trust, Commitment, Results” philosophy. +Executive Summary +After strong year-over-year growth in the first half of fiscal 2013, our revenue decreased slightly in the second half. This was primarily due to the anticipated slowdown from a large customer that reduced its production requirements in the second quarter. Although we saw a continued ramp up of new programs in the second half of fiscal 2013, those increases did not yet offset the decreased demand from this one customer. However, we maintained strong operating efficiencies and significantly strengthened our balance sheet and paid off our revolving line of credit. +During fiscal year 2013 we set a new record for annual revenue of $361.0 million , a 4.2 percent growth as compared to sales of $346.5 million in fiscal year 2012 . The increase in net sales was primarily driven by an increasingly diverse mix of new customer programs. At the end of fiscal year 2013 , we were generating revenue from 183 separate programs and 56 distinct customers as compared to 165 programs and 48 customers at the end of fiscal year 2012 . These new customers have programs that represent small annual sales while others have multi-million-dollar potenti al. Moving into the first quarter of fiscal 2014, we are currently seeing a reduction in orders from another large customer and a few of our new programs are not ramping up as rapidly as anticipated. Net sales for the first quarter of fiscal year 2014 are expected to be within the range o f $73 million to $78 million. Future results will depend on actual levels of customers’ orders, the timing of the start up of production of new product programs and the potential impact of the macroeconomic uncertainty. We believe that we are well positioned in the EMS industry to continue expansion of our customer base and continue long-term growth. +The concentration of our largest customers decreased during fiscal year 2013 with the top five customers’ sales decreasing to 71 percent of total sales in 2013 from 73 percent in 2012 , and 62 percent in 2011 . Our current customer relationships involve a variety of products, including consumer electronics, electronic storage devices, plastics, household products, gaming devices, specialty printers, telecommunications, industrial equipment, military supplies, computer accessories, electronic whiteboards, medical, educational, irrigations, automotive, transportation management, robotics, RFID, power supply and offroad vehicle equipment. The growth during fiscal year 2013 was powered by an increasingly diverse mix of new customer programs. +Gross profit as a percent of sales was 9.6 percent in fiscal year 2013 compared to 8.6 percent for the prior fiscal year. This 1.0 percentage point increase in gross profit as a percentage of net sales during fiscal year 2013 as compared to fiscal year 2012 is primarily related to a 1.9 percentage point improvement in material costs, as a percent of sales, partially offset by a 0.9 percentage point increase in certain overhead costs as we brought on additional headcount and equipment to support new customer programs. The level of gross margin is impacted by product mix, timing of the start up of new programs, facility utilization, pricing within the electronics industry and material costs, which can fluctuate significantly from quarter to quarter and year to year. +Operating income as a percentage of sales for fiscal year 2013 was 5.0 percent compared to 4.1 percent for fiscal year 2012 . The increase in operating income as a percentage of sales was due to an increase in gross margin, while keeping operating expenses relatively flat and by improving efficiencies during fiscal year 2013 . +Net income for fiscal year 2013 was $12.6 million or $1.15 per diluted share, as compared to net income of $11.6 million or $1.10 per diluted share for fiscal year 2012 . The increase in net income for fiscal year 2013 as compared to fiscal year 2012 was primarily due to the increase in net sales that led an improvement in our gross margin and operating income, partially offset by an increase in income tax expense. +18 +We maintain a strong balance sheet with a current ratio of 2.9 and a long-term debt to equity ratio of 0.01 . Total cash provided by operating activities as defined on our cash flow statement was $29.3 million during fiscal year 2013 . We maintain sufficient liquidity for our expected future operations. We did not have an outstanding balance on our revolving line of credit with Wells Fargo Bank, N.A. as of June 29, 2013 . As a result, $30.0 million remained available to borrow as of June 29, 2013 . We believe cash flow from operations, our borrowing capacity, and equipment lease financing should provide adequate capital for planned growth over the long term. +RESULTS OF OPERATIONS +Comparison of the Fiscal Year Ended June 29, 2013 with the Fiscal Year Ended June 30, 2012 +The following table sets forth for the periods indicated certain items of the consolidated statements of income expressed as a percentage of net sales. The financial information and discussion below should be read in conjunction with the consolidated financial statements and notes contained in this Annual Report. +Fiscal Year Ended +June 29, 2013 +% of +net sales +June 30, 2012 +% of +net sales +$ change +% point +change +Net sales +$ +361,033 +100.0 +% +$ +346,475 +100.0 +% +$ +14,558 +— +Cost of sales +326,521 +90.4 +316,639 +91.4 +9,882 +(1.0 +) +Gross profit +34,512 +9.6 +29,836 +8.6 +4,676 +1.0 +Operating expenses: +Research, development and engineering +5,156 +1.4 +4,444 +1.3 +712 +0.1 +Selling, general and administrative +11,230 +3.1 +11,041 +3.2 +189 +(0.1 +) +Total operating expenses +16,386 +4.5 +15,485 +4.5 +901 +— +Operating income +18,126 +5.0 +14,351 +4.1 +3,775 +0.9 +Interest expense, net +271 +0.1 +510 +0.1 +(239 +) +— +Income before income taxes +17,855 +4.9 +13,841 +4.0 +4,014 +0.9 +Income tax provision +5,272 +1.5 +2,215 +0.6 +3,057 +0.9 +Net income +$ +12,583 +3.5 +% +$ +11,626 +3.4 +% +$ +957 +0.1 +Effective income tax rate +29.5 +% +16.0 +% +Net Sales +The increase in net sales from prior year was primarily driven by an approximate $11.7 million increase in revenues related to new programs for both new and longstanding customers and to a lesser extent a net $5.5 million increase related to increased demand from current customer programs, which was partially offset by the previously disclosed slowdown from the large customer that began to reduce production levels in the second quarter of fiscal year 2013. In addition, the increases were negatively impacted by $2.6 million related to customer program losses. The negative impact resulting from the previously discussed slowdown of demand from one of our larger customers is reflected in the analysis above. +The following table shows the revenue by industry sectors as a percentage of revenue for fiscal years 2013 and 2012 : +Years Ended +June 29, 2013 +June 30, 2012 +Communication +29 +% +36 +% +Consumer +24 +20 +Gaming +22 +18 +Transaction Printer +11 +12 +Industrial +8 +6 +Computer and Peripheral +6 +7 +Commercial Printer +— +1 +Total +100 +% +100 +% +We provide services to customers in a number of industries and produce a variety of products for our customers in each industry. As we continue to diversify our customer base and win new customers we will continue to see a change in the industry concentrations of our revenue. +19 +Sales to foreign locations outside the United States represented 31.8 percent, and 40.6 percent of our total net sales in fiscal years 2013 , and 2012 , respectively. +Cost of Sales +Total cost of sales as a percentage of net sales was 90.4 percent and 91.4 percent in fiscal years 2013 , and 2012 , respectively. +Total cost of materials as a percentage of net sales was approximately 68.5 percent and 70.4 percent in fiscal years 2013 and 2012 , respectively. The change from year-to-year is primarily the result of a change in product mix and to a lesser degree improved pricing of certain raw materials. +Production and support costs as a percentage of net sales were 21.9 percent, and 21.0 percent in fiscal years 2013 and 2012 , respectively. The increase in fiscal year 2013 is primarily related to adding headcount and manufacturing capacity to support new programs. +We provide a reserve for obsolete and non-saleable inventories based on specific identification of inventory against current demand and recent usage. The amounts charged to expense for these inventories were approximately $0.5 million, and $0.8 million in fiscal years 2013 and 2012 , respectively. +We provide warranties on certain products we sell and estimate warranty costs based on historical experience and anticipated product returns. Warranty expense is related to workmanship claims on keyboards and EMS products. The amounts charged to expense are determined based on an estimate of warranty exposure. The net warranty expense was approximately $26,000 and $65,000 in fiscal years 2013 and 2012 , respectively. +Gross Profit +Gross profit as a percentage of net sales was 9.6 percent and 8.6 percent in fiscal years 2013 , and 2012 , respectively. The 1.0 percentage point increase in gross profit as a percentage of net sales during fiscal year 2013 as compared to fiscal year 2012 is primarily related to a 1.9 percentage point improvement in material costs, as a percent of sales, partially offset by a 0.9 percentage point increase in certain overhead costs. +Changes in gross profit margins reflect the impact of a number of factors that can vary from period to period, including product mix, start-up costs and efficiencies associated with new programs, product life cycles, sales volumes, capacity utilization of our resources, management of inventories, component pricing and shortages, end market demand for customers’ products, fluctuations in and timing of customer orders, and competition within the EMS industry. These and other factors can cause variations in operating results. There can be no assurance that gross margins will not decrease in future periods. +We took early pay discounts to suppliers that totaled approximately $946,000 and $932,000 in fiscal years 2013 and 2012 , respectively. Early pay discounts will fluctuate based on our liquidity and changes in the discounts and terms offered by our suppliers. +Research, Development and Engineering +Research, development and engineering expenses (RD&E) consists principally of employee related costs, third party development costs, program materials, depreciation and allocated information technology and facilities costs. Total RD&E expense was $5.2 million and $4.4 million in fiscal years 2013 and 2012 , respectively. This $0.7 million increase is primarily the result of an increase in payroll related expenses as additional headcount was necessary to support new programs as they ramp up. +Total RD&E expenses as a percent of net sales were 1.4 percent and 1.3 percent in fiscal years 2013 and 2012 , respectively. This 0.1 percentage point increase in RD&E is primarily related to our deleveraging of operating expenses as a percent of net sales. +Selling, General and Administrative +Selling, general and administrative expenses (SG&A) consist principally of salaries and benefits, advertising and marketing programs, sales commissions, travel expenses, provision for doubtful accounts, facilities costs, and professional services. Total SG&A expenses were $11.2 million and $11.0 million in fiscal years 2013 and 2012 , respectively. This $0.2 million increase is primarily related to an increase in payroll related expenses due to increased headcount and higher incentive compensation as compared to the prior year. This increase is partially offset by the positive impact of a non-recurring adjustment of approximately $0.5 million related to the elimination of a deferred compensation liability. +Total SG&A expenses as a percent of net sales were 3.1 percent and 3.2 percent in fiscal years 2013 and 2012 , respectively. This 0.1 percent percentage point improvement in SG&A is primarily related to our continued success in leveraging operating expenses as a percent of net sales. +20 +Interest Expense +We had net interest expense of $0.3 million and $0.5 million in fiscal years 2013 and 2012 , respectively. This decrease is primarily related to a decrease in the average balance outstanding on our line of credit during the year and the impact of not having an outstanding balance on our line of credit at fiscal year end 2013. +Income Tax Provision +We had an income tax expense of $5.3 million during fiscal year 2013 as compared to an income tax expense of $2.2 million in fiscal year 2012 . The income tax expense recognized during both fiscal 2013 and 2012 was primarily a function of U.S. and foreign taxes recognized at the statutory rates offset by the net benefit associated with federal research and development tax credits and changes in potential foreign tax credits. The impact of this offset was greater in 2012 because the Company recognized a benefit related to federal research and development tax credits during fiscal 2012, due to the results of a multi-year tax credit study performed during that year. Fiscal 2013 recognized credits were related to expenses incurred during the current year. +Due to increased profitability, revenue growth, and new customer programs, we utilized all remaining domestic and foreign net operating loss carryforwards (NOLs) during fiscal year 2012. As a result, there was no remaining deferred tax asset as of June 30, 2012 related to NOLs. In addition, we continually review our requirements for liquidity domestically to fund revenue growth and to look for potential future acquisitions. We continue to anticipate repatriating a portion of our unremitted foreign earnings. The associated taxes and potential foreign tax credits are included in the income tax calculation. For further information on taxes please review footnote 5 of the “Notes to Consolidated Financial Statements”. +International Subsidiaries +We offer customers a complete global manufacturing solution. Our facilities provide our customers the opportunity to have their products manufactured in the facility that best serves specific cost, product manufacturing, and distribution needs. The locations of active foreign subsidiaries are as follows: +• +Key Tronic Juarez, SA de CV owns an SMT, assembly and molding facility, newly acquired sheet metal fabrication, and five assembly and storage facilities in Juarez, Mexico. This subsidiary is primarily used to support our U.S. operations. +• +Key Tronic Computer Peripherals (Shanghai) Co., Ltd. leases two facilities with SMT, assembly, global purchasing and warehouse capabilities in Shanghai, China, which began operations in 1999. Its primary function is to provide EMS services for export; however, it is also currently manufacturing certain electronic keyboards. +Foreign sales (based on shipping instructions) from our worldwide operations, including domestic exports, were $115.0 million , $140.8 million and $81.1 million in fiscal years 2013 , 2012 and 2011 , respectively. Products and manufacturing services provided by our subsidiary operations are primarily sold to customers directly by the parent company. Key Tronic Computer Peripherals (Shanghai) Co., Ltd., our subsidiary in Shanghai, China, had only minimal direct sales to customers in China during the past two fiscal years. +21 +RESULTS OF OPERATIONS +Comparison of the Fiscal Year Ended June 30, 2012 with the Fiscal Year Ended July 2, 2011 +The following table sets forth for the periods indicated certain items of the consolidated statements of income expressed as a percentage of net sales. The financial information and discussion below should be read in conjunction with the consolidated financial statements and notes contained in this Annual Report. +Fiscal Year Ended +June 30, +2012 +% of +net sales +July 2, +2011 +% of +net sales +$ change +% point +change +Net sales +$ +346,475 +100.0 +% +$ +253,846 +100.0 +% +$ +92,629 +— +Cost of sales +316,639 +91.4 +233,198 +91.9 +83,441 +(0.5 +) +Gross profit +29,836 +8.6 +20,648 +8.1 +9,188 +0.5 +Operating expenses: +Research, development and engineering +4,444 +1.3 +3,782 +1.5 +662 +(0.2 +) +Selling, general and administrative +11,041 +3.2 +9,927 +3.9 +1,114 +(0.7 +) +Total operating expenses +15,485 +4.5 +13,709 +5.4 +1,776 +(0.9 +) +Operating income +14,351 +4.1 +6,939 +2.7 +7,412 +1.4 +Interest expense, net +510 +0.1 +457 +0.2 +53 +(0.1 +) +Income before income taxes +13,841 +4.0 +6,482 +2.6 +7,359 +1.4 +Income tax provision +2,215 +0.6 +746 +0.3 +1,469 +0.3 +Net income +$ +11,626 +3.4 +% +$ +5,736 +2.3 +% +$ +5,890 +1.1 +Effective income tax rate +16.0 +% +11.5 +% +Net Sales +Net sales increased $92.6 million during fiscal year 2012 as compared with fiscal year 2011. This increase in net sales was primarily driven by an approximate $90.6 million increase in revenues related to new programs for both new and longstanding customers and to a lesser extent a $2.9 million increase related to increased demand from certain current customer programs. These increases were partially offset by $0.9 million related to customer program losses. The negative impact resulting from the uncertain macroeconomic environment is reflected in the analysis of our new and longstanding customers programs as discussed above. +The following table shows the revenue by industry sectors as a percentage of revenue for fiscal years 2012 and 2011: +Years Ended +June 30, 2012 +July 2, 2011 +Communication +36% +22% +Consumer +20 +20 +Gaming +18 +16 +Transaction Printer +12 +18 +Computer and Peripheral +7 +13 +Industrial +6 +6 +Commercial Printer +1 +5 +Total +100% +100% +We provide services to customers in a number of industries and produce a variety of products for our customers in each industry. As we continue to diversify our customer base and win new customers we may continue to see a change in the industry concentrations of our revenue. +Sales to foreign locations represented 40.6 percent, and 31.9 percent of our total net sales in fiscal years 2012 and 2011, respectively. +22 +Cost of Sales +Total cost of sales as a percentage of net sales was 91.4 percent, and 91.9 percent in fiscal years 2012 and 2011, respectively. +Total cost of materials as a percentage of net sales was approximately 70.4 percent, and 68.6 percent in fiscal years 2012 and 2011, respectively. The change from year-to-year is primarily the result of higher material content in certain new customer programs and changes in product mix. +Production and support costs as a percentage of net sales were 21.0 percent, and 23.3 percent in fiscal years 2012 and 2011, respectively. The decrease in fiscal year 2012 is primarily related to the leveraging of our fixed costs as a percentage of sales during the fiscal year. +We provide for obsolete and non-saleable inventories based on specific identification of inventory against current demand and recent usage. The amounts charged to expense for these inventories were approximately $0.8 million, and $0.3 million in fiscal years 2012 and 2011, respectively. +We provide warranties on certain products we sell and estimate warranty costs based on historical experience and anticipated product returns. Warranty expense is related to workmanship claims on keyboards and EMS products. The amounts charged to expense are determined based on an estimate of warranty exposure. The net warranty expense was approximately $65,000 and $158,000 in fiscal years 2012 and 2011, respectively. +Gross Profit +Gross profit as a percentage of net sales was 8.6 percent, and 8.1 percent in fiscal years 2012 and 2011, respectively. The 0.5 percentage point increase in gross profit as a percentage of net sales during fiscal year 2012 as compared to fiscal year 2011 is primarily related to a 2.3 percentage point improvement in leveraging of certain overhead costs, as a percent of sales, partially offset by a 1.8 percentage point increase in material costs, as a percent of sales, resulting from higher material content in certain new customer programs and changes in product mix. +We took early pay discounts to suppliers that totaled approximately $932,000 and $678,000, in fiscal years 2012 and 2011, respectively. Early pay discounts will fluctuate based on our liquidity and changes in the discounts and terms offered by our suppliers. +Changes in gross profit margins reflect the impact of a number of factors that can vary from period to period, including product mix, start-up costs and efficiencies associated with new programs, product life cycles, sales volumes, capacity utilization of our resources, management of inventories, component pricing and shortages, end market demand for customers’ products, fluctuations in and timing of customer orders, and competition within the EMS industry. These and other factors can cause variations in operating results. There can be no assurance that gross margins will not decrease in future periods. +Research, Development and Engineering +Research, development and engineering expenses (RD&E) consists principally of employee related costs, third party development costs, program materials, depreciation and allocated information technology and facilities costs. Total RD&E expense was $4.4 million and $3.8 million in fiscal years 2012 and 2011, respectively. This $0.6 million increase is primarily the result of increased headcount and to a lesser extent higher incentive compensation. +Total RD&E expenses as a percent of net sales were 1.3 percent and 1.5 percent in fiscal years 2012 and 2011, respectively. This 0.2 percentage point improvement in RD&E is primarily related to our continued success in leveraging operating expenses as a percent of net sales. +Selling, General and Administrative +Selling, general and administrative expenses (SG&A) consist principally of salaries and benefits, advertising and marketing programs, sales commissions, travel expenses, provision for doubtful accounts, facilities costs, and professional services. Total SG&A expenses were $11.0 million and $9.9 million in fiscal years 2012, and 2011, respectively. This $1.1 million increase is primarily related to an increase in headcount. +Total SG&A expenses as a percent of net sales were 3.2 percent, and 3.9 percent in fiscal years 2012, and 2011, respectively. This 0.7 percentage point improvement in SG&A is primarily related to our continued success in leveraging operating expenses as a percent of net sales. +Interest Expense +We had net interest expense of $0.5 million, and $0.5 million in fiscal years 2012 and 2011, respectively. Interest expense for fiscal year 2012 remained relatively flat as did the average balance and interest rate compared to fiscal year 2011. +23 +Income Tax Provision +We had an income tax expense of $2.2 million during fiscal year 2012 as compared to an income tax expense of $746,000 in fiscal year 2011. The income tax expense recognized during fiscal 2012 was primarily a function of U.S. and foreign taxes recognized at the statutory rates offset by the net benefit associated with federal research and development tax credits and changes in potential foreign tax credits. The income tax expense recognized during fiscal 2011 was primarily a function of U.S. and foreign taxes recognized at the statutory rates offset by the net benefit associated with federal research and development tax credits, the release of the valuation allowance in China, and changes in potential foreign tax credits. +Due to increased profitability, revenue growth, and new customer programs, we utilized all remaining domestic net operating loss carryforwards (NOLs) during fiscal year 2012. Furthermore, all previous NOL carryforwards in China have been fully utilized as well. As a result, there is no remaining deferred tax asset as of June 30, 2012 related to NOLs. In addition, we reviewed our requirements for liquidity domestically to fund our revenue growth and to look for potential future acquisitions. We continue to anticipate repatriating a portion of our unremitted foreign earnings. The associated taxes and potential foreign tax credits were first included in the income tax benefit that was realized during fiscal year 2010 and certain changes in the estimates of foreign earnings and profits and tax pools resulted in the recognition of additional tax benefits during fiscal years 2011 and 2012. For further information on taxes please review footnote 5 of the “Notes to Consolidated Financial Statements”. +Capital Resources and Liquidity +Operating Cash Flow +Net cash provided by operating activities for fiscal year 2013 was $29.3 million compared to net cash used in operating activities of $5.1 million and $2.6 million in fiscal years 2012 and 2011 , respectively. Cash flows provided by operating activities increased primarily due to a drop in working capital caused by decreased revenue in the fourth quarter of fiscal 2013 when compared to fiscal 2012. The decreased revenue allowed the company to decrease its accounts receivable and inventories. Additionally, the Company improved its inventory turns through better management of order quantities and requiring certain customer payments on aged inventory purchased to forecast but subsequently not consumed. +The working capital increase year-over-year is primarily related to a $13.3 million decrease in inventory, and a $13.6 million decrease in accounts receivable partially offset by a $16.6 million decrease in accounts payable. The working capital changes during fiscal year 2012 , are primarily due to a $17.6 million increase in inventory and a $20.3 million increase in accounts receivable, which were partially offset by a $16.9 million increase in accounts payable. The increase in working capital during fiscal 2012 was related to a significant increase in revenue occurring during the year. +We purchase inventory based on customer forecasts and orders, and when those forecasts and orders change, the amount of inventory may also fluctuate. Accounts receivable fluctuates based on the timing of shipments, terms offered and collections. Accounts payable fluctuates with changes in inventory levels, volume of inventory purchases, negotiated supplier terms, and taking advantage of early pay discounts. +Investing Cash Flow +Cash flows used in investing activities were $3.3 million , $4.6 million , and $3.7 million in fiscal years 2013 , 2012 and 2011 , respectively. Our investing cash flows primarily consist of capital expenditures to purchase manufacturing equipment to support production and to a lesser extent leasehold improvements at our corporate headquarters. +Operating and capital leases may be utilized when potential technical obsolescence and funding requirement advantages outweigh the benefits of equipment ownership. Capital expenditures and periodic lease payments are expected to be financed with internally generated funds and available borrowing capacities. +Financing Cash Flow +Cash flows used in financing activities were $15.7 million in fiscal year 2013 as compared to cash flows provided by financing activities of $9.0 million and $6.7 million in fiscal years 2012 and 2011 , respectively. Our primary financing activity in fiscal years 2013 , 2012 , and 2011 was borrowing and repayment under our revolving line of our credit facility. Our credit agreement with Wells Fargo Bank, N.A. provides a revolving line of credit facility of up to $30.0 million. The agreement specifies that the proceeds of the revolving line of credit be used primarily for working capital and general corporate purposes of the Company and its subsidiaries. The Company did not have an outstanding balance on the line of credit as of June 29, 2013 . We had availability to borrow $30.0 million under the Wells Fargo line of credit and we were in compliance with our loan covenants. During fiscal year 2013 , cash used in financing activities also reflected payments of $0.7 million on capital leases. +Our cash requirements are affected by the level of current operations and new EMS programs. We believe that projected cash from operations, funds available under the revolving credit facility and leasing capabilities will be sufficient to meet our working and fixed capital requirements for the foreseeable future. +24 +As of June 29, 2013 , we had approximately $0.8 million of cash held by foreign subsidiaries. If cash is to be repatriated in the future from these foreign subsidiaries, the Company could be subject to additional income taxes payable in the U.S. The total amount of U.S. taxes required to be paid for the amount of foreign subsidiary cash on hand as of June 29, 2013 would approximate $81,000. The Company also has approximately $19.1 million of foreign earnings that has not been repatriated back to the U.S. Of that amount, the Company estimates that $9.3 million is to be repatriated in the future, requiring U.S. taxes of $1.5 million that is currently accrued in our deferred tax liabilities. The remaining $9.8 million is considered to be permanently reinvested in Mexico and China. If these amounts were required to be repatriated it would create an additional $1.2 million U.S. tax liability. +Contractual Obligations and Commitments +In the normal course of business, we enter into contracts which obligate us to make payments in the future. The table below sets forth our significant future obligations by fiscal year: +Payments Due by Fiscal Year (in thousands) +Total +2014 +2015 +2016 +2017 +2018 +Thereafter +Wells Fargo Bank N.A. revolving loan (1) +$ +— +$ +— +$ +— +$ +— +$ +— +$ +— +$ +— +Operating leases (2) +8,526 +1,874 +1,898 +1,420 +881 +735 +1,718 +Capital leases (3) +588 +588 +— +— +— +— +— +Purchase orders (4) +(1) +The terms of the Wells Fargo Bank N.A. revolving loan are discussed in the consolidated financial statements at Note 4, “Long-Term Debt”. As of June 29, 2013 , we were in compliance with our loan covenants. Breaching these covenants could have resulted in a material impact on our operations or financial condition. +(2) +We maintain vertically integrated manufacturing operations in Mexico and China. We lease some of our administrative and manufacturing facilities. A complete discussion of properties can be found in Part 1, Item 2 at “Properties”. Leases have proven to be an acceptable method for us to acquire new or replacement equipment and to maintain facilities with a minimum impact on our short term cash flows for operations. In addition, such operations are heavily dependent upon technically superior manufacturing equipment including molding machines in various tonnages, Surface Mount Technology (SMT) lines, clean rooms, and automated insertion, and test equipment for the various products we are capable of producing. +(3) +During fiscal year 2011, we entered into capital leases for the purchase of certain equipment and leasehold improvements. See Note 8, “Commitments and Contingencies” for additional discussion of capital lease obligations. Amounts presented above include interest and principal, if applicable. +(4) +As of June 29, 2013 , we had open purchase order commitments for materials and other supplies of approximately $68.5 million. Included in the open purchase orders are various blanket orders for annual requirements. Actual needs under these blanket purchase orders fluctuate with our manufacturing levels. In addition, we have contracts with our customers that minimize our exposure to losses for material purchased within lead-times necessary to meet customer forecasts. Purchase orders generally can be cancelled without penalty within specified ranges that are determined in negotiations with our suppliers. These agreements depend in part on the type of materials purchased as well as the circumstances surrounding any requested cancellations. +In addition to the cash requirements presented above, we have various other accruals which are not included in the table above. For example, we owe our suppliers approximately $26.4 million for accounts payable and shipments in transit at the end of the fiscal year. We generally pay our suppliers in a range from 30 to 120 days depending on terms offered. These payments are financed by operating cash flows and our revolving line of credit. +We believe that cash flows generated from operations, leasing facilities, and funds available under the revolving credit facility will satisfy cash requirements for a period in excess of 12 months and into the foreseeable future. +Critical Accounting Policies and Estimates +Preparation of our consolidated financial statements requires management to make estimates and assumptions that affect the reported amount of assets, liabilities, revenues and expenses. Note 1 to our consolidated financial statements describes the significant accounting policies used in the preparation of our consolidated financial statements. Management believes the most complex and sensitive judgments, because of their significance to our consolidated financial statements, result primarily from the need to make estimates about effects of matters that are inherently uncertain. The most significant areas involving management judgments are described below. Actual results in these areas could differ from management’s estimates. +25 +Revenue +Sales revenue from manufacturing is recognized upon shipment of the manufactured product per contractual terms. Upon shipment, title transfers and the customer assumes risks and rewards of ownership of the product. The price to the buyer is fixed or determinable and recoverability is reasonably assured. Unless specifically stated in contractual terms, there are no formal customer acceptance requirements or further obligations related to the manufacturing services; if any such requirements exist, then sales revenue is recognized at the time when such requirements are completed and such obligations are fulfilled. Revenue is recorded net of estimated returns of manufactured product based on management’s analysis of historical returns. +Revenues and associated costs from engineering design, development services and tooling, which are performed under contract of short term durations, are recognized only after the completed performance of the service. +Inactive, Obsolete, and Surplus Inventory Reserve +We reserve for inventories that we deem inactive, obsolete or surplus. This reserve is calculated based upon the demand for the products that we produce. Demand is determined by expected sales, customer purchase orders, or customer forecasts. If expected sales do not materialize, then we would have inventory in excess of our reserves and would have to charge the excess against future earnings. In the case where we have purchased material based upon a customer’s forecast or purchase orders, we are usually covered by lead-time assurance agreements or purchase orders with each customer. These contracts state that the financial liability for material purchased within agreed upon lead-time and based upon the customer’s forecasts, lies with the customer. If we purchase material outside the lead-time assurance agreement and the customer’s forecasts do not materialize or if we have no lead-time assurance agreement for a specific program, we would have the financial liability and may have to charge inactive, obsolete or surplus inventory against earnings. +Allowance for Doubtful Accounts +We value our accounts receivable net of an allowance for doubtful accounts. The allowance for doubtful accounts was $40,000 as of June 29, 2013. As of June 30, 2012, we deemed that no allowance was necessary. This allowance is based on estimates of the portion of accounts receivable that may not be collected in the future. The estimates used are based primarily on specific identification of potentially uncollectible accounts. Such accounts are identified using publicly available information in conjunction with evaluations of current payment activity. However, if any of our customers were to develop unexpected and immediate financial problems that would prevent payment of open invoices, we could incur additional and possibly material expenses that would negatively impact earnings. +Accrued Warranty +An accrual is made for expected warranty costs, with the related expense recognized in cost of goods sold. We review the adequacy of this accrual quarterly based on historical analysis and anticipated product returns and rework costs. As we have made the transition from manufacturing primarily keyboards to primarily EMS products, our exposure to warranty claims has declined significantly. Our warranty period for keyboards is generally longer than that for EMS products. We only warrant materials and workmanship on EMS products, and we do not warrant design defects for EMS customers. +Income Taxes +Income tax expense includes U.S. and international income taxes and the provision for U.S. taxes on undistributed earnings of foreign subsidiaries not deemed to be permanently invested. We do not record U.S. tax liabilities on undistributed earnings of international subsidiaries that are deemed to be permanently reinvested. Certain income and expenses are not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is reported as deferred income taxes. The deferred income taxes are classified as current or long-term based on the classification of the related asset or liability. The most significant areas involving management judgments include deferred income tax assets and liabilities, uncertain tax positions, and research and development tax credits. Our estimates of the realization of the deferred tax assets related to our tax credits are based upon our estimates of future taxable income which may change. +Stock-Based Compensation +Stock-based compensation is accounted for according to Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 718, Compensation—Stock Compensation . ASC 718 requires us to expense the fair value of employee stock options, stock appreciation rights and other forms of stock-based compensation. Under the fair value recognition provisions of ASC 718, share-based compensation cost is estimated at the grant date based upon the fair value of the award and is recognized as expense ratably over the requisite service period of the award (generally the vesting period). Determining the appropriate fair value model and calculating the fair value of share-based awards requires judgment, including estimating the expected life of the share-based award, the expected stock price volatility over the expected life of the share-based award and forfeitures. +26 +To determine the fair value of stock based awards on the date of grant we use the Black-Scholes option-pricing model. Inherent in this model are assumptions related to expected stock price volatility, option life, risk-free interest rate and dividend yield. The risk-free interest rate is a less-subjective assumption as it is based on factual data derived from public sources. We use a dividend yield of zero as we have never paid cash dividends and have no intention to pay cash dividends in the foreseeable future. The expected stock price volatility and option life assumptions require a greater level of judgment. Our expected stock-price volatility assumption is based upon the historical volatility of our stock which is obtained from public data sources. The expected life represents the weighted average period of time that share-based awards are expected to be outstanding, giving consideration to vesting schedules and historical exercise patterns. We determine the expected life assumption based upon the exercise and post-vesting behavior that has been exhibited historically, adjusted for specific factors that may influence future exercise patterns. If expected volatility or expected life were to increase, that would result in an increase in the fair value of our stock options which would result in higher compensation charges, while a decrease in volatility or the expected life would result in a lower fair value of our stock option awards resulting in lower compensation charges. +We estimate forfeitures for all of our awards based upon historical experience of stock-based pre-vesting forfeitures. We believe that our estimates are based upon outcomes that are reasonably likely to occur. If actual forfeitures are higher than our estimates it would result in lower compensation expense and to the extent the actual forfeitures are lower than our estimate we would record higher compensation expense. +Impairment of Long-Lived Assets +Long-lived assets, such as property, plant, and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge would be recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. +Derivatives and Hedging Activity +Derivatives are recognized on the balance sheet at their estimated fair value. On the date a derivative contract is entered into, the Company designates the derivative as a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (a “cash flow” hedge). The Company does not enter into derivatives for speculative purposes. Changes in the fair value of a derivative that qualifies as a cash flow hedge are recorded in “Accumulated Other Comprehensive Income”, until earnings are affected by the variability of cash flows. See Note 10 of the Company’s consolidated financial statements for additional information. +New and Future Accounting Pronouncements +See Note 1 to our consolidated financial statements. +Item 7A: +QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK +Interest Rate Risk +We are subject to the risk of fluctuating interest rates in the normal course of business. Our major market risk relates to our secured debt. Our revolving credit facility is secured by substantially all of our assets. The interest rates applicable to our revolving credit facility fluctuate with the JP Morgan Chase Bank prime rate and LIBOR rates. The Company did not have an outstanding balance on the line of credit as of June 29, 2013 . See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources and Liquidity” and Note 4 – “Long-Term Debt” to the Consolidated Financial Statements for additional information regarding our revolving credit facility. +Foreign Currency Exchange Risk +A significant portion of our operations are in foreign locations. As a result, transactions occur in currencies other than the U.S. dollar. Exchange rate fluctuations among other currencies used by us would directly or indirectly affect our financial results. We currently use Mexican peso forward contracts to hedge foreign currency fluctuations for a portion of our Mexican peso denominated expenses. There was $69.7 million of foreign currency forward contracts outstanding as of June 29, 2013 . The fair value of these contracts was approximately $2.0 million . See Note 10 – “Derivative Financial Instruments” to the Consolidated Financial Statements for additional information regarding our derivative instruments. +27 +Item 8: +FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA +Report of Independent Registered Public Accounting Firm +Board of Directors and Stockholders +Key Tronic Corporation +Spokane Valley, Washington +We have audited the accompanying consolidated balance sheets of Key Tronic Corporation (the “Company”) as of June 29, 2013 and June 30, 2012 and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended June 29, 2013. In connection with our audits of the financial statements, we have also audited the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. +We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and schedule. 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 Key Tronic Corporation at June 29, 2013 and June 30, 2012, and the results of its operations and its cash flows for each of the three years in the period ended June 29, 2013 , in conformity with accounting principles generally accepted in the United States of America. +Also, in our opinion, the 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. +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Key Tronic Corporation's internal control over financial reporting as of June 29, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria) and our report dated September 6, 2013 expressed an unqualified opinion thereon. +/s/ BDO USA, LLP +Spokane, Washington +September 6, 2013 +28 +KEY TRONIC CORPORATION AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +(In thousands) +June 29, 2013 +June 30, 2012 +ASSETS +Current assets: +Cash and cash equivalents +$ +10,819 +$ +502 +Trade receivables, net +47,009 +60,709 +Inventories +44,664 +58,439 +Deferred income tax asset +1,767 +5,201 +Other +7,508 +4,639 +Total current assets +111,767 +129,490 +Property, plant and equipment, net +17,911 +17,306 +Other assets: +Deferred income tax asset +3,179 +2,703 +Other +2,273 +1,413 +Total other assets +5,452 +4,116 +Total assets +$ +135,130 +$ +150,912 +LIABILITIES AND SHAREHOLDERS' EQUITY +Current liabilities: +Accounts payable +$ +26,400 +$ +43,025 +Accrued compensation and vacation +7,413 +6,337 +Current portion of other long-term obligations +576 +729 +Other +3,551 +3,163 +Total current liabilities +37,940 +53,254 +Long-term liabilities: +Revolving loan +— +15,011 +Deferred income tax liability +1,585 +1,094 +Other long-term obligations +1,445 +2,945 +Total long-term liabilities +3,030 +19,050 +Total liabilities +40,970 +72,304 +Commitments and contingencies (Note 4 and 8) +Shareholders’ equity: +Common stock, no par value—shares authorized 25,000; issued and outstanding 10,502 and 10,481 shares, respectively +43,369 +42,372 +Retained earnings +49,478 +36,895 +Accumulated other comprehensive income (loss) +1,313 +(659 +) +Total shareholders’ equity +94,160 +78,608 +Total liabilities and shareholders’ equity +$ +135,130 +$ +150,912 +See accompanying notes to consolidated financial statements. +29 +KEY TRONIC CORPORATION AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF INCOME +(In thousands, except per share amounts) +Years Ended +June 29, 2013 +June 30, 2012 +July 2, 2011 +Net sales +$ +361,033 +$ +346,475 +$ +253,846 +Cost of sales +326,521 +316,639 +233,198 +Gross profit +34,512 +29,836 +20,648 +Research, development and engineering expenses +5,156 +4,444 +3,782 +Selling, general and administrative expenses +11,230 +11,041 +9,927 +Total operating expenses +16,386 +15,485 +13,709 +Operating income +18,126 +14,351 +6,939 +Interest expense, net +271 +510 +457 +Income before income taxes +17,855 +13,841 +6,482 +Income tax provision +5,272 +2,215 +746 +Net income +$ +12,583 +$ +11,626 +$ +5,736 +Net income per share — Basic +$ +1.20 +$ +1.11 +$ +0.55 +Weighted average shares outstanding — Basic +10,490 +10,447 +10,344 +Net income per share — Diluted +$ +1.15 +$ +1.10 +$ +0.55 +Weighted average shares outstanding — Diluted +10,897 +10,609 +10,407 +See accompanying notes to consolidated financial statements. +30 +KEY TRONIC CORPORATION AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +(In thousands) +Years Ended +June 29, 2013 +June 30, 2012 +July 2, 2011 +Comprehensive income: +Net income +$ +12,583 +$ +11,626 +$ +5,736 +Other comprehensive income: +Unrealized gain (loss) on foreign exchange contracts, net of tax +1,972 +(2,399 +) +1,982 +Comprehensive income +$ +14,555 +$ +9,227 +$ +7,718 +Other comprehensive income for fiscal years 2013 , 2012 , and 2011 is reflected net of tax expense (benefit) of approximately $1.0 million , $(1.2) million , and $1.0 million respectively. +See accompanying notes to consolidated financial statements. +31 +KEY TRONIC CORPORATION AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended +June 29, 2013 +June 30, 2012 +July 2, 2011 +Operating activities: +Net income +$ +12,583 +$ +11,626 +$ +5,736 +Adjustments to reconcile net income to cash provided by (used in) operating activities: +Depreciation and amortization +2,965 +2,333 +2,212 +Accretion of deferred gain on sale of building +— +— +(39 +) +Excess tax benefit from exercise of stock options +(103 +) +(509 +) +— +Provision for obsolete inventory +525 +762 +299 +Provision for warranty +26 +60 +158 +Provision for (recovery of) doubtful accounts +62 +(111 +) +15 +Loss (gain) on disposal of fixed assets +27 +5 +(6 +) +Share-based compensation expense +848 +624 +500 +Deferred income taxes +2,493 +221 +1,036 +Deferred compensation +(546 +) +— +— +Changes in operating assets and liabilities: +Trade receivables +13,638 +(20,268 +) +(5,748 +) +Inventories +13,250 +(17,647 +) +(2,078 +) +Other assets +(2,381 +) +(1,732 +) +(274 +) +Accounts payable +(16,625 +) +16,876 +(3,009 +) +Accrued compensation and vacation +1,148 +1,829 +(661 +) +Other liabilities +1,372 +865 +(710 +) +Cash provided by (used in) operating activities +29,282 +(5,066 +) +(2,569 +) +Investing activities: +Purchase of property and equipment +(3,470 +) +(4,654 +) +(3,818 +) +Proceeds from sale of fixed assets +27 +9 +15 +Proceeds from life insurance +144 +— +113 +Cash used in investing activities +(3,299 +) +(4,645 +) +(3,690 +) +Financing activities: +Payment of financing costs +(75 +) +(75 +) +(50 +) +Proceeds from long term debt +— +— +2,244 +Principal payments on long term debt +(729 +) +(689 +) +(251 +) +Borrowings under revolving credit agreement +66,528 +114,591 +98,985 +Repayment of revolving credit agreement +(81,539 +) +(105,580 +) +(94,539 +) +Excess tax benefit from exercise of stock options +103 +509 +— +Proceeds from exercise of stock options +46 +225 +332 +Cash (used in) provided by financing activities +(15,666 +) +8,981 +6,721 +Net increase (decrease) in cash and cash equivalents +10,317 +(730 +) +462 +Cash and cash equivalents, beginning of period +502 +1,232 +770 +Cash and cash equivalents, end of period +$ +10,819 +$ +502 +$ +1,232 +Supplemental cash flow information: +Interest payments +$ +317 +$ +443 +$ +463 +Income tax payments, net of refunds +$ +2,708 +$ +1,412 +$ +533 +See accompanying notes to consolidated financial statements. +32 +KEY TRONIC CORPORATION AND SUBSIDIARIES +CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY +(In thousands) +Shares +Common +Stock +Retained +Earnings +Accumulated +Other +Comprehensive +Income (Loss) +Total +Shareholders’ +Equity +Balances, July 3, 2010 +10,264 +$ +40,126 +$ +19,533 +$ +(242 +) +$ +59,417 +Net Income +— +— +5,736 +— +5,736 +Unrealized gain on foreign exchange contracts, net +— +— +— +1,982 +1,982 +Exercise of stock options +135 +332 +— +— +332 +Share-based compensation +— +556 +— +— +556 +Balances, July 2, 2011 +10,399 +$ +41,014 +$ +25,269 +$ +1,740 +$ +68,023 +Net Income +— +— +11,626 +— +11,626 +Unrealized loss on foreign exchange contracts, net +— +— +— +(2,399 +) +(2,399 +) +Exercise of stock options +82 +225 +— +— +225 +Share-based compensation +— +624 +— +— +624 +Tax benefit from exercise of stock options +— +509 +— +— +509 +Balances, June 30, 2012 +10,481 +$ +42,372 +$ +36,895 +$ +(659 +) +$ +78,608 +Net income +— +— +12,583 +— +12,583 +Unrealized gain on foreign exchange contracts, net +— +— +— +1,972 +1,972 +Exercise of stock options +21 +46 +— +— +46 +Share-based compensation +— +848 +— +— +848 +Tax benefit from exercise of stock options +— +103 +— +— +103 +Balances, June 29, 2013 +10,502 +$ +43,369 +$ +49,478 +$ +1,313 +$ +94,160 +See accompanying notes to consolidated financial statements. +33 +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. SIGNIFICANT ACCOUNTING POLICIES +Business +Key Tronic Corporation and subsidiaries (the Company) is engaged in electronic manufacturing services (EMS) for original equipment manufacturers (OEMs), and also manufactures keyboards and other input devices. The Company’s headquarters are located in Spokane Valley, Washington with manufacturing operations in Spokane Valley; Juarez, Mexico; and Shanghai, China. +Principles of Consolidation +The consolidated financial statements include the Company and its wholly owned subsidiaries in Mexico and China. Intercompany balances and transactions have been eliminated in consolidation. +Reclassifications +Certain prior period reclassifications were made to conform with the current period presentation. These reclassifications had no effect on reported income, comprehensive income, cash flows, total assets, or shareholders' equity as previously reported. +Use of Estimates +The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates include the allowance for doubtful receivables, the provision for obsolete and non-saleable inventories, deferred tax assets and liabilities, uncertain tax positions, impairment of long-lived assets, medical self-funded insurance liability, long-term incentive compensation accrual, the provision for warranty costs, and the fair values of options and stock appreciation rights granted under the Company’s stock-based compensation plans. Due to uncertainties with respect to the assumptions and estimates actual results could differ from those estimates. +Cash and Cash Equivalents +The Company considers investments with an original maturity of three months or less to be cash equivalents. Cash equivalents are carried at cost, which approximates fair value. The Company may have cash and cash equivalents at financial institutions that are in excess of federally insured limits from time to time. +Allowance for Doubtful Accounts +The Company evaluates the collectability of accounts receivable and records an allowance for doubtful accounts, which reduces the receivables to an amount that management reasonably estimates will be collected. A specific allowance is recorded against receivables considered to be impaired based on the Company’s knowledge of the financial condition of the customer. In determining the amount of the allowance, the Company considers several factors including the aging of the receivables, the current business environment, and historical experience. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. +Inventories +Inventories are stated at the lower of cost or market. Cost is determined principally using the first-in, first-out (FIFO) method. Customer orders are based upon forecasted quantities of product manufactured for shipment over defined periods. Raw material inventories are purchased to fulfill these customer requirements. Within these arrangements, customer demands for products frequently change, sometimes creating excess and obsolete inventories. The Company regularly reviews raw material inventories by customer for both excess and obsolete quantities. Wherever possible, the Company attempts to recover its full cost of excess and obsolete inventories from customers or, in some cases, through other markets. When it is determined that the Company's carrying cost of such excess and obsolete inventories cannot be recovered in full, a charge is taken against income for the difference between the carrying cost and the estimated realizable amount. +Property, Plant and Equipment +Property, plant and equipment are carried at cost and depreciated using straight-line methods over the expected useful lives of the assets. Internally constructed molds and dies are depreciated over the expected useful lives of one to two years. Repairs and maintenance costs are expensed as incurred. +34 +Impairment of Long-lived Assets +The Company, using its best estimates based on reasonable and supportable assumptions and projections, reviews assets for impairment whenever events or changes in circumstances have indicated that the carrying amount of its assets might not be recoverable. Impaired assets are reported at the lower of cost or fair value. +Accrued Warranty +An accrual is made for expected warranty costs, with the related expense recognized in cost of goods sold. Management reviews the adequacy of this accrual quarterly based on historical analyses and anticipated product returns. +Self-funded Insurance +The Company self-funds its domestic employee health plan. The Company contracted with a separate administrative service company to supervise and administer the program and act as its representative. The Company reduces its risk under this self-funded platform by purchasing stop-loss insurance coverage for individual claims. In addition, if the aggregate annual claims amount to more than 125 percent of expected claims for the plan year this insurance will also pay those claims amounts exceeding that level. +The Company estimates its exposure for claims incurred but not paid at the end of each reporting period and uses historical claims data supplied by the Company’s broker to estimate its self-funded insurance liability. This liability is subject to a total limitation that varies based on employee enrollment and factors that are established at each annual contract renewal. Actual claims experience may differ from the Company’s estimates. Costs related to the administration of the plan and related claims are expensed as incurred. +Revenue Recognition +Sales revenue from manufacturing is recognized upon shipment of the manufactured product per contractual terms. Upon shipment, title transfers and the customer assumes risks and rewards of ownership of the product. The price to the buyer is fixed or determinable and recoverability is reasonably assured. Unless specifically stated in contractual terms, there are no formal customer acceptance requirements or further obligations related to the manufacturing services; if any such requirements exist, then sales revenue is recognized at the time when such requirements are completed and such obligations are fulfilled. Revenue is recorded net of estimated returns of manufactured product based on management’s analysis of historical returns. +Revenues and associated costs from engineering design, development services and tooling, which are performed under contract of short term durations, are recognized only after the completed performance of the service. Revenue from engineering design, development services and tooling represented approximately 2.5 percent , 2.1 percent , and 3.3 percent of total revenue in fiscal years 2013 , 2012 , and 2011 , respectively. +Shipping and Handling Fees +The Company classifies costs associated with shipping and handling fees as a component of cost of goods sold. Customer billings related to shipping and handling fees are reported as revenue. +Research, Development and Engineering +Research, development and engineering expenses include unreimbursed EMS costs as well as design and engineering costs associated with the production of EMS programs. Research, development and engineering costs are expensed as incurred. +Income Taxes +Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences and benefits attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, as well as operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which temporary differences and carryforwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities for a change in tax rates is recognized in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that is more likely than not to be realized. +35 +We utilize a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments based on new assessments and changes in estimates and which may not accurately forecast actual outcomes. Our policy is to recognize interest and penalties related to the underpayment of income taxes as a component of income tax provision. To date, we have not incurred charges for interest or penalties in relation to the underpayment of income taxes. The tax years 1997 through the present remain open to examination by the major U.S. taxing jurisdictions to which we are subject. Refer to Note 5 for further discussions. +Derivative Instruments and Hedging Activities +The Company has entered into foreign currency forward contracts which are accounted for as cash flow hedges in accordance with ASC 815, Derivatives and Hedging . The effective portion of the gain or loss on the derivative is reported as a component of accumulated other comprehensive income (AOCI) and is reclassified into earnings in the same period in which the underlying hedged transaction affects earnings. The derivative’s effectiveness represents the change in fair value of the hedge that offsets the change in fair value of the hedged item. +The Company transacts business in Mexico and is subject to the risk of foreign currency exchange rate fluctuations. The Company enters into foreign currency forward contracts to manage the foreign currency fluctuations for Mexican peso denominated payroll, utility, tax, and accounts payable expenses. The foreign currency forward contracts have terms that are matched to the underlying transactions being hedged. As a result, these transactions fully offset the hedged risk and no ineffectiveness has been recorded. +The Company's foreign currency forward contracts potentially expose the Company to credit risk to the extent the counterparties may be unable to meet the terms of the agreement. The Company minimizes such risk by seeking high quality counterparties. The Company’s counterparties to the foreign currency forward contracts are major banking institutions. These institutions do not require collateral for the contracts, and the Company believes that the risk of the counterparties failing to meet their contractual obligations is remote. The Company does not enter into derivative instruments for trading or speculative purposes. +Earnings Per Common Share +Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed by dividing net income by the combination of other potentially dilutive weighted average common shares and the weighted average number of common shares outstanding during the period using the treasury stock method. The computation assumes the proceeds from the exercise of stock options were used to repurchase common shares at the average market price during the period. The computation of diluted earnings per common share does not assume conversion, exercise, or contingent issuance of common stock equivalent shares that would have an anti-dilutive effect on earnings per share. +Foreign Currency Transactions +The functional currency of the Company’s subsidiaries in Mexico and China is the U.S. dollar. Realized foreign currency transaction gains and losses for local currency denominated assets and liabilities are included in cost of goods sold. +Fair Value of Financial Instruments +The carrying values of cash and cash equivalents, accounts receivable and current liabilities reflected on the balance sheets at June 29, 2013 and June 30, 2012 , reasonably approximate their fair value. Based on the borrowing rates currently available to the Company for loans with similar terms and average maturities, the fair value of long-term debt was estimated to be $15.0 million as of June 30, 2012 . As of June 29, 2013 , the Company did not have an outstanding balance on the line of credit. +Share-based Compensation +The Company’s incentive plan may provide for equity and liability awards to employees in the form of stock options, stock appreciation rights, restricted stock, restricted stock units, stock awards, stock units, performance shares, performance units, and other stock –based or cash-based awards. Compensation cost is recognized on a straight-line basis over the requisite employee service period, which is generally the vesting period, and is included in cost of goods sold and selling, general, and administrative expenses. +36 +Newly Adopted and Recent Accounting Pronouncements +In December 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2011-11 (ASU 2011-11), Disclosures about Offsetting Assets and Liabilities . The amendments in this Update will enhance disclosures required by U.S. GAAP by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement. The amendments are effective for fiscal years beginning after January 1, 2013 and for interim periods within those fiscal years. The amendments of ASU 2011-11 are not expected to have a material impact on the Company’s consolidated financial statements. +In January 2013, the FASB issued Accounting Standards Update 2013-01 (ASU 2013-01), Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities . The main objective in developing this Update is to address implementation issues about the scope of Accounting Standards Update No. 2011-11, Balance Sheet Topic 210: Disclosures about Offsetting Assets and Liabilities. The amendments are effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. The amendments of ASU 2013-01 are not expected to have a material impact on the Company’s consolidated financial statements. +In February 2013, the FASB issued Accounting Standards Update 2013-02 (ASU 2013-02), Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income . The objective of this Update is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments in this Update seek to attain that objective by requiring an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. GAAP to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. The amendments are effective prospectively for annual reporting periods beginning after December 15, 2012 and interim periods within those annual periods. The amendments of ASU 2013-02, when adopted, are not expected to have a material impact on the Company’s consolidated financial statements, however will require additional disclosure within the notes to the financial statements. +In July 2013, the FASB issued Accounting Standards Update 2013-11 (ASU 2013-11), Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists a consensus of the FASB Emerging Issues Task Force . The objective of this Update is to eliminate the diversities that exist in financial statement presentation. The amendments aim at attaining this objective by giving explicit guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The amendments of ASU 2013-11, when adopted, are not expected to have a material impact on the Company's consolidated financial statements. +Fiscal Year +The Company operates on a 52/53 week fiscal year. Fiscal years end on the Saturday nearest June 30. As such, fiscal years 2013 , 2012 , and 2011 , ended on June 29, 2013 , June 30, 2012 , and July 2, 2011 , respectively and each year was a 52 week year. +2. INVENTORIES +The components of inventories consist of the following (in thousands): +June 29, 2013 +June 30, 2012 +Finished goods +$ +7,097 +$ +9,805 +Work-in-process +5,098 +6,340 +Raw materials and supplies +32,469 +42,294 +$ +44,664 +$ +58,439 +37 +3. PROPERTY, PLANT AND EQUIPMENT +Property, plant and equipment consists of the following: +Life +June 29, 2013 +June 30, 2012 +(in years) +(in thousands) +Land +— +$ +2,629 +$ +2,629 +Buildings and improvements +3 to 30 +18,919 +18,300 +Equipment +1 to 10 +37,317 +35,160 +Furniture and fixtures +3 to 5 +2,730 +2,378 +61,595 +58,467 +Accumulated depreciation +(43,684 +) +(41,161 +) +$ +17,911 +$ +17,306 +4. LONG-TERM DEBT +Note Payable - Bank +On October 15, 2010, the Company entered into an amended credit agreement with Wells Fargo Bank, N.A. thereby increasing its revolving line of credit for up to $30.0 million . On January 30, 2012, the Company entered into a second amendment to the credit agreement extending the term to October 15, 2016. The agreement specifies that the proceeds of the revolving line of credit be used primarily for working capital and general corporate purposes of the Company and its subsidiaries. Borrowings under this revolving line of credit bear interest at either a “Base Rate” or a “Fixed Rate”, as elected by the Company. The base rate is the higher of the Wells Fargo Bank prime rate, daily one month London Interbank Offered Rate (LIBOR) plus 1.5% , or the Federal Funds rate plus 1.5% . The fixed rate is LIBOR plus 2.1% or LIBOR plus 2.5% depending on the level of the Company’s trailing four quarters Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). The revolving line of credit is secured by substantially all of the assets of the Company. +The Company must comply with certain financial covenants, including a cash flow leverage ratio and a trading ratio. The credit agreement requires the Company to maintain a minimum profit threshold, limits the maximum lease expenditures and restricts the Company from declaring or paying dividends in cash or stock. The Company is in compliance with all financial covenants for all periods presented. +As of June 29, 2013 , the Company had availability to borrow $30.0 million under the line of credit. The Company did not have an outstanding balance on the line of credit as of June 29, 2013 . The outstanding balance under the credit facility was $15.0 million as of June 30, 2012 and the interest rate on the outstanding balances was in the range of 2.35% - 3.25% . +38 +5. INCOME TAXES +Income tax provision consists of the following: +Year Ended +June 29, 2013 +June 30, 2012 +July 2, 2011 +(in thousands) +Current income tax provision: +United States +$ +1,729 +$ +1,483 +$ +34 +Foreign +1,050 +511 +242 +2,779 +1,994 +276 +Deferred income tax provision: +United States +2,049 +(85 +) +1,250 +Foreign +444 +306 +(780 +) +2,493 +221 +470 +Total income tax provision +$ +5,272 +$ +2,215 +$ +746 +The Company has total tax credit carryforwards of approximately $7.9 million at June 29, 2013 . Included in total tax credits carryforwards is approximately $5.7 million in research and development (R&D) tax credits. +Management also has reviewed its other deferred tax assets for purposes of determining whether or not a valuation allowance may be required. A valuation allowance against these deferred tax assets is required if it is more likely than not that some of the deferred tax assets will not be realized. Based on the Company’s increased profitability and estimated future repatriations from foreign subsidiaries, it has been determined that it is more likely than not that the deferred tax assets will be realized. +Management has reviewed and updated as necessary estimates of future repatriations of the undistributed earnings of its foreign subsidiaries. Based on this analysis, management expects to repatriate a portion of the foreign undistributed earnings based on increased sales growth driving additional U.S. capital requirements, cash requirements for potential acquisitions and to potentially implement certain tax strategies. No foreign earnings were repatriated from either foreign subsidiary during fiscal 2013 or 2012 . The Company currently estimates that future repatriations from foreign subsidiaries will approximate $9.3 million . As such, as earnings are recognized in the United States, the Company would be subject to U.S. federal and state income taxes and potential withholding taxes estimated to be approximately $4.6 million . Both the domestic tax and estimated withholding tax have been recorded as part of deferred taxes as of June 29, 2013 . Included in tax credits is $3.9 million related to foreign tax credits that can be used to offset future domestic income tax. All other unremitted foreign earnings are expected to remain permanently reinvested for planned fixed asset purchases in foreign locations. +The Company has not provided for U.S. income taxes or foreign withholding taxes on approximately $9.8 million of earnings from foreign subsidiaries which are permanently reinvested outside the U.S. The unrecognized net tax provision, after netting U.S. federal and state income tax and any related foreign tax credits, would be approximately $1.2 million associated to these earnings. +The Company has a wholly owned foreign subsidiary in Mexico that applies certain tax credits related to production assets that currently offset all of the income tax liabilities under general Mexican income tax law. However, the Company is subject to a Mexican business flat tax called Impuesto Empresarial a Tasa Unica (IETU). The Company anticipates that it will be taxable under IETU for the foreseeable future based on projected assets used in its operations and anticipated future cash flows. The effect of IETU and the associated presidential decrees have been included in the effective tax rate for the year ended June 29, 2013 . +39 +The Company’s effective tax rate differs from the federal tax rate as follows: +Year Ended +June 29, 2013 +June 30, 2012 +July 2, 2011 +(in thousands) +Federal income tax provision at statutory rates +$ +6,071 +$ +4,706 +$ +2,205 +Foreign tax rate differences +(625 +) +(361 +) +(326 +) +Effect of income tax credits +(340 +) +(2,104 +) +(1,249 +) +Effect of repatriation of foreign earnings, net +188 +— +72 +Other +235 +436 +(86 +) +Change in valuation allowance +(257 +) +(462 +) +130 +Income tax provision +$ +5,272 +$ +2,215 +$ +746 +The domestic and foreign components of income before income taxes were: +Year Ended +June 29, 2013 +June 30, 2012 +July 2, 2011 +(in thousands) +Domestic +$ +12,863 +$ +10,666 +$ +4,048 +Foreign +4,992 +3,175 +2,434 +Income before income taxes +$ +17,855 +$ +13,841 +$ +6,482 +Deferred income tax assets and liabilities consist of the following at: +June 29, 2013 +June 30, 2012 +(in thousands) +Deferred tax assets: +Tax credit carryforwards, net +$ +3,414 +$ +4,559 +Foreign subsidiaries – future tax credits +3,389 +2,600 +Inventory +131 +396 +Accruals +1,925 +3,069 +Fixed Assets +755 +378 +Other +185 +362 +Deferred income tax assets +9,799 +11,364 +Valuation allowance +— +(257 +) +Deferred income tax assets, net of valuation allowance +$ +9,799 +$ +11,107 +Deferred tax liabilities: +Foreign subsidiaries – unremitted earnings +(4,115 +) +(3,138 +) +Fixed assets +(1,617 +) +(1,157 +) +Other +(706 +) +(2 +) +Deferred income tax liabilities +$ +(6,438 +) +$ +(4,297 +) +Net deferred income tax assets +$ +3,361 +$ +6,810 +Balance sheet caption reported in: +Current deferred tax asset +$ +1,767 +$ +5,201 +Long-term deferred tax asset +3,179 +2,703 +Long term deferred income tax liability +(1,585 +) +(1,094 +) +Net deferred income tax asset +$ +3,361 +$ +6,810 +At June 30, 2012 the Company utilized all its NOLs carried forward from prior years in both the U. S. and Chinese jurisdictions. The Company has R&D tax credits that approximate $5.7 million that have 20 year carryforwards before expiring. The Company’s R&D tax credits expire in various fiscal years from 2019 to 2033. The Company also has alternative minimum tax credits, which do not expire, approximating $726,000 . +40 +Uncertain Tax Positions +As of June 29, 2013 , the Company had unrecognized tax benefits of $3.0 million related to its gross R&D tax credits. The unrecognized tax benefits relate to certain R&D tax credits generated from 1999 to 2013. +A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: +Balances, July 2, 2011 +$ +781 +Additions in fiscal 2012 +2,222 +Balances, June 30, 2012 +$ +3,003 +Additions in fiscal 2013 +97 +Deletions in fiscal 2013 +(69 +) +Balances, June 29, 2013 +$ +3,031 +The increase from the prior year is due to additional R&D credits that were recorded in 2013 as discussed above. Management does not anticipate any material changes to this amount during the next 12 months. +The Company recognizes interest accrued related to unrecognized tax benefits and penalties in its income tax provision. The Company has not recognized any interest or penalties in the fiscal years presented in these financial statements. The Company is subject to income tax in the U.S. federal jurisdiction, Mexico and China. Certain years remain subject to examination but there are currently no ongoing exams in any taxing jurisdictions. +41 +6. EARNINGS PER SHARE +Basic earnings per share (EPS) is calculated by dividing net income (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Diluted EPS is computed by including both the weighted-average number of shares outstanding and any dilutive common share equivalents in the denominator. The following table presents a reconciliation of the denominator and the number of antidilutive common share awards that were not included in the diluted earnings per share calculation. These antidilutive securities occur when equity awards outstanding have an option price greater than the average market price for the period: +Years Ended +(in thousands, except per share information) +June 29, 2013 +June 30, 2012 +July 2, 2011 +Net income +$ +12,583 +$ +11,626 +$ +5,736 +Weighted average shares outstanding– basic +10,490 +10,447 +10,344 +Effect of dilutive common stock options +407 +162 +63 +Weighted average shares outstanding – diluted +10,897 +10,609 +10,407 +Earnings per share – basic +$ +1.20 +$ +1.11 +$ +0.55 +Earnings per share – diluted +$ +1.15 +$ +1.10 +$ +0.55 +Antidilutive options not included in diluted earnings per share +— +— +541 +7. STOCK OPTION AND BENEFIT PLANS +The Company’s incentive plan provides for equity and liability awards to employees and non-employee directors in the form of stock options, stock appreciation rights (SARs), restricted stock, restricted stock units, stock awards, stock units, performance shares, performance units, and other stock – based or cash-based awards. Compensation cost is recognized on a straight-line basis over the requisite employee service period, which is generally the vesting period, and is recorded as employee compensation expense in cost of goods sold and selling general and administrative expenses. Share-based compensation is recognized only for those awards that are expected to vest, with forfeitures estimated at the date of grant based on historical experience and future expectations. +In addition to service conditions, these SARs contain a performance condition. The additional performance condition is based upon the achievement of Return on Invested Capital (ROIC) goals relative to a peer group. All awards with performance conditions are measured over the vesting period and are charged to compensation expense over the requisite service period based on the number of shares expected to vest. The SARs cliff vest after a three-year period from date of grant and expire five years from date of grant. +On July 25, 2012, the Company granted 210,666 SARs under the 2010 Incentive Plan to certain key employees and outside directors at a strike price of $7.44 and a grant date fair value of $3.71 , as of June 29, 2013 203,166 remain outstanding. The grant date fair value for the awards granted during fiscal year 2013 were estimated using the Black Scholes option valuation method with the following weighted average assumptions as July 25, 2012: +Fiscal Year 2013 +July 25, 2012 +Expected dividend yield +— +% +Risk – free interest rate +0.46 +% +Expected volatility +66.50 +% +Expected life +4.00 +42 +On July 27, 2011, the Company granted 184,666 SARs under the 2010 Incentive Plan to certain key employees and outside directors at a strike price of $4.40 and a grant date weighted average fair market value of $2.20 , as of June 29, 2013 , 179,666 remain outstanding. On January 26, 2012, the Company granted 32,000 SARs under the 2010 Incentive Plan to certain key employees at a strike price of $6.30 and grant date weighted average fair market value of $3.08 . The grant date fair value for the awards granted during fiscal year 2012 were estimated using the Black Scholes option valuation method with the following weighted average assumptions at each of the respective grant dates: +Fiscal Year 2012 +January 26, 2012 +July 27, 2011 +Expected dividend yield +— +% +— +% +Risk – free interest rate +0.52 +% +1.16 +% +Expected volatility +64.90 +% +65.50 +% +Expected life +4.00 +4.00 +On October 21, 2010, the Company obtained shareholder approval of the 2010 Incentive Plan at the Annual Shareholder Meeting. As a result, the Company replaced the cash-settlement feature with a net-share-settlement feature for the 522,000 SARs granted during the fourth quarter of fiscal 2010. Therefore, the awards were reclassified from liability awards to equity awards effective October 21, 2010 at a weighted average fair value of $2.89 . The fair value for the liability awards amended to equity awards during fiscal year 2011 were estimated using the Black-Scholes option valuation model with the following weighted average assumptions as of October 21, 2010: +Fiscal Year 2011 +October 21, 2010 +Expected dividend yield +— +% +Risk – free interest rate +0.73 +% +Expected volatility +68.30 +% +Expected life +3.56 +Share-based compensation expense is recognized only for those awards that are expected to vest, with forfeitures estimated at the date of grant based on the Company’s historical experience and future expectations. This forfeiture rate will be revised, if necessary, in subsequent periods if actual forfeitures differ from the amount estimated. Share-based compensation expense for fiscal years ended June 29, 2013 , June 30, 2012 and July 2, 2011 was $0.8 million , $0.6 million and $0.5 million , respectively. +The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which differ significantly from the SARs, as traded options have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, particularly for the expected term and expected stock price volatility. Changes in these assumptions can materially affect the fair value estimates. +The intrinsic value for options exercised in fiscal years 2013 , 2012 and 2011 was $0.2 million , $0.3 million and $0.2 million , respectively. +As of June 29, 2013 , total unrecognized compensation expense related to nonvested share-based compensation arrangements was approximately $0.7 million . This expense is expected to be recognized over a weighted-average period of 1.84 years . +43 +The following table summarizes option/SARs activity of all plans from June 30, 2012 through June 29, 2013 : +Shares +Available +For Grant +Options/SARs +Outstanding +Aggregate +Intrinsic +Value (in +thousands) +Weighted +Average +Exercise +Price +Weighted +Average +Remaining +Contractual +Life (in +years) +Balances, June 30, 2012 +461,334 +784,360 +$ +2,261 +$ +5.36 +3.1 +Shares authorized +— +— +— +— +— +Options/SARs granted +— +210,666 +— +7.44 +— +Options canceled and expired +— +(12,502 +) +— +6.22 +— +Options exercised +— +(20,832 +) +157 +2.23 +— +Balances, June 29, 2013 +461,334 +961,692 +$ +4,309 +$ +5.87 +2.6 +Exercisable at June 29, 2013 +546,860 +$ +3,141 +$ +5.74 +1.8 +Additional information regarding options outstanding as of June 29, 2013 , is as follows: +Options/SARs +Outstanding +Options/SARs +Exercisable +Range of +Exercise Prices +Number Outstanding +Weighted Avg. +Remaining +Contractual Life (yrs.) +Weighted Avg. +Exercise Price +Number +Exercisable +Weighted +Avg. Exercise +Price +$1.81 – $2.72 +15,000 +0.3 +$ +2.20 +15,000 +$ +2.20 +2.73 – 4.09 +9,860 +3.0 +3.40 +9,860 +3.40 +4.10 – 6.15 +701,666 +2.5 +5.51 +522,000 +5.89 +6.16 – 7.44 +235,166 +4.0 +7.28 +— +— +$1.81 to $7.44 +961,692 +2.6 +$ +5.87 +546,860 +$ +5.74 +The Company also has a defined contribution plan (401(k)) available to U.S. employees who have attained age 21. The Company contributes an amount equal to 100% of the employee’s contribution on the first 3% of the employee’s compensation and an additional 50% of the employee’s contribution on the following 2% of the employee’s compensation. Company contributions to the plan were approximately $0.5 million for each of fiscal years 2013 , 2012 , and 2011 . +8. COMMITMENTS AND CONTINGENCIES +Leases : The Company had equipment financed through capital leases with a net book value of $1.7 million , $1.9 million , and $2.2 million during fiscal years 2013, 2012, and 2011, respectively. The related depreciation expense was $0.3 million for fiscal years 2013 and 2012, and $0.1 million for fiscal year 2011. The Company has operating and capital leases for certain equipment and production facilities, which expire at various dates during the next ten years . +Future minimum payments under non-cancelable operating and capital leases with initial or remaining terms of one year or more at June 29, 2013 , are summarized as follows (in thousands): +Fiscal Years Ending +Operating +Leases +Capital +Leases +2014 +$ +1,874 +$ +588 +2015 +1,898 +— +2016 +1,420 +— +2017 +881 +— +2018 +735 +— +Thereafter +1,718 +— +Total minimum lease payments +$ +8,526 +$ +588 +* +* Includes $12 of interest. +44 +Subsequent to fiscal year 2013, the Company completed the acquisition of Sabre Manufacturing resulting in an additional 66,000 square feet of leased manufacturing space with the lease expiring on August 30, 2016. The operating lease obligation is included in the table above. +On January 11, 2011 , the Company entered into a capital lease agreement. The term of the capital lease agreement extends to January 2014 with monthly payments of $16,760 and a fixed interest rate of 3.86% . At June 29, 2013 , the outstanding principal balance was $197,379 under the capital lease agreement and the net book value of the equipment was $483,788 . +On April 1, 2011 , the Company entered into two capital lease agreements. The term of the capital lease agreements extends to March 2014 with monthly payments of $39,445 and $8,961 , with fixed interest rates of 6.21% . At June 29, 2013 , the outstanding principal balances were $308,336 and $70,051 under the capital lease agreements. The net book value at June 29, 2013 for the equipment under the capital lease agreements was $969,522 and $171,468 , respectively. +Rental expense under operating leases was approximately $1.5 million , $1.5 million , and $2.4 million during fiscal years 2013 , 2012 , and 2011 , respectively. +Warranty Costs : The Company provides warranties on certain product sales, and allowances for estimated warranty costs are recorded during the period of sale. The determination of such allowances requires the Company to make estimates of product return rates and expected costs to repair or to replace the products under warranty. The Company establishes warranty reserves based on historical warranty costs for each product line combined with liability estimates based on the prior twelve months’ sales activities. +If actual return rates and/or repair and replacement costs differ significantly from estimates, adjustments to recognize additional cost of sales may be required in future periods. +Components of the reserve for warranty costs during fiscal years 2013 , 2012 , and 2011 were as follows (in thousands): +Balances, July 3, 2010 +$ +25 +Additions +158 +Warranty costs incurred +(173 +) +Balances, July 2, 2011 +10 +Additions +65 +Warranty costs incurred +(52 +) +Balances, June 30, 2012 +23 +Additions +26 +Warranty costs incurred +(40 +) +Balances, June 29, 2013 +$ +9 +Warranty expense for fiscal years 2013 , 2012 and 2011 is related to workmanship claims on keyboards and certain EMS products. +Litigation : The Company is party to certain lawsuits or claims in the ordinary course of business. The Company does not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on the financial position, results of operations or cash flow of the Company. +Indemnification Rights : Under the Company’s bylaws, the Company’s directors and officers have certain rights to indemnification by the Company against certain liabilities that may arise by reason of their status or service as directors or officers. The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers and former directors in certain circumstances. +9. FAIR VALUE MEASUREMENTS +The Company has adopted ASC 820, Fair Value Measurements, which defines fair value, establishes a framework for assets and liabilities being measured and reported at fair value and expands disclosures about fair value measurements. There are three levels of fair value hierarchy inputs used to value assets and liabilities which include: Level 1 – inputs are quoted market prices for identical assets or liabilities; Level 2 – inputs other than quoted market prices included in Level 1 that are observable for the asset or liability, either directly or indirectly; and Level 3 – inputs are unobservable inputs for the asset or liability. There have been no changes in the fair value methodologies used at June 29, 2013 and June 30, 2012 . +45 +The following table summarizes the Company’s financial assets and liabilities (only those required to be measured at fair value on a recurring basis) at fair value as of June 29, 2013 and June 30, 2012 (in thousands): +June 29, 2013 +Level 1 +Level 2 +Level 3 +Total +Fair Value +Financial Assets: +Foreign currency forward contracts +$ +— +$ +2,429 +$ +— +$ +2,429 +Financial Liabilities: +Foreign currency forward contracts +$ +— +$ +(434 +) +$ +— +$ +(434 +) +June 30, 2012 +Level 1 +Level 2 +Level 3 +Total +Fair Value +Financial Assets: +Foreign currency forward contracts +$ +— +$ +858 +$ +— +$ +858 +Financial Liabilities: +Foreign currency forward contracts +$ +— +$ +(1,851 +) +$ +— +$ +(1,851 +) +The Company currently has forward contracts to hedge known future cash outflows for expenses denominated in the Mexican peso. These contracts are measured on a recurring basis based on the foreign currency spot rates and forward rates quoted by banks or foreign currency dealers. These contracts are marked to market using level 2 input criteria every period with the unrealized gain or loss, net of tax, reported as a component of shareholders’ equity in accumulated other comprehensive income, as they qualify for hedge accounting. +The carrying values of cash and cash equivalents, accounts receivable and current liabilities reflected on the balance sheets at June 29, 2013 and June 30, 2012 , reasonably approximate their fair value. The Company’s long-term debt primarily consists of a revolving line of credit. Borrowings under this revolving line of credit bear interest at the higher of Wells Fargo Bank prime rate, daily one month London Interbank Offered Rate (LIBOR) plus 1.5% to 2.5% , or the Federal Funds rate plus 1.5% . Each of these rates is a variable floating rate dependent upon current market conditions and the Company’s current credit risk. As a result of the determinable market rate for our revolving credit debt it is classified within Level 2 of the fair value hierarchy. The Company did not have an outstanding balance on the line of credit as of June 29, 2013 . The discounted cash flow of the revolving line of credit was estimated to be $15.0 million as of June 30, 2012 , which carrying value approximates the fair value. +10. DERIVATIVE FINANCIAL INSTRUMENTS +As of June 29, 2013 , the Company had outstanding foreign currency forward contracts of $69.7 million . These contract maturity dates extend through September 2016 . As of June 29, 2013 , the net amount of existing gains expected to be reclassified into earnings within the next 12 months is $0.4 million . During the fiscal year ended June 29, 2013 , the Company entered into $34.7 million of foreign currency forward contracts and settled $22.7 million of such contracts. During the fiscal year ended June 30, 2012 , the Company entered into $41.1 million of foreign currency forward contracts and settled $21.2 million of such contracts. During the fiscal year ended July 2, 2011 , the Company entered into $21.7 million of foreign currency forward contracts and settled $14.6 million of such contracts. Subsequent to June 29, 2013 , the Company entered into $5.0 million of additional foreign currency forward contracts that extended our hedge position through December 2016. +The following table summarizes the fair value of derivative instruments in the Consolidated Balance Sheets as of June 29, 2013 and June 30, 2012 (in thousands): +June 29, 2013 +June 30, 2012 +Derivatives Designated as Hedging Instruments +Balance Sheet Location +Fair Value +Fair Value +Foreign currency forward contracts +Other current assets +$ +760 +$ +199 +Foreign currency forward contracts +Other long-term assets +$ +1,669 +$ +659 +Foreign currency forward contracts +Other current liabilities +$ +(145 +) +$ +(923 +) +Foreign currency forward contracts +Other long-term liabilities +$ +(289 +) +$ +(928 +) +46 +The following table summarizes the gain (loss) of derivative instruments on the Consolidated Statement of Operations for the fiscal year 2013 (in thousands): +Derivatives Designated as Hedging Instruments +AOCI Balance +as of +June 30, 2012 +Effective +Portion +Recorded In +AOCI +Effective Portion +Reclassified From +AOCI Into Cost +of Sales +AOCI Balance +as of +June 29, 2013 +Settled foreign currency forward contracts +$ +(479 +) +$ +1,060 +$ +(581 +) +$ +— +Unsettled foreign currency forward contracts +(180 +) +1,493 +— +1,313 +Total +$ +(659 +) +$ +2,553 +$ +(581 +) +$ +1,313 +The following table summarizes the gain (loss) of derivative instruments on the Consolidated Statement of Operations for the fiscal year 2012 (in thousands): +Derivatives Designated as Hedging Instruments +AOCI Balance +as of +July 2, 2011 +Effective +Portion +Recorded In +AOCI +Effective Portion +Reclassified From +AOCI Into +Cost of Sales +AOCI Balance +as of +June 30, 2012 +Settled foreign currency forward contracts +$ +1,035 +$ +(1,119 +) +$ +84 +$ +— +Unsettled foreign currency forward contracts +705 +(1,364 +) +— +(659 +) +Total +$ +1,740 +$ +(2,483 +) +$ +84 +$ +(659 +) +The following table summarizes the gain (loss) of derivative instruments on the Consolidated Statement of Operations for the fiscal year 2011 (in thousands): +Derivatives Designated as Hedging Instruments +AOCI Balance +as of +July 3, 2010 +Effective +Portion +Recorded In +AOCI +Effective Portion +Reclassified From +AOCI Into +Cost of Sales +AOCI Balance +as of +July 2, 2011 +Settled foreign currency forward contracts +$ +279 +$ +1,253 +$ +(1,532 +) +$ +— +Unsettled foreign currency forward contracts +(521 +) +2,261 +— +1,740 +Total +$ +(242 +) +$ +3,514 +$ +(1,532 +) +$ +1,740 +As of June 29, 2013 , the Company does not have any foreign exchange contracts with credit-risk-related contingent features. The Company is subject to the risk of fluctuating interest rates from our line of credit and foreign currency risk resulting from our China operations. The Company does not currently manage these risk exposures by using derivative instruments. +11. ENTERPRISE-WIDE DISCLOSURES +Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is its Chief Executive Officer. As of June 29, 2013 , the Company operates and internally manages a single operating segment, Electronics Manufacturing Services. +Products and Services +Of the revenues for the years ended June 29, 2013 , June 30, 2012 , and July 2, 2011 , EMS sales and services were $358.6 million , $343.7 million , and $249.9 million , respectively. Keyboard sales for the years ended June 29, 2013 , June 30, 2012 , and July 2, 2011 were $2.4 million , $2.8 million , and $3.9 million , respectively. +47 +Geographic Areas +Net sales and long-lived assets (property, plant, and equipment) by geographic area for the years ended June 29, 2013 , June 30, 2012 , and July 2, 2011 are summarized in the following table. Net sales set forth below are based on the shipping destination. +Domestic (U.S.) +Foreign +(in thousands) +Total +2013 +Net sales +$ +246,059 +$ +114,974 +$ +361,033 +Long-lived assets +$ +2,045 +$ +15,866 +$ +17,911 +2012 +Net sales +$ +205,668 +$ +140,807 +$ +346,475 +Long-lived assets +$ +1,660 +$ +15,646 +$ +17,306 +2011 +Net sales +$ +172,778 +$ +81,068 +$ +253,846 +Long-lived assets +$ +1,588 +$ +13,329 +$ +14,917 +For the year ended June 29, 2013 , 70.3% of the Company’s foreign net sales were to customers in Canada, 10.6% were to Australia, 9.5% were to Switzerland, 3.2% were to England, 1.5% were to New Zealand, and the remaining 4.9% were spread among customers in other parts of Europe and Asia. +For the year ended June 30, 2012 , 70.9% of the Company’s foreign net sales were to customers in Canada, 12.5% were to Australia, 5.4% were to Switzerland, 3.9% were to England, 1.5% were to New Zealand, and the remaining 5.8% were spread among customers in other parts of Europe and Asia. +For the year ended July 2, 2011 , 50.7% of the Company’s foreign net sales were to customers in Canada, 24.4% were to Australia, 6.9% were to Switzerland, 6.1% were to England, 5.1% were to New Zealand, and the remaining 6.8% were spread among customers in other parts of Europe and Asia. +Significant Customers +The percentage of net sales to and trade accounts receivables from significant customers were as follows: +Percentage of Net +Sales Fiscal Year +Percentage of +Trade Accounts Receivable +Fiscal Year +2013 +2012 +2011 +2013 +2012 +Customer A +23 +% +29 +% +15 +% +21 +% +30 +% +Customer B +21 +% +17 +% +16 +% +13 +% +16 +% +Customer C +19 +% +16 +% +16 +% +24 +% +20 +% +There can be no assurance that the Company’s principal customers will continue to purchase products from the Company at current levels. Moreover, the Company typically does not enter into long-term volume purchase contracts with its customers, and the Company’s customers have certain rights to extend or delay the shipment of their orders. The loss of one or more of the Company’s major customers, or the reduction, delay or cancellation of orders from such customers, could materially and adversely affect the Company’s business, operating results and financial condition. +48 +12. QUARTERLY FINANCIAL DATA (Unaudited) +Year Ended June 29, 2013 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +Net sales +$ +97,508 +$ +94,567 +$ +84,343 +$ +84,615 +Gross profit +9,475 +9,496 +7,860 +7,681 +Income before income taxes +5,580 +5,240 +3,555 +3,480 +Net income +3,744 +3,579 +2,863 +2,397 +Earnings per common share-basic +$ +0.36 +$ +0.34 +$ +0.27 +$ +0.23 +Earnings per common share-diluted +$ +0.35 +$ +0.33 +$ +0.26 +$ +0.22 +Weighted average shares outstanding +Basic +10,486 +10,489 +10,489 +10,495 +Diluted +10,830 +10,899 +10,931 +10,946 +Year Ended June 30, 2012 +First +Quarter +Second +Quarter +Third +Quarter +Fourth +Quarter +(in thousands, except per share amounts) +Net sales +$ +69,761 +$ +84,454 +$ +95,527 +$ +96,733 +Gross profit +5,005 +6,868 +8,724 +9,239 +Income before income taxes +1,512 +2,671 +4,562 +5,096 +Net income +1,247 +3,174 +3,394 +3,811 +Earnings per common share-basic +$ +0.12 +$ +0.30 +$ +0.32 +$ +0.36 +Earnings per common share-diluted +$ +0.12 +$ +0.30 +$ +0.32 +$ +0.35 +Weighted average shares outstanding +Basic +10,418 +10,447 +10,447 +10,474 +Diluted +10,446 +10,479 +10,762 +10,843 +49 +13. SUBSEQUENT EVENTS +On July 1, 2013, the Company acquired Sabre Assembly & Manufacturing Co. of Texas (“Sabre”), a sheet metal fabrication company with facilities located in Juarez, Mexico. Sabre enables the Company to offer metal fabrication directly to its customers, in combination with plastic molding, PCB assembly, complete product assembly, design engineering and testing engineering services. Under the terms of the transaction, the assets acquired included manufacturing equipment, inventory, customer relationships and non-compete agreements with key employees. No debt or liabilities were assumed. The total cash payment of $6.0 million was funded through existing cash. The Company incurred an immaterial amount of costs related to due diligence and closing this acquisition. The Company has not yet determined the initial purchase price allocation in connection with the Sabre acquisition. +Item 9: +CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES +None +Item 9A: +CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +It is the responsibility of our management to establish, maintain, and monitor disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission rules and forms. Additionally, these disclosure controls include controls and procedures that are designed to accumulate and communicate the information required to be disclosed to our Company’s Chief Executive Officer and Chief Financial Officer, allowing for timely decisions regarding required disclosures. As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(f). Based on our assessment, we believe that as of June 29, 2013 , the Company’s disclosure controls and procedures are effective based on that criteria. +Management’s Report on Internal Control over Financial Reporting +Our management has the responsibility to establish and maintain adequate internal controls over our financial reporting, as defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934. Our internal controls are designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our external financial statements in accordance with generally accepted accounting principles (GAAP). +Due to inherent limitations of any internal control system, management acknowledges that there are limitations as to the effectiveness of internal controls over financial reporting and therefore recognize that only reasonable assurance can be gained from any internal control system. Accordingly, our internal control system may not detect or prevent material misstatements in our financial statements and projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Under the supervision and participation of management, including the Chief Executive Officer and Chief Financial Officer, we have performed an assessment of the effectiveness of our internal controls over financial reporting as of June 29, 2013 . This assessment was based on the criteria established in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we believe that as of June 29, 2013 , the Company’s internal control over financial reporting is effective based on that criteria. +The effectiveness of the Company's internal control over financial reporting as of June 29, 2013 has been audited by BDO USA LLP, an independent registered public accounting firm, as stated in their report which is included herein. +Changes in Internal Control over Financial Reporting +There have been no significant changes in our internal controls over financial reporting during our fourth fiscal quarter ended June 29, 2013 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)). +50 +Report of Independent Registered Public Accounting Firm +Board of Directors and Stockholders +Key Tronic Corporation +Spokane Valley, Washington +We have audited Key Tronic Corporation's internal control over financial reporting as of June 29, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Key Tronic Corporation's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A “Management's Report on Internal Control over Financial Reporting”. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, Key Tronic Corporation maintained, in all material respects, effective internal control over financial reporting as of June 29, 2013, based on the COSO criteria . +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Key Tronic Corporation as of June 29, 2013 and June 30, 2012, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended June 29, 2013 and our report dated September 6, 2013 expressed an unqualified opinion thereon. +/s/ BDO USA, LLP +Spokane, Washington +September 6, 2013 +Item 9B: +OTHER INFORMATION +None +51 +PART III +Item 10: +DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE +Directors of the Registrant +Information on the nominees for election as Directors of the Company is incorporated by reference from the Company’s definitive proxy statement for the 2013 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A under the Exchange Act no later than 120 days after the end of the Company’s 2013 fiscal year. +Executive Officers of the Registrant +This information is included in a separate item captioned “Executive Officers of the Registrant” in Item 1 of Part 1 of this report pursuant to Instruction G(3) of Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K. +Compliance with Section 16(a) of the Exchange Act: +Incorporated by reference to Key Tronic Corporation’s 2013 Proxy Statement to Shareholders. +Code of Conduct +The Board of Directors has adopted a written Code of Conduct which applies to its directors and employees, including its executive officers. The Code of Conduct is available on the Company’s website at www.keytronic.com . The Company intends to disclose on its website any amendments to or waivers of the Code of Conduct. +Item 11: +EXECUTIVE COMPENSATION +Information appearing under the caption “Executive Compensation” in the Company’s 2013 Proxy Statement is incorporated herein by this reference. +52 +Item 12: +SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS +The following table sets forth the aggregate information for the Company’s equity compensation plans in effect as of June 29, 2013 . +EQUITY COMPENSATION PLAN INFORMATION +Plan category +Number of securities to +be issued upon exercise +of outstanding options, +warrants, and rights +(a) +Weighted-average +exercise price of +outstanding options, +warrants, and rights +(b) +Number of securities +remaining available for +future issuance under +equity compensation +plans (excluding +securities reflected in +column (a) +(c) +Equity compensation plans approved by security holders (1) +961,692 +$ +5.87 +— +Equity compensation plans not approved by security holders +— +$ +— +— +Total +961,692 +$ +5.87 +— +(1) +Included are the 1,200,000 shares subject to the 2010 Plan, the issuance of which were approved by the shareholders at the 2010 Annual Meeting. As a result of the shareholder approval, the Company made the decision to amend the cash-settled SARs granted during fiscal year 2010 to stock-settled SARs effective October 21, 20 11. Also included are the shares subject to the 1990 Stock Option Plan for Non-Employee Directors. +Information under the caption “Beneficial Ownership of Securities” in the Company’s 2013 Proxy Statement is incorporated herein by this reference. +Item 13: +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Information appearing under the caption “Related Person Transactions”, “Compensation Committee Interlocks and Insider Participation”, and “Directors’ Independence” in the Company’s 2013 Proxy Statement is incorporated herein by this reference. +Item 14: +PRINCIPAL ACCOUNTING FEES AND SERVICES +Information appearing under the caption “Principal Accountant Fees and Services” in the Company’s 2013 Proxy Statement is incorporated herein by this reference. +PART IV +Item 15: +EXHIBITS AND FINANCIAL STATEMENT SCHEDULES +(a) 1. FINANCIAL STATEMENTS +Page in +Form 10-K +FINANCIAL STATEMENTS +Report of Independent Registered Public Accounting Firm +28 +Consolidated Balance Sheets +29 +Consolidated Statements of Income +30 +Consolidated Statements of Comprehensive Income +31 +Consolidated Statements of Cash Flows +32 +Consolidated Statements of Shareholders’ Equity +33 +Notes to Consolidated Financial Statements +34-50 +53 +2. SCHEDULES +II. Consolidated Valuation and Qualifying Accounts +59 +Other schedules are omitted because of the absence of conditions under which they are required, or because required information is given in the financial statements or notes thereto. +3. EXHIBITS +Exhibit No. +Description +3.1 +Articles of Incorporation, incorporated by reference to the Exhibits to the Company’s form 10-K for the year ended June 30, 1986 +3.2 +Bylaws, as amended, incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended June 30, 1986 +10.1* +Executive Stock Option Plan, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended June 30, 1986 +10.2* +Amended and Restated 1990 Stock Option Plan for Non-Employee Directors, as amended, incorporated by reference to the Company’s 1997 Proxy Statement (dated October 10, 1997), pages 14-17 +10.3* +1995 Executive Stock Option Plan, incorporated by reference to the Company’s 1995 Proxy Statement, pages 19-22 +10.4* +2000 Employee Stock Option Plan, incorporated by reference to the Exhibits to the Company’s Form 10-Q for the quarter ended January 1, 2000 +10.5* +Officers’ Employment Contracts, incorporated by reference to the Company’s 1998 Proxy Statement, pages 10 and 11 +10.6* +Addenda to Officers’ Employment Contracts, incorporated by reference to Exhibits to the Company’s Form 10-Q for the quarter ended January 1, 2000 +10.7* +Description of Retention Bonus Plan, incorporated by reference to the Exhibits to the Company’s 10-Q for the quarter ended December 28, 2002 +10.8* +Addenda to Officers’ Employment Contracts, incorporated by reference to Exhibits to the Company’s Form 10-K for the year ended June 29, 2002 +10.9 +Promise to execute a Purchase and Sale Agreement with Key Safety Systems de Mexico, S.A. de C.V., incorporated by reference to the Exhibit to the Company’s Form 8-K filed April 26, 2005 +10.10 +Summary of material terms and conditions of the Purchase and Sale Agreement with Key Safety Systems de Mexico, S.A. de C.V., incorporated by reference to the Exhibit to the Company’s Form 8-K filed June 6, 2005 +10.11* +Summary of Key Tronic Corporation Incentive Compensation Plan, incorporated by reference to Exhibit 10.23 to the Company’s Form 10-K for the year ended July 2, 2005 +54 +10.12* +Summary of Incentive Compensation Plan Performance goals and Target Payments for fiscal year 2007, incorporated by reference to the Company’s Form 8-K filed July 28, 2006 +10.13* +Summary of Fiscal Years 2007 – 2009 Long Term Incentive Plan Performance Measures and Awards, incorporated by reference to the Company’s Form 8-K filed July 28, 2006 +10.14* +Summary of Key Tronic Corporation Long Term Incentive Compensation Plan, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed September 27, 2005 +10.15 +Summary of material terms and conditions of the Purchase and Sale Agreement with Todenko Mexico S.A. de C.V., incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed October 12, 2006 +10.16 +Summary of material terms and conditions of the Purchase and Sale Agreement with Todenko Mexico S.A. de C.V., incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed November 20, 2006 +10.17 +Summary of material terms and conditions of the Sale and Purchase Agreement with Adevco Corporation, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed January 5, 2007 +10.18 +Summary of Second Amendment to Agreement of Sale and Purchase Agreement with Adevco Corporation, incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed April 11, 2007 +10.19* +Summary of Incentive Compensation Plan Performance Goals and Target Payments for Fiscal Year 2008 and Fiscal Years 2008-2010 Long Term Incentive Plan Performance Measures and Awards incorporated by reference to the Company’s Form 8-K filed July 27, 2007 +10.20* +Summary of Incentive Compensation Plan Performance Goals and Target payments for Fiscal Year 2009 and Fiscal Years 2009 – 2011 Long Term Incentive Plan Performance Measures and Awards incorporated by reference to the Company’s Form 8-K filed July 24, 2008 +10.21* +Summary of Incentive Compensation Plan Performance Goals and Target payments for Fiscal Year 2010 and Fiscal Years 2010 – 2012 Long Term Incentive Plan Performance Measures and Awards incorporated by reference to the Company’s Form 8-K filed July 23, 2009 +10.22 +Financing Agreement with Wells Fargo Bank, N.A., incorporated by reference to the Exhibits to the Company’s Form 8-K filed on August 24, 2009 +10.23* +2010 Incentive Plan, incorporated by reference to Exhibit 10.36 to the Company’s Form 10-K for the year ended July 3, 2010 +10.24* +Employment Contract with Douglas G. Burkhardt, incorporated by reference to Exhibit 10.37 to the Company’s Form 10-K for the year ended July 3, 2010 +10.25 +Summary of material terms and conditions of the Purchase and Sale Agreement with Autopartes Y Arneses de Mexico S.A. de C.V., incorporated by reference to Exhibit 10.38 to the Company’s Form 10-K for the year ended July 3, 2010 +10.26* +Summary of Incentive Compensation Plan Performance Goals and Target Payments for Fiscal Year 2011 and Fiscal Years 2011 – 2013 Long Term Incentive Plan Performance Measures and Awards incorporated by reference to the Company’s Form 8-K filed July 27, 2011 +55 +10.27* +Amendment to Employment Contract of Craig D. Gates, dated August 23, 2011; of Ronald F. Klawitter, dated August 23, 2011 and of Douglas G. Burkhardt dated September 6, 2011; incorporated by reference to the Exhibits to the Company’s Form 10-K for the year ended July 2, 2011 +10.28 +Second Loan Modification Agreement to the Credit Agreement with Wells Fargo Bank, N.A., incorporated by reference to the Exhibits to the Company’s Form 8-K filed on January 30, 2012 +10.29* +Amendment to Employment Contract of Craig D. Gates, dated May 10, 2012, and of Douglas G. Burkhardt dated May 10, 2012; incorporated by reference to the Exhibits to the Company’s Form 10-Q filed on May 14, 2012 +10.30* +Summary of Incentive Compensation Plan Performance Goals and Target Payments for Fiscal Year 2013 and Fiscal Years 2013 – 2015 Long Term Incentive Plan Performance Measures and Awards incorporated by reference to the Company’s Form 8-K filed August 7, 2012 +10.31* +Summary of Incentive Compensation Plan Performance Goals and Target Payments for Fiscal Year 2014 and Fiscal Years 2014 – 2016 Long Term Incentive Plan Performance Measures and Awards incorporated by reference to the Company’s Form 8-K filed August 6, 2013 +21. +Subsidiaries of Registrant, submitted herewith +23.1 +Consent of Independent Registered Public Accounting Firm, submitted herewith +31.1 +Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer, submitted herewith +31.2 +Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer, submitted herewith +32.1 +Section 1350 Certification of Chief Executive Officer, submitted herewith +32.2 +Section 1350 Certification of Chief Financial Officer, submitted herewith +101.INS +XBRL Instance Document ** +101.SCH +XBRL Taxonomy Extension Schema Document ** +101.CAL +XBRL Taxonomy Extension Calculation Linkbase Document ** +101.DEF +XBRL Taxonomy Extension Definition Linkbase Document ** +101.LAB +XBRL Taxonomy Extension Label Linkbase Document ** +101.PRE +XBRL Taxonomy Extension Presentation Linkbase Document ** +* +Management contract or compensatory plan or arrangement +** +Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities and Exchange Act of 1934, as amended and otherwise are not subject to liability under those sections. +56 +SCHEDULE II +KEY TRONIC CORPORATION AND SUBSIDIARIES +CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS +FISCAL YEARS ENDED JUNE 29, 2013 , JUNE 30, 2012 , AND JULY 2, 2011 +2013 +2012 +2011 +(in thousands) +Allowance for Obsolete Inventory +Balance at beginning of year +$ +1,146 +$ +732 +$ +1,303 +Provisions +525 +762 +299 +Dispositions +(1,290 +) +(348 +) +(870 +) +Balance at end of year +$ +381 +$ +1,146 +$ +732 +Allowance for Doubtful Accounts +Balance at beginning of year +$ +— +$ +111 +$ +111 +Provisions +60 +— +15 +Write-offs +(20 +) +(111 +) +(15 +) +Balance at end of year +$ +40 +$ +— +$ +111 +57 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. +Dated: September 6, 2013 +KEY TRONIC CORPORATION +By: +/s/ Craig D. Gates +Craig D. Gates, President and Chief +Executive Officer +(Principal 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: +/s/ Craig D. Gates +September 6, 2013 +Craig D. Gates +Date +Director and President and Chief Executive Officer +(Principal Executive Officer) +/s/ Ronald F. Klawitter +September 6, 2013 +Ronald F. Klawitter +Date +Director and Executive Vice President of Administration, Chief Financial Officer and Treasurer +(Principal Financial Officer) +/s/ Brett R. Larsen +September 6, 2013 +Brett R. Larsen +Date +Vice President of Finance and Controller +(Principal Accounting Officer) +/s/ James R. Bean +September 6, 2013 +James R. Bean, Director +Date +/s/ Yacov A. Shamash +September 6, 2013 +Yacov A. Shamash, Director +Date +/s/ Patrick Sweeney +September 6, 2013 +Patrick Sweeney, Director and Chairman of the Board +Date +58 \ No newline at end of file diff --git a/raw/filings/0000719733/2013/0000719733-13-000015/filing_metadata.csv b/raw/filings/0000719733/2013/0000719733-13-000015/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..fb9d11402164c5884d777ae47084bf191a6a6d21 --- /dev/null +++ b/raw/filings/0000719733/2013/0000719733-13-000015/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0000719733,KTCC,KEY TRONIC CORP,10-K,2013-09-06,2013-06-29,2013-09-06T18:02:25.000Z,0000719733-13-000015,ktcc-06292013x10k.htm,10-K,13795594,1,0,https://www.sec.gov/Archives/edgar/data/719733/000071973313000015/ktcc-06292013x10k.htm,https://www.sec.gov/Archives/edgar/data/719733/000071973313000015/,2013,2013,1 diff --git a/raw/filings/0000719733/2013/0000719733-13-000015/item1.txt b/raw/filings/0000719733/2013/0000719733-13-000015/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..9f0130aaf5286a9783056821eae40432414eef6e --- /dev/null +++ b/raw/filings/0000719733/2013/0000719733-13-000015/item1.txt @@ -0,0 +1,104 @@ +Item 1. +BUSINESS +Background +Key Tronic Corporation (dba: KeyTronicEMS Co.), was organized in 1969 as a Washington corporation that locally manufactured computer keyboards. The ability to design, build and deliver a quality product led us to become a leading independent manufacturer of keyboards for computers in the United States. Our fully integrated design, tooling, and automated manufacturing capabilities enabled us to rapidly respond to customers’ needs for keyboards in production quantities worldwide. We supported our sales growth through the development and purchase of international manufacturing facilities. As the computer keyboard market matured with increasing competition from other international providers, we determined that our business could no longer solely rely on keyboard sales. +After assessing market conditions and our strengths and capabilities, we shifted focus from keyboard manufacturing to contract manufacturing for a wide range of products. Our unique strategic attributes are based on our core strengths of innovative design and engineering expertise in electronics, mechanical engineering, sheet metal and stamping, and precision plastics combined with high-quality, low cost production, and assembly on an international basis while providing exceptional customer service. These strengths have made our company a strong competitor in the electronic manufacturing services (EMS) market. +Our Industry and Strategy +The expansion of the EMS industry has allowed us to continue to expand our customer base and the industries that we serve. The challenging global macroeconomic environment has had a negative impact on previously held customer programs. However, we are successfully confronting the challenging global macroeconomic environment by controlling our costs and winning new customer programs, which allowed us to increase our profitability and maintain a strong balance sheet. The increase in new programs represents a growing portion of our revenue and a promising foundation for our future. In keeping with our long-term strategic objectives, we have been successfully building a more diversified customer portfolio, spanning a wider range of industries. We currently offer our customers the following services: integrated electronic and mechanical engineering, precision plastic molding, sheet metal fabrication, assembly, component selection, sourcing and procurement, worldwide logistics, and new product testing and production all at competitive pricing due to our global footprint. +We believe that we are well positioned in the EMS industry to continue the expansion of our customer base and achieve long term growth. Our unique blend of multinational facilities, centralized management, and core strengths continue to support our growth and our customers’ needs. We continue to focus on controlling operating expenses and leveraging the synergistic capabilities of our world-class facilities in the United States, Mexico, and China. This international production capability provides our customers with the benefits of improved supply-chain management, reduced inventory, lower labor costs, lower transportation costs, and reduced product fulfillment time. Given our competitive advantages and the growing pressure for new potential customers to move forward with their outsourcing strategies, we are strongly positioned to win new business in coming periods and grow our revenue and profits. +The EMS industry is intensely competitive. Although our customer base is growing we still have less than 1% of the potential global market and our revenue can fluctuate significantly due to reliance on a concentrated base of customers. We are planning for new customer growth in the coming quarters by securing new programs with new and existing customers, increasing our worldwide manufacturing capacity, and continuing to improve our manufacturing and procurement processes. Ongoing challenges that we face include the following: Continuing to win programs from new and existing customers, balancing production capacity and key personnel in support of new customer programs, improving operating efficiencies, controlling costs while developing competitive pricing strategies, and successfully transitioning new program wins to full production during a time of macroeconomic uncertainty. +4 +Customers and Marketing +We provide a mix of manufacturing services for outsourced Original Equipment Manufacturing (OEM) products. We provide the following EMS services: Product design, surface mount technologies (SMT) and pin through hole capability for printed circuit board assembly, tool making, precision plastic molding, sheet metal fabrication, liquid injection molding, complex assembly, automated tape winding, prototype design and full product assembly. +Sales of the majority of our products have historically not been seasonal in nature, but may be seasonal in the future if there are changes in the types of products manufactured. Sales can, however, fluctuate significantly between quarters from changes in customers and customer demand due to the concentration of sales generated by our largest customers. +For the fiscal years 2013 , 2012 and 2011 , the five largest customers in each year accounted for 71%, 73%, and 62% of combined total net sales, respectively. At the end of fiscal year 2013 , we were generating revenue from 183 separate programs and 56 distinct customers as compared to 165 programs and 48 customers at the end of fiscal year 2012 . As these new customers’ sales ramp up and new programs are won our concentration of revenue should decrease in the future. +The following table represents all customers that represented 10% or more of total net sales during the last three fiscal years: +Percentage of Net Sales by Fiscal Year +2013 +2012 +2011 +Customer A +23% +29% +15% +Customer B +21% +17% +16% +Customer C +19% +16% +16% +Although keyboard manufacturing is still included in our product offerings, we do not expect annual keyboard sales to be a material component of our business. We realized revenues of approximately $2.4 million , $2.8 million , and $3.9 million in fiscal years 2013 , 2012 , and 2011 , respectively, from the sale of keyboards. In order to accommodate the demand for standard keyboard layouts, we maintain a purchase-from-stock program. The more popular standard layouts are built and stocked for immediate availability. +We market our products and services primarily through our direct sales department aided by strategically located field sales people and distributors. Although we maintain relationships with several independent sales organizations to assist in marketing our EMS product lines, commissions earned and paid are not material to the consolidated financial statements. +Manufacturing +We have continually made investments in developing and expanding a capital equipment base to achieve vertical integration and efficiencies in our manufacturing processes. We have invested significant capital into SMT for volume manufacturing of complex printed circuit board assemblies. We also design and develop tooling for injection molding and manufacture the majority of plastic parts used in the products we manufacture. Additionally, we have equipment to maintain a controlled clean environment for manufacturing processes that require a high level of precise control. +We use a variety of manual and automated assembly processes in our facilities, depending upon product complexity and degree of customization. Some examples of automated processes include component insertion, SMT, flexible robotic assembly, automated storage tape winding, computerized vision system quality inspection, automated switch and key top installation, and automated functional testing. +Our engineering expertise and automated manufacturing processes enable us to work closely with our customers during the design and prototype stages of production and to jointly increase productivity and reduce response time to the marketplace. We use computer-aided design techniques and software to assist in preparation of the tool design layout and component placement, to reduce tooling and production costs, improve component and product quality, and enhance turnaround time during product development. +We purchase materials and components for our products from many different suppliers, including both domestic and international sources. We develop close working relationships with our suppliers, many of whom have been supplying products to us for several years. +5 +Research, Development, and Engineering +As part of our long-term strategy, we are committed to supporting our customers by providing research, development, and engineering services. These services allow us to facilitate in optimizing new product designs, and the production processes of our customers programs. +Research, development, and engineering (RD&E) expenses consist principally of employee related costs, third party development costs, program materials costs, depreciation, and allocated information technology and facilities costs. +Competition +The market for the products and services we provide is highly competitive. There are numerous competitors in the EMS industry, many of which have substantially more resources and are more geographically diverse than we are. Some of our competitors have similar international production capabilities, large financial resources and some have substantially greater manufacturing, research and development, and marketing resources. There is also competition from the manufacturing operations of our current and potential customers, who are continually evaluating the merits of manufacturing their products internally versus the advantages of outsourcing. We believe that we can currently compete favorably in these areas primarily on the basis of our international footprint, responsiveness, creativity, vertical production capability, quality, and cost. +Trademarks and Patents +Our name and logo are federally registered trademarks, and we believe they are valuable assets of our business. During 2001, we began operating under the trade name “KeyTronicEMS” to better identify our primary business concentration. We also own several keyboard patents; however, since our focus is EMS, management believes that these patents will not have a significant impact on future revenues. +Employees +We consider our employees to be our primary strength and we make considerable efforts to maintain a well-qualified workforce. Our employee benefits include bonus programs involving periodic payments to all employees based on meeting quarterly or fiscal year performance targets. We regularly provide transportation, medical services, and meals to all of our employees in foreign locations. We maintain a 401(k) plan for U.S. employees, which provides a discretionary matching company contribution of up to 4% of an employee’s salary. We provide group health, life, and disability insurance plans. We also maintain stock option plans and other long term incentive plans for certain employees and outside directors. +As of June 29, 2013 we had 2,584 employees compared to 2,700 on June 30, 2012 , and 1,997 on July 2, 2011 . Since we can have significant fluctuations in product demand, we seek to maintain flexibility in our workforce by utilizing skilled temporary and short-term contract labor in our manufacturing facilities in addition to full-time employees. +Backlog +On July 27, 2013 our order backlog was valued at approximately $60.0 million, compared to approximately $83.1 million on July 28, 2012. Even though our order backlog is comprised of firm purchase orders, the amount of backlog is not necessarily indicative of future sales but can be indicative of trends in expected future sales revenue. Due to the relationships with our customers, we will occasionally allow orders to be canceled or rescheduled and as a result it is not a meaningful indicator of future financial results. If there are canceled or rescheduled orders, we typically negotiate fees to cover the costs we have incurred. Order backlog consists of purchase orders received for products expected to be shipped approximately within the next twelve months, although shipment dates are subject to change due to design modifications, customer forecast changes, or other customer requirements. +Foreign Markets +Information concerning net sales and long-lived assets (property, plant, and equipment) by geographic areas is set forth in Note 11, “Enterprise-Wide Disclosures” of the consolidated financial statements of this Annual Report on Form 10-K and that information is incorporated herein. +6 +Executive Officers of the Registrant +The table below sets forth the name, current age and current position of our executive officers and other significant employees: +Name +Age +Positions Held +Executive Officers +Craig D. Gates +54 +President and Chief Executive Officer +Ronald F. Klawitter +61 +Executive Vice President of Administration, Chief Financial Officer and Treasurer +Douglas G. Burkhardt +55 +Executive Vice President of Worldwide Operations +Philip S. Hochberg +51 +Executive Vice President of Business Development +Lawrence J. Bostwick +61 +Vice President of Engineering and Quality +Brett R. Larsen +40 +Vice President of Finance and Controller +Frank Crispigna III +52 +Vice President of Materials +Duane D. Mackleit +45 +Vice President of Program Management +Executive Officers +CRAIG D. GATES – President and Chief Executive Officer +Mr. Gates, age 54 , has been President and Chief Executive officer of the Company since April 2009. Previously he was Executive Vice President and General Manager from August 2002 to April 2009. He served as Executive Vice President of Marketing, Engineering and Sales from July 1997 to August 2002 and served as Vice President and General Manager of New Business Development from October 1995 to July 1997. He joined the Company as Vice President of Engineering in October of 1994. From 1982 to 1991 he held various engineering and management positions within the Microswitch Division of Honeywell, Inc., in Freeport, Illinois, and from 1991 to October 1994 he served as Director of Operations, Electronics for Microswitch. Mr. Gates has a Bachelor of Science Degree in Mechanical Engineering and a Masters in Business Administration from the University of Illinois, Urbana. +RONALD F. KLAWITTER – Executive Vice President of Administration, Chief Financial Officer, and Treasurer +Mr. Klawitter, age 61 , has been Executive Vice President of Administration, CFO, and Treasurer since July 1997. Previously he was Vice President of Finance, Secretary, and Treasurer of the Company from October 1995 to July 1997. He was Acting Secretary from November 1994 to October 1995 and Vice President of Finance and Treasurer from 1992 to October 1995. From 1987 to 1992, Mr. Klawitter was Vice President of Finance at Baker Hughes Tubular Service, a subsidiary of Baker Hughes, Inc. Mr. Klawitter has a BA degree from Wittenberg University and is a Certified Public Accountant. +DOUGLAS G. BURKHARDT – Executive Vice President of Worldwide Operations +Mr. Burkhardt, age 55 , has been Executive Vice President of Worldwide Operations of the Company since July 22, 2010. Previously Mr. Burkhardt was Vice President of Worldwide Operations from July 2008 to July 2010 and Director of China Operations and Program Management from January 2006 to July 2008. Mr. Burkhardt also served as Director of Northwest and China Operations from November of 1998 to January of 2006. Mr. Burkhardt also served as Director of Customer Satisfaction from March 1997 to November 1998 and Director of Molding from September of 1995 to March of 1997. Prior to this, Mr. Burkhardt served in other various senior management positions within the Company. Mr. Burkhardt has been with the Company since May of 1989. Prior to joining Key Tronic, Mr. Burkhardt worked for House of Aluminum and Glass for 12 years where he was the plant manager. +PHILIP S. HOCHBERG – Executive Vice President of Business Development +Mr. Hochberg, age 51 , has been Executive Vice President of Business Development since July 2012. Prior this, Mr. Hochberg served as Vice President of Business Development from October 2009 through June 2012. He was Director of Business Development and Program Management from July 2008 to October 2009. Mr. Hochberg served as Director of Business Development from October 2004 to July 2008 and as Director of EMS Sales and Marketing from July 2000 to October 2004. Prior to joining Key Tronic, Mr. Hochberg worked for Quinton Instrument Company as their Director of Marketing and Product Management from 1992 to 2000. From 1988 to 1992, he was employed by SpaceLabs Medical as their Business Development Marketing Manager. Mr. Hochberg has an MBA from the University of British Columbia, a BA Psychology, with a minor in Business from Washington University in St. Louis. +7 +LAWRENCE J. BOSTWICK – Vice President of Engineering and Quality +Mr. Bostwick, age 61 , has been Vice President of Engineering and Quality since July 2008. Previously he was Director of Engineering and Quality from February 2007 to July 2008 and served as Corporate Director of Quality from February 2006 to February 2007. From 2003 to 2006 he was Director of Supply Chain Management and Quality for the Lancer Corporation and from 1998 to 2003 he was Vice President of Operations for Thermacore International. He is a graduate of the Westinghouse and General Electric – Engineering and Manufacturing Professional Development Programs. He is certified in both Quality and Industrial Engineering and is a Lean – Six Sigma Master Black Belt. Mr. Bostwick has a combined B.S. degree in Production and Operation and Industrial Engineering from Bowling Green State University and a Masters degree in Industrial Engineering and Business Administration from Syracuse University. +BRETT R. LARSEN – Vice President of Finance, and Controller +Mr. Larsen, age 40 , has served as Vice President of Finance and Controller since February 2010. He was Chief Financial Officer of FLSmidth Spokane, Inc. from December 2008 to February 2010. From October 2005 through November 2008, Mr. Larsen served as Controller of Key Tronic Corporation. From May 2004 to October 2005, Mr. Larsen served as Manager of Financial Reporting of Key Tronic Corporation. From 2002 to May 2004, Mr. Larsen was an audit manager for the public accounting firm BDO Seidman, LLP. He also held various auditing and supervisory positions with Grant Thornton LLP from 1997 to 2002. Mr. Larsen has a Bachelor of Science degree in Accounting and a Masters degree in Accounting from Brigham Young University and is a Certified Public Accountant. +FRANK CRISPIGNA III – Vice President of Materials +Mr. Crispigna, age 52 , has been Vice President of Materials of the company since October 2011. Prior to this, Mr. Crispigna held a variety of Materials and Supply Chain positions at Plexus Corporation since 1997, most recently serving as the Director – Supply Chain Solutions from 2005 - 2011. He has a Masters degree in Business Administration, and a Bachelor of Business Administration Degree in Marketing from the University of Wisconsin – Oshkosh. Mr. Crispigna also is a C.P.M., and received his certification in Supply Chain Leadership from the University of Wisconsin. +DUANE D. MACKLEIT – Vice President of Program Management +Mr. Mackleit, age 45 , has been Vice President of Program Management of the company since July 2012. He served as Director of Program Management from July 2008 through June 2012. From May 2006 to July 2008 he served as Principal Program Manager. Prior to that, he served as Program Manager from March 2002 to May 2006 and Associate Program Manager from August 2000 to March 2002. Mr. Mackleit has also held several other positions with Key Tronic Corporation. Mr. Mackleit has an AA in Business from Spokane Falls Community College and a BA in Business/Marketing from Eastern Washington University. He also holds a MBA from Gonzaga University. +Available Information +Our principal executive offices are located at N. 4424 Sullivan Road, Spokane Valley, Washington 99216, and our telephone number is (509) 928-8000. Our website is located at http://www.keytronicems.com where filings of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q or current reports on Form 8-K are available after they have been filed with the Securities and Exchange Commission. The information presented on our website currently and in the future is not considered to be part of this document or any document incorporated by reference in this document. \ No newline at end of file diff --git a/raw/filings/0000719733/2013/0000719733-13-000015/item13.txt b/raw/filings/0000719733/2013/0000719733-13-000015/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..6a75627e86f940aed0b2fa55165431f2291b6cae --- /dev/null +++ b/raw/filings/0000719733/2013/0000719733-13-000015/item13.txt @@ -0,0 +1,3 @@ +Item 13: +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE +Information appearing under the caption “Related Person Transactions”, “Compensation Committee Interlocks and Insider Participation”, and “Directors’ Independence” in the Company’s 2013 Proxy Statement is incorporated herein by this reference. \ No newline at end of file diff --git a/raw/filings/0000719733/2013/0000719733-13-000015/item9a.txt b/raw/filings/0000719733/2013/0000719733-13-000015/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..2973c7cd87990c42ea5253b5f3d76cbd2e645319 --- /dev/null +++ b/raw/filings/0000719733/2013/0000719733-13-000015/item9a.txt @@ -0,0 +1,25 @@ +Item 9A: +CONTROLS AND PROCEDURES +Evaluation of Disclosure Controls and Procedures +It is the responsibility of our management to establish, maintain, and monitor disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission rules and forms. Additionally, these disclosure controls include controls and procedures that are designed to accumulate and communicate the information required to be disclosed to our Company’s Chief Executive Officer and Chief Financial Officer, allowing for timely decisions regarding required disclosures. As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(f). Based on our assessment, we believe that as of June 29, 2013 , the Company’s disclosure controls and procedures are effective based on that criteria. +Management’s Report on Internal Control over Financial Reporting +Our management has the responsibility to establish and maintain adequate internal controls over our financial reporting, as defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934. Our internal controls are designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our external financial statements in accordance with generally accepted accounting principles (GAAP). +Due to inherent limitations of any internal control system, management acknowledges that there are limitations as to the effectiveness of internal controls over financial reporting and therefore recognize that only reasonable assurance can be gained from any internal control system. Accordingly, our internal control system may not detect or prevent material misstatements in our financial statements and projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +Under the supervision and participation of management, including the Chief Executive Officer and Chief Financial Officer, we have performed an assessment of the effectiveness of our internal controls over financial reporting as of June 29, 2013 . This assessment was based on the criteria established in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we believe that as of June 29, 2013 , the Company’s internal control over financial reporting is effective based on that criteria. +The effectiveness of the Company's internal control over financial reporting as of June 29, 2013 has been audited by BDO USA LLP, an independent registered public accounting firm, as stated in their report which is included herein. +Changes in Internal Control over Financial Reporting +There have been no significant changes in our internal controls over financial reporting during our fourth fiscal quarter ended June 29, 2013 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a – 15(f) and 15d – 15(f)). +50 +Report of Independent Registered Public Accounting Firm +Board of Directors and Stockholders +Key Tronic Corporation +Spokane Valley, Washington +We have audited Key Tronic Corporation's internal control over financial reporting as of June 29, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Key Tronic Corporation's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A “Management's Report on Internal Control over Financial Reporting”. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit. +We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, Key Tronic Corporation maintained, in all material respects, effective internal control over financial reporting as of June 29, 2013, based on the COSO criteria . +We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Key Tronic Corporation as of June 29, 2013 and June 30, 2012, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended June 29, 2013 and our report dated September 6, 2013 expressed an unqualified opinion thereon. +/s/ BDO USA, LLP +Spokane, Washington +September 6, 2013 \ No newline at end of file diff --git a/raw/filings/0000719733/2013/0000719733-13-000015/rp_note.txt b/raw/filings/0000719733/2013/0000719733-13-000015/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0000719733/2013/0000719733-13-000015/rpt_disclosure.txt b/raw/filings/0000719733/2013/0000719733-13-000015/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..00e9ed21cde481b9e5cde30e743950ac88f27141 --- /dev/null +++ b/raw/filings/0000719733/2013/0000719733-13-000015/rpt_disclosure.txt @@ -0,0 +1,13 @@ +Related Person Transactions +In April 2007, the Board of Directors adopted a written policy and procedures for the approval or ratification of Interested Transactions with Related +Parties. The policy and procedures supplement the Company’s Code of Conduct. The policy defines an “Interested Transaction” as any transaction, arrangement or relationship or series of similar transactions, arrangements or +relationships (including any indebtedness or guarantee of indebtedness) in which (1) the aggregate amount involved will or may be expected to exceed $120,000 in any calendar year, (2) the Company is a participant, and (3) any Related +Party has or will have a direct or indirect interest (other than solely as a result of being a director or a less than 10 percent beneficial owner of another entity). +The policy defines a “Related Party” as any (a) person who is or was (since the beginning of the last fiscal year for which the Company has filed a Form 10-K and proxy statement, even if +they do not presently serve in that role) an executive officer, director or nominee for election as a director, (b) greater than 5 percent beneficial owner of the Company’s common stock, or (c) immediate family member of any of the +foregoing. Immediate family member includes a person’s spouse, parents, stepparents, children, stepchildren, siblings, mothers- and fathers-in-law, sons- and daughters-in-law, and brothers- and sisters-in-law and anyone residing in such +person’s home (other than a tenant or employee). +The Audit Committee is responsible for review, approval, ratification or disapproval of +Interested Transactions. In determining whether to approve or ratify an Interested Transaction, the Committee will take into account, among other factors it deems appropriate, whether the Interested Transaction is on terms no less favorable than +terms generally available to an unaffiliated third party under the same or similar circumstances and the extent of the Related Party’s interest in the Transaction. +6 \ No newline at end of file diff --git a/raw/filings/0001334036/2005/0001047469-06-004382/filing.txt b/raw/filings/0001334036/2005/0001047469-06-004382/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..129d68bd334a15cb51b863a80f30b0047849b543 --- /dev/null +++ b/raw/filings/0001334036/2005/0001047469-06-004382/filing.txt @@ -0,0 +1,4164 @@ +10-K +1 +a2168966z10-k.htm +10-K +Use these links to rapidly review the document +Crocs Inc. 2005 Annual Report on Form 10-K Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2005 +or +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission File No. 0-51754 +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware +(State or other jurisdiction of +incorporation or organization) +20-2164234 +(I.R.S. Employer +Identification No.) +6273 Monarch Park Place +Niwot, Colorado 80503 +(303) 648-4260 +(Address, including zip code and telephone number, including area code, of Registrant's of principal executive Office) +Securities +registered pursuant to Section 12(b) of the Act: None +Securities +registered pursuant to Section 12(g) of the Act: +Common Stock, par value $0.001 per share +(Title of Class) +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Act. Yes o No ý +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 o No ý +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be +contained, to the best of the registrants's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment +to the Form 10-K. ý +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of +"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer o +Accelerated filer o +Non-accelerated filer ý +Indicate +by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the Exchange +Act). Yes o No ý +The aggregate market value of the voting common stock held by non-affiliates of the Registrant as of February 28, 2006 was $625,146,874. The +Registrant's common stock was not publicly traded as of June 30, 2005, and began trading on the NASDAQ National Market on February 8, 2006. For the purpose of the foregoing calculation +only, all directors and executive officers of the Registrant and owners of more than 5% of the Registrant's common stock are assumed to be affiliates of the Registrant. This determination of affiliate +status is not necessarily conclusive for any other purpose. +The +number of shares of the Registrant's common stock outstanding as of February 28, 2006 was 38,272,247. +Crocs Inc. +2005 Annual Report on Form 10-K +Table of Contents +PART I +Item 1. +Business +Item 1A. +Risk Factors +Item 1B. +Unresolved Staff Comments +Item 2. +Properties +Item 3. +Legal Proceedings +Item 4. +Submission of Matters to a Vote of Security Holders +PART II +Item 5. +Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +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 +Item 9A. +Controls and Procedures +Item 9B. +Other Information +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 and Related Stockholder Matters +Item 13. +Certain Relationships and Related Transactions +Item 14. +Principal Accountant Fees and Services +PART IV +Item 15. +Exhibits and Financial Statement Schedules +Signatures +Schedule I +Not Applicable +Schedule II +Not Applicable +2 +FORWARD-LOOKING INFORMATION +Statements in this Form 10-K (or otherwise made by Crocs or on Croc's behalf) contain various forward-looking statements within the meaning of +Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the "Exchange Act," which represent +our management's beliefs and assumptions concerning future events. When used in this document and in documents incorporated by reference, forward-looking statements include, without limitation, +statements regarding financial forecasts or projections, and our expectations, beliefs, intentions or future strategies that are signified by the words "expects," "anticipates," "intends," "believes," +"plans," or similar language. These forward-looking statements are subject to risks, uncertainties and assumptions that could cause our actual results and the timing of certain events to differ +materially from those expressed in the forward-looking statements. It is routine for our internal projections and expectations to change as the year or each quarter in the year progresses, and +therefore it should be clearly understood that the internal projections, beliefs and assumptions on which we base our expectations may change prior to the end of each quarter or year. Although these +expectations may change, we may not inform you if they do. +You +should understand that many important factors, in addition to those discussed or incorporated by reference in this report, could cause our results to differ materially from those +expressed in the forward-looking statements. Potential factors that could affect our results include, in addition to others not described in this report, those described in Item 1A "Risk Factors" of +this report. In light of these risks and uncertainties, the forward-looking events discussed in this report might not occur. +Throughout +this report, references to the "Company," we and "our" refer to Crocs, Inc. and its consolidated subsidiaries, unless the context indicates otherwise. +3 +PART 1 +ITEM 1. Business +Overview +We are a rapidly growing designer, manufacturer and marketer of footwear for men, women and children under the crocs brand. All of our +footwear products incorporate our proprietary closed-cell resin material which enables us to produce a soft and +lightweight, non-marking, slip- and odor- resistant shoe. We believe our proprietary closed-cell resin, which we refer to as croslite , combined with our unique styling, represents a substantial +innovation in footwear comfort and functionality, allowing us to offer a +differentiated line of products in the casual lifestyle footwear category at attractive retail price points ranging from $19.99 to $59.99, as of February 28, 2006. We currently offer 11 +footwear models in up to 18 different colors. We market our footwear products to a broad range of distribution channels and currently sell our products in over 6,500 retail locations in the United +States, and have begun selling our products in over 40 additional countries. +Product Overview +Our primary product line is crocs -branded footwear for men, women and children, which we first introduced in 2002 with a single model in +six colors. We have since expanded our line +of footwear to include 11 models in up to 18 different colors and a range of sizes, representing over 1,100 stock keeping units, or SKUs, and we +intend to continue diversifying our footwear portfolio with new model introductions. In addition to our footwear products, we market a line of crocs-branded apparel and accessory items that are +intended to increase awareness of our brand and our products. We also selectively use croslite to manufacture a variety of other non-branded +products, such as spa pillows and kayak seats, which are marketed to original equipment manufacturers. +Footwear +A key differentiating feature of our footwear products is croslite , which is uniquely suited for comfort and +functionality. We have carefully formulated croslite to be of a density that creates a comfortable shoe with a high coefficient of friction, allowing +for slip-resistant, non-marking footwear that is extremely lightweight. For example, a size large Beach model weighs approximately six ounces, which is significantly lighter +than more traditional casual footwear products. Croslite softens as it warms to better conform to the wearer's feet. Our shoes are also +non-absorbent, which makes them water resistant and virtually odor-free, and allows them to be cleaned simply with water or bleach. +We +have combined the unique properties of croslite with designs that are intended to be functional across a broad range of activities. As +a result, we believe our products appeal to a wide range of consumers. We introduced crocs as a footwear brand in the U.S. with the launch of our Beach model in 2002. Based on our initial success, we +made refinements to the Beach model +and introduced a second generation of footwear (the Cayman, Highland and Metro models) that incorporated a broader range of sizing, provided different levels of ventilation for various climates and +offered slightly different styling. We have further broadened our footwear line into new product categories, such as the Athens, a flip-flop with a soft footbed; the Nile, an open toe +model designed for women; and the Islander, a deck shoe integrating a base made from croslite with a stitched leather upper. +We +currently sell our shoes in an assortment of colors, styles and sizes to provide consumers and retailers a wide variety of options at suggested retail prices ranging from $19.99 to +$59.99. We have designed our shoes to offer a number of beneficial structural features to provide maximum comfort and functionality, such as Italian-designed orthotic heels, built-in arch +supports and tarsal bars. We also offer models that are based on either general shoe sizing ranging from XXS through 4XL, or specific shoe sizing ranging from children's 8-9 through men's +13. This allows retailers to offer a complete +4 +range +of sizes or carry a more limited number of SKUs, enabling them to tailor their offerings to their particular clientele and more efficiently allocate limited floor space. +Apparel and Accessories +We have introduced several crocs -branded accessory items that complement the fun styling, colors and image of our footwear and that we +believe will appeal to a similar demographic +base. We have developed a line of crocs sunglasses that we intend to market to larger retail customers where we believe accessories will appeal to the retailer's customer base and +complement the retailer's merchandising strategy for our footwear. We also intend to develop additional crocs accessories for certain targeted markets. For example, we have developed a line of +lightweight, colorful kneepads made from croslite , which we are marketing to gardening retailers and hardware stores. Our strategy is to develop accessory items that benefit from our unique +material and complement the market positioning of our crocs footwear. +As +part of our strategy to increase awareness of our brand, we have also introduced a line of branded logo apparel which is complementary to our footwear line and embodies the functional +and fun aspects of the crocs brand. These products include t-shirts, sweatshirts, hats, beanies and socks, all of which come in various colors and prominently +feature the crocs logo. +Other Products +Croslite is well suited to a number of other applications and, in many cases, is superior to materials currently +used in such applications. Foam Creations, our wholly owned subsidiary, manufactures spa pillows for the home spa market, seats and pads for use in kayaks and canoes, and scuba diving fins as croslite +is highly functional for water sports products. These products employ croslite , but we do not +market them under the crocs brand name. +Sales and Distribution +Domestic Distribution Sales +In the U.S., we sell our products through over 6,500 domestic retail store locations representing over 3,400 customer accounts. Our footwear is currently sold +through traditional retail channels, including specialty footwear stores, sporting goods and outdoor retailers. Sales to Dillard's accounted for approximately 12% of our revenues during the year ended +December 31, 2005. No other customer accounted for more than 10% of our revenues during the year ended December 31, 2005. Our products are also sold through a variety of other specialty +channels, including gift shops, independent bicycle dealers, specialty food retailers, health and beauty stores, catalogs, uniform suppliers and kiosks. +Our +domestic accounts are primarily serviced through our internal sales force and a network of independent sales representatives, who focus on selling the appropriate mix and quantity of +our products to our retail accounts. They ensure our products are displayed effectively at retail locations and educate our retailers about our crocs brand and the quality of our products. We compensate +our internal and independent sales representatives on a commission basis, which we believe +provides them with strong incentives to promote our products. We are typically the exclusive footwear brand sold by the independent sales representatives, who may also sell complementary products, +such as sunglasses or apparel, from other companies. For certain of our larger retail accounts and distributors, we manage the sales relationship through in-house sales executives rather +than through independent sales representatives. +5 +International Distribution Sales +Outside of the U.S., we sell our products through over 1,500 international retail store locations. Our strategy is to sell through a broad range of sporting goods +and department stores, as well as through specialty retailers, similar to the retail sales channels we have established in the U.S. We intend to continue to establish a direct sales presence in major +foreign markets, rather than rely on distributors, which we believe will improve our margins and allow us to better control our marketing and distribution. We have established direct sales efforts in +Australia, Austria, the Caribbean, France, Germany, Hong Kong, Japan, the Netherlands, Singapore, and the United Kingdom. +We +also use distributors in select foreign markets where we believe such arrangements are preferable to direct sales. In markets where we use third party distributors, these distributors +purchase products pursuant to a price list and are granted the right to resell such products in a defined territory, usually a country or group of countries. Our typical distribution agreements have +terms of one to four years, are +terminable on 60 days' notice prior to the end of the term or on six months prior notice at any time, and require our distributors to meet a minimum sales threshold. +Retail Sales +We are currently expanding our direct sales efforts to consumers. We believe that direct sales provide us with an opportunity to showcase our entire line of +footwear, apparel and accessory offerings, and believe this strategy will serve as an important and effective means to enhance our product and brand awareness. We also believe that our direct sales +initiatives require low levels of capital investment while enabling us to sell our products at retail, rather than wholesale prices, resulting in higher potential gross margins. +Retail Sites. As of December 31, 2005, we operated approximately 50 retail kiosks domestically and internationally +located in malls and other high foot traffic areas. With bright and colorful displays, efficient use of retail space and limited initial capital investment, we believe that kiosks are an effective +outlet for selling our products. Kiosks enable us to highlight a wide range of our product offering, more effectively interact with potential consumers and enhance our brand awareness among both +consumers and local retailers. We plan to continue to open and operate additional kiosk sites in select, high foot traffic locations. +Internet. We currently offer our products domestically and internationally through our website at www.crocs.com. Our Internet +presence enables us to educate consumers about our products and brand. As we expand our international marketing efforts, we intend to create local websites targeting consumers in each major market we +enter. +Distribution and Logistics +In July 2005, we engaged Expeditors International of Washington, Inc., a global supply chain management and logistics provider, to operate our +warehouse, distribution and fulfillment process for a significant portion of our domestic sales. Expeditors operates a distribution center in Aurora, Colorado through which we distribute a substantial +portion of our products in the U.S. We have negotiated the use of up to 320,000 square feet of the distribution center to accommodate fluctuations in our inventory. We do not have a +long-term contract with Expeditors, and the relationship may be terminated at will on 60 days' notice by either party. +A +substantial portion of our products are shipped to Expeditors' distribution center in Aurora, Colorado. From there, Expeditors packages orders and generally ships by package express or +truck to our customers, depending on size of order, customer location and availability of inventory. In select cases, large customers may receive shipments of footwear directly from the manufacturing +facilities. We have additional company-operated warehouse and fulfillment operations in Canada, China, Mexico, the +6 +Netherlands +and Singapore, and are developing relationships with third parties in Australia, Japan, New Zealand and Singapore to provide such services to us. In addition, we have established a +company-operated warehouse facility and customer order facility in Niwot, Colorado, and we are currently processing our Internet, accessories and apparel orders from this facility. We believe that +these warehousing, distribution and fulfillment services will enable us to ship our products from facilities adjacent to our manufacturing operations directly to our customers, rather than through +Expeditors' distribution facility in Colorado. +Raw Materials +Our proprietary closed-cell resin, which we refer to as croslite , is the primary raw material used in +all of our footwear and non-branded products. Croslite is also used in our crocs -branded accessory items, such as our kneepads. We have formulated +croslite to offer a number of +unique properties that make our material suitable for a wide range of commercial uses including those mentioned above. Our material is soft and durable and is of a density that provides a high +coefficient of friction allowing our material to be slip-resistant and non-marking in addition to being extremely lightweight. Additionally, the closed-cell nature +of croslite makes it resistant to the bacteria and fungus that cause shoe and foot odor. We continue to invest in research and development in order to +refine our materials to enhance these properties as well as target the development of new properties for specific applications. +Croslite is produced by compounding elastomer resins that we or one of our third party processors purchase from a major chemicals +manufacturer together with certain other production inputs, such as color dyes. Other than the elastomer resins, all of the raw materials we use to produce croslite are readily available for purchase +from multiple suppliers. At this time, we have identified two suppliers that produce the particular +elastomer resins used in croslite . However, we may in the future identify and utilize materials produced by other suppliers as an alternative to the +elastomer resins we currently use in the production of our proprietary material. +We +have historically contracted to have croslite compounded by Finproject S.p.A., or Finproject, our third party manufacturer in Italy, +and we have recently begun compounding croslite at our manufacturing facility in Quebec City, Canada. We have also engaged a processor in Canada to +compound a portion of our croslite requirements. We believe that in-house production of croslite will lower our production costs, reduce the risk of supply +shortages from our third party processors and provide us with greater production +flexibility to meet changing retail demand. +Manufacturing and Sourcing +We operate our own production facilities in North America, and we also contract with third party manufacturers located in the U.S. and around the world. We +believe our in-house manufacturing capabilities enable us to rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high-demand +models and colors throughout the year, while outsourcing allows us to capitalize on the efficiencies and cost benefits of using contract manufacturing. +The +process for manufacturing our footwear was developed over an eight year period of continual refinement to improve consistency, softness, durability and yield. Prior to +October 2004, all of our footwear was manufactured at Foam Creations's facility in Quebec City. In the year ended December 31, 2005, we manufactured approximately 16.8% of our footwear +products in our Quebec City facility and have increased our internal manufacturing capacity through our acquisition in April 2005, and subsequent expansion, of a manufacturing operation in +Mexico. We obtain the remainder of our footwear products from third party manufacturers in China, Florida and Italy. In the year ended December 31, 2005, a supplier in China produced +approximately 70.3% of our footwear unit volume. We have long-term contracts with third party manufacturers in Italy and Florida, but do not have a written supply agreement with our +primary third party manufacturer in China. During 2006 +7 +we +intend to expand our manufacturing capacity at the facility we operate in Mexico, in addition to adding third party manufacturing capacity at a facility in Romania operated by one of our existing +suppliers. +While +we are currently dependent on a limited number of third party manufacturers to produce a majority of our footwear products, we have evaluated and qualified over 15 alternative +third party manufacturers that have the current ability and capacity to manufacture our footwear products in the event that one or more of our current third party manufacturers were to reduce or cease +production of our footwear. +We +purchase our apparel and accessories from various suppliers in the U.S. that source our products from manufacturers in Guatemala, Honduras and South Korea. +Backlog +As of December 31, 2005, our backlog was approximately $6.7 million compared to $1.4 million as of December 31, 2004. Although orders +in the backlog are subject to cancellation by customers, we have not experienced any material levels of cancellation of orders by our customers in the past. For a variety of reasons, including our +short operating history, continued growth in customer demand for our products, the addition of new customers in each of our channels, the timing of production and shipments, seasonality, product mix +of customer orders, and a shift toward shorter lead times for orders, backlog may not be a reliable measure of future sales for any succeeding period. In addition, our historical cancellation +experience may not be indicative of future cancellation rates. +Competition +The global casual footwear and apparel industry is highly competitive. The principal elements of competition in this industry include brand awareness, product +functionality, design, quality, pricing, marketing and distribution. We believe that our unique footwear designs, croslite and our expanding product +offering and distribution network position us well in the marketplace. However, some companies in the casual footwear and apparel industry have substantially greater financial, distribution and +marketing resources than we have. Furthermore, the unique designs and resulting success of our footwear products have attracted new players in the market with imitation products that are similar to +ours, and we face competition from these new market entrants. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress and patent protection to establish, protect and enforce our intellectual property +rights in our product designs, brand, materials and research and development efforts, although no such methods can afford complete protection. +We +own a variety of trademarks, including the crocs trademark, in a number of countries around the world. Our trademarks are used on all of our crocs -branded +footwear, apparel and accessory products. We have registered our crocs trademark in Australia, the European Union, Japan, Mexico, New Zealand and Panama, and have registered our crocs logo as a trademark with the World Intellectual Property Office, or WIPO. As of February 7, 2006, we had 18 pending applications for our +trademarks in the U.S., including an application for the crocs trademark and our crocs logo. As of February 7, 2006, we also had 180 pending +trademark applications in foreign jurisdictions. Trademarks registered outside of the +U.S. generally have a duration of ten years depending on the jurisdiction and are also generally subject to an indefinite number of renewals for a like period on appropriate application. We believe +our trademarks are crucial to the successful marketing and sale of our products, and we intend to vigorously prosecute and defend our rights throughout the world. +8 +As +of February 7, 2006, we had three utility patent applications and 23 design patent applications pending in the U.S., as well as one utility patent issued in the United States. +We also had European Union Community Design Registrations directed to our Beach, Highland, Nile, Metro, Islander, Aspen, and a number of planned future shoe models. We also had three issued design +registrations in South Korea, three issued design registrations in India, three pending design applications in Brazil, and three pending design applications in China directed to our Beach, Highland, +and Nile models. We also had 78 other design applications pending directed to our Islander, Aspen, and a number of planned future shoe models in foreign jurisdictions. In addition, we had 27 utility +patent applications pending in several foreign jurisdictions. We expect to continue to pursue patent protection on our inventions that are significant to our business and pursue other intellectual +property protection where applicable. +We +consider the formulation of croslite used to produce our products to be a valuable trade secret. Prior to our acquisition of Foam +Creations in June 2004, Foam Creations developed the formula for croslite , and we believe that they did not publish or otherwise make the formula +available to third parties without the protection of confidentiality or similar agreements. Since the acquisition, we continue to protect the formula by using confidentiality agreements with our third +party processors and by requiring our employees who have access to the formula to execute confidentiality agreements or to be bound by similar agreements concerning the protection of our confidential +information. Neither we nor Foam Creations have attempted to seek patent protection for the formula but we are not aware of any third party that has independently developed the formula or that +otherwise has the right to use the formula in their products other than Finproject. Under the terms of our supply agreement with Finproject, Finproject has certain limited rights to use croslite , which +were originally negotiated in connection with our purchase of Foam Creations from Finproject's parent company. We believe the comfort +and utility of our shoes depend on the properties achieved from the compounding of croslite and is a key competitive advantage for us, and we intend to +vigorously protect this trade secret. +We +actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors and retailers to police against infringing +products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives are also educated on our pending patents and trade dress and assist +in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as +do the laws of the United States, and therefore we may have difficulty obtaining legal protection for our intellectual property in certain jurisdictions. +Employees +As of December 31, 2005, we employed approximately 1,130 employees. As of December 31, 2005, none of our employees were represented by a union, +other than 275 of our Canadian employees who were represented by the Teamsters Union. We believe our relationship with our employees is good. +ITEM 1A. Risk Factors +The following factors, in addition to those discussed elsewhere in this report, should be carefully considered in evaluating our company and our business. +We have a limited operating history, which makes it difficult to evaluate our business and prospects. +We +commenced sales of our crocs footwear, which currently constitute a substantial majority of our sales, in 2002. As an early stage company with a limited operating history, our +business is subject to all of the risks inherent in a new business enterprise, including: +• products +without a significant history in the market; +• reliance +on a small number of products; +9 +• limited +manufacturing experience; +• lack +of established distribution channels; +• a +small and relatively new management team and an evolving organizational infrastructure; and +• weaknesses +in newly implemented or limited management information systems. +Furthermore, +we have recently experienced rapid growth, which has made our current operations and our expected future operations substantially different from our past operating history. +For example, to support our growth we have added additional manufacturing capacity and have expanded our distribution and fulfillment capabilities. New manufacturing capacity that we have recently +added may not meet our projections or may suffer from operating difficulties. Similarly, our outsourced distribution and fulfillment provider may not perform as we expect, and our expanded +in-house fulfillment capabilities may prove difficult to manage. Our limited operating history will make it difficult for you to evaluate this growth in our business and our prospects for +the future. +We have significantly expanded the nature and scope of our operations over the past two years, and if we fail to manage any future growth effectively we may experience greater +difficulty in filling customer orders, declines in product quality, increases in costs or other operating difficulties. +We +have significantly expanded the nature and scope of our operations over the past two years, and we anticipate that substantial further expansion will be required to address potential +growth in our customer base and new market opportunities. Prior to June 2004, we distributed in the U.S. under our crocs brand a limited range of footwear products manufactured and sold to us by +Foam Creations. In June 2004, we acquired Foam Creations. Since +that acquisition, we have expanded our product line, increased the number of employees and increased our production of shoes. +The +expansion of the scope and nature of our business and the growth in the number of employees, customers and other third parties with whom we have relationships and in the number of +facilities we use for manufacturing, distribution, and corporate operations, have placed and will continue to place a significant strain on our management and our information systems and resources. To +manage growth in our operations, we will need to increase the number of people we employ, upgrade or replace our existing financial and reporting systems as well as improve our business processes and +controls. Failure to effectively manage growth could result in greater difficulty in completely filling customer orders, declines in product quality or increases in costs or other production and +distribution difficulties, any of which could adversely impact our business performance and operating results. +The popularity of our crocs footwear may not continue to grow as rapidly as it has in the recent past or may decline, which would have a negative impact on our sales +and +results of operations. +Our +recent growth is substantially attributable to sales of crocs footwear, which represented approximately 94.4% of our revenues in the year ended December 31, 2005. We expect that footwear will +constitute our principal product line for the foreseeable future. The footwear industry is subject to rapidly changing consumer demands and preferences and fashion trends, and our crocs footwear may not +remain popular or we may fail to develop additional models that appeal to consumers. If the popularity of our crocs footwear declines or does not expand in the future, we may experience, among other +things: +• lower +sales; +• loss +of retail customers; +• excess +inventories; +• inventory +markdowns and discounts provided to retailers; +10 +• deterioration +of our brand image; and +• lower +gross and operating margins. +Given +the limited history of our crocs brand, it is especially difficult to evaluate whether our products will hold long-term consumer appeal. +We are dependent on sales of a small number of products and the absence of continued market demand for these products would have a significant adverse effect on our operating +results. +We +generated approximately 94.4% of our revenues for the year ended December 31, 2005 from sales of our crocs footwear, which currently consists of 11 models, plus children's versions of two of our +models. Sales of our Beach model accounted for +approximately 60.9% of our footwear revenues in the year ended December 31, 2005. Most of our crocs footwear models are developed from the same base design as our Beach model, and we expect to +continue to derive a substantial portion of our +revenues from these models or related products in the foreseeable future. Because we are dependent on a line of footwear models that have substantial similarities, factors such as changes in consumer +preferences and general market conditions in the footwear industry may have a disproportionately greater impact on us than on our competitors. In addition, other footwear companies have introduced +products that are substantially similar to our footwear models, which may reduce sales of our footwear products. In the event that consumer preferences evolve away from our footwear models or from +casual lifestyle footwear in general, or our retail customers purchase similar products sold by our competitors, the resulting loss of sales, increase in inventories and discounting of our products +are likely to be significant, and this could have a material and adverse impact on our business and operations. +Expanding our crocs footwear product line may be difficult and expensive, and if we are unable to successfully continue such expansion, our brand may be adversely +affected, and we may not achieve our planned sales growth. +Our +growth strategy is founded primarily on the continued growth in sales of crocs footwear, and we intend to continue to expand the number of models offered in our crocs footwear product line to broaden the appeal of our products to consumers. To successfully expand our footwear product line, we must anticipate, +understand and react to the rapidly changing tastes of footwear consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with +consumers or our brand may fall out of favor with consumers. If we are unable to anticipate, identify or react appropriately to changes in consumer preferences, we may not grow as fast as we plan or +our sales may decline, and our brand image and operating performance may suffer. +Furthermore, +achieving market acceptance for new products will likely require us to exert substantial product development and marketing efforts, which could result in a material increase +in our selling, general and administrative expense, and there can be no assurance that we will have the resources necessary to undertake such efforts. Material increases in our selling, general and +administrative expense could adversely impact our results of operations. +We +may also encounter difficulties in producing new crocs footwear models that we did not anticipate during the development stage. Our development schedules for new products are difficult to predict and +are subject to change as a result of shifting priorities in response to consumer preferences and competing footwear products. Once we have begun to design a new model, it can take six to nine months +to progress to full production because of the need to fabricate new molds and to implement modified production tooling and revised manufacturing techniques. If we are not able to efficiently +manufacture newly-developed products in quantities sufficient to support retail distribution, we may not be able to recoup our investment in the development of new models, and we would continue to be +subject to the risks inherent in having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new model may depend +on our product pricing. We have a limited history of introducing new products, and we may set the prices +11 +of +new models too high for the market to bear. Failure to gain market acceptance for new footwear products that we introduce could impede our growth, reduce our profits, adversely affect the image of +our brands, erode our competitive position and result in long term harm to our business. +We will incur significant time and expense in documenting, testing and certifying our internal control over financial reporting, and any deficiencies in our financial reporting +or internal controls could adversely affect our business and the price of our common stock. +SEC +rules require that our chief executive officer and chief financial officer periodically certify the existence and effectiveness of our internal control over financial reporting. Our +independent auditors will be required, beginning with our Annual Report on Form 10-K for our fiscal year ending on December 31, 2007, to attest to our officers' assessment of +our internal controls. This process generally requires significant documentation of policies, procedures and systems, review of that documentation by our internal accounting staff and our outside +auditors, and testing of our internal control over financial reporting by our internal accounting staff and our outside auditors. Documentation and testing of our internal controls, which we have only +undertaken to a limited extent in the past, will involve considerable time and expense, and may strain our internal resources and have an adverse impact on our costs. +During +the course of our testing, we may identify deficiencies which we may not be able to remediate in time to meet the deadline imposed by SEC rules for certification of our internal +control over financial reporting. As a consequence, we may have to disclose in periodic reports we file with the SEC any significant deficiencies or material weaknesses in our system of internal +controls. The existence of such material weaknesses would preclude management from concluding that our internal control over financial reporting is effective and would preclude our independent +auditors from issuing an unqualified opinion that internal controls are effective. In addition, disclosures of this type in our SEC reports could cause investors to lose confidence in our financial +reporting and may negatively affect the price of our common stock. Moreover, effective internal controls are necessary to produce reliable +financial reports and to prevent fraud. If we have deficiencies in our internal control over financial reporting it may negatively impact our business, results of operations and reputation. +Our current management information systems are insufficient for the growth of our business, and planned system improvements may not be successfully implemented on a timely +basis or be sufficient for our growing business. +We +do not have an integrated management information system. For certain business planning, finance and accounting functions, we rely on manual processes that are difficult to control and +are subject to human error. We expect to use approximately $4.5 million of the net proceeds from the IPO to upgrade our financial reporting systems and to implement new information technology +systems to better track our business, streamline our financial reporting, and improve our internal controls. We may experience difficulties in transitioning to our new or upgraded systems, including +loss of data and decreases in productivity as our personnel become familiar with new systems. In addition, our management information systems will require modification and refinement as we grow and +our business needs change, which could prolong difficulties we experience with systems transitions, and we may not always employ the most effective systems for our purposes. If we experience +difficulties in implementing new or upgraded information systems or experience significant system failures, or if we are unable to successfully modify our management information systems to respond to +changes in our business needs, our ability to properly run our business could be adversely affected. +Sales of our products are likely to be subject to seasonal variations, which could increase the volatility of the price of our common stock. +The +footwear industry generally is characterized by significant seasonality of sales. Due to the growth in sales of our products in the past two years we cannot assess with certainty the +degree to +12 +which +sales of our footwear products will be subject to seasonal variation, but a majority of our footwear is more suited for fair weather use, so we expect some degree of seasonality in the future. +Our revenues for the three months ended December 31, 2005 were approximately 12% lower than our revenues for the three months ended September 30, 2005, and we believe that the decline +was primarily attributable to seasonal declines in demand for our products. In addition, extended periods of unusually cold weather during the spring and summer could reduce demand for our footwear. +Seasonal variations in consumer demand may result in fluctuations in our results of operations from quarter to quarter, and the effect of favorable or unfavorable weather on sales may be significant +enough to materially affect our quarterly results. Wide variations in our quarterly operating results may increase the volatility of the price of our common stock. +Because we depend on third party manufacturers, we face challenges in maintaining a sufficient supply of goods to meet sales demand, and we may experience interruptions in our +supply chain. Any shortfall in the supply of our products may decrease our sales and have an adverse impact on our customer relationships. +In +the year ended December 31, 2005, third party manufacturers produced approximately 78.1% of our footwear products as measured by number of units, and one such manufacturer +produced approximately 70.3% of our footwear products. Currently, we have footwear manufacturing arrangements with third party manufacturers located in China, Florida and Italy. We depend on these +manufacturers' ability to finance the production of goods ordered and to maintain adequate manufacturing capacity. We do not exert direct control over the third party manufacturers, so we may be +unable to obtain timely delivery of acceptable products. +In +addition, we do not have long-term supply contracts with most of these third party manufacturers, including the third party manufacturer that produced the majority of our +footwear products in the year ended December 31, 2005, and any of them may unilaterally terminate their relationship with us at any time or seek to increase the prices they charge us. As a +result, we are not assured of an uninterrupted supply of products of an acceptable quality and price from our third party manufacturers. We may not be able to offset any interruption or decrease in +supply of our products by increasing production in our company-operated manufacturing facilities due to capacity constraints, and we may not be able to substitute suitable alternative third party +manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third party manufacturers may harm our business and could result in a loss of sales and an +increase in production costs, which would adversely affect our results of operations. +Our business could suffer if our third party manufacturers violate labor laws or fail to conform to generally accepted ethical standards. +We +generally require our third party manufacturers to meet our standards for working conditions and other matters before we are willing to place business with them. As a result, we may +not always obtain the lowest cost production. Moreover, we do not control our third party manufacturers or their respective labor practices. If one of our third party manufacturers violates generally +accepted labor standards by, for example, using forced or indentured labor or child labor, failing to pay compensation in accordance with local law, failing to operate its factories in compliance with +local safety regulations, or diverging from other labor practices generally accepted as ethical, we likely would cease dealing with that manufacturer, and we could suffer an interruption in our +product supply. In addition, such a manufacturer's actions could result in negative publicity and may damage our reputation and the value of our brand and discourage retail customers and consumers +from buying our products. +We manufacture a portion of our crocs products, and any difficulties or disruptions in our manufacturing operations could adversely affect our sales and results of +operations. +We +produce some of our products at our company-operated manufacturing facilities in Canada and Mexico. In the year ended December 31, 2005, we produced approximately 16.8% of our crocs +13 +footwear +production at our Canadian facility, and we recently commenced production at our company-operated facility in Mexico. The manufacturing of our products from our proprietary +closed-cell resin, which we refer to as croslite , requires the use of a complex process, and we may experience difficulty in producing +footwear that meets our high quality control standards. We will be required to absorb the costs of manufacturing and disposing of products that do not meet our quality standards. These costs are +primarily incurred in connection with the initial production of new products, although we may also experience increases in training costs when we initiate production of new products. Additionally, we +may incur increased costs as a result of the introduction of new manufacturing equipment such as molds and injection molding machines. Any increases in our manufacturing costs could adversely impact +our margins. Furthermore, our manufacturing capabilities are subject to many of the same risks and challenges noted above with respect to our third party manufacturers, including our ability to scale +our production capabilities to meet the needs of our customers, and our manufacturing may be disrupted for reasons beyond our control, including work stoppages, fires, earthquakes, floods or other +natural disasters. Any disruption to our manufacturing operations will hinder our ability to deliver products to our customers in a timely manner, and could have a material and adverse effect on our +business. +We +established our own manufacturing facility in Mexico by acquiring the assets of an existing footwear manufacturer in April 2005, and subsequently added capacity at our adjacent +facility that we leased. Prior to April 2005, we had never independently established our own manufacturing facility, and this newly-established facility may not be as efficient or as productive +as our other company-operated or third party manufacturing operations. Moreover, the expansion of our company-operated manufacturing capabilities will increase our fixed cost base, and could adversely +impact our margins and results of operations in the event our sales decline or do not continue to grow. +We depend on a limited number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and increase +product costs. +We +depend on a limited number of sources for the primary materials used to make our crocs footwear. We source the elastomer resins that constitute the primary raw materials used in compounding +croslite , which we use to produce our footwear products, from one supplier. We do not have any formal purchase agreement with the provider of the +elastomer resins, and we purchase these elastomer resins on a purchase order basis. If the supplier we rely on for elastomer resins were to cease production of these materials, we may not be able to +obtain suitable substitute materials in time to avoid interruption of our production cycle, if at all. We may also have to pay materially higher prices in the future for the elastomer resins or any +substitute materials we use, which would increase our production costs and could have a materially adverse impact on our margins and results of operations. +Additionally, +a single third party processor in Italy compounded all of the croslite we used in producing crocs footwear in 2004, and we expect that this third party +processor will continue to provide at least a majority of our requirements for the +foreseeable future. Although we have arranged for another third party processor to compound croslite and we began compounding croslite at Foam Creations's +facility in Quebec City, Canada in 2005, the compounding process is complex and difficult to perfect on a large scale, and +neither we nor our new third party processor may be able to compound meaningful quantities of croslite suitable for use in our products. +If +we are unable to obtain suitable elastomer resins or if we are unable to procure sufficient quantities of croslite , we may not be able +to meet our production requirements in a timely manner. Such failure could result in lost potential sales, delays in shipments to customers, strained relationships with customers and diminished brand +loyalty. +14 +If we are unable to assimilate our new managers and recruit and retain key personnel necessary to operate our business, our ability to successfully develop and market our +products may be harmed. +Several +of our executive officers have recently joined us and therefore have limited experience in managing our company. For example, we hired Ronald Snyder, our President and Chief +Executive Officer, in June 2004, and Caryn Ellison, our Chief Financial Officer and Vice President—Finance, in November 2004 and, on February 2, 2006, we hired Peter +Case as our Senior Vice President—Finance, and a new corporate controller, each of whose appointment became effective on February 6, 2006. We may experience difficulty assimilating +our recently hired managers, which may adversely impact our business. It is possible that the changes to our finance and accounting staff will hamper, rather than aid, our efforts to improve our +internal control over financial reporting due to, among other things, the time and effort required to integrate the new employees. Furthermore, we are now subject to SEC reporting obligations and if +these new employees are not properly integrated into our finance and accounting staff, we may be unable to adequately address our SEC reporting obligations. +To +expand our business we will also need to attract, retain and motivate highly skilled design, development, management, accounting, sales, merchandising, marketing and customer service +personnel. We plan to hire additional personnel in all areas of our business. Competition for many of these types of personnel is intense. As a result, we may be unable to successfully attract or +retain qualified personnel. Additionally, any of our officers or employees can terminate their employment with us at any time, and we do not maintain key person life insurance on any of our employees, +including any member of our management team. The loss of any key employee or our inability to attract or retain other qualified employees could harm our business and results of operations. +We rely on a single third party for a significant portion of our warehouse, distribution and fulfillment operations. If this party is unwilling or unable to continue providing +services to us, our business could be materially harmed. +We +engaged Expeditors International of Washington, Inc. in July 2005 to operate our warehouse, distribution and fulfillment process for a significant portion of our +domestic sales. We are dependent on Expeditors to manage inventory, process orders and distribute products to our customers in a timely manner. We do not have a long-term contract with +Expeditors and they may unilaterally terminate their relationship with us at any time or seek to increase the prices they charge us. Any disruption in our relationship with Expeditors could cause +significant delays in the fulfillment of our customers' orders, and we may not be able to locate another distributor that can provide comparable warehouse, distribution and fulfillment services in a +timely manner or on acceptable commercial terms. +Additionally, any serious disruption to the services provided to us by Expeditors could harm our ability to supply products to our customers, including: +• damage +or destruction to Expeditors's warehouse and distribution center used for our products due to fire, earthquake or any other natural disaster; +• work +stoppages, disputes or difficulties between Expeditors and its employees; +• malfunctions +in Expeditors's information systems; or +• disruptions +in Expeditors's shipping channels. +In +the event that the distribution of our products by Expeditors is interrupted for any reason, our business may be materially and adversely affected. +We are in the process of establishing our own warehouse, distribution and fulfillment capabilities, and are also developing relationships with additional third parties to +conduct similar services for us. Any additional +15 +expenses incurred in connection with, or any disruption in the supply of our products that is caused by, such changes in our logistical infrastructure could adversely affect our +business. +We +have recently established a company-operated warehouse and order processing and customer order facility in Niwot, Colorado that manages all Internet, apparel and accessories orders +and shipments. We have established or are in the process of establishing additional company-operated warehouse and fulfillment operations in Mexico, China, Canada, the Netherlands and Singapore and +are developing relationships with third parties in Australia, Japan and New Zealand to provide such services to us. We believe these warehousing, distribution and fulfillment services will enable us +to ship our products from the facilities that manufacture our products directly to our customers, rather than remaining dependent on Expeditors's distribution facility in Colorado. The transition from +Expeditors to another vendor or to a company-operated warehousing, distribution and fulfillment operation could result in significant +delays and disruptions in the supply of our products and could require that we make significant additional expenditures that may adversely impact our operating results. +Moreover, +until recently we had never engaged in the warehousing of our products or provided order fulfillment for our retail customers or consumers. As such, we cannot ensure that we +will be able to successfully conduct these activities, or that other third parties will be able to conduct these activities for us in a satisfactory manner. Additionally, these warehouse, distribution +and fulfillment operations subject us to many of the same risks that our current relationship with Expeditors does, as noted above. In the event that we or a third party are unable to conduct +warehousing, distribution and fulfillment activities in a cost effective, timely, and accurate manner, the distribution of our products may be adversely affected, which could result in harm to our +relationships with our retail customers and consumers, a reduction in demand for our products, and additional expenses to us. +We face significant competition and if we are unable to compete effectively, sales of our products may decline and our business could be harmed. +The +footwear industry is highly competitive. Recent growth in the market for casual footwear has encouraged the entry of new competitors into the marketplace and has increased +competition from established companies. Some of our competitors are offering products that are substantially similar, in design and materials, to our crocs -branded footwear. In addition, access to +offshore manufacturing is also making it easier for new companies to enter the markets in which we +compete. +Our +competitors include most major athletic and footwear companies, branded apparel companies and retailers with their own private labels. A number of our competitors: +• have +significantly greater financial resources than we have; +• have +more comprehensive product lines than ours; +• have +broader market presence than we have in, or have their own, retail outlets; +• have +longer-standing relationships with retailers than we have; +• have +a longer operating history than ours; +• have +greater distribution capabilities than we have; +• have +stronger brand recognition than we have; and +• spend +substantially more on product advertising and sales than we do. +Our +competitors' greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and +production and more quickly develop new products. If we fail to compete successfully in the future, our sales and profits may decline, our financial condition may deteriorate and the market price of +our common stock is likely to fall. +16 +If we are unable to establish and protect our trademarks and other intellectual property rights, competitors may sell products that are substantially similar to our crocs footwear, or may produce counterfeit versions of our products, and such competing or counterfeit products could divert sales and may damage our +brand image. +We +believe our trademarks, trade names, copyrights, trade secrets, issued and pending patents, trade dress and designs are valuable and integral to our success and competitive position. +From time to time, we have identified competitors selling products that are very similar in design to certain of our crocs footwear models, and that are manufactured from what may be comparable +materials to our products. We believe that some of these products may +infringe our intellectual property rights. Given the increased popularity of our crocs brand, we believe there is a high likelihood that counterfeit products or other products infringing on our +intellectual property rights will +continue to emerge, seeking to benefit from the consumer demand for crocs footwear. In order to protect our brand, we may be required to spend significant resources to monitor and police our +intellectual property rights. +We may not be able to detect infringement and may lose our competitive position in the market before we are able to do so. In addition, enforcing rights to +our intellectual property may be difficult and expensive, and we may not be successful in combating counterfeit products and stopping infringement of our intellectual property rights, particularly in +some foreign countries, which could make it easier for competitors to capture market share. Intellectual property rights may also be unavailable or limited in some foreign countries. Furthermore, our +efforts to enforce our trademark and other intellectual property rights may be met with defenses, counterclaims and countersuits attacking the validity and enforceability of our trademark and other +intellectual property rights. If we are unsuccessful in protecting and enforcing our intellectual property rights, continued sales of such competing products by third parties could harm our brand and +adversely impact our business, financial condition and results of operations. +We +have registered crocs as a trademark for footwear in Australia, the European Union, Japan, Mexico, New Zealand and Panama. We have also applied to register crocs and the crocs logo as trademarks in 36 jurisdictions around the world, including the U.S., but such applications have not been approved and are currently +pending. In addition, we have recently extended the scope of our trademark registrations and applications for both the crocs mark and logo to cover non-footwear products such as sunglasses, goggles, +knee pads, watches, luggage, and some of our Internet sales +activities. Although we believe that we have applied for trademark registrations in all jurisdictions where we are doing or intend to do business, there is a possibility that we have not applied to +register the crocs mark, the company logos, the individual brand names for our products or our marketing slogans in countries where we will do business in the +future, and we have elected not to apply for trademark registrations for some marks in some jurisdictions. Furthermore, we may not obtain trademark registrations in connection with any applications +that we file, and trademark protection, whether registered or common law, may not be available in every country in which we offer or intend to offer our products. Failure to adequately protect our +trademark rights could damage or even destroy our crocs brand, expose us to trademark liability and impair our ability to compete effectively. In addition, defending or enforcing our trademark rights +could result in the expenditure of significant financial and managerial resources. +We +believe our success may be enhanced by our ability to obtain and enforce patent protection for our products, and therefore have elected to pursue patent protection for our products in +the U.S. and other countries. Currently, we have been issued one Community Design Registration and three Community Multiple Design Registrations in the European Union covering a total of ten shoe +designs. Three of our shoe designs have also received registrations in South Korea and India and we have recently been issued one utility patent in the U.S., but we have not been granted any other +utility patents or design patents in the U.S. or any utility patents or additional design registrations in other countries. We do not know whether any of our pending or future patent applications will +result in the issuance of patents, and competitors may challenge the validity or scope of our issued patent, or our +17 +registered +designs or patent applications that proceed to issuance. We cannot predict how the patent claims in our issued patent, or any patents issued from any pending or future patent application, +will be construed, and such patents may not provide us with the ability to prevent the development, manufacturing, and/or marketing of competing products, or may be challenged by third parties on the +basis of validity and enforceability. +We +also rely on trade secrets, confidential information and other unpatented proprietary information, related to, among other things, the formulation of croslite and product development, especially where +we do not believe patent protection is appropriate or obtainable. Using third party manufacturers may +increase risk of misappropriation of our trade secrets, confidential information and other unpatented proprietary information. The agreements we use to try to protect our intellectual property, +confidential information and other unpatented proprietary information may not effectively protect such intellectual property and information and may not be sufficient to prevent unauthorized use or +disclosure of such trade secrets and information. A party to one of these agreements may breach the agreement and we may not have adequate remedies for such breach. As a result, our trade secrets, +confidential information and other unpatented proprietary information may become known to others, including our competitors. Furthermore, as with any trade secret, confidential information or other +proprietary information, our competitors and other third parties, may independently develop or discover such trade secrets and information, which would render them less valuable to us. +Third parties may claim that we are infringing their intellectual property rights, and such claims may be costly to defend, may require us to pay licensing fees, damages, or +other amounts, and may prevent, or otherwise impose limitations on, the manufacture, distribution or sale of our products. +From +time to time, third parties may claim that we are infringing on their intellectual property rights, and we may be found to infringe those intellectual property rights. While we do +not believe that any of our products infringe the valid intellectual property rights of third parties, we may be unaware of the intellectual property rights of others that may cover some of our +technology or products. If we are forced to defend against such third party claims, whether or not such claims are resolved in our favor, we could encounter expensive and time consuming litigation +which could divert our management and key personnel from business operations. Further, if we are found to be infringing on the intellectual property rights of others, we may be required to pay damages +or ongoing royalty payments, or comply with other unfavorable terms. Additionally, if we are found to be infringing on the intellectual property rights of others, we may not be able to obtain license +agreements on terms acceptable to us, and this may prevent us from manufacturing, marketing or selling our products. Thus, such third party claims may significantly reduce the sales of our products or +increase our cost of goods sold. Any such reductions in sales or cost increases could be significant, and could have a material and adverse affect on our business. +Our financial success may be limited to the strength of our relationships with our retail customers and to the success of such retail customers. +Our +financial success is significantly related to the willingness of our retail customers to continue to carry our products and to the success of such customers. We do not have long term +contracts with any of our retail customers, and sales to our retail customers are generally on an order-by-order basis and are subject to rights of cancellation and +rescheduling by the customer. If we cannot fill our retail customers' orders in a timely manner, the sales of our products and our relationships with those customers may suffer, and this could have a +material adverse effect on our product sales and ability to grow our product line. +In +the year ended December 31, 2005, our ten largest retail customers accounted for approximately 34% of our revenues, with Dillard's, our largest customer for the period, +accounting for approximately 12% of our revenues. If any of our major retail customers experiences a significant downturn in their business or fails to remain committed to our products or brand, then +these customers may reduce or +18 +discontinue +purchases from us. In addition, we extend credit to our customers based on an evaluation of each customer's financial condition. If a significant customer to whom we have extended credit +experiences financial difficulties, our bad debt expense may increase relative to revenues in the future. Any significant increase in our bad debt expense relative to revenues would adversely impact +our net income and cash flow and could affect our ability to pay our own obligations as they become due. +Furthermore, +many of our retail customers compete with each other, and if they perceive that we are offering their competitors better pricing and support, they may reduce purchases of +our products. In addition, we compete directly with our retail customers by selling our products to consumers via the Internet and through our company-operated kiosks. If our retail customers believe +that our direct sales to consumers divert sales from their stores, this may weaken our relationships with such customers and cause them to reduce purchases of our products. +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers' orders, either of which could +adversely affect our business. +The +footwear industry is subject to cyclical variations and declines in performance, as well as fashion risks and rapid changes in consumer preferences, the effects of weather, general +economic conditions and other factors affecting demand. These factors make it difficult to forecast consumer demand, and if we overestimate demand for our products, we may be forced to liquidate +excess inventories at a discount to customers, resulting in markdowns and lower gross margins. Conversely, if we underestimate consumer demand, we could have inventory shortages, which can result in +lost potential sales, delays in shipments to customers, strains on our relationships with customers and diminished brand loyalty. Moreover, because our product line is limited, we may be +disproportionately affected by cyclical downturns in the footwear industry, changes in consumer preferences and other factors affecting demand, which may make it more difficult for us to accurately +forecast our production needs, exacerbating these risks. A decline in demand for our products, or any failure on our part to satisfy increased demand for our products, could adversely affect our +business and results of operations. +We may fail to successfully expand our distribution network or introduce our products internationally, and this may cause our results of operations to fall short of +expectations. +As +part of our growth strategy, we plan to expand our distribution network and expand the sales of our products into new locations internationally. Successfully executing this strategy +will depend on many factors, including: +• the +strength of the +crocs brand and competitive conditions in new markets that we attempt to enter; +• our +ability to attract and retain qualified distributors or agents or to develop direct sales channels; +• our +ability to use and protect the +crocs brand, and our other intellectual property, in these new markets and territories; and +• our +ability to successfully enter and compete in markets and territories, especially internationally, where we have little distribution experience and where our +crocs brand is not well known. +If +we are unable to successfully expand our distribution channels and sell our crocs -branded products internationally, our business may fail to grow, our brand may suffer and our results of operations may +be adversely impacted. +We can issue shares of preferred stock without stockholder approval, which could adversely affect the rights of common stockholders. +Our +restated certificate of incorporation permits us to establish the rights, privileges, preferences and restrictions, including voting rights, of future series of our preferred stock +and to issue such stock +19 +without +approval from our stockholders. The rights of holders of our common stock may suffer as a result of the rights granted to holders of preferred stock that we may issue in the future. In +addition, we could issue preferred stock to prevent a change in control of our company, depriving common stockholders of an opportunity to sell their stock at a price in excess of the prevailing +market price. +Our restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could discourage a third party from acquiring us and +consequently decrease the market value of an investment in our stock. +Our +restated certificate of incorporation, amended and restated bylaws and Delaware corporate law each contain provisions that could delay, defer or prevent a change in control of our +company or changes in our management. Among other things, these provisions: +• authorize +us to issue preferred stock that can be created and issued by the board of directors without prior stockholder approval, with rights senior to those of common +stock; +• do +not permit cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates; +• prohibit +stockholders from calling special meetings of stockholders; +• prohibit +stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders; +• allow +the authorized number of directors to be changed only by resolution of the board of directors; +• establish +advance notice requirements for submitting nominations for election to the board of directors and for proposing matters that can be acted on by stockholders at a +meeting; and +• classify +our board of directors so that only some of our directors are elected each year. +These +provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of +control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in +control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to +decline. +ITEM 1B. Unresolved Staff Comments +Not Applicable. +ITEM 2. Properties +Our principal executive and administrative offices and internet distribution center are located at 6273 Monarch Park Place, Niwot, Colorado. We also operate a +76,000 square foot manufacturing facility in Quebec City, Canada, a 115,000 square foot manufacturing facility in Purísima del Rincón, Mexico and a 55,000 square foot +warehouse in Rijswijk, the Netherlands. We lease, rather than own, all of our facilities and our leases will all expire in 2007. Our distribution center, which is owned and operated by Expeditors +International of Washington, Inc., our third party logistics provider, is located in Aurora, Colorado. We consider our facilities to be suitable for our needs. +20 +The +general location, use and approximate size of our principal properties are given below: +Location +Use +Approximate Square Feet +Niwot, Colorado +Corporate offices/warehouse +49,000 +Purísima del Rincón, Mexico +Manufacturing facility +115,000 +Quebec City, Canada +Manufacturing facility +76,000 +Rijswijk, the Netherlands +Warehouse +55,000 +We +also maintain small branch sales offices in Hong Kong, Tokyo, Melbourne, Singapore and The Hague. All of these sales offices are leased. We enter into short-term leases +for kiosks domestically and internationally with fixed monthly rents subject to certain covenants with contingent rents based on percentage of revenues. +ITEM 3. Legal Proceedings +In January 2005, we filed a lawsuit, through Foam Creations, against Holey Soles Holdings Ltd. in the Federal Court of Canada, Trial Division, in +Toronto, Canada. The complaint alleges trademark and copyright infringement relating to the design of some of their shoe models. We believe that we own all copyrights associated with our Beach +footwear model and that the design of the Beach model has developed a substantial reputation and goodwill in Canada. Holey Soles offers footwear that is identical in style and visual appearance in +every material respect to our Beach model, and we believe Holey Soles has infringed our intellectual property rights. We are seeking a permanent injunction with respect to any further acts of +infringement of our intellectual property, as well as damages and attorneys' fees. +In +August 2005, Holey Soles filed a lawsuit against us in the United States District Court for the Southern District of New York. Holey Soles seeks a declaratory judgment that we +do not have any valid +copyright or trade dress rights with respect to the design of our footwear. In addition, Holey Soles seeks a declaratory judgment that the manufacture, sale and distribution of its footwear products +does not constitute unfair competition and does not infringe on our copyrights or trade dress rights. We have filed a motion to dismiss the action or, in the alternative, to transfer the action to the +United States District Court for the District of Colorado. We do not expect the ultimate resolution of this matter will have a material adverse impact on our business. +Although +we are subject to litigation from time to time in the ordinary course of our business, we are not party to any pending legal proceedings that we believe will have a material +adverse impact on our business. +ITEM 4. Submission of Matters to a Vote of Security Holders +No matters were submitted for a vote of security holders during the fourth quarter of the fiscal year covered by this report. +21 +PART II +ITEM 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock, par value $0.001, is listed on the Nasdaq National Market under the stock symbol "CROX" and has been so listed since February 8, 2006, +when it was first listed in connection with our initial public offering. We have no public trading history prior to February 8, 2006. The initial public offering price of our common stock on +February 8, 2006 was $21.00 per share. +Holders +The approximate number of stockholders of record of our common stock was 156 as of February 28, 2006. Because many of the shares of our common stock are +held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial owners represented by these stockholders of record. +Dividends +We have never declared or paid cash dividends on our common equity. We currently intend to retain all available funds and any future earnings for use in the +operation of our business and do not anticipate paying any cash dividends in the foreseeable future. Any future determination to declare cash dividends will be made at the discretion of our board of +directors, subject to compliance with covenants under any existing financing agreements, which may restrict or limit our ability to declare or pay dividends, and will depend on our financial +condition, results of operations, capital requirements, general business conditions, and other factors that our board of directors may deem relevant. +Use of Proceeds from Sales of Registered Securities +On February 13, 2006, we closed an initial public offering of our common stock consisting of 11,385,000 shares of common stock. Of these shares, 4,950,000 +were newly issued shares sold by us and 6,435,000 were existing shares sold by the selling stockholders, including 1,485,000 shares pursuant to an exercise by the underwriters of their +over-allotment option. The offering was effected pursuant to a Registration Statement on Form S-1 (File No. 333-127526), which the SEC declared +effective on February 8, 2006. Piper Jaffrey & Co. and Thomas Weisel Partners, LLC acted as managing underwriters. +The +public offering price was $21.00 per share and $239.1 million in the aggregate. Underwriting discounts and commissions were $1.42 per share and $16.2 million in the +aggregate. Proceeds before expenses to us were $19.58 per share and $96.9 million in the aggregate. Proceeds, before expenses, to the selling stockholders were $19.58 per share and +$126.0 million in the aggregate. +We +did not receive any of the proceeds from the sale of shares by selling stockholders or on any exercise of the underwriters' over-allotment option. The net proceeds +received by us in the offering were $96.9 million as follows: +Aggregate offering proceeds to the Company +$ +103.9 million +Underwriting discounts and commissions +7.0 million +Finders fees +-0- +Total expenses (estimated) +7.0 million +Net proceeds to the Company +$ +96.9 million +22 +We +used approximately $9.7 million of the proceeds from the offering to repay all amounts outstanding under our revolving credit facility and Canadian bank loans, +$3.5 million to expand and upgrade our existing information technology systems and the remaining proceeds for general corporate purposes including capital investment and working capital. +Conversion of Membership Units to Shares of Common Stock +In February 2004, we reclassified all of the outstanding membership interests and non-voting profit sharing interests of our predecessor +limited liability company held by eight employees and investors by converting such interests into 72,000 Class A and Class B membership units. In connection with our conversion from a +limited liability company to a corporation, on January 4, 2005, we converted all of the outstanding Class A and Class B membership units of our predecessor company into 24,981,454 +shares of our common stock and all of the outstanding Class C membership units of our predecessor company into 7,452,492 shares of our Series A preferred stock. These conversions were +determined by our management to be exempt from registration under the Securities Act of 1933, as amended, in reliance on Section 3(a)(9) or in reliance on Section 4(2) of the Securities +Act because the issuance of securities to the recipients on conversion did not involve a public offering. +Recent Sales of Unregistered Securities +On March 1, 2005, we issued 233,620 shares of our common stock as compensation to a consultant for services valued at $360,438. +On +April 27, 2005, we granted the right to receive 1,717,342 shares of our common stock in the future to employees and executive officers under our 2005 Equity Incentive Plan +pursuant to restricted stock award agreements. The recipients of these awards will be issued the shares as compensation for services at various dates in the future and will not be required to pay a +purchase price for the shares. +Between +June 29, 2005 and July 1, 2005, we issued 427,992 shares of our common stock as compensation to employees, executive officers and consultants pursuant to the terms +of restricted stock award agreements for services valued at $2,125,120 in the aggregate. +On +September 1, 2005, we issued 70,086 shares of our common stock as compensation to an employee and an executive officer pursuant to the terms of restricted stock award +agreements for services valued at $501,100 in the aggregate. +On +October 1, 2005, we issued 137,097 shares of our common stock as compensation to an employee and two executive officers pursuant to the terms of restricted stock award +agreements for services valued at $1,472,950 in the aggregate. +On +each of November 1, 2005 and December 1, 2005 we issued 4,868 shares of our common stock to our chief executive officer as compensation for services pursuant to the +terms under a restricted stock award agreement. The shares were valued at $204,456 in the aggregate. +We +believe the offers, sales and issuances of our equity securities described above were exempt from registration under the Securities Act in reliance on Rule 701 because the +transactions were under compensatory benefit plans and contracts relating to compensation as provided under such rule or in reliance on Section 4(2) of the Securities Act because the +issuance of securities to the recipients did not involve a public offering. The recipients of such equity securities were our employees, directors or bona fide consultants and received the securities +as compensation for services. Appropriate legends have been affixed to the securities issued in these transactions. Each of the recipients of securities in these transactions had adequate access, +through employment, business or other relationships, to information about us. +23 +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, as of December 31, 2005, we reserved 2,923,754 shares of common stock for future issuance on exercise of outstanding options +under equity compensation plans. +Number of Securities +to be Issued on +Exercise of +Outstanding Options +Weighted Average +Exercise Price of +Outstanding +Options +Number of Shares Remaining +Available for Issuance Under +Equity Compensation Plans, +Excluding Securities Available +in First Column +Equity compensation plans approved by stockholders(1) +1,638,844 +$ +6.33 +4,201,656 +(3) +Equity compensation plans not approved by stockholders(2) +1,284,910 +1.02 +— +(1) On +April 27, 2005, our board of directors adopted the 2005 Equity Incentive Plan, referred to as the 2005 Plan. On January 10, 2006, our board of directors amended the +2005 Plan to increase the number of shares of our common stock available for issuance under the 2005 Plan from 5,840,500 shares to 7,008,600 shares. The 2005 Plan provides for the grant of incentive +stock options, within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, to our employees, and nonstatutory stock options, restricted stock, performance units, and +other stock based awards to our employees, directors, and consultants. +(2) Represents +non-plan stock options granted to our officers, directors and employees prior to the adoption of the 2005 Equity Incentive Plan. +(3) Includes +1,072,433 shares of common stock reserved for issuance under our 2005 Plan to employees and consultants in the future under restricted stock award agreements. +ITEM 6. Selected Financial Data +The following table presents selected historical financial data of Crocs, Inc. and subsidiaries for each of the years in the four-year period +ended December 31, 2005. We were founded in 1999 but did not commence operations until 2002, when we began selling footwear in the U.S. As a result, there were no material operations prior to +2002. This data was derived from our audited consolidated financial statements and reflects our operations and financial position at the dates and for the periods indicated, with the exception of the +summary financial data presented below under the heading "Consolidated Balance Sheet Data" as of and for the year ended December 31, 2002, which was derived from our unaudited consolidated +financial statements. The information in this table should be +24 +read +with the consolidated financial statements and accompanying notes and other financial data included herein. +Year Ended December 31, +2002(1) +2003 +2004(2) +2005(2) +(in thousands, except share and per share data) +Consolidated Statements of Operations Data +Revenues +$ +24 +$ +1,165 +$ +13,520 +$ +108,581 +Cost of sales (including stock-based compensation expense of $—, $—, $— and $84 respectively) +16 +891 +7,162 +47,773 +Gross profit +8 +274 +6,358 +60,808 +Operating Expenses +Selling, general and administrative (including stock-based compensation expense of $240, $356, $1,792 and $4,673 respectively) +453 +1,471 +7,929 +33,916 +Income (loss) from operations +(445 +) +(1,197 +) +(1,571 +) +26,892 +Interest expense +— +3 +47 +611 +Other (income) expenses—net +— +— +19 +(8 +) +Income (loss) before income taxes +(445 +) +(1,200 +) +(1,637 +) +26,289 +Income tax expense (benefit) +— +— +(143 +) +9,317 +Net income (loss) +(445 +) +(1,200 +) +(1,494 +) +16,972 +Dividend on redeemable convertible preferred shares(3) +— +— +142 +275 +Net income (loss) attributable to common stockholders +$ +(445 +) +$ +(1,200 +) +$ +(1,636 +) +$ +16,697 +Income (loss) per common share: +Basic +$ +(0.05 +) +$ +(0.06 +) +$ +(0.07 +) +$ +0.51 +Diluted +$ +(0.05 +) +$ +(0.06 +) +$ +(0.07 +) +$ +0.51 +Weighted average common shares: +Basic +8,288,710 +20,855,385 +24,641,953 +25,493,577 +Diluted +8,288,710 +20,855,385 +24,641,953 +33,570,000 +As of December 31, +2002(1) +2003 +2004 +2005 +(in thousands) +Consolidated Balance Sheets Data +Cash and cash equivalents +$ +73 +$ +326 +$ +1,054 +$ +4,787 +Total assets +454 +1,304 +16,224 +78,032 +Long term obligations +— +400 +3,660 +5,513 +Redeemable common shares +— +1,800 +1,800 +1,800 +Redeemable convertible preferred stock +— +— +5,500 +5,500 +Total stockholders' equity (deficit) +389 +(1,642 +) +(3,591 +) +18,914 +(1) We +were founded in 1999 but did not commence operations until 2002, when we began selling footwear in the United States. As a result, there were no material operations prior to 2002. +(2) On +January 4, 2005, we converted from a limited liability company to a taxable corporation. For the tax years beginning on January 1, 2005 and afterward, we will be +subject to corporate-level U.S. federal, state and foreign income taxes. The statement of operations for the year ended December 31, 2005 reflects a one-time income tax benefit of +$797,000 to record the net deferred tax assets at the date of conversion. The income tax benefit recognized in 2004 represents the tax benefit recognized by Foam Creations subsequent its acquisition. +(3) Dividends +accrued in 2004 were paid to holders of our Class C convertible preferred membership units. Our Class C membership units were converted into shares of our +Series A preferred stock in connection with our conversion from a limited liability company to a corporation on January 4, 2005. +25 +ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations +The following discussion should be read in conjunction with our consolidated financial statements and notes thereto included elsewhere in +this report. The following discussion contains certain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from the results anticipated in these +forward-looking statements as a result of the factors set forth in this report, including those set forth under Item 1A, "Risk Factors." +Overview +We are a rapidly growing designer, manufacturer and marketer of footwear for men, women and children under the crocs brand. We have been +marketing and distributing footwear products since November 2002, shortly after completing the modification and +improvement of a shoe produced by Foam Creations. In June 2004, we acquired Foam Creations, including its manufacturing operations, product lines and rights to the proprietary +closed-cell resin, which we refer to as croslite . All of our footwear +products incorporate croslite , which enables us to produce a soft and lightweight, non-marking, slip- and +odor-resistant shoe that retails at attractive price points ranging from $19.99 to $59.99. In addition to our footwear products, we recently introduced a line of crocs -branded apparel and accessory +items. We also use croslite to manufacture non-branded +products that we sell to original equipment manufacturers. +On +February 13, 2006, we completed an initial public offering of our common stock in which we sold 4,950,000 shares and our selling shareholders sold 6,435,000 shares. Our net +proceeds from the offering totaled approximately $96.9 million, after payment of underwriters' commissions and offering expenses. We used the net proceeds from the offering to repay all amounts +outstanding under our amended and restated credit facility and amounts outstanding under Foam Creations loans from the National Back of Canada and for capital expenditures related to increasing our +manufacturing capacity and infrastructure improvements as well as to develop our international operations and increase our marketing activities. We did not receive any of the proceeds from the sale of +shares of our common stock by the selling shareholders. +We +currently sell our crocs -branded products throughout the U.S. and in over 40 countries worldwide. Outside the U.S., we sell our products directly to retailers, or through +distributors where we believe they offer a preferable alternative to direct sales. We also sell directly to consumers through our website and our company-operated kiosks. The broad appeal of our +footwear has allowed us to market our products to a wide range of distribution channels in the U.S., including traditional footwear retailers as well as a variety of specialty channels. As of +December 31, 2005, our retail customer base in the U.S. included over 3,400 accounts that represented over 6,500 retail store locations selling our products. +We +have achieved significant growth since our inception, driven largely by the popularity of our footwear products and our ability to significantly expand the breadth and depth of our +distribution network. Since we started marketing our first footwear model in November 2002, we have increased our unit volumes from 76,000 pairs of footwear sold in 2003 to 649,000 pairs of +footwear sold in 2004. We sold 6.0 million pairs of footwear in the year ended December 31, 2005. As a result, our revenues have increased from $1.2 million in 2003 to +$13.5 million in 2004 and $108.6 million in 2005. Our net loss for the year ended December 31, 2003 was $1.2 million compared to a loss of $1.5 million for the year +ended December 31, 2004 and net income of $17.0 million for the year ended December 31, 2005. Continued growth of our revenues and profitability will depend substantially on the +continued popularity of our existing footwear products, our ability to continue to introduce new models of footwear that meet the evolving demands of our retail customers and end consumers, our +ability to effectively manage our sales and distribution network, and our ability to maintain sufficient product supply to meet expected growth in demand. +26 +We +have achieved strong gross profit margins since commencing sales of our crocs footwear. For the year ended December 31, 2005, our gross profit was $60.8 million, or 56.0% of revenues, compared +to +$6.4 million, or 47.0% of revenues, for the year ended December 31, 2004. We believe a number of factors have contributed to our ability to achieve gross profit margins at these levels. +Generally, we have not discounted the purchase price of our crocs footwear due to high levels of demand for our products. Additionally, our use of third party manufacturers as well as company-operated +manufacturing facilities has allowed us to maintain a relatively low cost structure while enabling us to achieve significant production flexibility. However, gross profit margins will be affected by +our ability to accurately forecast demand and avoid excess inventory, our ability to control our supply, manufacturing and distribution costs, and by changes in the mix of products we sell. +We +currently manufacture our footwear products and accessories, and all of our non-branded products for original equipment manufacturers, at Foam Creations' facility in +Quebec City, Canada. We also manufacture our footwear products at our company-operated facility located in Mexico. In addition, we contract with third party manufacturers in China, Florida and Italy +for the production of our footwear products, and we expect to initiate production in the first quarter of 2006 at a facility in Romania operated by one of our existing third party manufacturers. We +believe our in-house production capabilities enable us to make rapid changes to manufacturing schedules, providing us the flexibility to quickly ship in-demand models and +colors, while outsourcing allows us to lower our capital investment and retain the cost-effectiveness of using third party manufacturing. +The +popularity of our footwear has often resulted in our inability to produce shoes in sufficient volumes to satisfy the demands of our retail customers and consumers. We have been +attempting to meet this demand by actively expanding our company-operated manufacturing capacity, as well as increasing the number of shoes produced for us by third party manufacturers. During 2006, +we intend to expand our manufacturing capacity at the facility we operate in Mexico, in addition to adding third party manufacturing capacity in Romania. We also recently expanded production capacity +at our third party manufacturers located in China. In the event we are successful in further growing our brand and increasing sales of our products, we will need to continue to increase our supply of +raw materials and our manufacturing capacity in our company-owned and third party facilities, as well as handle increased shipments through our distribution facilities. +We +intend to continue to diversify our product line with new footwear models in order to capitalize on a growing market for casual lifestyle footwear. Successful introduction of new +products will require us to identify and address changing consumer preferences and will also require us to devote additional resources to product development and marketing. In addition, in order to +capitalize on what we believe to be a growing market for our products, we intend to expand our distribution network and increase sales to our existing retail customers, which will require us to expand +our sales and marketing activities. +Revenues +are recorded when products are shipped and the customer takes title and assumes risk of loss, collection of related receivables are probable, persuasive evidence of an +arrangement exists and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer depending on the country of the sale and the agreement with the customer. +Allowances for estimated returns and discounts are recognized when related revenue is recorded. Because we use internal manufacturing as well as contract with third parties to manufacture our +products, our cost of sales +represents our costs to manufacture products in our own facilities, including raw materials costs and all overhead expenses related to production, as well as the cost to purchase finished products +from our third party manufacturers. Cost of sales also includes the cost to transport these products to our facilities and all warehouse and outbound freight expenses. Our selling, general and +administrative expense consists primarily of selling, marketing, wages and related payroll and employee benefit costs, travel and insurance expenses, research and development costs, depreciation, +amortization, professional fees, facility expenses, bank charges and non-cash charges for stock based compensation. +27 +We were organized as a limited liability company and until January 4, 2005 were treated as a partnership for U.S. federal and state income tax purposes for each of the tax years +ended December 31, 2003 and 2004. Under U.S. tax law, partnerships are treated as pass-through entities and are not subject to direct taxation. However, partners are subject to +income tax on their allocable share of the partnership's income. On January 4, 2005, we converted from a limited liability company to a taxable corporation. For tax years beginning on +January 1, 2005 and afterward, we will be subject to corporate-level U.S. federal and state and foreign income taxes. +Effect of Future Amortization of Deferred Compensation +We adopted SFAS No. 123(R) as of January 1, 2006 using the prospective method for option grants and restricted stock issued prior to +August 15, 2005, which was the date we filed a Registration Statement on Form S-1 and the modified prospective method for option grants issued after August 15, 2005. Estimated +stock based compensation for 2006 related to stock options and restricted stock oustanding as of December 31, 2005 will be approximately $5.4 million. +Acquisition of Foam Creations +Foam Creations has developed and manufactured consumer products from specialty resins since 1995. In November 2002, we began marketing and distributing in +the U.S., under the crocs brand, a footwear model that was manufactured by Foam Creations. Due to the popularity of this shoe and our successful launch in the U.S., we +expanded our sales infrastructure, strengthened our senior management team and developed relationships with a range of retailers in the U.S. In June 2004, we acquired Foam Creations, including +its manufacturing operations, product lines and rights to the trade secrets for croslite for a total cash purchase price of $5.2 million and the +assumption of $1.7 million of long-term debt. To fund our purchase of Foam Creations, we issued $5.5 million of preferred securities in connection with the acquisition. The +consolidated financial statements referred to in this report reflect the acquisition of Foam Creations as of June 29, 2004, the date of acquisition. +As +a result of the acquisition, our consolidated statements of operations included amortization of intangible assets related to the acquisition. In addition, as a result of purchase +accounting, the fair values of Foam Creations's assets on the date of the acquisition became their new "cost" basis. Expenses attributable to amortization of intangible assets resulting from the +acquisition will continue to +adversely affect our results of operations in the future. As set forth in Note 6 to the consolidated financial statements included in this report, the estimated expense of amortizing these +intangible assets is approximately $1.0 million annually in 2005 through 2008, $600,000 in 2009 and $400,000 thereafter. +Seasonality +Due to our short operating history and significant sales growth since our inception, we cannot assess with certainty the degree to which sales of our footwear +products will be subject to seasonality. However, we expect that our business, similar to other vendors of footwear and related merchandise, will be subject to seasonal variation. We believe many +vendors that market footwear products suited for warm weather normally experience their highest sales activity during the second and third quarters of the calendar year. Our revenues for the three +months ended December 31, 2005 were lower than our revenues for the three months ended September 30, 2005, and we believe that the decline was primarily attributable to a seasonal +decline in the demand for our products. While we have introduced footwear models that are more suitable for cold weather uses, such as the Aspen, Highland and the Georgie, we expect that demand for +our products, and therefore our sales, may continue to be subject to seasonal variations and significantly impacted by weather conditions, as 86.7% of shoes sold during 2005 were Beach and Cayman +models, models more suitable for warm weather. In addition, our quarterly results of operations may fluctuate significantly as a result of a variety of other factors, including the timing of new model +introductions or general economic or consumer conditions. Accordingly, results for any one +28 +quarter +are not necessarily indicative of results to be expected for any other quarter or for any year, and revenues for any particular period may decrease. +Results of Operations +Comparison of the Year Ended December 31, 2005 and 2004 +Revenues. Revenues increased $95.1 million, to $108.6 million, in the year ended December 31 2005, from +$13.5 million in the year ended December 31, 2004. This increase was primarily a result of significantly +higher unit sales of our footwear products, which increased to 6.0 million pairs for the year ended December 31, 2005, from 649,000 pairs for the year ended December 31, 2004. The +higher unit sales resulted from an increase to 8,000 retail stores domestically and internationally selling our products and stronger sales to our existing customers. During the year ended +December 31, 2005, our results included revenues of $5.2 million from sales by Foam Creations. Revenues from sales by Foam Creations that were included in our results of operations for +the date of acquisition to December 31, 2004 were $2.7 million. We expect our sales to continue to grow and our revenues to increase as we enter new markets and introduce new products. +In addition, our revenues from sales outside of North America were $5.8 million in the year ended December 31, 2005 and we expect our revenues from international sales to increase in the +future. +Gross profit. Gross profit increased $54.4 million, to $60.8 million, in the year ended December 31, +2005, from $6.4 million in the year ended December 31, 2004. Our gross profit margin improved to 56.0% in the year ended December 31, 2005, from 47.0% in the year ended +December 31, 2004. The increase in gross profit margin was due primarily to lower unit costs resulting from the addition of a third party manufacturer located in China, partially offset by +higher freight and duty costs, from which we did not obtain footwear products in the year ended December 31, 2004. +Selling, general and administrative expense. Selling, general and administrative expense increased $26.0 million, to +$33.9 million in the year ended December 31, 2005, from $7.9 million in the year ended December 31, 2004. This increase was primarily a result of higher costs associated +with increased sales volumes, including an increase in selling and marketing expenses of $6.9 million, increases in personnel expenses of $7.4 million. In addition, professional and +consulting fees increased approximately $2.5 million, primarily as a result of increased legal fees, as well as settlement costs with consultants. In addition, stock-based compensation expense +was $4.8 million for the year ended December 31, 2005, compared to $1.8 million for the year ended December 31, 2004. As a percentage of revenues, selling, general and +administrative expense decreased to 31.2% in the year ended December 31, 2005, from 58.6% in the year ended December 31, 2004, primarily due to substantially higher revenues in 2005. +Interest expense. Interest expense was $611,000 in the year ended December 31, 2005, compared to $47,000 in the year +ended December 31, 2004. The increase is related to the interest expense associated with the indebtedness incurred under our line of credit during 2005 and the long term debt at our subsidiary +Foam Creations, which we acquired in June 2004. +Other income/expense, net. Other income was $8,000 in the year ended December 31, 2005, compared to expense of $19,000 +in the year ended December 31, 2004, which primarily related to a minority interest associated with Foam Creations, which was acquired in June 2004 and an increase in interest income +related to the increase in cash and cash equivalents. +Income tax expense (benefit). In the year ended December 31, 2005, income tax expense was $9.3 million, +representing an effective income tax rate of 35%, compared to a benefit of $143,000 in the year ended December 31, 2004. In the year ended December 31, 2004, we were not a +tax-paying entity for U.S. income tax purposes and therefore did not record any income tax expense for the U.S. entity for this period. However, we acquired Foam Creations, a Canadian +corporation, in June 2004. During +29 +the +period subsequent to the acquisition, Foam Creations recorded a tax benefit of $143,000. We recognized a tax benefit of $797,000 in the year ended December 31, 2005 to establish our +deferred tax assets in connection with the conversion from a limited liability company to a taxable corporation. +Dividends on redeemable convertible preferred stock. Dividends on our outstanding redeemable convertible preferred stock were +$275,000 for the year ended December 31, 2005 compared to $142,000 for the year ended December 31, 2004. We first issued equity with preferred liquidation and dividend rights in +June 2004, when we sold our Class C membership units. In connection with our conversion from a limited liability company to a corporation, our Class C membership units converted +into shares of our Series A preferred stock. Our Series A preferred stock provides for a dividend at the rate of five percent per annum on the initial investment amount per share. The +Series A preferred stock converted into shares of our common stock in connection with the closing of the initial public offering on February 13, 2006. +Comparison of the Years Ended December 31, 2004 and 2003 +Revenues. Revenues increased $12.3 million, to $13.5 million, in 2004 from $1.2 million in 2003, +primarily as a result of higher unit sales. Sales of our footwear products increased to 649,000 pairs in 2004 from 76,000 pairs in 2003. The higher sales volume in 2004 was primarily a result of the +popularity of our Beach model and an increase to 2,400 retail stores selling our products. Our results in 2004 include $2.7 million of revenues from sales by Foam Creations of our +non-branded products, which we acquired in June 2004. +Gross profit. Gross profit increased by $6.1 million, to $6.4 million, in 2004, from $274,000 in 2003. Gross +profit margin improved to 47.0% in 2004 from 23.5% in 2003. The increase in gross profit margin was due primarily to lower unit costs associated with production efficiencies resulting from higher +sales volumes. Gross profit margin for our non-branded products sold by Foam Creations was approximately 40.0% for the six months ended December 31, 2004. +Selling, general and administrative expense. Selling, general and administrative expense increased $6.4 million, to +$7.9 million, in 2004, from $1.5 million in 2003. This increase was primarily a result of higher costs associated with increased sales volumes, including an increase in selling and +marketing expenses of $2.3 million, personnel expenses of $1.6 million, a portion of which was included in selling and marketing expenses, and the associated facility expansion costs of +$125,000 required to support our growth. The absorption of Foam Creations selling, general and administrative expense contributed an additional $1.5 million to this increase of which $487,000 +relates to the amortization of intangibles associated with this acquisition. Depreciation and amortization expense increased to $586,000 in 2004 from $18,000 in 2003, primarily as a result of +amortization of intangibles associated with our acquisition of Foam Creations. Stock-based compensation expense was $1.8 million in 2004 compared to $356,000 in 2003. This increase was due to a +greater number of awards granted to employees, directors and consultants, along with higher equity values for such awards. Additionally, a number of awards were granted in 2004 with immediate vesting, +and as a result, we recognized the entire expense associated with those grants at the time of the grant. As a percentage of revenues, selling, general and administrative expense decreased to 58.6% in +2004 from 126.3% in 2003, largely due to substantially higher revenues generated in 2004. +Interest expense. Interest expense was $47,000 in 2004, compared to $3,000 in 2003. The increase in interest expense was +primarily the result of an increase in long term debt that was assumed as part of our acquisition of Foam Creations in June 2004. +Other expense, net. Other expense was $19,000 in 2004, and we did not recognize any other income or expenses, net, in 2003. +The increase in other income was primarily related to a minority interest that arose after our acquisition of Foam Creations in June 2004. +30 +Income tax expense (benefit). We recorded a tax benefit of $143,000 in 2004, compared to no recorded tax benefit or expense +in 2003. Prior to our conversion from a limited liability company to a corporation on January 4, 2005, we were not a taxpaying entity for U.S. federal and state income tax purposes. However, we +acquired Foam Creations, a Canadian corporation, in June 2004. During the period subsequent to the acquisition, Foam Creations recorded a tax benefit of $143,000. +Dividends on redeemable convertible preferred stock. Dividends on our Class C membership units were $142,000 in 2004. +No dividends were recorded in 2003. We sold Class C membership units in June and July 2004 that provided for a dividend at the rate of five percent per annum on the initial investment +amount per share. +Liquidity and Capital Resources +Our principal sources of liquidity have been sales of our securities, borrowings under our credit facility and cash provided by operating activities. We raised a +total of $7.1 million, which is net of repurchases of $162,000, from the sale of equity interests and units from 2002 through 2004. As of December 31, 2005, there was $5.9 million +in outstanding borrowings on our secured revolving credit facility, as discussed below. Foam Creation also borrowed $3.0 million in 2005. The remainder of our liquidity needs have been met from +cash provided by operating activities of $10.5 million through December 31, 2005. +Our +principal uses of cash have been for our acquisition of Foam Creations in June 2004 for $5.2 million, for the distribution in April 2005 of $3.0 million +in cash to the members of our predecessor limited liability company pursuant to the operating agreement for that entity, for the purchase of our manufacturing operation in Mexico and associated +operating assets in April 2005 for approximately $1.3 million, and for capital expenditures of $11.5 million through December 31, 2005. +The +significant components of our working capital are cash, accounts receivable and inventory, reduced by accounts payable and accrued expenses. Capital requirements related to +manufacturing include compounding and injection molding equipment for facilities we operate, as well as footwear molds used in our company-operated facilities or purchased for our third party +manufacturers. +Cash +provided by, or used in, operating activities consists primarily of net income or net loss adjusted for certain non-cash items including depreciation, amortization, +deferred income taxes, provision for bad debts, stock compensation expense and for the effect of changes in working capital and other activities. Cash provided by operating activities in the year +ended December 31, 2005 was $10.5 million and was primarily related to net income of $17.0 million plus non-cash items of depreciation and amortization of +$3.3 million and equity-based compensation expense of $4.8 million, partially offset by increases in working capital resulting from significant increases in prepaid expenses and other +assets of $3.5 million, inventory of $26.0 million and accounts receivable of $15.2 million offset by increases in accounts payable of $17.7 million and accrued and other +liabilities of $14.0 million, all related to our sales growth and expanded operations. Cash provided by operating activities in 2004 was $777,000, primarily related to non-cash +expenses for stock-based compensation of $1.8 million and depreciation and amortization of $700,000 that offset our net loss of $1.5 million. Cash used in operating activities was +$439,000 in 2003, primarily related to a loss from operations offset by working capital changes. +Cash +used in investing activities for the year ended December 31, 2005 was $12.2 million, which was related to capital expenditures for molds, machinery and equipment of +$11.5 million and $636,000 related to the acquisition of a non-compete agreement. Cash used in investing activities in 2004 was $6.7 million, primarily related to the +acquisition of Foam Creations for $5.2 million and capital expenditures of $1.6 million related to an increase in our manufacturing capacity. Cash used in investing activities was +$321,000 in 2003, related to capital expenditures. +31 +Cash +provided by financing activities was $5.5 million for the year ended December 31, 2005, primarily as a result of $5.9 million borrowed against our secured +revolving credit facility and $3.0 million in borrowings at Foam Creations partially offset by a $3.0 million cash distribution to our members. Cash provided by financing activities was +$6.6 million in 2004, consisting primarily of $6.0 million in equity financing, and the remainder from indebtedness incurred in connection with purchases of capital equipment. Cash +provided by financing activities was $1.0 million in 2003 related to $625,000 in equity financing and $400,000 of member loan proceeds. +On +April 8, 2005 we entered into a $5.0 million secured revolving credit facility, and on October 26, 2005 we entered into an amended and restated credit facility +increasing the amount available under the original facility to $20.0 million. As of December 31, 2005, we had $5.9 million in borrowings outstanding under the amended and restated +credit facility. We used a portion of the proceeds of borrowings under the credit facility to fund a cash distribution of $3.0 million which was declared to members as of December 31, +2004 of our predecessor limited liability company pursuant to the operating agreement for that entity, and of the remaining $2.9 million, we used $1.3 million for the purchase of our +manufacturing operation in Mexico and associated operating assets in April 2005 and $1.6 million for working capital purposes. The effective annual interest rate, on borrowings +outstanding under the credit facility was 7.25% as of December 31, 2005. Our obligations under the revolving credit facility were secured by substantially all of our property, including, among +other things, our accounts receivable, inventory, equipment and fixtures. The credit facility also contained financial covenants that required us to meet a specified consolidated fixed charge coverage +ratio and specified levels of consolidated EBITDA. The credit facility was subject to an early termination fee of 1% if we terminated the facility on or prior to October 26, 2006. In +February 2006 we repaid all amounts outstanding under the credit facility, together with accrued interest thereon, with a portion of the proceeds from our initial public offering. The repayment +totaled $3.9 million. +As +of October 31, 2005, we were not in compliance with several covenants in our revolving credit facility including the EBITDA and capital expenditure covenants. With respect to +our EBITDA covenant, we failed to achieve the minimum EBITDA threshold required by our revolving credit facility for October 2005; and with respect to our capital expenditure covenant, our +expenditures in October 2005, when aggregated with our other capital expenditures in 2005, surpassed the total amount of annual capital expenditures permitted under our revolving credit +facility. On January 18, 2006, we received a waiver of our non-compliance with these covenants. +Foam +Creations, a wholly subsidiary, has a demand note payable from a bank in the amount of up to $2.1 million, bearing interest at base rate plus 0.50% (actual rate of 5.00% at +December 31, 2005). At December 31, 2004 and 2005, $655,000 and $2.0 million, respectively, were outstanding on the loan. Foam Creations also has an authorized credit line of +$300,000 for currency exchanges. No amounts were outstanding on this line as of December 31, 2005. The bank loan is secured by the accounts receivable and inventories associated with its +Canadian operations. Annually the note payable is required to be renewed by the bank taking place in April. Under the terms of the bank loans, Foam Creations must satisfy certain restrictive covenants +as to minimum financial ratios. Foam Creations was not in compliance with these covenants as of December 31, 2005 and has obtained a waiver from the banks. +On +February 13, 2006, we completed an initial public offering of 11,385,000 shares of common stock at a price to the public of $21.00 per share, of which 4,950,000 shares were +sold by us and 6,435,000 were sold by certain selling stockholders, including 1,485,000 shares that were sold by the selling stockholders pursuant to the underwriters' over-allotment +option. On completing the offering, we received net proceeds of approximately $96.9 million. We used to use the proceeds to repay amounts outstanding under its U.S. credit facility and Canadian +bank loans and for working capital and general corporate purposes. +32 +Beginning +in 2005, we were required to pay income taxes due to the conversion from an LLC to a corporation in January 2005. As we continue to grow, our future cash needs for +income taxes will increase accordingly. +In +connection with our initial public offering, a series of transactions took place including the conversion of redeemable convertible preferred shares to common shares, the put options +on the redeemable common shares were terminated, and 4,950,000 common shares were issued in the offering. In January 2005 we converted from a limited liability company to a corporation and the +unaudited pro forma data presented below gives effect to these transactions as if they occurred at the beginning of the year ended December 31, 2004 (in thousands, except share and per share +data). +December 31, +2004 +2005 +Pro forma net income (loss) and income (loss) for pro forma dilutive computation +$ +(1,494 +) +$ +16,972 +Unaudited pro forma income tax benefit +(441 +) +— +Unaudited pro forma net income (loss) attributable to common stockholders +$ +(1,053 +) +$ +16,972 +Basic pro forma income (loss) per common share: +Weighted average common shares outstanding +24,641,953 +25,493,577 +Conversion of redeemable convertible preferred shares to common shares +7,452,492 +7,452,492 +Common shares issued in initial public offering +4,950,000 +4,950,000 +Pro forma weighted average common shares outstanding +37,044,445 +37,896,069 +Basic pro forma income (loss) per common share +$ +(0.03 +) +$ +0.45 +Diluted pro forma income (loss) per common share: +Pro forma weighted average common shares outstanding +32,094,445 +32,946,069 +Common shares issued in initial public offering +4,950,000 +4,950,000 +Dilutive effect of stock options +— +220,034 +Dilutive effect of unvested stock +— +403,897 +Weighted average diluted common shares outstanding +37,044,445 +38,520,000 +Diluted income per common share +$ +(0.03 +) +$ +0.44 +33 +Contractual Obligations and Commercial Commitments +The following table describes our commitments to settle contractual obligations as of December 31, 2005: +Payments due by period +Total +Less than +1 year +1-3 years +3-5 years +More than 5 +years +Notes payable +$ +7,957 +$ +7,957 +$ +— +$ +— +$ +— +Long-term debt(1) +3,759 +546 +1,625 +1,094 +494 +Operating leases(2) +2,197 +1,578 +589 +30 +— +Capital leases +331 +101 +230 +— +— +Redeemable common shares(3) +808 +808 +— +— +— +Redeemable convertible preferred shares(4) +5,500 +— +— +5,500 +— +Purchase obligations +1,425 +900 +525 +— +— +Contractual severance commitment +504 +168 +336 +— +— +Total contractual obligations +$ +22,481 +$ +12,058 +$ +3,305 +$ +6,624 +$ +494 +(1) Loan +with Development Bank of Canada including estimated interest based on current London InterBank Offered Rate ("LIBOR") plus 3.3%. +(2) Operating +leases for real property, vehicles, and equipment, excluding operating leases entered into after December 31, 2004 totaling $714,000 of future cash commitments. +(3) The +redeemable common shares are redeemable commencing in the second quarter of 2006 at the option of the holder. Under the terms of the agreements under which such shares were +issued, the purchase price is the greater of the holder's original investment or the holder's then current percentage ownership in Crocs, Inc., multiplied by the aggregate of the prior three +fiscal years' net income. The amount in this table represents the original investment which is our current contractual obligation. The redemption option associated with these shares was terminated in +connection with our initial public offering. +(4) Excludes +dividends payable of $275,000 per year on shares of our Series A preferred stock, which is redeemable commencing on July 1, 2009 at the option of a majority the +holders, to the extent not previously converted. All outstanding shares of Series A preferred stock were converted to common stock in connection with our initial public offering. +Critical Accounting Policies and Estimates +Our financial statements have been prepared in accordance with accounting principles generally accepted in the U.S., which require us to make estimates and +judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure at the date of our financial statements. On an ongoing basis, we evaluate our estimates +and judgments, including those related to revenue, intangible assets, and stock compensation. We base our estimates and judgments on historical experience and on various other factors that we believe +to be reasonable under the circumstances, the results of which form the basis of our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. +Actual results or changes in the estimates or other judgments of matters inherently uncertain that are included within these accounting policies could result in a significant change to the information +presented in the consolidated financial statements. We believe that the estimates and assumptions below are among those most important to an understanding of our consolidated financial statements +contained in this report. +34 +We +consider certain accounting policies related to revenue recognition, reserves for uncollectible accounts receivable and inventories, and stock-based compensation to be critical +policies due to the estimates and judgments involved in each. +Revenue Recognition. Our revenues are derived principally from wholesale sales to retailers. Our standard arrangement for our +customers includes a valid purchase order or contract with no customer acceptance provisions. We recognize revenues from sales of products when: +• we +enter into a legally binding arrangement with a customer; +• delivery +has occurred; +• customer +payment is deemed fixed or determinable and free of contingencies or significant uncertainties; and +• collection +is reasonably assured. +Title +passes generally on shipment or on receipt by the customer depending on the country of the sale and the arrangement with the customer. Allowances for estimated returns and claims +are provided for when related revenue is recorded. We base our estimates on historical rates of product returns and claims, and specific identification of outstanding claims and outstanding returns +not yet received from customers. Since inception, actual returns and claims have not exceeded our reserves. However, actual returns and claims in any future period are inherently uncertain and thus +may differ from our estimates. If actual returns and claims exceed reserves, we would need to reduce our revenues at the time of such determination. +Reserve for Uncollectible Accounts Receivable. We make ongoing estimates relating to the collectibility of our accounts +receivable and maintain a reserve for estimated losses resulting from the inability of our customers to make required payments. In determining the amount of the reserve, we consider our historical +level of credit losses and make judgments about the creditworthiness of significant customers based on ongoing credit evaluations. Since we cannot predict future changes in the financial stability of +our customers, actual future losses from uncollectible accounts may differ from our estimates. If the financial condition of our customers were to deteriorate, resulting in their inability to make +payments, a larger reserve might be required. In the event we determined that a smaller or larger reserve was appropriate, we would record a credit or a charge to selling, general and administrative +expense in the period in which we made such a determination. +Inventory Reserves. We also make ongoing estimates relating to the net realizable value of inventories, based on our +assumptions about future demand and market conditions. If we estimate that the net realizable value of our inventory is less than the cost of the inventory recorded on our books, we record a reserve +equal to the difference between the cost of the inventory and the estimated net realizable value. This reserve is recorded as a charge to cost of sales. If changes in market conditions result in +reductions in the estimated net realizable value of our inventory below our previous estimate, we would increase our reserve in the period in which we made such a determination and record a charge to +cost of sales. +Stock-Based Compensation. We have elected to follow the intrinsic value-based method prescribed by Accounting Principles +Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees , and the related interpretations in accounting for employee stock options +rather than adopting the alternative fair value accounting provided under SFAS No. 123, Accounting for Stock Based Compensation . Therefore, we do +not record any compensation expense for stock options we grant to our employees where the exercise price equals the fair market value of the stock options on the date of grant and the exercise price, +number of shares eligible for issuance under the options and vesting period are fixed. We comply with the disclosure provisions of SFAS No. 123 and SFAS No. 148, Accounting for Stock-Based +Compensation—Transition and Disclosure , which require that we disclose our +35 +pro +forma net income or loss and net income or loss per common share attributable to common stockholders as if we had expensed the fair value of the options. In calculating fair values of our options, +we use assumptions of estimated option life, dividend policy, volatility and interest rates. +The +fair value of equity units granted from October 2002 through December 2004 was originally estimated by our board of directors based on information available to them on +the dates of grant, including third party sales of equity units. We did not obtain contemporaneous valuations by valuation specialists because, at the time of the issuances of stock options during +this period, our efforts were focused on acquiring new customers, developing our operational infrastructure and executing our business plan. We engaged an independent third party valuation specialist +to perform a valuation of our common stock at December 31, 2004, May 1, 2005, June 31, 2005, August 1, 2005, December 1, 2005 and October 1, 2005 in +connection with the grant of options to purchase shares of our common stock to employees, consultants and members of our board of directors. The May 1, 2005 valuation was restated in the third +quarter of 2005 to adjust certain estimates based on our expected market value in the initial public offering. The original value of $3.38 per share was revised to $5.91 per share. Our estimates of +fair value of our stock are based on assumptions that we believe are reasonable. The fair value of our stock is affected by a number of assumptions and judgments including the timing of sales of +equity instruments, the negotiated value of those sales, the timing of our third party valuations and significant assumptions included in those valuations, including our estimates of our future +performance, discount factors used and comparable companies and transactions selected, among others. If we were to make different assumptions, the estimated value of our stock could differ materially +from our estimates. +As +discussed below under "Recent Accounting Pronouncements," the FASB has issued SFAS No. 123(R), which we implemented beginning January 1, 2006. On this implementation, we +will continue to account for any portion of awards outstanding prior to August 15, 2005, which was the date we initially filed a Registration Statement on Form S-1, at the date of +initial application using the accounting principles originally applied to those awards which were the provisions of Opinion 25 and its related interpretive guidance. For awards granted after +August 15, 2005, and to awards modified, repurchased, or cancelled after the required effective date, we will apply the provisions of SFAS No. 123(R). This will require us to estimate +the volatility of the price of our common stock, expected option life and expected forfeiture rates. +Recent Accounting Pronouncements +In November 2004, the FASB issued SFAS No. 151, Inventory +Costs — an amendment of ARB No. 43, Chapter 4 . SFAS No. 151 amends the guidance in ARB No. 43, +Chapter 4, Inventory Pricing , to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material +(spoilage), and requires that such items be recognized as current-period charges regardless of whether they meet the "so abnormal" criterion outlined in ARB No. 43. SFAS No. 151 also +introduces the concept of "normal capacity" and requires the allocation of fixed production overheads to inventory based on normal capacity of the production facilities. Unallocated overheads must be +recognized as an expense in the period incurred. SFAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005, and is required to be adopted +in the first quarter of fiscal year 2006. We do not anticipate the adoption of SFAS No. 151 will have a significant impact on our results of operations, financial condition or cash flows. +In +December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment , which is a revision of SFAS +No. 123. SFAS No. 123(R) supersedes APB Opinion No. 25, and amends SFAS No. 95, Statement of Cash Flows . Generally, the +approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of +employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. We adopted SFAS No. 123(R) on January 1, +2006. +36 +SFAS +No. 123(R) permits companies to adopt its requirements using various methods. We adopted the prospective method for all stock option grants issued prior to August 15, +2005, which was the date we initially filed a Registration Statement on Form S-1 in connection with our initial public offering. Under the prospective method, those nonpublic companies that +used the minimum value method of measuring equity share options and similar instruments for either recognition or pro forma disclosure purposes under Statement will apply SFAS No. 123(R) +prospectively to new awards and to awards modified, repurchased, or cancelled after the required effective date. We will continue to account for any portion of awards outstanding at the date of +initial application using the accounting principles originally applied to those awards which were the provisions of Opinion 25 and its related interpretive guidance. For stock option grants issued +after filing our Registration Statement on Form S-1 on August 15, 2005, the modified prospective method will be applied. Estimated stock based compensation for 2006 related to stock +options and restricted stock outstanding as of December 31, 2005 will be approximately $5.4 million. +In +December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets . The statement refines the measurement of +exchanges of non-monetary assets between entities. The provisions of this statement are effective for fiscal periods beginning after June 15, 2005. Historically, we +have not transacted significant exchanges of non-monetary assets, but future such exchanges would be accounted for under the standard, when effective. +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +We pay our overseas third party manufacturers in U.S. dollars and have not had significant revenues from foreign sales in past periods. Our ability to sell our +products in foreign markets and the U.S. dollar value of the sales made in foreign currencies can be significantly influenced by foreign currency fluctuations. A decrease in the value of foreign +currencies relative to the U.S. dollar could result in downward price pressure for our products or losses from currency exchange rates. We have performed a sensitivity analysis to estimate our +exposure to market risk of foreign exchange rates. If the U.S. dollar were to increase in value by 10%, the impact on international sales of $12.9 million during the year ended +December 31, 2005 would have been an increase in consolidated revenues by $841,000, net of tax. The volatility of the applicable rates and prices are dependent on many factors that cannot be +forecast with reliable accuracy. Therefore, actual changes in fair values could differ significantly from the results above. +In +the event our foreign sales increase and are denominated in currencies other than the U.S. dollar, our operating results may be affected by fluctuations in the exchange rate of +currencies we receive for such sales. In addition, if we pay foreign suppliers in currencies other than U.S. dollar, our operating expenses may be impacted by fluctuations in the exchange rate of +currencies in which we pay such expenses. +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the "Index To Consolidated Financial Statements" on page F-1. +ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +We have established disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Exchange Act to ensure that material +information relating to us, including our consolidated +37 +subsidiaries, +is made known to the officers who certify our financial reports and to other members of senior management and the board of directors. +There +has been no change in our internal control over financial reporting that occurred during our most recent quarter ended December 31, 2005 that has materially affected, or is +reasonably likely to materially affect, our internal control over financial reporting. +During +the first quarter of 2006, we have been taking actions to improve our internal control over financial reporting, including hiring additional experienced personnel in finance and +accounting and improve our IT systems to strengthen our accounting and financial reporting and consolidation capabilities. We expect that these actions will materially improve our internal controls. +Based +on their evaluation as of December 31, 2005, our chief executive officer and chief financial officer have concluded that our company's disclosure controls and procedures are +effective to ensure that the information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods +specified in SEC rules and forms. +ITEM 9B. Other Information +Not applicable. +PART III +ITEM 10. Directors and Executive Officers of the Registrant +Information +required by this item will be contained in our definitive Proxy Statement with respect to the 2006 Annual Meeting of Stockholders (the "2006 Proxy Statement") and is hereby incorporated by +reference thereto. +ITEM 11. Executive Compensation +Information +required by this item will be contained in the 2006 Proxy Statement and is hereby incorporated by reference thereto. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +Information +required by this item will be contained in the 2006 Proxy Statement and is hereby incorporated by reference thereto. +ITEM 13. Certain Relationships and Related Transactions +Information +required by this item will be contained in the 2006 Proxy Statement and is hereby incorporated by reference thereto. +ITEM 14. Principal Accountant Fees and Services +Information +required by this item will be contained in the 2006 Proxy Statement and is hereby incorporated by reference thereto. +38 +PART IV +ITEM 15. Exhibits and Financial Statement Schedules +(a) (1) Financial Statements +The financial statements filed as part of this report are listed on the index to financial statements on page F-1. +(2) Financial Statement Schedules +All financial statement schedules have been omitted because they are not required, are not applicable or the information is included in the Financial Statements +or Notes thereto. +(3) Exhibit list +Exhibit Number +Description +3.1** +Restated Certificate of Incorporation of Crocs, Inc. +3.2** +Amended and Restated Bylaws of Crocs, Inc. +4.1 +Reference is made to Exhibits 3.1 through 3.4. +4.2* +Specimen common stock certificate. +10.1*@ +Form of Indemnity Agreement between Crocs, Inc. and each of its directors and executive officers. +10.2*@ +Crocs, Inc. 2005 Equity Incentive Plan (the "2005 Plan"). +10.2.2*@ +Amendment No. 1 to the 2005 Plan. +10.3*@ +Form of Notice of Grant of Stock Option under the 2005 Plan. +10.4*@ +Form of Notice of Grant of Stock Option for Non-Exempt Employees under the 2005 Plan. +10.5*@ +Form of Stock Purchase Agreement under the 2005 Plan. +10.6*@ +Form of Stock Option Agreement under the 2005 Plan. +10.7*@ +Form of Restricted Stock Award Grant Notice under the 2005 Plan. +10.8*@ +Form of Restricted Stock Award Agreement under the 2005 Plan. +10.9*@ +Form of Non-Statutory Stock Option Agreement. +10.10* +Commercial Lease between DiiG, LLP and the Registrant dated as of December 26, 2004. +10.11* +Sublease between Flextronics USA, Inc. and the Registrant dated as of May 19, 2005. +10.12* +Lease Agreement between 9077-7152 Québec Inc. and Foam Creations dated as of August 17, 2005. +10.13* +Lease Agreement between Jose Pablo Hernandez Gonzalez and Crocs Mexico, S.de.R.L. de C.V. dated as of May 1, 2005, as amended in August, 2005, for the facility located in Emiliano Zapata, Primer Sector, No. 204, zona centro, C.P. 36400 in the +city of Purísima del Rincón, Guanajuato. +39 +10.14* +Stock Purchase Agreement among 4246519 Canada, Inc., Finproject Group S.p.A., 3107019 Canada, Inc. and Daniel J. Hunter dated as of June 29, 2004. +10.15* +Asset Purchase and Property Transfer Agreement between Hana Phylon Tech S.A. de C.V. and Crocs Mexico, S.de.R.L. de C.V. dated as of April 23, 2005. +10.16* +Asset Purchase and Property Transfer Agreement between St. Vrain Trading, LLC, d/b/a Crocs Hawaii, LLC and the Registrant dated May 19, 2005. +10.17* +Amended and Restated Credit Agreement between the Registrant and Bank of America, N.A., dated as of October 26, 2005. +10.18* +Amended and Restated Security Agreement between the Registrant and Bank of America, N.A., dated as of October 26, 2005. +10.19†* +Distribution Agreement between Crocodile Distribution and the Registrant dated as of April 1, 2005. +10.20* +Kiosk Agreement between Crocodile Kiosk, LLC and the Registrant dated as of July 1, 2005. +10.21†* +Amended and Restated Agreement for Supply between Finproject S.p.A. and the Registrant dated as of July 26, 2005. +10.22*@ +Separation and Release Agreement between George Boedecker and the Registrant dated as of January 1, 2005. +10.23*@ +Employment Letter Agreement of Caryn D. Ellison. +10.24*@ +Independent Contractor Agreement between Ronald Snyder and the Registrant dated as of October 1, 2003. +10.25* +Lease Agreement between Jose Pablo Hernandez Gonzalez and Crocs Mexico, S.de.R.L. de C.V. dated as of May 1, 2005, as amended in August, 2005, for the facilities located in Emiliano Zapata, Primer Sector, Nos. 208 and 212, zona centro, C.P. +36400 in the city of Purísima del Rincón, Guanajuato. +10.26* +First Amendment to Amended and Restated Credit Agreement, dated as of January 18, 2006, among Crocs, Inc., Crocs Retail, Inc., Western Brands Holding Company, Inc. and Bank of America, N.A. +10.27*@ +Offer Letter between Peter Case and the Registrant dated as of February 2, 2005. +10.28**@ +Nonstatutory Stock Option Agreement between the Registrant and Raymond D. Croghan dated September 1, 2004. +10.29**@ +Nonstatutory Stock Option Agreement between the Registrant and Michael E. Marks dated September 1, 2004. +10.30**@ +Nonstatutory Stock Option Agreement between the Registrant and Mark A. Retzloff dated September 1, 2004. +10.31**@ +Nonstatutory Stock Option Agreement between the Registrant and Ronald R. Snyder dated September 1, 2004. +10.32**@ +Nonstatutory Stock Option Agreement between the Registrant and Brad L. Stoffer dated September 1, 2004. +40 +10.33**@ +Nonstatutory Stock Option Agreement between the Registrant and George B. Boedecker, Jr. dated January 4, 2005. +10.34**@ +Nonstatutory Stock Option Agreement between the Registrant and Lyndon V. Hanson, III dated January 4, 2005. +10.35**@ +Nonstatutory Stock Option Agreement between the Registrant and Erik Rebich dated January 4, 2005. +10.36**@ +Nonstatutory Stock Option Agreement between the Registrant and Scott Seamans dated January 4, 2005. +10.37**@ +Nonstatutory Stock Option Agreement between the Registrant and Andy Reddyhoff dated January 4, 2005. +21†† +Subsidiaries of the Registrant. +23†† +Consent of Deloitte & Touche LLP. +31.1†† +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2†† +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +32.1†† +Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +32.2†† +Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act +* Incorporated +herein by reference to Crocs, Inc.'s Registration Statement on Form S-1 (File No. 333-127526). +** Incorporated +by reference to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File NO. 333-132312). +@ Management +contract or compensatory plan or arrangement. +† The +Registrant is applying for confidential treatment with respect to portions of these exhibits. +†† Filed +herewith. +41 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its +behalf by the undersigned, thereunto duly authorized, as of March 31, 2006. +CRCOS INC. +a Delaware Corporation +By: +/s/ RONALD R. SNYDER +Name: +Ronald R. Snyder +Title: +President and Chief Executive Officer +Pursuant +to the requirements of the Securities Exchange Act of 1934, this report has been signed below as of March 31, 2006 by the following persons on behalf of the registrant +and in the capacities indicated. +Signature +Title +/s/ RONALD R. SNYDER Ronald R. Snyder +President and Chief Executive Officer (Principal Executive Officer) +/s/ CARYN D. ELLISON Caryn D. Ellison +Vice President of Finance and Chief Financial Officer (Principal Financial and Accounting Officer) +George B. Boedecker, Jr. +Director +/s/ RAYMOND D. CROGHAN Raymond D. Croghan +Director +/s/ MICHAEL E. MARKS Michael E. Marks +Director +/s/ MARK A. RETZLOFF Mark A. Retzloff +Director +/s/ RICHARD L. SHARP Richard L. Sharp +Chairman of the Board +/s/ THOMAS J. SMACH Thomas J. Smach +Director +/s/ BRAD L. STOFFER Brad L. Stoffer +Director +42 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2004 and 2005, and the related consolidated +statements of operations, stockholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of +the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. +We +conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal +control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, +but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes +examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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, such consolidated financial statements present fairly, in all material respects, the financial position of Crocs, Inc. and subsidiaries as of December 31, +2004 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally +accepted in the United States of America. +/s/ +Deloitte & Touche LLP +Denver, Colorado +March 31, 2006 +F-1 +CROCS, INC. +CONSOLIDATED BALANCE SHEETS +(In thousands, except share and per share data) +December 31, +2004 +2005 +ASSETS +Current assets: +Cash and cash equivalents +$ +1,054 +$ +4,787 +Accounts receivable, less allowance for doubtful accounts of $159 and $566, respectively +3,252 +18,030 +Inventories—net +2,414 +28,494 +Deferred tax assets +— +1,939 +Prepaid expenses and other current assets +350 +3,103 +Total current assets +7,070 +56,353 +Property and equipment—net +3,726 +14,765 +Goodwill +326 +336 +Intangible assets—net +5,102 +5,311 +Deferred tax assets—net +— +1,084 +Other assets +— +183 +Total Assets +$ +16,224 +$ +78,032 +LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) +Current liabilities: +Accounts payable +$ +3,048 +$ +20,829 +Members' distribution payable +3,000 +— +Accrued expenses and other current liabilities +1,829 +8,276 +Income taxes payable +— +8,697 +Notes payable and current installments of long-term debt +978 +8,503 +Total current liabilities +8,855 +46,305 +Long-term debt +1,409 +3,213 +Deferred tax liabilities +1,783 +1,772 +Other liabilities +468 +528 +Total liabilities +12,515 +51,818 +Commitments and contingencies (note 12) +Redeemable common shares, 8,410,320 shares issued and outstanding +1,800 +1,800 +Redeemable convertible preferred shares, par value $0.001 per share; 8,000,000 shares authorized, 7,452,492 shares issued and outstanding in 2004 and 2005—preference in liquidation of $5,500 +5,500 +5,500 +Stockholders' equity (deficit): +Common shares, par value $0.001 per share; 42,000,000 shares authorized, 17,449,699 shares issued and outstanding in 2005 +— +17 +Members' interest—Class A +14 +— +Members' interest—Class B +1,905 +— +Additional paid-in capital +— +13,976 +Deferred compensation +(2,358 +) +(12,364 +) +Retained earnings (accumulated deficit) +(3,672 +) +16,697 +Accumulated other comprehensive income +520 +588 +Total stockholders' equity (deficit) +(3,591 +) +18,914 +Total Liabilities and Stockholders' equity +$ +16,224 +$ +78,032 +See +notes to consolidated financial statements. +F-2 +CROCS, INC. +CONSOLIDATED STATEMENTS OF OPERATIONS +(In thousands, except share and per share data) +Year Ended December 31, +2003 +2004 +2005 +Revenues +$ +1,165 +$ +13,520 +$ +108,581 +Cost of sales (including stock-based compensation expense of $Nil, $Nil, and $84, respectively) +891 +7,162 +47,773 +Gross profit +274 +6,358 +60,808 +Selling, general and administrative expense (including stock-based compensation expense of $356, $1,792, and $4,673, respectively) +1,471 +7,929 +33,916 +Income (loss) from operations +(1,197 +) +(1,571 +) +26,892 +Interest expense +3 +47 +611 +Other (income) expense—net +— +19 +(8 +) +Income (loss) before income taxes +(1,200 +) +(1,637 +) +26,289 +Income tax expense (benefit) +— +(143 +) +9,317 +Net income (loss) +(1,200 +) +(1,494 +) +16,972 +Dividends on redeemable convertible preferred shares +— +142 +275 +Net income (loss) attributable to common stockholders +$ +(1,200 +) +$ +(1,636 +) +$ +16,697 +Income (loss) per common share: +Basic +$ +(0.06 +) +$ +(0.07 +) +$ +0.51 +Diluted +$ +(0.06 +) +$ +(0.07 +) +$ +0.51 +Weighted average common shares: +Basic +20,855,385 +24,641,953 +25,493,577 +Diluted +20,855,385 +24,641,953 +33,570,000 +See +notes to consolidated financial statements. +F-3 +CROCS, INC. +CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) +FOR THE YEARS ENDED DECEMBER 31, 2003, 2004 AND 2005 +(In thousands) +Members' Interest +Common Stock +Retained +Earnings +(Accumulated +Deficit) +Accumulated +Other +Comprehensive +Income +Total +Stockholders' +Equity +(Deficit) +Voting +Non- +Voting +Class A +Class B +Total +Shares +Amount +Additional +Paid in +Capital +Deferred +Compensation +Comprehensive +Income +(Loss) +BALANCE—December 31, 2002 +$ +394 +$ +700 +— +— +$ +1,094 +— +— +— +$ +(260 +) +$ +(445 +) +— +$ +389 +Conversion of membership interest +(394 +) +(700 +) +394 +700 +— +— +— +— +— +— +— +— +Members' investments +— +— +— +625 +625 +— +— +— +— +— +— +625 +Repurchase of members' investment +— +— +— +(12 +) +(12 +) +— +— +— +— +— +— +(12 +) +Reclassification of redeemable members' investment +— +— +— +(1,409 +) +(1,409 +) +— +— +— +— +(391 +) +— +(1,800 +) +Amortization of equity compensation +— +— +— +96 +96 +— +— +— +260 +— +— +356 +Net loss +— +— +— +— +— +— +— +— +— +(1,200 +) +— +(1,200 +) +$ +(1,200 +) +Total comprehensive loss +$ +(1,200 +) +BALANCE—December 31, 2003 +— +— +394 +— +394 +— +— +— +— +(2,036 +) +— +(1,642 +) +Members' investments +— +— +— +525 +525 +— +— +— +— +— +— +525 +Repurchase of members' investment +— +— +— +(150 +) +(150 +) +— +— +— +— +— +— +(150 +) +Accrued distribution to members +— +— +(380 +) +(2,620 +) +(3,000 +) +— +— +— +— +— +— +(3,000 +) +Deferred equity compensation +— +— +— +2,686 +2,686 +— +— +— +(2,686 +) +— +— +— +Amortization of equity compensation +— +— +— +1,464 +1,464 +— +— +— +328 +— +— +1,792 +Accrued preferred dividend +— +— +— +— +— +— +— +— +— +(142 +) +— +(142 +) +Net loss +— +— +— +— +— +— +— +— +— +(1,494 +) +— +(1,494 +) +$ +(1,494 +) +Foreign currency translation +— +— +— +— +— +— +— +— +— +— +520 +520 +520 +Total comprehensive loss +$ +(974 +) +BALANCE—December 31, 2004 +— +— +14 +1,905 +1,919 +— +— +— +(2,358 +) +(3,672 +) +520 +(3,591 +) +Conversion to C corporation +— +— +(14 +) +(1,905 +) +(1,919 +) +16,746 +17 +(1,770 +) +— +3,672 +— +— +Deferred stock compensation +— +— +— +— +— +— +— +14,516 +(14,516 +) +— +— +— +Amortization of stock compensation +— +— +— +— +— +— +— +320 +4,437 +— +— +4,757 +Forfeitures +— +— +— +— +— +— +— +(73 +) +73 +— +— +— +Tax benefit from vesting of stock-based awards +— +— +— +— +— +703 +— +983 +— +— +— +983 +Accrued preferred dividend +— +— +— +— +— +— +— +— +— +(275 +) +— +(275 +) +Net income +— +— +— +— +— +— +— +— +— +16,972 +— +16,972 +$ +16,972 +Foreign currency translation +— +— +— +— +— +— +— +— +— +— +68 +68 +68 +Total comprehensive income +$ +17,040 +BALANCE—December 31, 2005 +$ +— +$ +— +$ +— +$ +— +$ +— +17,449 +$ +17 +$ +13,976 +$ +(12,364 +) +$ +16,697 +$ +588 +$ +18,914 +See notes to consolidated financial statements. +F-4 +CROCS, INC. +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2003 +2004 +2005 +Cash flows from operating activities: +Net income (loss) +$ +(1,200 +) +$ +(1,494 +) +$ +16,972 +Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: +Depreciation and amortization +75 +700 +3,334 +Gain on disposal of fixed assets +— +— +(7 +) +Deferred tax benefit +— +(191 +) +(3,090 +) +Share based compensation +356 +1,792 +4,757 +Bad debt expense +24 +196 +502 +Income tax benefit of stock compensation +— +— +983 +Changes in operating assets and liabilities—net of effect of acquired business: +Accounts receivable +(81 +) +(1,297 +) +(15,202 +) +Inventories +(331 +) +(859 +) +(26,035 +) +Prepaid expenses and other assets +37 +(287 +) +(3,472 +) +Accounts payable +425 +1,499 +17,711 +Accrued expenses and other liabilities +256 +718 +14,049 +Cash provided by (used in) operating activities +(439 +) +777 +10,502 +Cash flows from investing activities: +Cash paid for purchases of property and equipment +(321 +) +(1,551 +) +(11,531 +) +Acquisition of non-competition agreement +— +— +(636 +) +Acquisition of Foam Creations +— +(5,166 +) +— +Cash used in investing activities +(321 +) +(6,717 +) +(12,167 +) +Cash flows from financing activities: +Proceeds from note payable, net +— +314 +6,949 +Proceeds from long-term debt +— +853 +2,009 +Payments on long-term debt +— +— +(158 +) +Distribution payment to members +— +— +(3,000 +) +Payment of preferred dividends +— +— +(275 +) +Proceeds from members' investments +625 +525 +— +Repurchase of members' investments +(12 +) +(150 +) +— +Proceeds from issuance of Class C convertible preferred membership units +— +5,500 +— +Proceeds from (payments on) member loan +400 +(400 +) +— +Cash provided by financing activities +1,013 +6,642 +5,525 +Effect of exchange rate changes on cash +— +26 +(127 +) +Net increase in cash and cash equivalents +253 +728 +3,733 +Cash and cash equivalents—beginning of year +73 +326 +1,054 +Cash and cash equivalents—end of year +$ +326 +$ +1,054 +$ +4,787 +Supplemental disclosure of cash flow information—cash paid during the year for: +Interest +$ +3 +$ +73 +$ +252 +Income taxes +$ +— +$ +585 +$ +2,510 +Supplemental disclosure of noncash, investing, and financing activities: +In conjunction with the acquisition of Foam Creations, liabilities were assumed as follows: +Fair value of assets acquired +$ +— +$ +9,936 +$ +— +Cash paid for capital stock +— +5,166 +— +Liabilities assumed +$ +— +$ +4,770 +$ +— +Accrued members' distribution +$ +— +$ +3,000 +$ +— +Accrued preferred stock dividends +$ +— +$ +142 +$ +161 +Assets acquired under capitalized leases +$ +— +$ +— +$ +307 +Accrued purchases of property and equipment +$ +— +$ +— +$ +836 +See notes to consolidated financial statements. +F-5 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +AS OF AND FOR THE YEARS ENDED DECEMBER 31, 2003, 2004, AND 2005 +1. FORMATION AND BUSINESS OF THE COMPANY +Crocs, Inc. and its subsidiaries (collectively, the "Company"): Crocs Retail, Inc., Crocs Online, Inc., Foam Creations, Inc., Crocs Mexico +S.de.R.L. de CV, Crocs Servicios S.de.R.L. de CV, Crocs Asia Pte Ltd., Crocs Australia Pty Ltd. and Crocs Hong Kong Ltd. are engaged in the design, development and manufacturing +of consumer products from specialty resins. The Company was organized as a limited liability company in Colorado in 1999 under the name of Western Brands, LLC. In January 2005, the Company +renamed itself and converted to a Colorado corporation. The Company was reincorporated in Delaware in June 2005. +The +Company's wholly owned subsidiary, Foam Creations, Inc. (formerly Finproject N.A. Inc.), located in Quebec, Canada, has designed, developed, and manufactured consumer +products from specialty resins since 1995. In 2000, Foam Creations completed the formulation of, and began manufacturing, a footwear model made from the proprietary closed-cell resin the +Company currently uses in its footwear product line, which it refers to as croslite . In 2002, the Company established a business relationship with Foam +Creations to distribute footwear in the United States. In October 2002, the Company modified and improved the design of this shoe and began marketing and distributing it under the Crocs brand +in the United States. In June 2004, Crocs Inc. acquired Foam Creations, including its manufacturing operations, product lines and rights to the trade secrets for croslite . +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Basis of Consolidation —The consolidated financial statements include the accounts of +Crocs, Inc. and all of its subsidiaries. All significant intercompany transactions and balances are eliminated in consolidation. The consolidated financial statements include the accounts of +the Company and all entities that are wholly-owned by the Company and entities that are not variable interest entities but are voting-controlled subsidiaries or affiliates of the Company. +Variable Interest Entities —Under Financial Accounting Standards Board (FASB) Interpretation No. 46 (revised +December 2003), Consolidation of Variable Interest Entities ("FIN 46R") , once an entity is determined to be a variable interest entity, +the party with the controlling financial interest, the primary beneficiary, is required to consolidate it. On the acquisition of Foam Creations in 2004 the Company has an interest in Les Plastiques +Fintech Inc. ("Fintech") in which the Company is the primary beneficiary under FIN 46R. Fintech is a joint venture with the President of Foam Creations, in which the Company holds a 50% +interest. Fintech carries out research and development for Crocs and produces the raw materials for the Company's products. At December 2005 and 2004, this entity was consolidated. +Recognition of Revenues —Revenues are recognized when products are shipped and the customer takes title and assumes risk of +loss, collection of related receivables is probable, persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer +depending on the country of the sale and the agreement with the customer. Allowances for estimated returns and discounts are recognized when related revenue is recorded. +Shipping and handling costs —Amounts billed for shipping and handling costs are recorded as a component of revenues and totaled +$69,000, $678,000 and $2.5 million for the years ended December 31, 2003 and 2004 and 2005, respectively. Related costs paid to third party shipping +F-6 +companies +are recorded in cost of sales and totaled $124,000, $1.2 million and $10.4 million for the years ended December 31, 2003, 2004 and 2005, respectively. +Income (Loss) per Share —Basic income (loss) per common share ("EPS") is computed by dividing the net income (loss) available +to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from securities that could share in the earnings of the +Company. Antidilutive securities are excluded from diluted EPS. +In +April 2005, the Company amended its articles of incorporation to allow the holders of its redeemable preferred stock to participate in dividends paid on the Company's common +shares. Under the amended articles, if the Company were to pay a dividend on any share of common stock, the Company must pay a dividend on all outstanding shares of its redeemable preferred stock on +an as if converted basis in a per share amount equal to the amount paid on each share of common stock. In accordance with Emerging Issues Task Force No. 03-6, "Participating +Securities and the Two Class Method Under SFAS 128," the Company has presented basic and diluted earnings per share for common shares using the two class method for the year ended +December 31, 2005 (in thousands, except share and per share data). +December 31 +2003 +2004 +2005 +Reconciliation of net income (loss) attributable to common stockholders for basic computation: +Net income attributable to common stockholders +$ +16,697 +Less: Undistributed net income allocated to redeemable convertible preferred stockholders +(3,736 +) +Undistributed net income allocated to common stockholders +$ +12,961 +Reconciliation of net income (loss) for dilutive computation: +Net income (loss) attributable to common stockholders +$ +(1,200 +) +$ +(1,636 +) +$ +16,697 +Preferred dividend +— +— +275 +Net income (loss) for dilutive computation +$ +(1,200 +) +$ +(1,636 +) +$ +16,972 +Basic income (loss) per common share: +Weighted average common shares outstanding +20,855,385 +24,641,953 +25,493,577 +Basic income (loss) per common share +$ +(0.06 +) +$ +(0.07 +) +$ +0.51 +Diluted income (loss) per common share: +Weighted average common shares outstanding +20,855,385 +24,641,953 +25,493,577 +Dilutive effect of preferred stock +— +— +7,452,492 +Dilutive effect of stock options +— +— +220,034 +Dilutive effect of unvested stock +— +— +403,897 +Weighted average diluted common shares outstanding +20,855,385 +24,641,953 +33,570,000 +Diluted income (loss) per common share +$ +(0.06 +) +$ +(0.07 +) +$ +0.51 +The +effect of assumed conversion of the Class C preferred units was antidilutive in 2004. Stock options, preferred stock and restricted units that are antidilutive due to the +Company's net loss for the +F-7 +year +ended December 31, 2004 were excluded from the diluted income (loss) per common share computation, and included the following: +December 31, +2004 +Antidilutive effect: +Preferred stock +3,879,372 +Stock options +— +Unvested stock +686,761 +4,566,133 +There +were no antidilutive securities in the years ended December 31, 2003 and December 31, 2005. +For +purposes of computing income (loss) per common share, the Company has reflected the conversion of the membership interests into units, and the subsequent conversion of units into +shares of the Company's stock, including a 233.62-for-one split of the Company's common stock and preferred stock in conjunction with the Company's initial public offering, in +the 2003 and 2004 computation of shares outstanding (see Note 21). +Cash and Cash Equivalents —Cash and cash equivalents represent cash and short-term, highly liquid investments with +maturities of three months or less at date of purchase. The Company considers receivables from credit card companies to be cash equivalents. The carrying amounts reflected in the consolidated balance +sheet for cash and cash equivalents approximate fair value due to the short maturities. +Inventories —Raw materials and supplies are valued at the lower of cost and replacement cost. Work in process and finished +goods are valued at the lower of cost and net realizable value. Cost is determined on the first in, first out basis. The cost of work in process and finished goods consists of the cost of raw +materials and an applicable share of the cost of labor and manufacturing overhead. +Property and Equipment —Depreciation of machinery and equipment is computed using the straight-line method based on +estimated useful lives ranging from 3 to 5 years. Leasehold improvements are amortized on the straight-line basis over their estimated economic useful lives or the lease term, +whichever is shorter. +Intangible Assets Finite-Lived —Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets , (SFAS No. 142) +requires that intangible assets with finite lives be amortized over their estimated useful +lives and reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets , +(SFAS No. 144). The Company is currently amortizing its acquired intangible assets with finite lives over periods ranging from five to seven years. Intangible assets are comprised of core +technology and customer relationships acquired in the acquisition of Foam Creations (see Note 5), a non-competition agreement entered into in connection with the acquisition of +assets in Mexico and capitalized costs related to pending patents that the Company is pursuing related to its +technology. Patents will be amortized on approval of the patent registration application over their estimated useful lives. +Goodwill —In accordance with SFAS No. 142, goodwill acquired in business combinations consists of the excess purchase +price paid over the fair value of assets acquired and liabilities assumed in the acquisition of Foam Creations (see Note 5). The Company assesses goodwill for impairment annually during the +fourth quarter, or more frequently if events and circumstances indicate impairment may have occurred. If the carrying value of goodwill exceeds its implied fair value, the Company records an +impairment loss equal to the difference. There was no impairment of goodwill at December 31, 2004 and 2005. +F-8 +Impairment of Long-Lived Assets —In accordance with SFAS No. 144, the Company estimates the future +undiscounted cash flows to be derived from an asset to assess whether or not a potential impairment exists when events or circumstances indicate the carrying value of a long-lived asset +may be impaired. If the carrying value exceeds the estimate of future undiscounted cash flows, the Company calculates the impairment as the excess of the carrying value of the asset over the estimate +of its fair value. There were no impairments recorded during 2003, 2004 or 2005. +Research and Development —Research and development costs are expensed as incurred. Research and development expenses amounted +to $4,000, $80,000 and $534,000 for the years ended December 31, 2003, 2004, and 2005, respectively and are included in selling, general and administrative expenses. +Advertising —Advertising costs are expensed as incurred and were $6,000, $41,000 and $545,000 for the years ended +December 31, 2003, 2004, and 2005, respectively and are included in selling, general and administrative expenses. +Foreign Currency Translation and Foreign Currency Transactions —The U.S. dollar is the Company's reporting currency. Assets and +liabilities of 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 applicable period. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are included in the foreign currency translation +adjustment, a component of accumulated other comprehensive income (loss) in stockholders' equity (deficit). Gains and losses generated by transactions denominated in a currency different from the +functional currency of the applicable entity are recorded in selling, general and administrative expense in the period in which they occur. +Derivative Foreign Currency Contracts —Foam Creations, a wholly-owned subsidiary of the Company, uses derivative foreign +exchange contracts to hedge the variability in cash flows from the forecasted payment or receipt of currencies other than the functional currency. These contracts are not designated as hedges under +SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities . The futures contracts are marked to market and gains and losses are +recognized in earnings. The mark to market value of these contracts was not material for the years ended December 31, 2004 and 2005. +Stock-Based Compensation —The Company measures compensation expense to employees using the intrinsic value method in accordance +with Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees , as permitted by SFAS No. 123, Accounting for Stock-Based +Compensation . Accordingly, as allowable under SFAS No. 123, the Company does not recognize compensation expense for +options granted to employees when the exercise price equals or exceeds the fair value of common stock as of the grant date. The Company records compensation expense related to +non-employees under the provisions of SFAS No. 123 and Emerging Issues Task Force EITF 96-18, Accounting for Equity Instruments that are Issued to +Other than Employees for Acquiring, or in conjunction with Selling, Goods or Services and recognizes compensation expense over the vesting periods of such awards. +As +required by SFAS No. 123 as amended by SFAS No. 148, Accounting for Stock-Based Compensation—Transition and +Disclosure , the Company has computed, for pro forma disclosure purposes, the fair value of options granted using the Black-Scholes option pricing model. In order to calculate +the fair value of the options, certain assumptions are made regarding components of the model, including risk-free interest rate, volatility, expected dividend yield rate, and expected +option life. Changes to the assumptions could cause significant adjustments to the valuation. For options granted before August 15, 2005, expected volatility was not considered as the Company +was a non-public entity at the grant date of these options. For stock option grants issued after the filing of the Company's Registration Statement on Form S-1 on August 15, +2005, the minimum value method no longer is used and the Company used a volatility rate of 50% and began to estimate forfeiture rates. The Company +F-9 +factored +in expected retention rates combined with vesting periods to determine the average expected life. The risk-free interest rate for periods within the contractual life of the +options is based on the U.S. Treasury yield curve in effect at the time of each grant. Accordingly, for purposes of the proforma disclosures presented below, the Company has computed the fair values +of all options under the plans during 2003, 2004 and 2005, using the Black-Scholes option pricing model and the following weighted average assumptions: +Year Ended December 31 +2003 +2004 +2005 +Dividend yield +— +— +— +Risk-free interest rate +— +3.36 +% +3.97 +% +Weighted average expected life (in years) +— +5 +5 +If +the Company had applied the fair value recognition provisions of SFAS No. 123 for these stock options issued to employees, the Company's pro forma net income (loss) and pro +forma income (loss) per common share would have been reported as follows (in thousands except per share data): +Year Ended December 31 +2003 +2004 +2005 +Net income (loss) as reported +$ +(1,200 +) +$ +(1,494 +) +$ +16,972 +Add: Share-based employee compensation expense included in reported net income (loss)—net of tax +— +53 +1,740 +Deduct: Total share-based employee compensation expense under fair-value-based method for all awards—net of tax +— +(13 +) +(575 +) +Pro forma net income (loss) +(1,200 +) +(1,454 +) +18,137 +Less: Preferred stock dividends +— +(142 +) +(275 +) +Less: Undistributed net income allocated to redeemable convertible preferred stockholders +— +— +(3,997 +) +Pro forma net income (loss) allocated to common stockholders +$ +(1,200 +) +$ +(1,596 +) +$ +13,865 +Income (loss) per share: +Basic—as reported +$ +(0.06 +) +$ +(0.07 +) +$ +0.51 +Basic—pro forma +$ +(0.06 +) +$ +(0.06 +) +$ +0.54 +Diluted—as reported +$ +(0.06 +) +$ +(0.07 +) +$ +0.51 +Diluted—pro forma +$ +(0.06 +) +$ +(0.06 +) +$ +0.54 +The +pro forma effects of applying SFAS No. 123 may not be representative of the effects on reported net income (loss) and income (loss) per share for future years since options +vest over several years and additional awards are made each year. +Income Taxes —Prior to the Company's conversion to a C-corporation on January 4, 2005, the Company was not a +taxpaying entity for U.S. federal and state income tax purposes. The Company accounts for income taxes using the asset and liability method. This approach requires the recognition of deferred tax +assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. The Company provides for income +taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. See Note 11 for further discussion. +Management Estimates —Management of the Company has made certain estimates and assumptions relating to the reporting of assets, +liabilities, net sales and expenses and the disclosure of contingent +F-10 +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 the allowance for doubtful accounts, returns and discounts, impairment assessments and charges, deferred taxes, stock-based compensation expense, fair value of +acquired intangibles, assessment of lower of cost or market on inventory, and useful lives assigned to long-lived assets. Actual results could differ from these estimates and the +differences could be material. +Concentration of Risk —The Company's cash and cash equivalents are maintained in several different financial institutions in +amounts that typically exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to significant credit risk. +The +Company considers its concentration risk related to accounts receivable to be mitigated by the Company's credit policy, the significance of outstanding balances owed by each +individual customer at any point in time and the geographic dispersion of these customers. +The +Company relies on both internal and external manufacturers for each of its products. Establishing a replacement source for our product offerings could require significant additional +time and expense. +Recent Accounting Pronouncements —In November 2004, the FASB issued SFAS No. 151, Inventory Costs—an amendment of ARB No. 43, Chapter 4 . +SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, +Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage), and requires that such items be recognized as +current period charges regardless of whether they meet the "so abnormal" criterion outlined in ARB No. 43. SFAS No. 151 also introduces the concept of "normal capacity" and requires the +allocation of fixed production overheads to inventory based on normal capacity of the production facilities. Unallocated overheads must be recognized as an expense in the period incurred. SFAS +No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005, and is required to be adopted in the first quarter of fiscal year 2006. The Company +does not anticipate the adoption of SFAS No. 151 will have a significant impact on its results of operations, financial condition or cash flows. +In +December 2004, the FASB issued SFAS No. 123 (revised 2004), Share Based Payment , which is a revision of SFAS +No. 123. SFAS No. 123(R) supersedes APB Opinion No. 25, and amends SFAS No. 95, Statement of Cash Flows . Generally, the approach in SFAS No. 123(R) is similar to the approach +described in SFAS No. 123. However, SFAS +No. 123(R) requires all share based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure +is no longer an alternative. The Company adopted SFAS No. 123(R) on January 1, 2006. +SFAS +No. 123(R) permits companies to adopt its requirements using various methods. The Company adopted the prospective method for all stock option grants issued prior to +August 15, 2005, which was the date the Company initially filed a Registration Statement on Form S-1 in connection with the Company's initial public offering as of January 1, +2006. Under the prospective method, those nonpublic companies that used the minimum value method of measuring equity share options and similar instruments for either recognition or pro forma +disclosure purposes under Statement will apply SFAS No. 123(R) prospectively to new awards and to awards modified, repurchased, or cancelled after the required effective date. The Company will +continue to account for any portion of awards outstanding at the date of initial application using the accounting principles originally applied to those awards which were the provisions of Opinion 25 +and its related interpretive guidance. For stock option grants issued after the filing of the Company's Registration Statement on Form S-1 on August 15, 2005, the modified prospective +method will be applied. Estimated stock based compensation for 2006 related to stock options and restricted stock outstanding as of December 31, 2005 will be approximately $5.4 million. +F-11 +In +December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets . The statement refines the measurement of +exchanges of non-monetary assets between entities. The provisions of this statement are effective for fiscal periods beginning after June 15, 2005. Historically, the Company has not +transacted significant exchanges of non-monetary assets, but future such exchanges would be accounted for under the standard, when effective. +3. INVENTORIES +Inventories by major classification are as follows (in thousands): +December 31 +2004 +2005 +Finished goods +$ +1,259 +$ +25,449 +Work-in-progress +35 +6 +Raw materials +1,120 +3,039 +$ +2,414 +$ +28,494 +4. PROPERTY AND EQUIPMENT +Property and equipment includes the following (in thousands): +December 31 +2004 +2005 +Machinery and equipment +$ +4,235 +$ +16,790 +Leasehold improvements +26 +664 +Subtotal +4,261 +17,454 +Less accumulated depreciation and amortization +(535 +) +(2,689 +) +$ +3,726 +$ +14,765 +Depreciation +expense of $74,000, $211,000 and $2.0 million was recorded for the years ended December 31, 2003, 2004 and 2005, respectively. As the Company translates the +ending accumulated depreciation at the balance sheet rate and records depreciation expense using the weighted average rate of exchange for the applicable period, a difference between the recorded +depreciation expense and the change in accumulated depreciation exists. Certain equipment held under capital lease in the amount of $307,000 at December 31, 2005 is classified as equipment and +amortized using the straight-line method over the lease term. Amortization of assets under capitalized leases is included in depreciation expense. +5. ACQUISITION +On June 29, 2004, the Company purchased all of the issued and outstanding shares of the capital stock of Finproject N.A., Inc. ("Foam Creations"), a +Canadian corporation. Foam Creations manufactures, and distributes crocs -branded footwear products. Foam Creations also produces spa pillows and other +products for original equipment manufacturers. The Company acquired Foam Creations including its manufacturing operations, product lines and rights to the trade secrets for the proprietary +closed-cell resin used in its products to expand its business. The acquisition was accounted for under the purchase method of accounting in accordance with SFAS No. 141, Business Combinations. The +cash purchase price, including acquisition costs, was approximately $5.2 million. The Company retained approximately +$150,000 as security against any breaches of the purchase agreement including representations and warranties of the sellers. The retained funds shall be released to the sellers on the +two-year anniversary of the execution of the purchase agreement less any deductions. +F-12 +All +assets and liabilities of Foam Creations have been recorded in the Company's consolidated balance sheet based on their estimated fair values at the date of acquisition. Identifiable +intangible assets and goodwill relating to the purchase approximated $5.0 million and $294,000, respectively. Identifiable intangible assets include $3.6 million for core technology that +has a five-year life, and $1.4 million for customer relationships that have a seven-year life. The purchase accounting included a deferred tax liability of +$1.8 million recorded for the book-tax difference in future tax consequences for the acquired identifiable intangible assets. None of the amount allocated to goodwill is tax +deductible. +The +following table summarizes the fair value of the assets and liabilities assumed at the date of acquisition (in thousands): +Current assets +$ +2,818 +Property and equipment +1,823 +Goodwill +294 +Intangible assets +5,001 +Current liabilities +(2,251 +) +Long-term debt +(739 +) +Deferred tax liability +(1,780 +) +Net assets acquired +$ +5,166 +The +results of Foam Creations operations have been included in the consolidated financial statements since the date of the acquisition. +The +following table summarizes supplemental statement of operations information for the year ended December 31, 2003 and 2004, on a pro forma basis as if the acquisition of Foam +Creations had occurred on January 1, 2003 (in thousands): +December 31 +2003 +2004 +(Unaudited) +Net sales +$ +5,628 +$ +16,921 +Gross profit +2,365 +8,392 +Operating loss +(1,543 +) +(933 +) +Net loss +(1,464 +) +(1,084 +) +Net loss per common share: +Basic +$ +(0.07 +) +$ +(0.04 +) +Diluted +$ +(0.07 +) +$ +(0.04 +) +F-13 +6. GOODWILL AND INTANGIBLE ASSETS +Intangible assets that are determined to have finite lives are amortized over their useful lives on a straight-line basis. The following table +summarizes the Company's identifiable intangible assets as of December 31, 2004 and 2005 (in thousands): +2004 +2005 +Gross +Carrying +Amount +Accumulated +Amortization +Net Carrying +Amount +Gross +Carrying +Amount +2005 +Accumulated +Amortization +Net Carrying +Amount +Amortized intangible assets: +Patents and trademarks +$ +67 +$ +2 +$ +65 +$ +604 +$ +— +$ +604 +Customer relationships +1,521 +107 +1,414 +1,569 +336 +1,233 +Core technology +4,028 +405 +3,623 +4,154 +1,248 +2,906 +Non-competition agreement +— +— +— +636 +86 +550 +Capitalized software +— +— +— +18 +— +18 +Total +$ +5,616 +$ +514 +$ +5,102 +$ +6,981 +$ +1,670 +$ +5,311 +Amortization expense of intangible assets with finite lives, which is included in selling, general and administrative expense, was $1,000, +$488,000 and $1.1 million for the years ended December 31, 2003, 2004 and 2005, respectively. As the Company translates the ending accumulated amortization at the balance sheet rate and +records amortization expense using the weighted average rate of exchange for the applicable period, a difference between the recorded amortization expense and the change in accumulated amortization +exists. Estimated future annual amortization of intangible assets is as follows (in thousands): +Fiscal years ending December 31, +2006 +$ +1,249 +2007 +1,249 +2008 +1,249 +2009 +825 +2010 +326 +Thereafter +413 +Total +$ +5,311 +The +following table summarizes the activity in the Company's goodwill account during the years ended December 31, 2004 and 2005 (in thousands): +Balance at January 1, 2004 +$ +— +Acquisition of Foam Creations +294 +Foreign currency translation adjustments +32 +Balance at December 31, 2004 +326 +Foreign currency translation adjustments +10 +Balance at December 31, 2005 +$ +336 +F-14 +7. ACCRUED EXPENSES AND OTHER LIABILITIES +Accrued expenses and other liabilities include the following (in thousands): +December 31 +2004 +2005 +Accrued compensation and benefits +$ +872 +$ +1,936 +Professional services +340 +2,110 +Fulfillment and freight +80 +1,695 +Preferred dividends +142 +161 +Other +395 +2,374 +$ +1,829 +$ +8,276 +8. NOTES PAYABLE +Notes Payable include the following (in thousands): +December 31 +2004 +2005 +Foam Creations demand note payable +$ +655 +$ +2,016 +Revolving credit facility +— +5,941 +$ +655 +$ +7,957 +Foam +Creations, a wholly owned subsidiary, has a demand note payable from a bank in the amount of up to $2.1 million, bearing interest at base rate plus 0.50% (actual rate of +5.00% at December 31, 2005). At December 31, 2004 and 2005, $655,000 and $2.0 million, respectively, were outstanding on the loan. Foam Creations also has an authorized credit +line of $300,000 for currency exchanges. No amounts were outstanding on these lines as of December 31, 2005. The bank loan is secured by the accounts receivable and inventories associated with +its Canadian operations. Annually the note payable is required to be renewed by the bank in April. Under the terms of the bank loans, Foam Creations must +satisfy certain restrictive covenants as to minimum financial ratios. Foam Creations was not in compliance with these covenants as of December 31, 2005 and has obtained a waiver from the banks. +In +April 2005, Crocs, Inc. entered into a $5.0 million secured revolving credit facility. The total amount available at any time is subject to a borrowing base +calculation based on various percentage of accounts receivable, inventory and fixed assets. The revolving credit facility bears interest at floating rates based on the higher of the lender's prime +rate plus 1.0% or the Federal Funds rate plus 1.5%. The revolving credit facility is secured by all of the Company's assets and terminates on October 26, 2008. Debt issue costs incurred in +connection with the issuance of the revolving credit facility are included in other non-current assets and are being amortized over the term of the related agreements on the interest +method. During the year ended December 31, 2005, the Company recognized interest expense related to amortization of debt issuance costs of approximately $75,000. +In +October 2005, the Company amended and restated the existing credit facility increasing the amount available under the original facility to $20.0 million. The total +amount available at any time is subject to a borrowing base calculation based on various percentages of accounts receivable and inventory. The revolving credit facility bears interest at floating +rates based on the higher of the lender's prime rate. As of December 31, 2005, $5.9 million in borrowings were outstanding on this line. As of December 31, 2005, the interest rate +on the revolving credit facility was 7.25%. The funds were drawn primarily to fund accrued members' distributions, to purchase manufacturing operations in Mexico, and to make inventory purchases. +F-15 +The carrying amounts reflected in the consolidated balance sheet for notes payable approximate fair value due to the short maturities and market rate of interest. +In +January 2006, in connection with the preparation of a compliance certificate for the Crocs, Inc. secured facility entered into in October 2005, the Company +determined it was not in compliance with certain covenants including its monthly EBITDA and capital expenditure financial covenants. On January 18, 2006, the Company received a waiver of all +non-compliance with its covenants under this borrowing. +In +February 2006, the Company repaid all amounts borrowed against the revolving credit facility. +9. LONG-TERM DEBT +Long-term debt consists of the following (in thousands): +December 31 +2004 +2005 +Loan from Development Bank of Canada, payable in monthly installments of $35,895 USD plus interest starting on September 1, 2005, at the one-month London InterBank Offered Rate ("LIBOR") plus 3.3%, maturing August +2011. Loan is secured by a first mortgage on all of the assets of the Company, subordinated only with respect to the assignment of the accounts receivable and inventories pertaining to the bank notes payable and the machinery and equipment on the +second loan with National Bank of Canada (see Note 8) +$ +1,732 +$ +2,433 +Loan from National Bank of Canada for the purchase of fixed assets. Payable in monthly installments of $11,310 CAD plus interest starting in November 2005, maturing October 2012 at Canadian prime rate plus 0.75%. Loan is +secured by machinery and equipment. +— +796 +Loan from National Bank of Canada, payable in 2007 plus interest, at one-month Canadian prime rate plus 0.75%. Loan is secured by machinery and equipment. +— +530 +1,732 +3,759 +Less current portion +323 +546 +$ +1,409 +$ +3,213 +The +fair value of the Company's long-term debt, including current portion, approximates the carrying value at December 31, 2004 and 2005, due to the notes carrying a +market rate of interest. +Long-term +debt maturities in each of the next five years are as follows (in thousands): +Years Ending December 31 +2006 +$ +546 +2007 +1,078 +2008 +547 +2009 +547 +2010 +547 +Thereafter +494 +Total +$ +3,759 +F-16 +10. ALLOWANCES +The changes in the Company's allowance for doubtful accounts and reserve for sales returns and allowances for the years ended December 31, 2003, 2004 and +2005, are as follows (in thousands): +Balance at +Beginning +of Year +Charged to costs +and expenses +Deductions and +write-offs +Balance at +End +of Year +Year ended December 31, 2003: +Allowance for doubtful accounts +$ +— +$ +89 +$ +65 +$ +24 +Reserve for sales returns and allowances +— +— +— +— +Year ended December 31, 2004: +Allowance for doubtful accounts +24 +193 +58 +159 +Reserve for sales returns and allowances +— +46 +— +46 +Year ended December 31, 2005: +Allowance for doubtful accounts +159 +594 +187 +566 +Reserve for sales returns and allowances +46 +2,977 +2,461 +562 +11. INCOME TAXES +Prior to the Company's conversion to a C corporation in January 2005, the Company was treated as a partnership for U.S. federal and state income tax +purposes. Under U.S. tax law, partnerships are treated as flow-through entities and are not subject to direct taxation. +In +June 2004, the Company acquired Foam Creations, Inc., a Canadian company. Foam Creations is subject to federal and provincial level income taxes in Canada. +The +provision for income taxes consisted of the following (in thousands): +December 31, +2004 +December 31, +2005 +Current—U.S. federal +$ +— +$ +10,223 +Current—U.S. state +— +1,451 +Current—foreign +48 +733 +Total current income taxes +48 +12,407 +Deferred—U.S. federal +— +(2,779 +) +Deferred—U.S. state +— +(244 +) +Deferred—foreign +(191 +) +(67 +) +Total deferred income taxes +(191 +) +(3,090 +) +Total income tax expense (benefit) +$ +(143 +) +$ +9,317 +On +October 22, 2004 the American Jobs Creation Act was signed into law. This Act created a temporary incentive for U.S. multinational corporations to repatriate accumulated income +earned outside the U.S. by providing an 85% dividend received deduction for certain dividends from controlled foreign corporations. The Company elected not to repatriate any earnings under the Act. +The Company has indefinitely reinvested approximately $1.2 million of the cumulative undistributed earnings of its foreign subsidiaries. Such earnings would be subject to U.S. taxation if +repatriated to the U.S. +F-17 +Reconciliations +of the statutory federal income tax rate to the Company's actual rates based on income or loss before income tax are summarized as follows: +December 31, +2004 +December 31, +2005 +Consolidated pre tax book income +35.0 +% +35.0 +% +State taxes +— +2.8 +Deferred tax benefit from conversion to C Corporation +— +(3.0 +) +Foreign rate differential +(0.1 +) +(0.3 +) +Other permanent differences +— +0.9 +Partnership income not subject to tax +(26.2 +) +— +8.7 +% +35.4 +% +The +Company's deferred income tax assets and liabilities are as follows (in thousands): +December 31, +2004 +December 31, +2005 +Current deferred tax assets: +Accrued expenses +$ +— +$ +747 +Inventory +— +1,192 +Total current deferred tax asset +$ +— +$ +1,939 +Long-term deferred tax assets: +Other liabilities +$ +— +$ +121 +Stock compensation expense +— +1,367 +Total non-current deferred tax asset +$ +— +$ +1,488 +Long-term deferred tax liabilities: +Property and equipment +$ +260 +$ +856 +Intangible assets +1,523 +1,320 +Total non-current deferred tax liabilities +$ +1,783 +$ +2,176 +Deferred +tax liabilities arise from temporary differences in the remaining depreciable basis of assets for financial and tax reporting purposes. The purchase of Foam +Creations, Inc. gave rise to adjustments to the asset values on allocation of the purchase price for financial reporting purposes. These adjustments are not recorded for income tax reporting +purposes. As a result, the Company will record greater depreciation and amortization on the acquired assets for financial reporting purposes than they will for tax reporting purposes and consequently +has recorded a deferred tax liability for purchase price adjustments of $1.5 million. During the year ended December 31, 2005, $983,000 was recorded as additional paid-in +capital related to the excess tax benefit of vested restricted stock. +On +January 3, 2005, the Company converted from a limited liability company to a C corporation. For tax years beginning and subsequent to January 1, 2005, the Company will +be subject to corporate-level U.S. federal and state income taxes. The Company recognized an income tax benefit of $797,000 in 2005 related to the net deferred tax assets of the partnership existing +as of December 31, 2004. +12. COMMITMENTS AND CONTINGENCIES +The Company leases space for certain of its offices, warehouses, vehicles and equipment under leases expiring at various dates through 2010. Certain leases also +contain rent escalation clauses (step rents) that require additional rental amounts in the later years of the term. Rent expense for leases with step rents is recognized on a straight-line +basis over the minimum lease term. Certain leases also +F-18 +contain +escalation clauses based on an existing rate, such as the consumer price index. These items are factored into the minimum lease payment and recognized on a straight-line basis over +the minimum lease term. Deferred rent is included in the balance sheet in accrued expenses. Rent expense was $28,000, $208,000 and $1.9 million for the years ended December 31, 2003, +2004 and 2005, respectively. Amounts of minimum future annual rental commitments under non-cancelable operating leases in each of the five years ending December 31, 2006 through +2010 are $1.6 million, $485,000, $104,000, $20,000 and $10,000, respectively. +On +September 17, 2004, the Company entered into a Manufacturing Supply Agreement with MDI Products, LLC ("MDI"), a Florida limited liability company under which the Company agreed +to purchase 15,000 pairs of shoes per month for 36 months to maintain exclusivity. The pricing will be agreed on every twelve months. Termination fees apply for losses incurred by MDI for +premature termination by the Company. +On +June 30, 2004, the Company entered in to a four year Supply Agreement with Finproject S.p.A., the former majority owner of Foam Creations, under which the Company has the +exclusive right to purchase the material for the manufacture of finished shoe products, except for certain other current customer dealings of FinProject S.p.A. (including boot manufacturers). Based on +the supply agreement, the Company has contractual purchase requirements to maintain exclusivity in the first two years. The pricing is to be agreed upon each quarter and fluctuates based on order +volume, currency fluctuations and raw material prices. +The +Company indemnifies certain of its vendors and its directors and executive officers for specified claims. To date, the Company has not paid or been required to defend any +indemnification claims, and accordingly, has not accrued any amounts for our indemnification obligations. +13. CAPITALIZED LEASE OBLIGATIONS +The Company had capitalized lease obligations for equipment due on various dates through 2008 of $307,000 as of December 31, 2005. The interest rates range +from 4.25% to 8.97% per annum. These lease obligations are collateralized by the related assets with a net book value of $307,000 as of December 31, 2005. +Maturities +of capital lease obligations as of December 31, 2005, are as follows (in thousands): +2006 +$ +101 +2007 +120 +2008 +110 +Total minimum lease payments +331 +Less—amount related to interest +(24 +) +Principal portion of future obligations +307 +Less—current portion +(98 +) +$ +209 +The +following table summarizes the assets recorded in property, plant and equipment in Note 4 that are recorded as capital leases (in thousands): +December 31 +2004 +2005 +Carrying value, gross +$ +— +$ +307 +Less accumulated depreciation +— +— +— +$ +307 +F-19 +14. RELATED PARTIES +The Company entered into the following related party transactions (in thousands): +December 31 +2003 +2004 +2005 +Founder: +Note payable +$ +36 +$ +39 +$ +— +Fee agreement +82 +— +— +Note payable +400 +— +— +Crocs Hawaii (owned by board member): +Period-end accounts receivable balance due to the Company +— +117 +— +Sales +8 +142 +250 +Sponsorship expense +— +— +58 +Consulting expense +— +— +41 +The +Company executed a separation agreement with the former chief executive officer on January 1, 2005. The terms of the arrangement were agreed to by the Company and the former +chief executive officer as of December 31, 2004, consequently, the Company has recorded the present value of the severance and health insurance continuation in the 2004 financial statements. +The total amount recorded was $606,000, which has been reflected in selling, general and administrative expenses. The amount recorded has been discounted over the future payment terms at 6%. The +corresponding liability is recorded in other current and non-current liabilities, for amounts due in 2007 and beyond, and accrued expenses and other liabilities for amounts due in 2006. +In +connection with the separation agreement discussed above, the Company and former chief executive officer entered into an exclusive distribution agreement that commenced July 1, +2005. The distribution agreement is for specified territories in Central America and has an initial term of two years. The agreement provides for renewal periods at the former chief executive +officer's option, if specified sales volumes are attained. Pricing under this agreement is set at a discount off the Company's then current wholesale pricing. Additionally, effective July 1, +2005, the Company and the former chief executive officer entered into an agreement providing him the right to license and/or franchise airport kiosks selling the Company's products for a period of +10 years, subject to the Company's right to terminate the agreement if specified numbers of kiosks are not opened in timeframes specified. +In +2005, the Company paid approximately $58,000 to sponsor the auto racing team of a director's family member which is recorded in selling, general and administrative expenses. +In +2005, the Company paid approximately $41,000 in consulting fees to family members of two executives which are recorded in selling, general and administrative expenses. +In +May 2005, the Company reacquired the distribution rights of their products in the State of Hawaii (Crocs Hawaii) from one of its directors for a cash purchase price of +approximately $50,000. +In +2003, the Company's former chief executive officer loaned the Company $400,000 under a non-interest bearing note which was repaid during 2004. The impact of discounting +this loan was not material. +15. EQUITY +In 1999, the Company was established by three partners, all owning an equal percentage interest in the Company. The Company was inactive until June 2002, +when one of the partners bought out the interest of the other two partners taking full ownership interest in the Company. +F-20 +In +2002, the Company issued membership interests to fund normal operating activities for $594,000 in cash. +During +2003, the membership interests were converted into Class A and Class B membership interests. The voting membership interests were converted into Class A +membership interests. The non-voting membership interests were converted into Class B membership interests. Although there were no conversion features on the original membership +interests, the rights and privileges were substantially the same for the old and new securities. Also in 2003, a net of $613,000 in cash was received for the issuance of Class B membership +interests to fund normal operating activities. In May 2003, certain Class B holders were issued redemption features (see Note 17). +In +2004, the Company issued membership interests for a net $375,000 in cash to fund normal operations. Also in 2004, membership interests in the Company were converted to membership +units at a rate of 233,620 units for each percentage membership interest in the Company. Although there were no conversion features on the original membership interest, the rights and privileges were +substantially the same for the old and new securities. As of December 31, 2004, a total of 27,333,540 units were authorized for issuance. A total of 24,981,454 units were outstanding, comprised +of 4,672,400 Class A units, and 22,182,219 Class B units of which 1,873,165 units were unvested. +In +January 2005, in connection with the change from an LLC to a corporation, the Company converted the Class A and B units into common stock on a one for one basis. +For +purposes of computing income (loss) per common share, the Company has reflected the conversion of the membership interests into units, and the subsequent conversion of units into +shares of the Company's stock, including a 233.62-for-one split of the Company's common stock and preferred stock in conjunction with the Company's initial public offering, in +the 2003 and 2004 computation of shares outstanding (see Note 21). +Equity-Based Compensation —The Company grants restricted stock and stock options for the retention of directors and employees +and to consultants as compensation in lieu of cash. In connection with certain equity grants to employees and non-employees, the Company recognized equity based compensation expenses as +follows (in thousands): +Year Ended December 31 +2003 +2004 +2005 +Employees +$ +356 +$ +783 +$ +4,437 +Non-employees +— +1,009 +320 +Total +$ +356 +$ +1,792 +$ +4,757 +The +Company's total deferred compensation as of December 31, 2005 was $12.4 million. Estimated future amortization of deferred compensation is as follows (in thousands): +Fiscal year ending December 31, 2006 +$ +4,603 +Fiscal year ending December 31, 2007 +4,115 +Fiscal year ending December 31, 2008 +3,104 +Fiscal year ending December 31, 2009 +542 +Total +$ +12,364 +The +Company issues stock grants to employees and non-employees with vesting schedules of varying lengths. Typically, these grants range from immediately vesting to vesting +periods of up to four years. Compensation expense is recognized over the vesting term for employees and non-employees on a straight-line basis. Deferred compensation represents +the unvested portion of employee grants and is recorded as a reduction of equity. The fair value of employee grants is fixed at date of grant, or the +F-21 +measurement +date, if later, while grants to non-employees are remeasured to fair value at each reporting period until vesting occurs. During 2004, the Company granted 549,007 restricted +units for which the measurement date did not occur until April 27, 2005. Consequently, the value of these grants is remeasured at each reporting period, based on the fair value of the +underlying stock, until such measurement date. The related compensation expense is recognized over the vesting period. +Additionally, +the Company's founder and another significant stockholder granted certain equity interests to independent contractors in 2004. As a result, the Company recorded $350,000 of +equity based compensation to non-employees in 2004 related to these grants. +The +fair value of the equity units granted from October 2002 through December 2004 was originally estimated by the Company's board of directors based on information +available to them on the dates of grant, including third party sales of these units. The Company did not obtain contemporaneous valuations by valuation specialists because, at the time of the +issuances of stock options during this period, the Company's efforts were focused on acquiring new customers, developing its operational infrastructure and executing its business plan. The Company +engaged an independent third party valuation specialist to perform a retrospective valuation of common stock at December 31, 2004. Additionally, the Company engaged a third party valuation +specialist to perform retrospective valuations of common stock at May 1, 2005, June 30, 2005, August 1, 2005, September 1, 2005 and October 1, 2005. At +December 31, 2005 the Company used the initial public offering price of $21.00 for the valuation of common stock. +Stock Options —The Company granted 934,480 stock options during 2004 for which the measurement date did not occur until +April 2005. The exercise price was set at the estimated fair value of the Company's common stock at date of grant of $1.02. The estimated grant date fair value of the options was $146,000. The +value of these grants is remeasured at each reporting period, based on the fair value of the underlying stock less the exercise price of the option, until the measurement date occurs. The related +compensation expense is recognized over the vesting period on a +straight-line basis. These stock options vest over four years and have a term of seven years. +The +Company granted 350,430 stock options in January 2005 for which the measurement date did not occur until April 2005. The exercise price was set at the estimated fair +value of the Company's common stock at date of grant of $1.70. The estimated grant date fair value of the options was $100,000. The value of these grants is remeasured at each reporting period, based +on the fair value of the underlying stock less the exercise price of the option, until the measurement date occurs. The related compensation expense is recognized over the vesting period on a +straight-line basis. These stock options vest over four years. 233,620 of these options have a 10 year term and 116,810 have a seven year term. +On +April 27, 2005, the Company's Board of Directors adopted the 2005 Equity Incentive Plan, ("2005 Plan"). The 2005 Plan provides for the grant of incentive stock options, within +the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, to employees, and nonstatutory stock options, restricted stock, performance units, and other stock-based awards to +employees, directors, and consultants. A total of 5,840,500 shares of the Company's common stock are reserved for issuance pursuant to the 2005 plan. +F-22 +The +following summarizes stock option transactions for the years ended December 31, 2004 and 2005. No stock options were issued in 2002 or 2003: +Year Ended +December 31, 2004 +Year Ended +December 31, 2005 +Options +Shares +Weighted Average +Exercise Price +Shares +Weighted Average +Exercise Price +Outstanding at beginning of period +— +$ +— +934,480 +$ +1.02 +Granted +934,480 +1.02 +2,014,972 +6.03 +Exercised +— +— +— +— +Forfeited or expired +— +— +(25,698 +) +3.71 +Outstanding at end of period +934,480 +$ +1.02 +2,923,754 +$ +5.60 +Weighted average fair value of options granted during the year where exercise price equaled fair value of the stock +$ +.16 +$ +0.29 +Weighted average fair value of options granted during the year where exercise price was less than fair value of stock +$ +— +$ +5.13 +Vested at end of period +— +— +233,620 +$ +1.02 +The +Company's options under the 2005 Plan are exercisable immediately upon grant. In order to preserve the vesting provisions or the options, the options that are exercised early are +subject to a repurchase right by the Company at the lower of exercise price or fair market value of the underlying stock at the date of repurchase. This repurchase right expires upon vesting of the +underlying option. +The +status of total stock options outstanding at December 31, 2005 was as follows: +Exercise Prices +Number of +Shares +Weighted +Average Remaining +Contractual Life (Years) +Fair Value Determination +$ +1.02 +934,480 +5.7 +Estimate of fair value +$ +1.70 +350,430 +8.0 +3rd party retrospective valuation +$ +3.38 +585,218 +7.8 +3rd party retrospective valuation +$ +5.69 +621,429 +9.2 +3rd party retrospective valuation +$ +7.15 +297,866 +8.5 +3rd party retrospective valuation +$ +10.74 +134,331 +9.8 +3rd party retrospective valuation +2,923,754 +7.6 +Distribution —In 2004, the Company declared a distribution to members in the amount of $3.0 million. This amount was +accrued in the financial statements at December 31, 2004 and was paid in April 2005. +16. REDEEMABLE CONVERTIBLE PREFERRED SHARES +In June 2004 the Company issued 7,452,492 Class C Redeemable Preferred Membership Units ("Class C Units") in the aggregate amount of +$5.5 million. The proceeds were used to fund the acquisition of Foam Creations (see Note 5). Holders of Class C Units are entitled to receive out of the net profits of the +Company, a dividend at the rate of five percent (5%) per annum on their initial investment payable semi-annually on the first day of June and December of each year beginning +December 1, 2004; the dividends are cumulative and payable before any dividend or distribution is set apart or paid to common stockholders. +F-23 +In +January 2005, in connection with the change from an LLC to a corporation, the Company redesignated the Class C Units as Series A Redeemable Preferred Shares +("Series A Shares"). Although there were no redesignation features on the original Class C Units, the redesignation was on a one for one basis and the rights and privileges were +substantially the same for the old and new securities. The rights and privileges of the Series A Shares are substantially the same as those of the Class C Units, except as follows. The +redemption feature of the Series A Shares consists of the right of the holder, commencing on July 1, 2009, to put any unconverted Series A Shares to the Company for the original +issuance amount plus all accumulated and unpaid dividends. The redesignation had no impact of the Company's accounting for this issuance. In April 2005, the Series A Shares were amended +to participate in dividends with common stock and in February 2006 converted to common stock in connection with the Company's initial public offering. +The +Series A Shares have a preference in liquidation equal to the amount of the initial investment, $5.5 million plus all accumulated and unpaid dividends. The shares are +convertible at any time at the option of the holder for common shares on a one for one basis and were automatically converted to common stock in February 2006 upon the Company's initial public +offering. +Because +the Series A Shares include a redemption feature that is outside of the control of the Company, the Company has classified the Series A Shares outside of +stockholders' equity in accordance with Emerging Issues Task Force ("EITF") Topic D-98, "Classification and Measurement of Redeemable Securities." In accordance with EITF Topic +D-98, the fair value at date of issuance, $5.5 million was recorded outside of stockholders' equity in the accompanying balance sheet. Dividends on the Series A Shares are +reflected as a reduction of net income (loss) attributable to common stockholders. +17. REDEEMABLE COMMON SHARES +In May 2003, the Company granted certain holders of its Class B Units the right to put the units back to the Company commencing in the second +quarter of 2006. Under the terms of the agreements, the +purchase price is the greater of the holder's original investment or the holder's then current percentage ownership of the Company multiplied by the aggregate of the prior three fiscal years' net +income. At December 31, 2005 and 2004, a total of 8,410,320 shares are subject to this put right. In accordance with EITF Topic D-98, the Company reclassified the estimated fair +value of these units, $1.8 million, outside of stockholders' equity as of the date of the agreements. In connection with the reclassification, there was a deficit of the carrying value of +Class B units in the amount of $391,000 which was recorded in accumulated deficit. In February 2006, in connection with the initial public offering of the Company's common stock, this +put right expired and these shares were converted to common stock on a one for one basis and classified in stockholders' equity. +18. OPERATING SEGMENTS AND RELATED INFORMATION +The Company primarily designs, manufactures, and markets footwear under the crocs -brand. The acquisition of Foam +Creations in 2004 (see Note 5) added an additional line of products for the spa and boat industries. All products are manufactured using the same manufacturing process. Operating results are +assessed on an aggregate basis to make decisions about necessary resources and in assessing performance. Consequently, under the provisions of SFAS No. 131, "Disclosure About Segments of an +Enterprise and Related Information," the Company has one reportable segment for financial statement purposes. All significant revenues from external customers and long-lived assets were +located in North America for the years ended December 31, 2003 and 2004. The Company's sales outside of North America totaled $5.8 million in the year ended December 31, 2005. +Sales outside North America were not material in any other period presented. The Company's long-lived assets outside North America were $183,000 at December 31, 2005 and were not +material in 2004. +F-24 +Revenues +from one customer totaled approximately 12% of consolidated revenues during the year ended December 31, 2005. There were no customers who represented 10% or more of +consolidated revenues in the years ended December 31, 2003 and 2004. +19. LEGAL PROCEEDINGS +In January 2005, the Company filed a lawsuit, through Foam Creations, against Holey Soles Holdings Ltd. in the Federal Court of Canada, Trial +Division, in Toronto, Canada. The complaint alleges trademark and copyright infringement relating to the design of some of their shoe models. The Company believes that it owns all copyrights +associated with its Beach footwear model and that the design of the Beach model has developed a substantial reputation and goodwill in Canada. Holey Soles offers footwear that is identical in style +and visual appearance in every material respect to the Company's Beach model, and the Company believes Holey Soles has infringed on its intellectual +property rights. The Company is seeking a permanent injunction with respect to any further acts of infringement of its intellectual property, as well as damages and attorneys' fees. +In +August 2005, Holey Soles filed a lawsuit against the Company in the United States District Court for the Southern District of New York. Holey Soles seeks a declaratory judgment +that the Company does not have any valid copyright or trade dress rights with respect to the design of its footwear. In addition, Holey Soles seeks a declaratory judgment that the manufacture, sale +and distribution of its footwear products does not constitute unfair competition and does not infringe upon its copyrights or trade dress rights. The Company does not expect the ultimate resolution of +this matter will have a material adverse impact on its business. +Although +the Company is subject to litigation from time to time in the ordinary course of its business, the Company is not party to any pending legal proceedings that the Company +believes will have a material adverse impact on its business. +F-25 +20. UNAUDITED QUARTERLY FINANCIAL INFORMATION +Subsequent +to the issuance of the Company's consolidated financial statements for the three months ended March 31, 2005, the Company determined that the fair value of +common stock used for certain equity grants during 2005 was understated. +The +accompanying consolidated financial statements as of and for the year ended December 31, 2005 includes the impact of these adjustments. The consolidated financial statements +for the three months ended March 31, 2005 will be restated at the time those financial statements are reissued with the Company's 2006 quarterly financial statements. The effect of the +change in fair value is shown below: +Quarter Ended +March 31, +As Previously +Reported +Quarter Ended +March 31,(a)(b) +As Restated +Quarter Ended +June 30, +Quarter Ended +September 30, +Quarter Ended +December 31,(c) +Year Ended December 31, 2005 +Revenues +$ +10,958 +$ +10,958 +$ +25,769 +$ +38,294 +$ +33,560 +Gross profit +6,839 +6,839 +13,969 +22,181 +17,819 +Income from operations +2,743 +2,166 +5,417 +12,347 +6,962 +Net income +2,396 +2,040 +3,350 +7,411 +4,171 +Net income attributable to common stockholders +2,328 +1,972 +3,282 +7,341 +4,102 +Basic income per common share +$ +0.09 +$ +0.08 +$ +0.13 +$ +0.20 +$ +0.12 +Diluted income per common share +$ +0.07 +$ +0.06 +$ +0.10 +$ +0.20 +$ +0.12 +Year Ended December 31, 2004 +Revenues +$ +973 +$ +2,047 +$ +5,117 +$ +5,383 +Gross profit +279 +1,035 +2,635 +2,409 +Income (loss) from operations +(993 +) +90 +422 +(1,090 +) +Net income +(994 +) +90 +346 +(936 +) +Net income (loss) attributable to common stockholders +(994 +) +90 +277 +(1,009 +) +Basic income (loss) per common share +$ +(0.04 +) +$ +0.00 +$ +0.01 +$ +(0.04 +) +Diluted income (loss) per common share +$ +(0.04 +) +$ +0.00 +$ +0.01 +$ +(0.04 +) +(a) On +January 4, 2005, the Company converted from a limited liability company to a taxable corporation. For the tax years beginning on January 1, 2005 and afterward, +the Company is subject to corporate-level U.S. federal and state income taxes. Additionally, the statement of operations for the three months ended March 31, 2005 reflects a +one-time income tax benefit of $797,000 to record the net deferred tax assets at the date of conversion. +(b) The +first quarter of 2004 includes a charge of $793,000 related to the vesting of certain stock based compensation. +(c) The +fourth quarter of 2004 includes a charge of $606,000 in connection with the separation agreement with the former chief executive officer; see Note 14. +F-26 +21. SUBSEQUENT EVENTS +In connection with the Company's initial public offering, on January 10, 2006 the Board of Directors approved a 233.62-for-1 stock +split of the Company's common stock and preferred stock to be consummated prior to completion of the offering. All share and per share amounts related to common stock, preferred stock and stock +options included in the accompanying financial statements and footnotes have been restated to reflect the stock split. In connection with the completion of the Company's initial public offering, the +number of authorized shares was increased to 125,000,000 shares of common stock and 5,000,000 shares of preferred stock. +On +January 10, 2006, the Company's board of directors amended the 2005 Plan to increase the number of shares of common stock available for issuance under the 2005 Plan from +5,840,500 shares to 7,008,600 shares. +On +January 23, 2006 Foam Creations entered into a new loan agreement with the Business Development Bank of Canada for the purchase of fixed assets in the amount of +$1.8 million, payable in monthly installments of $34,200 CAD plus interest starting in June 2006 and maturing May 2011 at the bank's float less 0.20%. The loan is secured by +machinery and equipment. +On +February 13, 2006, the Company completed an initial public offering of 11,385,000 shares of common stock at a price to the public of $21.00 per share, of which 4,950,000 shares +were sold by the Company and 6,435,000 were sold by certain selling shareholders, including 1,485,000 shares that were sold by the selling shareholders pursuant to the underwriters' +over-allotment option. Upon completing the offering, the Company received net proceeds of approximately $96.9 million. The Company used the proceeds to repay amounts outstanding +under its U.S. credit facility and Canadian bank loans and for working capital and general corporate purposes. In connection with the offering, the Company's redeemable common and preferred shares +were converted to common shares. +In +March 2006, the Company paid the December 2005 semi-annual dividend payment on the Series A Shares of $137,500 and the final dividend payment of +$57,000 for the time period January 1, 2006 through the Company's initial public offering, when the Series A Shares were converted into common stock. +In +March 2006, the Company paid $3.8 million related to the amounts outstanding under the loan from Development Bank of Canada and loans from the National Bank of Canada. +F-27 \ No newline at end of file diff --git a/raw/filings/0001334036/2005/0001047469-06-004382/filing_metadata.csv b/raw/filings/0001334036/2005/0001047469-06-004382/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..60423e97004e3e22d12c2bc181520fe03163a1ce --- /dev/null +++ b/raw/filings/0001334036/2005/0001047469-06-004382/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2006-03-31,2005-12-31,2006-03-31T22:18:22.000Z,0001047469-06-004382,a2168966z10-k.htm,10-K,676297,0,0,https://www.sec.gov/Archives/edgar/data/1334036/000104746906004382/a2168966z10-k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000104746906004382/,2005,2005,1 diff --git a/raw/filings/0001334036/2005/0001047469-06-004382/item1.txt b/raw/filings/0001334036/2005/0001047469-06-004382/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..3fd84a40804c218e09f2acf23b05c452f59f088c --- /dev/null +++ b/raw/filings/0001334036/2005/0001047469-06-004382/item1.txt @@ -0,0 +1,191 @@ +ITEM 1. Business +Overview +We are a rapidly growing designer, manufacturer and marketer of footwear for men, women and children under the crocs brand. All of our +footwear products incorporate our proprietary closed-cell resin material which enables us to produce a soft and +lightweight, non-marking, slip- and odor- resistant shoe. We believe our proprietary closed-cell resin, which we refer to as croslite , combined with our unique styling, represents a substantial +innovation in footwear comfort and functionality, allowing us to offer a +differentiated line of products in the casual lifestyle footwear category at attractive retail price points ranging from $19.99 to $59.99, as of February 28, 2006. We currently offer 11 +footwear models in up to 18 different colors. We market our footwear products to a broad range of distribution channels and currently sell our products in over 6,500 retail locations in the United +States, and have begun selling our products in over 40 additional countries. +Product Overview +Our primary product line is crocs -branded footwear for men, women and children, which we first introduced in 2002 with a single model in +six colors. We have since expanded our line +of footwear to include 11 models in up to 18 different colors and a range of sizes, representing over 1,100 stock keeping units, or SKUs, and we +intend to continue diversifying our footwear portfolio with new model introductions. In addition to our footwear products, we market a line of crocs-branded apparel and accessory items that are +intended to increase awareness of our brand and our products. We also selectively use croslite to manufacture a variety of other non-branded +products, such as spa pillows and kayak seats, which are marketed to original equipment manufacturers. +Footwear +A key differentiating feature of our footwear products is croslite , which is uniquely suited for comfort and +functionality. We have carefully formulated croslite to be of a density that creates a comfortable shoe with a high coefficient of friction, allowing +for slip-resistant, non-marking footwear that is extremely lightweight. For example, a size large Beach model weighs approximately six ounces, which is significantly lighter +than more traditional casual footwear products. Croslite softens as it warms to better conform to the wearer's feet. Our shoes are also +non-absorbent, which makes them water resistant and virtually odor-free, and allows them to be cleaned simply with water or bleach. +We +have combined the unique properties of croslite with designs that are intended to be functional across a broad range of activities. As +a result, we believe our products appeal to a wide range of consumers. We introduced crocs as a footwear brand in the U.S. with the launch of our Beach model in 2002. Based on our initial success, we +made refinements to the Beach model +and introduced a second generation of footwear (the Cayman, Highland and Metro models) that incorporated a broader range of sizing, provided different levels of ventilation for various climates and +offered slightly different styling. We have further broadened our footwear line into new product categories, such as the Athens, a flip-flop with a soft footbed; the Nile, an open toe +model designed for women; and the Islander, a deck shoe integrating a base made from croslite with a stitched leather upper. +We +currently sell our shoes in an assortment of colors, styles and sizes to provide consumers and retailers a wide variety of options at suggested retail prices ranging from $19.99 to +$59.99. We have designed our shoes to offer a number of beneficial structural features to provide maximum comfort and functionality, such as Italian-designed orthotic heels, built-in arch +supports and tarsal bars. We also offer models that are based on either general shoe sizing ranging from XXS through 4XL, or specific shoe sizing ranging from children's 8-9 through men's +13. This allows retailers to offer a complete +4 +range +of sizes or carry a more limited number of SKUs, enabling them to tailor their offerings to their particular clientele and more efficiently allocate limited floor space. +Apparel and Accessories +We have introduced several crocs -branded accessory items that complement the fun styling, colors and image of our footwear and that we +believe will appeal to a similar demographic +base. We have developed a line of crocs sunglasses that we intend to market to larger retail customers where we believe accessories will appeal to the retailer's customer base and +complement the retailer's merchandising strategy for our footwear. We also intend to develop additional crocs accessories for certain targeted markets. For example, we have developed a line of +lightweight, colorful kneepads made from croslite , which we are marketing to gardening retailers and hardware stores. Our strategy is to develop accessory items that benefit from our unique +material and complement the market positioning of our crocs footwear. +As +part of our strategy to increase awareness of our brand, we have also introduced a line of branded logo apparel which is complementary to our footwear line and embodies the functional +and fun aspects of the crocs brand. These products include t-shirts, sweatshirts, hats, beanies and socks, all of which come in various colors and prominently +feature the crocs logo. +Other Products +Croslite is well suited to a number of other applications and, in many cases, is superior to materials currently +used in such applications. Foam Creations, our wholly owned subsidiary, manufactures spa pillows for the home spa market, seats and pads for use in kayaks and canoes, and scuba diving fins as croslite +is highly functional for water sports products. These products employ croslite , but we do not +market them under the crocs brand name. +Sales and Distribution +Domestic Distribution Sales +In the U.S., we sell our products through over 6,500 domestic retail store locations representing over 3,400 customer accounts. Our footwear is currently sold +through traditional retail channels, including specialty footwear stores, sporting goods and outdoor retailers. Sales to Dillard's accounted for approximately 12% of our revenues during the year ended +December 31, 2005. No other customer accounted for more than 10% of our revenues during the year ended December 31, 2005. Our products are also sold through a variety of other specialty +channels, including gift shops, independent bicycle dealers, specialty food retailers, health and beauty stores, catalogs, uniform suppliers and kiosks. +Our +domestic accounts are primarily serviced through our internal sales force and a network of independent sales representatives, who focus on selling the appropriate mix and quantity of +our products to our retail accounts. They ensure our products are displayed effectively at retail locations and educate our retailers about our crocs brand and the quality of our products. We compensate +our internal and independent sales representatives on a commission basis, which we believe +provides them with strong incentives to promote our products. We are typically the exclusive footwear brand sold by the independent sales representatives, who may also sell complementary products, +such as sunglasses or apparel, from other companies. For certain of our larger retail accounts and distributors, we manage the sales relationship through in-house sales executives rather +than through independent sales representatives. +5 +International Distribution Sales +Outside of the U.S., we sell our products through over 1,500 international retail store locations. Our strategy is to sell through a broad range of sporting goods +and department stores, as well as through specialty retailers, similar to the retail sales channels we have established in the U.S. We intend to continue to establish a direct sales presence in major +foreign markets, rather than rely on distributors, which we believe will improve our margins and allow us to better control our marketing and distribution. We have established direct sales efforts in +Australia, Austria, the Caribbean, France, Germany, Hong Kong, Japan, the Netherlands, Singapore, and the United Kingdom. +We +also use distributors in select foreign markets where we believe such arrangements are preferable to direct sales. In markets where we use third party distributors, these distributors +purchase products pursuant to a price list and are granted the right to resell such products in a defined territory, usually a country or group of countries. Our typical distribution agreements have +terms of one to four years, are +terminable on 60 days' notice prior to the end of the term or on six months prior notice at any time, and require our distributors to meet a minimum sales threshold. +Retail Sales +We are currently expanding our direct sales efforts to consumers. We believe that direct sales provide us with an opportunity to showcase our entire line of +footwear, apparel and accessory offerings, and believe this strategy will serve as an important and effective means to enhance our product and brand awareness. We also believe that our direct sales +initiatives require low levels of capital investment while enabling us to sell our products at retail, rather than wholesale prices, resulting in higher potential gross margins. +Retail Sites. As of December 31, 2005, we operated approximately 50 retail kiosks domestically and internationally +located in malls and other high foot traffic areas. With bright and colorful displays, efficient use of retail space and limited initial capital investment, we believe that kiosks are an effective +outlet for selling our products. Kiosks enable us to highlight a wide range of our product offering, more effectively interact with potential consumers and enhance our brand awareness among both +consumers and local retailers. We plan to continue to open and operate additional kiosk sites in select, high foot traffic locations. +Internet. We currently offer our products domestically and internationally through our website at www.crocs.com. Our Internet +presence enables us to educate consumers about our products and brand. As we expand our international marketing efforts, we intend to create local websites targeting consumers in each major market we +enter. +Distribution and Logistics +In July 2005, we engaged Expeditors International of Washington, Inc., a global supply chain management and logistics provider, to operate our +warehouse, distribution and fulfillment process for a significant portion of our domestic sales. Expeditors operates a distribution center in Aurora, Colorado through which we distribute a substantial +portion of our products in the U.S. We have negotiated the use of up to 320,000 square feet of the distribution center to accommodate fluctuations in our inventory. We do not have a +long-term contract with Expeditors, and the relationship may be terminated at will on 60 days' notice by either party. +A +substantial portion of our products are shipped to Expeditors' distribution center in Aurora, Colorado. From there, Expeditors packages orders and generally ships by package express or +truck to our customers, depending on size of order, customer location and availability of inventory. In select cases, large customers may receive shipments of footwear directly from the manufacturing +facilities. We have additional company-operated warehouse and fulfillment operations in Canada, China, Mexico, the +6 +Netherlands +and Singapore, and are developing relationships with third parties in Australia, Japan, New Zealand and Singapore to provide such services to us. In addition, we have established a +company-operated warehouse facility and customer order facility in Niwot, Colorado, and we are currently processing our Internet, accessories and apparel orders from this facility. We believe that +these warehousing, distribution and fulfillment services will enable us to ship our products from facilities adjacent to our manufacturing operations directly to our customers, rather than through +Expeditors' distribution facility in Colorado. +Raw Materials +Our proprietary closed-cell resin, which we refer to as croslite , is the primary raw material used in +all of our footwear and non-branded products. Croslite is also used in our crocs -branded accessory items, such as our kneepads. We have formulated +croslite to offer a number of +unique properties that make our material suitable for a wide range of commercial uses including those mentioned above. Our material is soft and durable and is of a density that provides a high +coefficient of friction allowing our material to be slip-resistant and non-marking in addition to being extremely lightweight. Additionally, the closed-cell nature +of croslite makes it resistant to the bacteria and fungus that cause shoe and foot odor. We continue to invest in research and development in order to +refine our materials to enhance these properties as well as target the development of new properties for specific applications. +Croslite is produced by compounding elastomer resins that we or one of our third party processors purchase from a major chemicals +manufacturer together with certain other production inputs, such as color dyes. Other than the elastomer resins, all of the raw materials we use to produce croslite are readily available for purchase +from multiple suppliers. At this time, we have identified two suppliers that produce the particular +elastomer resins used in croslite . However, we may in the future identify and utilize materials produced by other suppliers as an alternative to the +elastomer resins we currently use in the production of our proprietary material. +We +have historically contracted to have croslite compounded by Finproject S.p.A., or Finproject, our third party manufacturer in Italy, +and we have recently begun compounding croslite at our manufacturing facility in Quebec City, Canada. We have also engaged a processor in Canada to +compound a portion of our croslite requirements. We believe that in-house production of croslite will lower our production costs, reduce the risk of supply +shortages from our third party processors and provide us with greater production +flexibility to meet changing retail demand. +Manufacturing and Sourcing +We operate our own production facilities in North America, and we also contract with third party manufacturers located in the U.S. and around the world. We +believe our in-house manufacturing capabilities enable us to rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high-demand +models and colors throughout the year, while outsourcing allows us to capitalize on the efficiencies and cost benefits of using contract manufacturing. +The +process for manufacturing our footwear was developed over an eight year period of continual refinement to improve consistency, softness, durability and yield. Prior to +October 2004, all of our footwear was manufactured at Foam Creations's facility in Quebec City. In the year ended December 31, 2005, we manufactured approximately 16.8% of our footwear +products in our Quebec City facility and have increased our internal manufacturing capacity through our acquisition in April 2005, and subsequent expansion, of a manufacturing operation in +Mexico. We obtain the remainder of our footwear products from third party manufacturers in China, Florida and Italy. In the year ended December 31, 2005, a supplier in China produced +approximately 70.3% of our footwear unit volume. We have long-term contracts with third party manufacturers in Italy and Florida, but do not have a written supply agreement with our +primary third party manufacturer in China. During 2006 +7 +we +intend to expand our manufacturing capacity at the facility we operate in Mexico, in addition to adding third party manufacturing capacity at a facility in Romania operated by one of our existing +suppliers. +While +we are currently dependent on a limited number of third party manufacturers to produce a majority of our footwear products, we have evaluated and qualified over 15 alternative +third party manufacturers that have the current ability and capacity to manufacture our footwear products in the event that one or more of our current third party manufacturers were to reduce or cease +production of our footwear. +We +purchase our apparel and accessories from various suppliers in the U.S. that source our products from manufacturers in Guatemala, Honduras and South Korea. +Backlog +As of December 31, 2005, our backlog was approximately $6.7 million compared to $1.4 million as of December 31, 2004. Although orders +in the backlog are subject to cancellation by customers, we have not experienced any material levels of cancellation of orders by our customers in the past. For a variety of reasons, including our +short operating history, continued growth in customer demand for our products, the addition of new customers in each of our channels, the timing of production and shipments, seasonality, product mix +of customer orders, and a shift toward shorter lead times for orders, backlog may not be a reliable measure of future sales for any succeeding period. In addition, our historical cancellation +experience may not be indicative of future cancellation rates. +Competition +The global casual footwear and apparel industry is highly competitive. The principal elements of competition in this industry include brand awareness, product +functionality, design, quality, pricing, marketing and distribution. We believe that our unique footwear designs, croslite and our expanding product +offering and distribution network position us well in the marketplace. However, some companies in the casual footwear and apparel industry have substantially greater financial, distribution and +marketing resources than we have. Furthermore, the unique designs and resulting success of our footwear products have attracted new players in the market with imitation products that are similar to +ours, and we face competition from these new market entrants. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress and patent protection to establish, protect and enforce our intellectual property +rights in our product designs, brand, materials and research and development efforts, although no such methods can afford complete protection. +We +own a variety of trademarks, including the crocs trademark, in a number of countries around the world. Our trademarks are used on all of our crocs -branded +footwear, apparel and accessory products. We have registered our crocs trademark in Australia, the European Union, Japan, Mexico, New Zealand and Panama, and have registered our crocs logo as a trademark with the World Intellectual Property Office, or WIPO. As of February 7, 2006, we had 18 pending applications for our +trademarks in the U.S., including an application for the crocs trademark and our crocs logo. As of February 7, 2006, we also had 180 pending +trademark applications in foreign jurisdictions. Trademarks registered outside of the +U.S. generally have a duration of ten years depending on the jurisdiction and are also generally subject to an indefinite number of renewals for a like period on appropriate application. We believe +our trademarks are crucial to the successful marketing and sale of our products, and we intend to vigorously prosecute and defend our rights throughout the world. +8 +As +of February 7, 2006, we had three utility patent applications and 23 design patent applications pending in the U.S., as well as one utility patent issued in the United States. +We also had European Union Community Design Registrations directed to our Beach, Highland, Nile, Metro, Islander, Aspen, and a number of planned future shoe models. We also had three issued design +registrations in South Korea, three issued design registrations in India, three pending design applications in Brazil, and three pending design applications in China directed to our Beach, Highland, +and Nile models. We also had 78 other design applications pending directed to our Islander, Aspen, and a number of planned future shoe models in foreign jurisdictions. In addition, we had 27 utility +patent applications pending in several foreign jurisdictions. We expect to continue to pursue patent protection on our inventions that are significant to our business and pursue other intellectual +property protection where applicable. +We +consider the formulation of croslite used to produce our products to be a valuable trade secret. Prior to our acquisition of Foam +Creations in June 2004, Foam Creations developed the formula for croslite , and we believe that they did not publish or otherwise make the formula +available to third parties without the protection of confidentiality or similar agreements. Since the acquisition, we continue to protect the formula by using confidentiality agreements with our third +party processors and by requiring our employees who have access to the formula to execute confidentiality agreements or to be bound by similar agreements concerning the protection of our confidential +information. Neither we nor Foam Creations have attempted to seek patent protection for the formula but we are not aware of any third party that has independently developed the formula or that +otherwise has the right to use the formula in their products other than Finproject. Under the terms of our supply agreement with Finproject, Finproject has certain limited rights to use croslite , which +were originally negotiated in connection with our purchase of Foam Creations from Finproject's parent company. We believe the comfort +and utility of our shoes depend on the properties achieved from the compounding of croslite and is a key competitive advantage for us, and we intend to +vigorously protect this trade secret. +We +actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors and retailers to police against infringing +products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives are also educated on our pending patents and trade dress and assist +in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as +do the laws of the United States, and therefore we may have difficulty obtaining legal protection for our intellectual property in certain jurisdictions. +Employees +As of December 31, 2005, we employed approximately 1,130 employees. As of December 31, 2005, none of our employees were represented by a union, +other than 275 of our Canadian employees who were represented by the Teamsters Union. We believe our relationship with our employees is good. \ No newline at end of file diff --git a/raw/filings/0001334036/2005/0001047469-06-004382/item13.txt b/raw/filings/0001334036/2005/0001047469-06-004382/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..2c79f4d98c40ed83eb9383f4686a107a9c9a73cd --- /dev/null +++ b/raw/filings/0001334036/2005/0001047469-06-004382/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. Certain Relationships and Related Transactions +Information +required by this item will be contained in the 2006 Proxy Statement and is hereby incorporated by reference thereto. \ No newline at end of file diff --git a/raw/filings/0001334036/2005/0001047469-06-004382/item9a.txt b/raw/filings/0001334036/2005/0001047469-06-004382/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..43437d89f1ee610c1da8e1c5cbd64c8eb567f43d --- /dev/null +++ b/raw/filings/0001334036/2005/0001047469-06-004382/item9a.txt @@ -0,0 +1,16 @@ +ITEM 9A. Controls and Procedures +We have established disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Exchange Act to ensure that material +information relating to us, including our consolidated +37 +subsidiaries, +is made known to the officers who certify our financial reports and to other members of senior management and the board of directors. +There +has been no change in our internal control over financial reporting that occurred during our most recent quarter ended December 31, 2005 that has materially affected, or is +reasonably likely to materially affect, our internal control over financial reporting. +During +the first quarter of 2006, we have been taking actions to improve our internal control over financial reporting, including hiring additional experienced personnel in finance and +accounting and improve our IT systems to strengthen our accounting and financial reporting and consolidation capabilities. We expect that these actions will materially improve our internal controls. +Based +on their evaluation as of December 31, 2005, our chief executive officer and chief financial officer have concluded that our company's disclosure controls and procedures are +effective to ensure that the information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods +specified in SEC rules and forms. \ No newline at end of file diff --git a/raw/filings/0001334036/2005/0001047469-06-004382/rp_note.txt b/raw/filings/0001334036/2005/0001047469-06-004382/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..60ced8c1430e9f98d0bd17c1633742b83ed589ee --- /dev/null +++ b/raw/filings/0001334036/2005/0001047469-06-004382/rp_note.txt @@ -0,0 +1,60 @@ +14. RELATED PARTIES +The Company entered into the following related party transactions (in thousands): +December 31 +2003 +2004 +2005 +Founder: +Note payable +$ +36 +$ +39 +$ +— +Fee agreement +82 +— +— +Note payable +400 +— +— +Crocs Hawaii (owned by board member): +Period-end accounts receivable balance due to the Company +— +117 +— +Sales +8 +142 +250 +Sponsorship expense +— +— +58 +Consulting expense +— +— +41 +The +Company executed a separation agreement with the former chief executive officer on January 1, 2005. The terms of the arrangement were agreed to by the Company and the former +chief executive officer as of December 31, 2004, consequently, the Company has recorded the present value of the severance and health insurance continuation in the 2004 financial statements. +The total amount recorded was $606,000, which has been reflected in selling, general and administrative expenses. The amount recorded has been discounted over the future payment terms at 6%. The +corresponding liability is recorded in other current and non-current liabilities, for amounts due in 2007 and beyond, and accrued expenses and other liabilities for amounts due in 2006. +In +connection with the separation agreement discussed above, the Company and former chief executive officer entered into an exclusive distribution agreement that commenced July 1, +2005. The distribution agreement is for specified territories in Central America and has an initial term of two years. The agreement provides for renewal periods at the former chief executive +officer's option, if specified sales volumes are attained. Pricing under this agreement is set at a discount off the Company's then current wholesale pricing. Additionally, effective July 1, +2005, the Company and the former chief executive officer entered into an agreement providing him the right to license and/or franchise airport kiosks selling the Company's products for a period of +10 years, subject to the Company's right to terminate the agreement if specified numbers of kiosks are not opened in timeframes specified. +In +2005, the Company paid approximately $58,000 to sponsor the auto racing team of a director's family member which is recorded in selling, general and administrative expenses. +In +2005, the Company paid approximately $41,000 in consulting fees to family members of two executives which are recorded in selling, general and administrative expenses. +In +May 2005, the Company reacquired the distribution rights of their products in the State of Hawaii (Crocs Hawaii) from one of its directors for a cash purchase price of +approximately $50,000. +In +2003, the Company's former chief executive officer loaned the Company $400,000 under a non-interest bearing note which was repaid during 2004. The impact of discounting +this loan was not material. \ No newline at end of file diff --git a/raw/filings/0001334036/2005/0001047469-06-004382/rpt_disclosure.txt b/raw/filings/0001334036/2005/0001047469-06-004382/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..e2ddbafa54d884cb80bc56b453ca936ae4edca10 --- /dev/null +++ b/raw/filings/0001334036/2005/0001047469-06-004382/rpt_disclosure.txt @@ -0,0 +1,14 @@ +CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS +Ronald Snyder's spouse, Kimberly Snyder, was employed during 2005 as our Director of Apparel and Accessories, and received $81,250 in salary and $27,000 in bonus +compensation in 2005. We also entered into a restricted stock award agreement with Ms. Snyder in 2005, pursuant to which Ms. Snyder received 15,419 shares of our common stock on +October 1, 2005 and will receive an additional 15,652 shares of our common stock on October 1, 2006 and 15,653 shares of our common stock on October 1, 2007. +In +April 2003, we entered into an oral distribution arrangement with St. Vrain Trading, LLC, an entity controlled by Mark Retzloff, a member of our board of directors, which +granted St. Vrain the exclusive right to distribute our footwear products in Hawaii. Under the arrangement, St. Vrain purchased our footwear products at a discount to our standard wholesale prices. In +May 2005, we purchased all of the assets of St. Vrain Trading for a net amount in cash equal to $55,563, and the assumption of a lease agreement and other liabilities. The purchased assets consisted +of $81,707 in cash and accounts receivable, inventory valued at $39,910 and $1,750 of other assets. +Director and Officer Indemnification +We have entered into agreements to indemnify our directors and executive officers, in addition to the indemnification provided for in our certificate of +incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys' fees), judgments, fines +and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person's services as a director or executive officer of +ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. \ No newline at end of file diff --git a/raw/filings/0001334036/2007/0001047469-08-002093/filing.txt b/raw/filings/0001334036/2007/0001047469-08-002093/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..d35f300de9d8a7b1a362921ad83ed127337eec34 --- /dev/null +++ b/raw/filings/0001334036/2007/0001047469-08-002093/filing.txt @@ -0,0 +1,4965 @@ +10-K +1 +a2183219z10-k.htm +FORM 10-K +Use these links to rapidly review the document +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2007 +or +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from to +Commission File No. 0-51754 +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware +20-2164234 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +6328 Monarch Park Place +Niwot, Colorado 80503 +(303) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant's of principal executive office) +Securities +registered pursuant to Section 12(b) of the Act: +Title of each class: +Name of each exchange on which registered: +Common Stock, par value $0.001 per share +The NASDAQ Global Select Market +Securities registered pursuant to Section 12(g) of the Act: +None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes ý No o +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Act. Yes o No ý +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 ý No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be +contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to +the Form 10-K. o . +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See +definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer ý +Accelerated filer o +Non-accelerated filer o +(Do not check if a smaller reporting company) +Smaller reporting company o +Indicate by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the Exchange +Act). Yes o No ý +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2007 was $3,330,822,527. For the +purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 5% of the registrant's common stock are assumed to be affiliates of the +registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The +number of shares of the registrant's common stock outstanding as of January 31, 2008 was 82,440,332. +DOCUMENTS INCORPORATED BY REFERENCE +Part III +incorporates certain information by reference from the registrant's proxy statement for the 2008 annual meeting of stockholders to be filed no later than 120 days +after the end of the registrant's fiscal year ended December 31, 2007. +Crocs Inc. +2007 Annual Report on Form 10-K +Table of Contents +PART I +Item 1. +Business +Item 1A. +Risk Factors +Item 1B. +Unresolved Staff Comments +Item 2. +Properties +Item 3. +Legal Proceedings +Item 4. +Submission of Matters to a Vote of Security Holders +PART II +Item 5. +Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +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 +Item 9A. +Controls and Procedures +Item 9B. +Other Information +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +Item 11. +Executive Compensation +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +Item 13. +Certain Relationships and Related Transactions, and Director Independence +Item 14. +Principal Accounting Fees and Services +PART IV +Item 15. +Exhibits, Financial Statement Schedules +Signatures +FORWARD-LOOKING INFORMATION +Throughout this report, references to the "Company," "we" and "our" refer to Crocs, Inc. and its consolidated subsidiaries, unless the context indicates +otherwise. +Statements +in this Form 10-K (or otherwise made by us or on our behalf) contain various forward-looking statements within the meaning of Section 27A of the +Securities Act of 1933, as amended, or the "Securities Act", and Section 21E of the Securities Exchange Act of 1934, as amended, or the "Exchange Act," which represent our management's beliefs +and assumptions concerning future events. When used in this document and in documents incorporated by reference, forward-looking statements include, without limitation, statements regarding financial +forecasts or projections and our expectations, beliefs, intentions or future strategies that are signified by the words "expects," "anticipates," "intends," "believes," "plans," or similar language. +These forward-looking statements are subject to risks, uncertainties and assumptions that could cause our actual results and the timing of certain events to differ materially from those expressed in +the forward-looking statements including risks such as "our limited operating history," "our significant recent expansion," "changing fashion trends," "our reliance on market acceptance of the small +number of products we sell," "our ability to develop and sell new products," "our limited manufacturing capacity and distribution channels," "our reliance on third party manufacturing and logistics +providers for the production and distribution of our products," "our reliance on two vendors for certain raw materials," "our management and information systems infrastructure," "our ability to obtain +and protect intellectual property rights," "the effect of competition in our industry," "the effects of seasonality on our sales," "our ability to attract, assimilate and retain management talent," +and other similar statements. It is routine for our internal projections and expectations to change as the year or each quarter in the year progresses, and, therefore, it should be clearly understood +that the internal projections, beliefs and assumptions on which we base our expectations may change prior to the end of each quarter or year. Although these expectations may change, we undertake no +obligation to publicly update or revise any forward-looking statements as a result of new information, future events or otherwise. +You +should understand that many important factors, in addition to those discussed or incorporated by reference in this report, could cause our results to differ materially from those +expressed in the forward-looking statements. Potential factors that could affect our results include, in addition to others not described in this report, those described in Item 1A. "Risk +Factors" of this report. In light of these risks and uncertainties, the forward-looking events discussed in this report might not occur. +PART I +ITEM I. Business +Overview +We are a rapidly growing designer, manufacturer, distributor, worldwide marketer and brand manager of footwear for men, women, and children. We design and sell a +broad offering of footwear, apparel, gear and accessories that utilize our proprietary closed cell-resin, called Croslite. In the past several years, we realized high demand for our +Croslite products, specifically, our classic Beach and Cayman models. Croslite is a unique material that enables us to produce an innovative, soft, lightweight, non-marking, slip and +odor-resistant shoe. Crocs shoes combine fun colors and innovative designs to provide a new level of comfort, functionality and style in the casual lifestyle footwear category. +Since +the initial introduction and popularity of our Beach and Cayman models, we have expanded our Croslite products to include a variety of new styles and products and have extended our +product reach through the acquisitions of new brand platforms such as Jibbitz, LLC ("Jibbitz"), Fury Hockey, +2 +formerly +55 Hockey Products, Inc. ("Fury"), Ocean Minded, LLC ("Ocean Minded"), Bite, LLC ("Bite"), and through various licensing agreements. +We +currently sell our Crocs-branded products throughout the U.S. and in over 90 countries worldwide. We sell our products through quality domestic and international retailers and +distributors and directly to end-user consumers through our webstores, Company-operated retail stores and kiosks. The broad appeal of our footwear has allowed us to market our products to +a wide range of distribution channels, including department stores and traditional footwear retailers as well as a variety of specialty channels. As of December 31, 2007, our customer base +domestically and internationally expanded to over 13,000 and 19,000 customer locations selling our products, respectively. +Our History +We were organized as a limited liability company in 1999 and began marketing and distributing footwear products in the U.S. under the Crocs brand in 2002, shortly +after completing the modification of a shoe produced by Crocs Canada Inc. ("Crocs Canada"), formerly known as Foam Creations Inc., and Finproject N.A., Inc. The unique +characteristics of Croslite, developed by Crocs Canada, enabled us to offer consumers an innovative shoe unlike any other footwear model then available. Initially, we targeted our products to water +sports enthusiasts, but the comfort and functionality of our products appealed to a more diverse group of consumers who used our footwear for a wide range of activities. To capitalize on the broad +appeal of our footwear, we expanded our sales infrastructure, strengthened our senior management team, and developed relationships with a range of retailers in the U.S. In June 2004, we acquired Crocs +Canada, including its manufacturing operations, product lines, and rights to the trade secrets for Croslite. We converted to a Colorado corporation in January 2005 and reincorporated in Delaware in +June 2005. Since June 2004, we have significantly expanded all aspects of our operations in order to take advantage of what we believe to be an attractive market opportunity. +Product Overview +Our primary product line is Crocs-branded footwear for men, women and children. In addition to our footwear products, we market a line of Crocs-branded apparel, +gear and accessory items that are intended to increase awareness of our brand and our products. Since 2002 our business has grown tremendously, both organically and through acquisitions that leverage +our business model. +In +2006, we added: +• Jibbitz, +which produces unique charms specifically suited to fit into Crocs shoes; and +• Fury, +which produces and distributes hockey, soccer and lacrosse equipment manufactured with Croslite. +In +2007, we added: +• Ocean +Minded, which produces sandals primarily for the beach, action and adventure market; +• Bite, +a manufacturer of performance shoes and sports sandals sold worldwide in five categories, including, golf, adventure, healthy lifestyle, travel and watersports; and +• YOU +by Crocs™, a women's fashion line that combines the comfort of Croslite with fashionable styles. +We +also selectively use Croslite to manufacture a variety of other non-branded products, such as spa pillows and kayak seats, which are marketed to original equipment +manufacturers. +3 +Footwear +A key differentiating feature of our footwear products is Croslite, which is uniquely suited for comfort and functionality. We have carefully formulated Croslite +to be of a density that creates a comfortable shoe with a high coefficient of friction, allowing for slip-resistant, non-marking footwear that is extremely lightweight. For +example, our size large Beach model weighs approximately six ounces, which is significantly lighter than more traditional casual footwear products. Croslite softens as it warms to better conform to +the wearer's feet. Croslite is a closed cell resin, which is water resistant and virtually odor-free, and allows our footwear products to be cleaned simply with water or bleach. Our +business has grown significantly since we first introduced our Crocs product line in 2002 with a single model in six colors. +Over +the past few years we have: +• Expanded +our Crocs product line to 11 models in 2005, to 25 models in 2006 and over 250 models in 2007 including Ocean Minded, YOU by Crocs™ and Bite footwear +models; +• Introduced +our SolesUnited program, the first-of-its-kind recycled footwear donation program that allows customers to give back their +worn-out Crocs shoes to be recycled into new shoes which are then donated to people in need around the world. Collected worn-out Crocs shoes are sorted, cleaned, ground and +manufactured into new SolesUnited recycled footwear; +• Established +licensing agreements with Disney, Nickelodeon, Marvel, DC Comics and Warner Bros., and introduced a limited edition line of footwear and Jibbitz charms featuring +such popular characters as Cinderella, Ariel, Mickey Mouse, Sponge Bob Square Pants, Dora the Explorer, Spiderman and Batman; +• Introduced +our Crocs at Work line that offers Crocs shoes targeted towards healthcare and food industry professionals; +• Developed +our Crocs Rx line, which offers three models, the Relief, the Cloud and the Silver Cloud, targeted towards consumers who require specialized footwear that provides +relief from certain medical conditions, such as diabetes, plantar pain, heel pain, metatarsalgia, achy feet and post-op conditions; and +• Entered +into and extended our existing collegiate licensing agreements with various colleges and universities, and our sports licensing agreements with, among others, NFL, +NHL, MLB, AVP, NASCAR and more recently the Olympics, Gaelic Athletic Association and Australian football leagues. +As +part of our strategy of expanding into new footwear categories, we are continually designing new footwear using our in-house design team as well as recognized footwear +design experts. As part of this strategy, we acquired EXO Italia ("EXO") in 2006, which expanded the capabilities of our in-house design team. EXO is based in Padova, Italy and is an +Italian producer of EVA (Ethylene Vinyl Acetate) based finished products, primarily for the footwear industry. Both organically and through acquisitions, we have incorporated the benefits of Croslite +with new shoe styles to introduce the following products: +Ocean Minded. In January 2007, we acquired substantially all of the assets of Ocean Minded +( www.oceanminded.com ), a designer and manufacturer of high quality leather and EVA based sandals primarily for the beach, adventure and action sports +market. Ocean Minded is headquartered in Santa Clemente, California and strives to be innovative in style and design in order to produce the most comfortable sandals in the market. In 2008, Ocean +Minded will be introducing a product line that includes Croslite foot beds to provide increased comfort. As the name, "Ocean Minded" implies, the brand takes an active role in protecting the oceans +and beaches through beach clean ups, supporting the Surfrider Foundation and various other environmental efforts. Ocean Minded utilizes recycled and +4 +recyclable +materials whenever possible and is well known in the action sports industry as a leading advocate for environmental awareness and responsibility. +YOU by Crocs™. In June 2007, we introduced YOU by Crocs™ +( www.youbycrocs.com ), a women's fashion line that combines the comfort of Croslite with 28 designs including various boots, slides, and high heels +composed of suede, smooth napa leather, metallic leather and patent leather. All 28 styles include the "Soleful™" comfort foot bed, which is manufactured with Croslite and has extra +padding on the ball of the foot and heel to provide increased comfort. +Bite. In July 2007, we acquired Bite +( www.biteshoes.com ), an adventure driven designer and manufacturer of comfortable and supportive performance shoes and sports sandals sold worldwide in +five categories, including, golf, adventure, healthy lifestyle, travel and watersports. Bite shoes are designed to provide comfort when participating in activities such as golfing, running, hiking, +fishing, going to the beach and everyday casual wear. Bite produces some of the lightest golf shoes in the market, golf sandals and will be introducing the Ace, the first Crocs golf shoe made of +Croslite material in order to fuse comfort and sport. +Footwear +sales made up 90.1%, 96.5%, and 94.4% of total revenues for the years ended December 31, 2007, 2006, and 2005, respectively. +Apparel, Accessories and Gear +Apparel. In 2007, we expanded our clothing line and launched a new clothing line for boys, girls and +men featuring Croslite material. We added a small amount of Croslite to the material to ensure that each piece is lightweight, durable, breathable, versatile and fade resistant. +Accessories. In addition to our footwear products, we own Jibbitz +( www.jibbitz.com ), a unique accessory brand with colorful snap-on charms specifically suited for Crocs footwear. We acquired Jibbitz in +December 2006 and have expanded the product line to include a wide variety of charms in varying shapes and sizes, with designs such as flowers, sports gear, seasonal and holiday designs, animals, +symbols, letters and rhinestones. Crocs licensing agreements also extend to Jibbitz, allowing Jibbitz to create designs bearing logos and emblems of Disney, NFL, MLB, NHL, NASCAR and the Crocs +collegiate line. Jibbitz designs allow Crocs consumers to personalize their footwear to creatively express their individuality. As of December 31, 2007, more than 5,500 stock keeping units +(SKU's) were available to consumers for personalizing their Crocs footwear. +We +have also introduced several Crocs-branded accessory items that complement the styling, colors, and image of our footwear and that we believe will appeal to a similar demographic +base. For example, we have developed a line of lightweight and durable backpacks and messenger bags that are marketed to a wide range of consumers, from professionals to students. The backpacks and +bags incorporate bright colors, Croslite shoulder pads for comfort and various holes for Jibbitz so the bags can be personally decorated. +Gear. In 2005, we developed a line of lightweight, colorful kneepads made from Croslite, which we are +marketing to gardening retailers and hardware stores. In October 2006, we acquired Fury ( www.furysport.com ), a manufacturer of performance-driven +hockey, soccer and lacrosse equipment. Fury produces and distributes hockey, soccer and lacrosse equipment that incorporates Croslite to provide odor-free, anti-bacterial +protection with endurance and protection for equipment that is unique in the hockey and lacrosse equipment market. Fury's product line includes gloves, sticks, pants, shin guards and pads, as well as +a wide variety of other apparel and accessories. +5 +Sales and Distribution +Financial information regarding our revenues, profits and total assets is included in our consolidated financial statements beginning on +page F-1. Information relating to our geographic operations is included in Note 17 of our consolidated financial statements. +Domestic Sales +In 2007, sales in the U.S. accounted for approximately 52% of total revenues, compared to 68% in 2006 and 93% in 2005. In the U.S., we sell our products through +over 13,000 customer store locations, including Company-operated kiosks and retail stores in such locations as New York, Boston, Chicago, and Maui, and through our webstores. We sell through a broad +range of sporting goods and department stores, as well as through specialty retailers. We do not have long term contracts with any of our retail customers, and sales to our retail customers are +generally on an order-by-order basis and are subject to rights of cancellation and rescheduling by the customer. +International Sales +In 2007, international sales accounted for approximately 48% of total revenues in 2007, compared to 32% in 2006 and 7% in 2005. Outside of the U.S., we sell our +products through over 19,000 international customer store locations, including 25 Company-operated retail stores in a variety of locations including Canada, Finland, United Kingdom, Singapore, Hong +Kong, Japan, China and the Netherlands, as well as through our kiosks and webstores. We also sell through a broad range of retailers, similar to the retail sales channels we have established in the +U.S. We occasionally utilize sales agents and buying groups in our international locations to service our retail customers. We established a direct sales presence in most major international markets, +rather than relying on distributors, which we believe enables us to obtain better margins and allows us to better control our marketing and distribution. As of December 31, 2007, we established +direct sales efforts in countries including, Australia, Austria, Brazil, France, Germany, Japan, the Netherlands, New Zealand, Singapore, Taiwan and the United Kingdom. +Wholesale and Distributor Sales +In 2007, approximately 91% of our net revenues were derived from sales to our wholesale customers and distributors. Our principal wholesale customers include +national and regional retail chains, department stores, sporting goods stores and specialty retailers, such as Nordstrom, Finish Line, Dicks Sporting Goods, The Sports Authority, Dillard's, The +Forzani Group and Journeys. No single customer accounted for 10% or more of our revenues for the year ended December 31, 2007. We believe we have established strong domestic and international +retail sales channels. +We +use distributors in select markets where we believe such arrangements are preferable to direct sales. In markets where we use third-party distributors, these distributors purchase +products pursuant to a price list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of +one to four years, are terminable +on 60 days' notice prior to the end of the term or on six months' prior notice at any time, and require our distributors to meet a minimum sales threshold. Our agreements with distributors do +not contain contractual rights of returns or price protection features, We will accept returns for defective products, quality issues, and shipment errors on an exception basis at the sole discretion +of our management. +Our +domestic accounts are primarily serviced through our internal sales force, which focuses on selling the appropriate mix and quantity of our products to our retail accounts. They +ensure our products are displayed effectively at retail locations and educate our retailers about our Crocs brand and the quality of our products. +6 +Our +financial success is significantly related to the willingness of our retail customers to continue to carry our products, the expansion to new retail customers, and to the success of +such customers. We do not have long term contracts with any of our retail customers, and sales to our retail customers are generally on an order-by-order basis and are subject +to rights of cancellation and rescheduling by the customer. If we cannot fill our retail customers' orders in a timely manner, the sales of our products and our relationships with those customers may +suffer, and this could have a material adverse effect on our product sales and ability to grow our product line. +Retail Sales +We are currently expanding our direct sales efforts to consumers. We believe that direct sales provide us with an opportunity to showcase our entire line of +footwear, apparel, gear and accessory offerings, and that this strategy will serve as an important and effective means to enhance our product and brand awareness. As of December 31, 2007, we +operate the following retail stores: +U.S Retail Stores +Crocs Kiosks +138 +Crocs Retail Stores +4 +Crocs Outlet Stores +6 +Total +148 +International Retail Stores +Crocs Kiosks +36 +Crocs Retail Stores +25 +Total +61 +Retail Stores. As of December 31, 2007, we operated 29 domestic and international retail stores. During 2007, we +opened retail stores in a variety of locations including New York, Boston, Chicago, London, Finland, Canada, Australia, Japan and China. Company-operated retail stores are designed with colorful +displays and allow us to effectively market our new and existing products and interact with customers in order to enhance brand awareness. We plan to continue to open additional Company-operated +retail stores in the future. +Kiosks. As of December 31, 2007, we operated 174 domestic and international retail kiosks located in malls and other +high foot traffic areas. With bright and colorful displays, efficient use of retail space, and limited initial capital investment, we believe that kiosks are an effective outlet for marketing our +products. Kiosks enable us to highlight a wide range of our products, more effectively interact with potential consumers, and enhance our brand awareness among both consumers and local retailers. We +plan to continue to open and operate additional kiosk sites in select, high foot traffic locations. +Internet. We currently offer our products domestically and internationally through our webstores, such as www.crocs.com and our European website www.crocs.eu . Our internet presence enables us to educate +consumers about our products and brand. As we expand our international marketing efforts, we intend to create local websites targeting consumers in most major markets. +Raw Materials +Our proprietary closed-cell resin, Croslite, is the primary raw material used in most of our footwear, some of our accessories, and +non-branded products, including spa pillows, and seats and pads for kayaks and canoes. Our material is soft and durable and is of a density that provides a high +7 +coefficient +of friction allowing our material to be slip-resistant and non-marking in addition to being extremely lightweight. Additionally, the closed-cell nature +of Croslite makes it resistant to the bacteria and fungus that cause shoe and foot odor. We continue to invest in research and development in order to refine our materials to enhance these properties +and to target the development of new properties for specific applications. +Croslite +is produced by compounding elastomer resins that we or one of our third-party processors purchase from major chemical manufacturers together with certain other production +inputs, such as color dyes. At this time, we have identified two suppliers that produce the particular elastomer resins used in Croslite. We may, however, in the future identify and utilize materials +produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. The other raw materials we use to produce Croslite are readily +available for purchase from multiple suppliers. +We +currently compound Croslite ourselves at our manufacturing facilities in Canada, and we contract with a third-party processor in Canada and China. To produce the subcomponents of +Croslite, we engage a third-party producer in the U.S. and a third-party producer in China. We believe that our production strategy, including in-house production, for the compounding of +Croslite will lower our production costs, reduce the risk of supply shortages from our third-party processors and provide us with greater production flexibility to meet changing retail demand. We +will, however, continue to purchase a portion of our Croslite requirements from a third-party in accordance with the terms of our supply agreement which expires in July 2009. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We have Company-operated production facilities in North +America, Italy and Brazil, and we also contract with third-party manufacturers located around the world. We believe that our in-house manufacturing capabilities enable us to rapidly make +changes to production, providing us with the flexibility to quickly respond to orders for high-demand models and colors throughout the year, while outsourcing allows us to capitalize on +the efficiencies and cost benefits of using contract manufacturing. We believe that this production strategy will enable us to continue to minimize our production costs, increase overall operating +efficiencies and shorten production and development times to better serve our retail customers. +The +process for manufacturing our footwear was developed over an eight year period of continual refinement to improve consistency, softness, durability, and yield. In the year ended +December 31, 2007, we manufactured approximately 17% of our footwear products at our Company-operated manufacturing facilities in North America, Italy and Brazil. We obtained the remaining 83% +of our footwear products from third-party manufacturers in China, Bosnia, Vietnam, Romania and the U.S. In the year ended December 31, 2007, our largest third-party supplier in China produced +approximately 56% of our footwear unit volume. We have a long-term contract with our third-party manufacturer in Florida, but do not have written supply agreements with our primary +third-party manufacturers in China. During 2007, we expanded our manufacturing capacities at the facilities we operate in North America and opened a new manufacturing facility in Brazil. +Distribution and Logistics +Once our products are manufactured, they are either shipped directly to a customer or to one of our regional distribution centers. In 2007, approximately 18% of +our business was shipped from our internal and third-party manufacturers directly to the customer. The other 82% of our business was fulfilled from the 20 distribution locations strategically located +throughout the world. At the end of 2007, we operated distribution centers in Australia, Brazil, California, Colorado, Canada, Finland, +8 +Hawaii, +the Netherlands, India, Japan, Mexico, Puerto Rico and Singapore. Our Company-operated centers had approximately 940,000 square feet of space. +We +also utilized third-party operated distribution centers to meet our continued growing business needs. The third-party centers were located in Canada, Colorado, Dubai, the Netherlands, +Hong Kong, Japan, Kansas, Korea, New Zealand, and Taiwan. These distribution centers gave us approximately 750,000 additional square feet of space. The combined total of 20 distribution locations and +1.7 million square feet of space gives us the flexibility to meet our rapidly changing business requirements and positions us to support the growth of all of our brands. +In +December 2007, we entered into an agreement with Manhattan Associates to provide warehouse management systems within all of our Company-operated distribution centers. The +implementation of their software is scheduled to be strategically rolled-out in all locations over the next 24 months. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress, and patent protection to establish, protect, and enforce our intellectual property +rights in our product designs, brand, materials, and research and development efforts, although no such methods can afford complete protection. We own the material trademarks used in connection with +the marketing, distribution and sale of all of our products, both domestically and internationally, where our products are currently either sold or manufactured. Our major trademarks include the Crocs +logo and design and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China and Canada among other places. We also own common +law trademark registrations or pending trademark applications for Jibbitz, YOU by Crocs™, Ocean Minded, Fury, Mambaz and Bite, as well as for our proprietary material Croslite and the +Croslite logo, globally. We intend to continue to strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the future. We +will also continue to aggressively police our trademarks and copyrights and pursue those who infringe, both domestically and internationally. +In +the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks are generally valid as long as they are +in use and their registrations are properly maintained and have not been found to become generic. Trademarks registered outside of the U.S. generally have a duration of 10 years depending on +the jurisdiction and are also generally subject to an indefinite number of renewals for a like period upon appropriate application. We believe our trademarks are crucial to the successful marketing +and sale of our products, and we intend to vigorously prosecute and defend our intellectual property rights throughout the world. +We +consider the formulation of Croslite used to produce our products to be a valuable trade secret. Prior to our acquisition of Crocs Canada in June 2004, Crocs Canada developed the +formula for Croslite, and we believe that it did not publish or otherwise make the formula available to third parties without the protection of confidentiality or similar agreements. Post acquisition, +we continue to protect the formula by using confidentiality agreements with our third-party processors and by requiring our employees who have access to the formula to execute confidentiality +agreements or to be bound by similar agreements concerning the protection of our confidential information. Neither we nor Crocs Canada have attempted to seek patent protection for the formula. We are +not aware of any third-party that has independently developed the formula or that otherwise has the right to use the formula in their products other than Finproject, our third-party supplier of +Croslite in Italy. Under the terms of our supply agreement with Finproject, Finproject has certain limited rights to use Croslite, which were originally negotiated in connection with our purchase of +Crocs Canada from Finproject's parent company. We believe the comfort and utility of our products depend on the properties achieved from +9 +the +compounding of Croslite and constitute a key competitive advantage for us, and we intend to vigorously protect this trade secret. +We +also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers to police against infringing +products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives are also educated on our patents, pending patents, trademarks and +trade dress and assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or +in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain jurisdictions. +Seasonality +Due to our significant sales growth since our inception, there is still uncertainty in the degree to which sales of our footwear products will be subject to +seasonality. For the year ended December 31, 2007, we experienced higher sales growth in the quarters ended March 31, 2007 and June 30, 2007, compared to the quarters ended +September 30, 2007 and December 31, 2007, for which sales remained fairly level. We +expect that our business, similar to other vendors of footwear and related merchandise, will be subject to seasonal variation. We believe many vendors that market footwear products suited for warm +weather normally experience their highest sales activity during the second and third quarters of the calendar year. While we have introduced footwear models that are more suitable for cold weather +uses, such as the Mammoth, Endeavor, Georgie, All Terrain, Snowmini, and YOU by Crocs™ styles, we expect demand for our products, and therefore our sales, may be subject to seasonal +variations and significantly impacted by weather conditions because over 70% of our revenues during the year ended December 31, 2007 were attributable to our footwear styles more suitable for +fair weather. In addition, our quarterly results of operations may fluctuate significantly as a result of a variety of other factors, including the timing of new model introductions or general +economic or consumer conditions. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year, and revenues for any +particular period may fluctuate. +Backlog +As of December 31, 2007, our backlog, which consists of open orders, was approximately $145.4 million compared to $74.6 million as of +December 31, 2006. For a variety of reasons, including our short operating history, continued growth in customer demand for our products, the addition of new customers in each of our channels, +the timing of production and shipments, seasonality, product mix of customer orders, and a shift toward shorter lead times for orders, backlog may not be a reliable measure of future sales for any +succeeding period and are subject to cancellation by customers at any time. In addition, our historical cancellation experience may not be indicative of future cancellation rates. +Competition +The global casual footwear and apparel industry is highly competitive. The principal elements of competition in this industry include brand awareness, product +functionality, design, quality, pricing, marketing and distribution. We believe that our unique footwear designs, Croslite, and our expanding product offering and distribution network position us well +in the marketplace. However, some companies in the casual footwear and apparel industry have substantially greater brand awareness, financial, distribution, and marketing resources than we currently +have. Furthermore, the unique designs and resulting success of our footwear products have attracted new players in the market with imitation products that are similar to ours, and we face competition +from these new market entrants. +10 +Product Design and Development +Our primary goal in product design and development is to create and introduce new and innovative footwear products that combine our standards of comfort, +functionality, and style, and enhance the awareness of the Crocs brand. Our footwear product line is designed by a combination of our internal design and development staff supported by outside +designers. By introducing outside sources to the design process, we believe that we are able to capture a variety of different design perspectives on a cost-efficient basis and anticipate +trends more quickly. To expand our internal design capabilities, we acquired EXO in 2006, an Italian company that has been involved in the design of several of our new styles. We are committed to +continuing to dedicate significant resources to product design and development to sustain our commitment to innovation, execute our growth strategy and drive our global brand. +We +develop footwear models based on what we identify as opportunities in the marketplace. Once a design has been identified and demand in the marketplace has been validated, the designs +are then translated into product specifications by our developers and made into prototypes at our facilities in Canada or Italy or by one of our third-party manufacturers in China. Our designers and +developers work closely with each other to develop product prototypes, test and refine products and provide quality assurance throughout the manufacturing process. Our design and development process +is highly collaborative, as members of the design team frequently meet with our sales and marketing staff, production and supply managers and certain of our retail customers to further refine our +products to meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs while maintaining +product quality. We spent $5.3 million, $1.8 million and $534,000 in Company-sponsored research, design and development activities for the years ended December 31, 2007, 2006, and +2005, respectively. +Employees +As of December 31, 2007, we employed approximately 5,300 persons compared to 2,900 as of December 31, 2006. This included 2,022 employees in the +U.S., 787 employees in Canada, 1,140 employees in Mexico, 863 employees in Asia, 252 employees in Brazil, and 236 employees in Europe. As of December 31, 2007, none of our employees were +represented by a union, other than 587 of our Canadian employees who were represented by the Teamsters Union. There has never been a material interruption of operations due to labor disagreements, and +we believe that our relations with our employees are good. +Public Filings and Corporate Information +Our internet address is www.crocs.com . On our website, we post the following filings as soon as reasonably +practicable after they are electronically filed with or furnished to the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on +Form 10-Q, our current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and +Exchange Act of 1934. All such filings on our web site are available free of charge. Also available on our web site are the charters of the committees of our board of directors, as well as our +corporate governance guidelines and code of ethics. Copies of any of these documents will be provided in print to any stockholder who submits a request in writing to Integrated Corporate Relations, +450 Post Road East, Westport, CT 06880. +11 +ITEM 1A. Risk Factors +Our short and long-term success is subject to many factors beyond our control. If any of the following risks, as well as any risks described elsewhere +in this Form 10-K, actually occur, our business, financial condition or results of operations could suffer. Other risks not presently known to us or not presently thought to be +material could also affect our business, our financial condition or results of operations. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements +as a prediction of actual results. +We have significantly expanded the nature and scope of our operations over the past several years, and if we fail to manage any future growth +effectively, we may experience greater difficulty in filling customer orders, declines in product quality, increases in costs or other operating difficulties. +We have significantly expanded the nature and scope of our operations since inception, and we anticipate that substantial further expansion will be required to +address potential growth in our customer base and new market opportunities. As of December 31, 2006, we had over 25 footwear models, which have increased to over 250 footwear models as of +December 31, 2007, including Ocean Minded, YOU by Crocs™, Bite and Crocs footwear models. In addition to acquiring new brands and developing and marketing a new apparel and clothing +line, over the last three years, we expanded from: +• 136 +employees at June 30, 2004, to approximately 5,300 employees at December 31, 2007; and +• $13.5 million +in revenues in the year ended December 31, 2004, to $847.4 million in revenues in the year ended December 31, 2007. +The +expansion of the scope and nature of our business, the growth in the number of employees, customers and other third parties with whom we have relationships, and the increase in the +number of facilities we use for manufacturing, distribution, and corporate operations, have placed and will continue to place a significant strain on our management and our information systems and +resources. To manage growth in our operations, we will need to increase the number of people we employ, upgrade our existing financial and reporting systems and improve our business processes, +operational systems and controls. Failure to effectively manage growth could result in greater difficulty in completely filling customer orders, declines in product quality or increases in costs or +other production and distribution difficulties, any of which could adversely impact our business performance and operating results. +The popularity of our Crocs footwear may not continue to grow as rapidly as it has in the recent past or may decline, which would have a negative impact +on our sales and results of operations. +Our recent growth is substantially attributable to footwear sales, which represented approximately 90.1% of our revenues for the year ended December 31, +2007. We expect that footwear will constitute our principal product line for the foreseeable future. The footwear industry is subject to rapidly changing consumer demands, preferences and fashion +trends, and our footwear may not remain popular or we may fail to develop additional models that appeal to consumers. In addition, new product lines like Ocean Minded, Bite and YOU by +Crocs™ may be rejected by customers. If the popularity of our footwear declines or does not expand in the future, we may experience, among other things: +• lower +sales; +• loss +of retail customers; +• excess +inventories; +• inventory +markdowns and discounts provided to retailers; +12 +• deterioration +of our brand image; and +• lower +revenues and gross and operating margins, as a result of price reductions. +Given +the limited history of our Crocs brand, it is especially difficult to evaluate whether our products will hold long-term consumer appeal. +Our current management information systems may not be sufficient for the growth of our business, and planned system improvements may not be successfully +implemented on a timely basis or be sufficient for our growing business. +We have made significant improvements to our management information systems over the past several years, specifically to upgrade our financial reporting systems +and to implement new information technology systems to better track our business, streamline our financial reporting, and improve our internal controls. However, for certain business planning, finance +and accounting functions, we still rely on manual processes that are difficult to control and are subject to human error. We may experience difficulties in transitioning to our new or upgraded +systems, including loss of data and decreases in productivity as our personnel become familiar with new systems. In addition, our management information systems will require modification and +refinement as we grow and our business needs change, which could prolong difficulties we experience with systems transitions, and we may not always employ the most effective systems for our purposes. +If we experience difficulties in implementing new or upgraded information systems or experience significant system failures, or if we are unable to successfully modify our management information +systems to respond to changes in our business needs, our ability to properly run our business could be adversely affected. +We have been named as a defendant in a securities class action lawsuit that may result in substantial costs and could divert management's attention. +Starting in November 2007, certain shareholders filed several purported shareholder class actions in the U.S. District Court for the District of Colorado alleging +violations of Sections 10(b) and 20(a) of the Exchange Act based on alleged statements made by us between July 27, 2007 and October 31, 2007. Plaintiffs seek compensatory damages +on behalf of the alleged class in an unspecified amount, interest, and an award of attorney's fees and costs of litigation. These actions were subsequently consolidated. The Court is currently +considering motions for the appointment of lead plaintiff and lead counsel. +After the Court appoints the lead plaintiff and lead counsel, an amended consolidated compliant will be filed. Thereafter, we will respond. +In +January 2008, plaintiffs filed a shareholder derivative action in the Colorado District Court for the City and County of Boulder alleging that certain officers and directors breached +their fiduciary duties, wasted corporate assets, and were unjustly enriched. This derivative action purports to state a claim on behalf of the corporation. The complaint alleges that the claims arise +from the same conduct as is alleged in the federal shareholder class action discussed above. We are in the process of responding. +We +are not able to predict the ultimate outcomes of these actions. It is possible that they could be resolved adversely to us, could result in substantial costs, and could divert +management's attention and resources, which could harm our business. Risks associated with legal liability are often difficult to assess or quantify, and their existence and magnitude can remain +unknown for significant periods of time. While we maintain director and officer insurance, the amount of insurance coverage may not be sufficient to cover a claim, and the continued availability of +this insurance cannot be assured. We may, in the future, be the target of additional proceedings, and these proceedings may result in substantial costs and divert management's attention and resources +that are needed to successfully run our business. +13 +We may fail to meet analyst expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly, and various securities analysts follow our financial results and issue reports on us. These reports include information about +our historical financial results as well as the analysts' estimates of our future performance. The analysts' estimates are based upon their own opinions and are often different from our estimates or +expectations. If our operating results are below the estimates or expectations of public market analysts and investors, our stock price could decline. Recently, multiple securities class action +litigations were brought against us and similar actions are frequently brought against other companies following a decline in the market price of their securities. If our stock price is volatile, we +may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management's attention and resources that are needed to successfully +run our business. +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers' orders, +either of which could adversely affect our business. +The footwear industry is subject to cyclical variations and declines in performance, as well as fashion risks, rapid changes in consumer preferences, the effects +of weather, general economic conditions, and other factors affecting demand. These factors make it difficult to forecast consumer demand, and if we overestimate demand for our products, we may be +forced to liquidate excess inventories at a discount to customers, resulting in markdowns and lower gross margins. Conversely, if we underestimate consumer demand, we could have inventory shortages, +which can result in lost potential sales, delays in shipments to customers, strains on our relationships with customers and diminished brand loyalty. Moreover, because our product line is limited, we +may be disproportionately affected by cyclical downturns in the footwear industry, changes in consumer preferences, and other factors affecting demand, which may make it more difficult for us to +accurately forecast our production needs, exacerbating these risks. A decline in demand for our products, or any failure on our part to satisfy increased demand for our products, could adversely +affect our business and results of operations. +Failure to adequately protect our trademarks and other intellectual property rights could adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents, and trade dress and designs on nearly all of our products and believe +that having distinctive marks that are readily identifiable is an important factor in creating a market for our goods, in identifying us, and in distinguishing our goods from the goods of others. We +believe that our trademarks, patents, and other intellectual property rights are important to our brand, our success and our competitive position. We periodically discover products that are +counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party's products on the basis of trademark or +design or utility patent infringement, continued sales of these products could adversely affect our sales and our brand and result in the shift of consumer preference away from our products. The +actions we take to establish and protect trademarks, patents, and other intellectual property rights may not be adequate to prevent imitation of our products by others or to prevent others from +seeking to block sales of our products as violations of proprietary rights. +In +addition, the laws of certain foreign countries may not protect intellectual property rights to the same extent as do the laws of the U.S. We have registered Crocs as a trademark for +footwear in Aruba, Australia, the European Union, Israel, Japan, Mexico, Netherlands, Antilles, New Zealand, Panama, and the World Intellectual Property Office. As of December 31, 2007, we have +also applied to register Crocs and the Crocs logo as trademarks in over 40 other jurisdictions around the world, including the U.S., but such applications have not been approved and are currently +pending. Although we believe that we have applied for trademark registrations in all jurisdictions where we are doing or intend to do business, there is a possibility that we have not applied to +register the Crocs mark, the company logos, +14 +the +individual brand names for our products or our marketing slogans in countries where we will do business in the future. We may face significant expenses and liability in connection with the +protection of our intellectual property rights outside the U.S., and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or +financial condition may be adversely affected. +If we are unable to establish and protect our trademarks and other intellectual property rights, we may be unable to use the Crocs name or logo, and +competitors may sell products that are substantially similar to our Crocs footwear, or may produce counterfeit versions of our products, and such competing or counterfeit products could divert sales +and may damage our brand image. +We believe our trademarks, trade names, copyrights, trade secrets, issued and pending patents, trade dress and designs are valuable and integral to our success +and competitive position. From time to time, we have identified competitors selling products that are very similar in design to certain of our Crocs footwear models and that are manufactured from what +may be comparable materials to our products. We believe that some of these products may infringe our intellectual property rights. Given the increased popularity of our Crocs brand, we believe there +is a high likelihood that counterfeit products or other products infringing on our intellectual property rights will continue to emerge, seeking to benefit from the consumer demand for Crocs footwear. +In order to protect our brand, we may be required to spend significant resources to monitor and police our intellectual property rights. We may not be able to detect infringement and may lose our +competitive position in the market before we are able to do so. In addition, enforcing rights to our intellectual property may be difficult and expensive, and we may not be successful in combating +counterfeit products and stopping infringement of our intellectual property rights, particularly in some foreign countries, which could make it easier for competitors to capture market share. +Intellectual property rights may also be unavailable or limited in the U.S. and some foreign countries. Furthermore, our efforts to enforce our trademark and other intellectual property rights may be +met with defenses, counterclaims, and countersuits attacking the validity and enforceability of our trademark and other intellectual property rights. For example, our attempts to register Crocs and +our Crocs logo as trademarks have been challenged by a large apparel company, and certain jurisdictions have rejected our attempted registration of our logo as a trademark based upon such challenge +and based upon trademarks owned by the same company and at least one other large apparel company. If we are unsuccessful in protecting and enforcing our intellectual property rights, or if we were +required to change our name or use a different logo, continued sales of such competing products by third parties could harm our brand and adversely impact our business, financial condition, and +results of operations. Similarly, in our enforcement litigation against manufacturers of knock-off products, at least one manufacturer has alleged +counterclaims challenging the validity and enforceability of our patents and we expect that other defendants in the litigation may assert similar claims. +As +of December 31, 2007, we have applied to register Crocs and the Crocs logo as trademarks in over 40 jurisdictions around the world, including the U.S., but such applications +have not been approved and are currently pending. In addition, we have recently extended the scope of our trademark registrations and applications for both the Crocs mark and logo to cover +non-footwear products such as sunglasses, goggles, knee pads, watches, luggage, and some of our internet sales activities. Although we believe that we have applied for trademark +registrations in all jurisdictions where we are doing or intend to do business, there is a possibility that we have not applied to register the Crocs mark, the company logos, the individual brand +names for our products or our marketing slogans in countries where we will do business in the future, and we have elected not to apply for trademark registrations for some marks in some jurisdictions. +Furthermore, we may not obtain trademark registrations in connection with any applications that we do file and trademark protection, whether registered or common law, may not be available in every +country in which we offer or intend to offer our products. Failure to adequately protect our trademark rights could damage or even destroy our Crocs brand, +15 +expose +us to trademark liability and impair our ability to compete effectively. In addition, defending or enforcing our trademark rights could result in the expenditure of significant financial and +managerial resources. +We +believe our success may be enhanced by our ability to obtain and enforce patent protection for our products, and therefore have elected to pursue patent protection for our products in +the U.S. and other countries. We do not know whether any of our pending or future patent applications will result in the issuance of patents, and competitors may challenge the validity or scope of our +issued patents, or our registered designs or patent applications that proceed to issuance. We cannot predict how the patent claims in our issued patents, or any patents issued from any pending or +future patent application, will be construed, and such patents may not provide us with the ability to prevent the development, manufacturing, and/or marketing of competing products, or may be +challenged by third parties on the basis of validity and enforceability. +We +also rely on trade secrets, confidential information, and other unpatented proprietary information related to, among other things, the formulation of Croslite and product development, +especially where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation of our trade +secrets, confidential information and other unpatented proprietary information. The agreements we use to try to protect our intellectual property, confidential information and other unpatented +proprietary information may not effectively protect such intellectual property and information and may not be sufficient to prevent unauthorized use or disclosure of such trade secrets and +information. A party to one of these agreements may breach the agreement and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other +unpatented proprietary information may become known to others, including our competitors. Furthermore, as with any trade secret, confidential information, or other proprietary information, others, +including our competitors, may independently develop or discover such trade secrets and information, which would render them less valuable to us. +We use in house warehousing, distribution, and fulfillment capabilities, and utilize third parties to conduct order fulfillment services for us. Any +additional expenses incurred in connection with, or any disruption in the supply of our products that is caused by changes in our logistical infrastructure could adversely affect our business. +As of December 31, 2007, we operated distribution centers in Australia, Brazil, California, Colorado, Canada, Finland, Hawaii, the Netherlands, India, +Japan, Mexico, Puerto Rico and Singapore. Our Company-operated distribution centers had approximately 940,000 square feet of space. In recent periods, our third-party vendors and Company-operated +warehouse, distribution, and fulfillment operations have been unable to entirely satisfy the increased demand for our products. The inability to process and deliver sufficient quantities of our +products has prevented us from completely filling in a timely manner orders placed by our customers. We have in the past, and may in the future, miss key shipments to customers as a result of +distribution and supply chain disruptions. +Other +possible interruptions which could prohibit us from timely customer deliveries could include the following: +• Damage +or destruction to the warehouse and distribution center used for our products due to fire, earthquake, or any other natural disaster; or +• Disruptions +in commercial shipping channels. +In +the event that we or a third-party are unable to conduct warehousing, distribution, and fulfillment activities in a cost effective, timely, and accurate manner, the distribution of +our products +16 +may +be adversely affected, which could result in harm to our relationships with our retail customers and consumers, a reduction in demand for our products, and additional expenses to us. +Because we depend on third-party manufacturers, we may face challenges in maintaining a sufficient supply of goods to meet sales demand, and we may +experience interruptions in our supply chain. Any shortfall in the supply of our products may decrease our sales and have an adverse impact on our customer relationships. +In the year ended December 31, 2007, third-party manufacturers produced approximately 83% of our footwear products as measured by number of units, and one +such manufacturer in China produced approximately 56% of our third-party footwear products. Currently, we have footwear manufacturing arrangements with third-party manufacturers located in the U.S., +China, Bosnia, Vietnam, and Romania. We depend on these manufacturers' ability to finance the production of goods ordered and to maintain adequate manufacturing capacity. We do not exert direct +control over the third-party manufacturers, so we may be unable to obtain timely delivery of acceptable products. +In +addition, we do not have long-term supply contracts with most of these third-party manufacturers, including the third-party manufacturer that produced the majority of our +footwear products in the year ended December 31, 2007, and any of them may unilaterally terminate their relationship with us at any time or seek to increase the prices they charge us. As a +result, we are not assured of an uninterrupted supply of products of an acceptable quality and price from our third-party manufacturers. We may not be able to offset any interruption or decrease in +supply of our products by increasing production in our Company-operated manufacturing facilities due to capacity constraints, and we may not be able to substitute suitable alternative third-party +manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in a loss of sales and an +increase in production costs, which would adversely affect our results of operations. +We manufacture a portion of our Crocs products, and any difficulties or disruptions in our manufacturing operations could adversely affect our sales and +results of operations. +In the year ended December 31, 2007, we produced approximately 17% of our footwear production at our Company-operated manufacturing facilities in North +America, Brazil and Italy. The manufacturing of our products from our proprietary closed-cell resin, which we refer to as Croslite, requires the use of a complex process, and we may +experience difficulty in producing footwear that meets our high quality control standards. We will be required to absorb the costs of manufacturing and disposing of products that do not meet our +quality standards. These costs are primarily incurred in connection with the initial production of new products, although we may also experience increases in training costs when we initiate production +of new products. Additionally, we may incur increased costs as a result of the introduction of new manufacturing equipment, such as molds and injection molding machines. Any increases in our +manufacturing costs could adversely impact our margins. Furthermore, our manufacturing capabilities are subject to many of the same risks and challenges noted above with respect to our third-party +manufacturers, including our ability to scale our production capabilities to meet the needs of our customers, and our manufacturing may be disrupted for reasons beyond our control, including work +stoppages, fires, earthquakes, floods, or other natural disasters. Any disruption to our manufacturing operations will hinder our ability to deliver products to our customers in a timely manner, and +could have a material and adverse effect on our business. +We +continued to invest in our manufacturing facilities in North America, Brazil and Italy. The expansion of our Company-operated manufacturing capabilities will increase our fixed cost +base, and could adversely impact our margins and results of operations in the event our sales decline or do not continue to grow. +17 +We depend on a limited number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product +manufacturing and increase product costs. +We depend on a limited number of sources for the primary materials used to make our footwear. We source the elastomer resins that constitute the primary raw +materials used in compounding Croslite, which we use to produce our footwear products, from two suppliers. We do not have any formal purchase agreement with the providers of the elastomer resins, and +we purchase these elastomer resins on a purchase order basis. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not be able to obtain suitable +substitute materials in time to avoid interruption of our production cycle, if at all. We may also have to pay materially higher prices in the future for the elastomer resins or any substitute +materials we use, which would increase our production costs and could have a materially adverse impact on our margins and results of operations. +If +we are unable to obtain suitable elastomer resins or if we are unable to procure sufficient quantities of Croslite, we may not be able to meet our production requirements in a timely +manner. Such failure could result in lost potential sales, delays in shipments to customers, strained relationships with customers, and diminished brand loyalty. +Our products are subject to risks associated with overseas sourcing, manufacturing, shipping and financing. +Because independent manufacturers manufacture a majority of our products outside of our principal sales market, our products must be transported by third parties +over large geographic distances. Delays in the shipment or delivery of our products due to the availability of transportation, work stoppages, port strikes, infrastructure congestion, or other +factors, and costs and delays associated with transitioning between manufacturers, could adversely impact our financial performance. In addition, manufacturing delays or unexpected demand for our +products may require us to use faster, but more expensive, transportation methods such as aircraft, which could adversely affect our profit margins. The cost of fuel is a significant component in +transportation costs, so increases in the price of petroleum products can adversely affect our profit margins. +We are dependent on sales of a small number of products, and the absence of continued market demand for these products would have a significant adverse +effect on our operating results. +We generated approximately 90.1% of our revenues for the year ended December 31, 2007 from sales of our footwear products, which consisted of more than 250 +models, including Ocean Minded, Bite, YOU by Crocs™ and our Crocs footwear models. Sales of our classic Beach and Cayman models accounted for approximately 30% of our footwear revenues in +the year ended December 31, 2007. A high portion of our Crocs footwear models are developed from the same base design as our Beach and Cayman models, and we expect to continue to derive a +substantial portion of our revenues from these models or related products in the foreseeable future. Because we are dependent on a line of footwear models that have substantial similarities, factors +such as changes in consumer preferences and general market conditions in the footwear industry may have a disproportionately greater impact on us than on our competitors. In addition, other footwear +companies have introduced products that are substantially similar to our footwear models, which may reduce sales of our footwear products. In the event that consumer preferences evolve away from our +footwear models or from casual lifestyle footwear in general, or if our retail customers purchase similar products sold by our competitors, the resulting loss of sales, increase in inventories and +discounting of our products are likely to be significant, and this could have a material and adverse impact on our business and operations. +18 +Expanding our footwear product line may be difficult and expensive, and if we are unable to successfully continue such expansion, our brand may be +adversely affected, and we may not achieve our planned sales growth. +Our growth strategy is founded primarily on the continued growth in sales of our footwear, and we intend to continue to expand the number of models offered in our +footwear product line to broaden the appeal of our products to consumers. To successfully expand our footwear product line, we must anticipate, understand, and react to the rapidly changing tastes of +consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce, including Ocean Minded, Bite and YOU by Crocs™, may not be successful with consumers, +or our brand may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, we may not grow as fast as we plan, or our sales +may decline, and our brand image and operating performance may suffer. +Furthermore, +achieving market acceptance for new products will likely require us to exert substantial product development and marketing efforts, which could result in a material increase +in our selling, general, and administrative expense, and there can be no assurance that we will have the resources +necessary to undertake such efforts. Material increases in our selling, general, and administrative expenses could adversely impact our results of operations. +We +may also encounter difficulties in producing new footwear models that we did not anticipate during the development stage. Our development schedules for new products are difficult to +predict and are subject to change as a result of shifting priorities in response to consumer preferences and competing products. For example, once we begin to design a new footwear model, it can take +six to nine months to progress to full production because of the need to fabricate new molds and to implement modified production tooling and revised manufacturing techniques. If we are not able to +efficiently manufacture newly-developed products in quantities sufficient to support retail distribution, we may not be able to recoup our investment in the development of new models and product +lines, and we would continue to be subject to the risks inherent in having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate +success of a new model may depend on our pricing. We have a limited history of introducing new products, and we may set the prices of new models too high for the market to bear. Failure to gain market +acceptance for new products that we introduce could impede our growth, reduce our profits, adversely affect the image of our brands, erode our competitive position, and result in long term harm to our +business. +Sales of our products are likely to be subject to seasonal variations, which could increase the volatility of the price of our common stock. +Due to our significant sales growth since our inception, there is still uncertainty in the degree to which sales of our footwear products will be subject to +seasonality. For the year ended December 31, 2007, we experienced higher sales growth in the quarters ended March 31, 2007 and June 30, 2007, compared to the quarters ended +September 30, 2007 and December 31, 2007, for which sales remained fairly level. We expect that our business, similar to other vendors of footwear and related merchandise, will be +subject to seasonal variation. We believe many vendors that market footwear products suited for warm weather normally experience their highest sales activity during the second and third quarters of +the calendar year. While we have introduced footwear models that are more suitable for cold weather uses, such as the Mammoth, Endeavor, Georgie, All Terrain, Snowmini, and YOU by +Crocs tm styles, we expect demand for our products, and therefore our sales, may be subject to seasonal variations and significantly impacted by weather conditions because over 70% of our +revenues during the year ended December 31, 2007 were attributable to our footwear styles more suitable for fair weather. In addition, our quarterly results of operations may fluctuate +significantly as a result of a variety of other factors, including the timing of new model introductions or general economic or consumer conditions. +19 +Accordingly, +results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year, and revenues for any particular period may fluctuate. +We will incur significant time and expense in documenting, testing and certifying our internal control over financial reporting, and any deficiencies in +our financial reporting or internal controls could adversely affect our business and the price of our common stock. +Beginning with this Annual Report on Form 10-K for our fiscal year ending on December 31, 2007, the Securities and Exchange Commission +("SEC"), rules require that our chief executive officer and chief financial officer periodically certify the existence and effectiveness of our internal control over financial reporting. This process +generally requires significant documentation of policies, procedures, and systems, review of that documentation by our internal accounting staff and our outside auditors, and testing of our internal +control over financial reporting by our internal accounting staff and the independent auditors. Continued documentation and testing of our internal controls will involve considerable time and expense, +and may strain our internal resources and have an adverse impact on our costs. +During +the ongoing course of our testing, we may identify deficiencies which we may not be able to remediate in time to meet the annual deadlines imposed by SEC rules for certification +of our internal control over financial reporting. As a consequence, we may have to disclose in periodic reports we file with the SEC any material weaknesses in our system of internal controls. The +existence of such material weaknesses would preclude management from concluding that our internal control over financial reporting is effective and would preclude our independent auditors from issuing +an unqualified opinion that our internal controls are effective. In addition, disclosures of this type in our SEC reports could cause investors to lose confidence in our financial reporting and may +negatively affect the price of our common stock. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud. If we have deficiencies in our internal +control over financial reporting, such deficiencies may negatively impact our business, results of operations and reputation. +Third parties may claim that we are infringing their intellectual property rights, and such claims may be costly to defend, may require us to pay +licensing fees, damages, or other amounts, and may prevent, or otherwise impose limitations on, the manufacture, distribution or sale of our products. +From time to time, third parties may claim that we are infringing their intellectual property rights, and we may be found to infringe those intellectual property +rights. While we do not believe that any of our products infringe the valid intellectual property rights of third parties, we may be unaware of the intellectual property rights of others that may +cover some of our technology or products. If we are forced to defend against such third-party claims, whether or not such claims are resolved in our favor, we could encounter expensive and time +consuming litigation, which could divert our management and key personnel from business operations. For example, a company has filed a lawsuit against us claiming that our Aspen model infringed its +trademark rights, and that by using the Aspen name and intellectual property we committed acts of false designation of origin, trademark dilution, unfair competition and unfair or deceptive trade +practices. We subsequently changed the name of our Aspen model to the Endeavor and entered into a settlement agreement with the company. If we are found to be infringing on the intellectual property +rights of other companies, we may be required to pay damages or ongoing royalty payments, or comply with other unfavorable terms. Additionally, if we are found to be infringing +on the intellectual property rights of other companies, we may not be able to obtain license agreements on terms acceptable to us, or at all, and this may prevent us from manufacturing, marketing or +selling our products. Thus, such third-party claims may significantly reduce the sales of our products or increase our cost of goods sold. Any such reductions in sales or cost increases could be +significant, and could have a material and adverse affect on our business. +20 +Our business could suffer if our third-party manufacturers violate labor laws or fail to conform to generally accepted ethical standards. +We require our third-party manufacturers to meet our standards for working conditions and other matters before we are willing to place business with them. As a +result, we may not always obtain the lowest cost production. Moreover, we do not control our third-party manufacturers or their respective labor practices. If one of our third-party manufacturers +violates generally accepted labor standards by, for example, using forced or indentured labor or child labor, failing to pay compensation in accordance with local law, failing to operate its factories +in compliance with local safety regulations, or diverging from other labor practices generally accepted as ethical, we likely would cease dealing with that manufacturer, and we could suffer an +interruption in our product supply. In addition, such a manufacturer's actions could result in negative publicity, damage to our reputation and the value of our brand, and discourage retail customers +and consumers from buying our products. +If we are unable to recruit and retain key personnel necessary to operate our business, our ability to successfully manage our business and develop and +market our products may be harmed. +To expand our business we will need to attract, retain, and motivate highly skilled design, development, management, accounting, sales, merchandising, marketing, +and customer service personnel. We plan to hire additional personnel in all areas of our business. Competition for many of these types of personnel is intense. As a result, we may be unable to +successfully attract or retain qualified personnel. Additionally, any of our officers or employees can terminate their employment with us at any time, and we do not maintain key person life insurance +on any of our employees, including any member of our management team. The loss of any key employee or our inability to attract or retain other qualified employees could harm our business and results +of operations. +Our financial success may be limited to the strength of our relationships with our retail customers and to the success of such retail customers. +Our financial success is significantly related to the willingness of our retail customers to continue to carry our products, the expansion to new retail +customers, and to the success of such customers. We do not have long term contracts with any of our retail customers, and sales to our retail customers are generally on an +order-by-order basis and are subject to rights of cancellation and rescheduling by the customer. If we cannot fill our retail customers' orders in a timely manner, the sales of +our products and our relationships with those customers may suffer, and this could have a material adverse effect on our product sales and ability to grow our product line. +Furthermore, +many of our retail customers compete with each other, and if they perceive that we are offering their competitors better pricing and support, they may reduce purchases of +our products. In addition, we compete directly with our retail customers by selling our products to consumers via the internet and through our Company-operated kiosks and stores. If our retail +customers believe that our direct sales to consumers divert sales from their stores, this may weaken our relationships with such customers and cause them to reduce purchases of our products. +We face significant competition, and if we are unable to compete effectively, sales of our products may decline and our business could be harmed. +The footwear industry is highly competitive. Recent growth in the market for casual footwear has encouraged the entry of new competitors into the marketplace and +has increased competition from established companies. Some of our competitors are offering products that are substantially similar, in design and materials, to our Crocs-branded footwear. In addition, +access to offshore manufacturing is also making it easier for new companies to enter the markets in which we compete. +21 +Our +competitors include most major athletic and footwear companies, branded apparel companies, and retailers with their own private labels. A number of our competitors: +• have +significantly greater financial resources than we have; +• have +more comprehensive product lines than ours; +• have +broader market presence than we have in retail stores, or have more Company-operated retail stores then we have; +• have +longer-standing relationships with retailers than we have; +• have +a longer operating history than ours; +• have +greater distribution capabilities than we have; +• have +stronger brand recognition than we have; and +• spend +substantially more on product advertising and sales than we do. +Our +competitors' greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and +production, and more quickly develop new products. If we fail to compete successfully in the future, our sales and profits may decline, our financial condition may deteriorate, and the market price of +our common stock is likely to fall. +We may fail to successfully expand our distribution network or introduce our products internationally, and this may cause our results of operations to +fall short of expectations. +As part of our growth strategy, we plan to expand our distribution network and expand the sales of our products into new locations internationally. Successfully +executing this strategy will depend on many factors, including: +• the +strength of the Crocs brand and competitive conditions in new markets that we attempt to enter; +• our +ability to attract and retain qualified distributors or agents or to develop direct sales channels; +• our +ability to use and protect the Crocs brand, and our other intellectual property, in these new markets and territories; and +• our +ability to successfully enter and compete in markets and territories, especially internationally, where we have little distribution experience and where our Crocs brand +is not well known. +If +we are unable to successfully expand our distribution channels and sell our Crocs-branded products internationally, our business may fail to grow, our brand may suffer, and our +results of operations may be adversely impacted. +We conduct, and in the future expect to conduct, a significant portion of our activities outside the U.S., and, therefore, we are subject to the risks +of international commerce. +We use third-party manufacturers located in foreign countries; we operate manufacturing facilities located in North America, Brazil and Italy; and we sell our +products to retailers outside of the U.S. Foreign manufacturing and sales activities are subject to numerous risks, including the following: +• tariffs, +import and export controls, and other non-tariff barriers such as quotas and local content rules; +• increased +transportation costs due to distance, energy prices, or other factors; +22 +• delays +in the transportation and delivery of goods due to increased security concerns; +• foreign +currency fluctuations, for which we do not currently engage in any material hedging transactions; +• restrictions +on the transfer of funds; +• changing +economic conditions; +• restrictions, +due to privacy laws, on the handling and transfer of consumer and other personal information; +• changes +in governmental policies and regulations; +• political +unrest, terrorism, or war, any of which can interrupt commerce; +• expropriation +and nationalization; +• difficulties +in managing foreign operations effectively and efficiently from the U.S.; and +• difficulties +in understanding and complying with local laws, regulations, and customs in foreign jurisdictions. +Furthermore, +our manufacturing activity outside of the U.S., including the production of our products by third-party manufacturers, is subject to risks of poor infrastructure, shortages +of equipment, and labor unrest, in addition to those risks noted above. Once our products are manufactured, we may also suffer delays in distributing our products due to work stoppages, strikes, or +lockouts at the ports where our products arrive. Such labor disruptions could result in product shortages and delays in distributing our products to retailers. These factors and the failure to +properly respond to them could make it difficult to obtain adequate supplies of quality products when we need them, resulting in reduced sales and harm to our business. +In +addition, during 2007, we generated $407.8 million, or 48% of our revenues outside of the U.S., and in the year ended December 31, 2006, we generated approximately +$112.5 million, or 32% of our revenues outside of the U.S. We expect to expand our international sales and marketing operations in the future. Our ability to capitalize on growth in new +international markets and to maintain the current level of operations in our existing international markets is subject to risks associated with international sales operations, as noted above, as well +as the difficulties associated with promoting products in unfamiliar cultures. +Acquisitions may be difficult to identify and successfully integrate into our business and could have other adverse consequences. +We have made, and may in the future make, acquisitions of, or investments in, other companies. For example, in June 2004, we acquired Crocs Canada; in October +2006, we acquired Fury and EXO; in December 2006, we acquired Jibbitz; in January 2007, we acquired Ocean Minded; and in July 2007, we acquired Bite. We expect to consider other opportunities to +acquire or make investments in other businesses and products that could enhance our manufacturing capabilities, complement our current products or expand the breadth of our markets or customer base. +The pursuit of acquisitions may divert the attention of management and cause us to incur various expenses in identifying, investigating and pursuing suitable acquisitions, whether or not they are +consummated. In the event we finance acquisitions by issuing equity or convertible debt securities, our stockholders may be diluted. +In +addition, we have limited experience in acquiring other businesses. If we acquire additional businesses, we may not be able to integrate the acquired operations successfully with our +business or effectively manage the combined business following completion of the acquisition. We may not achieve the anticipated benefits from the acquired business due to any of the following +factors: +• unanticipated +costs associated with the acquisition; +23 +• diversion +of management's attention from our core business; +• harm +to our existing business relationships with manufacturers and customers as a result of the acquisition; +• the +potential loss of key employees; or +• risks +associated with entering new product lines or markets in which we have little or no prior experience. +If +we are unable to integrate any new business successfully, we could be required either to dispose of the acquired operations or to undertake changes to the acquired operations in an +effort to integrate them with our business. If we experience any of the difficulties noted above, our business and financial condition could be materially and adversely affected. +We may be adversely affected by currency exchange rate fluctuations. +We purchase products and supplies from third parties in U.S. dollars and receive payments from certain of our international customers in foreign currencies. The +cost of these products and supplies sourced overseas, and payments received from customers, may be affected by changes in the value of the relevant currencies. Price increases caused by currency +exchange rate fluctuations could make our products less competitive or have an adverse effect on our profitability. Currency exchange rate fluctuations could also disrupt the business of the +third-party manufacturers that produce our products by making their purchases of raw materials more expensive and more difficult to finance. Foreign +currency fluctuations could have a material adverse effect on our results of operations and financial condition. +We can issue shares of preferred stock without stockholder approval, which could adversely affect the rights of common stockholders. +Our restated certificate of incorporation permits us to establish the rights, privileges, preferences, and restrictions, including voting rights, of future series +of our preferred stock and to issue such stock without approval from our stockholders. The rights of holders of our common stock may suffer as a result of the rights granted to holders of preferred +stock that we may issue in the future. In addition, we could issue preferred stock to prevent a change in control of us, depriving common stockholders of an opportunity to sell their stock at a price +in excess of the prevailing market price. +Our restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could discourage a third-party from +acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could delay, defer, or prevent a +change in control of us or changes in our management. Among other things, these provisions: +• authorize +us to issue preferred stock that can be created and issued by the board of directors without prior stockholder approval, with rights senior to those of common +stock; +• do +not permit cumulative voting in the election of directors, which would otherwise allow less than a majority of stockholders to elect director candidates; +• prohibit +stockholders from calling special meetings of stockholders; +• prohibit +stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders; +• allow +the authorized number of directors to be changed only by resolution of the board of directors; +24 +• establish +advance notice requirements for submitting nominations for election to the board of directors and for proposing matters that can be acted upon by stockholders at a +meeting; and +• classify +our board of directors so that only some of our directors are elected each year. +These +provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of +control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in +control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to +decline. +ITEM 1B. Unresolved Staff Comments +None. +ITEM 2. Properties +Our principal executive and administrative offices are located at 6328 Monarch Park Place, Niwot, Colorado. We lease, rather than own, all of our facilities. We +consider our facilities to be suitable for our needs. +The +general location, use and approximate size of our principal properties are given below: +Location +Use +Approximate +Square Feet +Rotterdam, the Netherlands +Warehouse +389,000 +Aurora, Colorado +Warehouse +264,000 +Quebec City, Canada +Corporate offices/warehouse/manufacturing facility +180,000 +Niwot, Colorado +Corporate offices/warehouse +177,000 +Leon, Mexico +Manufacturing facility +122,000 +Den Haag, the Netherlands +Corporate offices/warehouse +98,000 +Rijswijk, the Netherlands +Warehouse +79,000 +Boulder, Colorado +Jibbitz's Corporate offices/warehouse +55,000 +Longmont, Colorado +Warehouse +54,000 +Sao Paulo, Brazil +Warehouse/manufacturing facility +45,000 +Padova, Italy +EXO's Corporate offices/manufacturing facility +34,000 +Helsinki, Finland +Corporate offices/warehouse +25,000 +Japan +Corporate offices/warehouse +24,000 +Haryana, India +Corporate offices/warehouse +21,000 +Shanghai, China +Corporate offices +18,000 +Singapore +Corporate offices +17,000 +We +also maintain small branch sales offices in Hong Kong, Taiwan, Japan, Korea, New Zealand, Melbourne, Singapore, Puerto Rico, Hawaii, California and India. We enter into +short-term leases for kiosks domestically and internationally with fixed monthly rents subject to certain covenants with contingent rents based on percentage of revenues. We also lease +retail space at 4 domestic and 25 international retail stores. Our short term and long term leases expire at various dates throughout the year 2026. +ITEM 3. Legal Proceedings +On March 31, 2006, we filed a complaint with the ITC against Acme Ex-Im, Inc., Australia Unlimited, Inc., Cheng's +Enterprises, Inc., Collective Licensing International, LLC, D. Myers & +25 +Sons, Inc., +Double Diamond Distribution, Ltd., Effervescent, Inc., Gen-X Sports, Inc., Holey Soles, Inter-Pacific Trading Corporation, and Shaka +Holdings, Inc., alleging patent and trade dress infringement and seeking an exclusion order banning the importation and sale of infringing products. The utility and design patents asserted in +the complaint were issued to us on February 7, 2006 and March 28, 2006 respectively, by the United States Patent and Trademark Office. The ITC has issued final determinations terminating +Shaka Holdings, Inc., Inter-Pacific Trading Corporation, Acme Ex-Im, Inc., D. Myers & Sons, and Australia Unlimited, Inc. from the ITC investigation +No. 337-TA-567 on the basis of settlement and Cheng's Enterprises, Inc. on the suspension of accused activities. A trial was held before the ALJ from September +2007. After post-trial briefing was completed, the ALJ has set a target date of April 11, 2008 for completion of the Investigation. We do not expect that the ultimate resolution of +this matter to have a material adverse impact on our business. +On +April 3, 2006, we filed a complaint in the U.S. District Court for the District of Colorado alleging patent and trade dress infringement and seeking injunctive relief against +Acme EX-IM, Inc., Australia Unlimited, Inc., Cheng's Enterprises, Inc., Collective Licensing International, LLC, D. Myers & Sons, Inc., Double +Diamond Distribution, Ltd., Effervescent, Inc., Gen-X Sports, Inc., Holey Soles, Inter-Pacific Trading Corporation, Shaka Holdings, Inc., and Does +1-10. The utility and design patents asserted in the complaint were issued to us on February 7, 2006 and March 28, 2006 respectively, by the United States Patent and +Trademark Office. This case has been administratively stayed pending resolution of the ITC proceeding above. Consent judgments have been entered against Shaka Holdings, Inc., Interpacific +Trading Corporation and Acme Ex-Im, Inc. We have entered into a settlement agreement with Australia Unlimited, Inc., and on January 25, 2007, we filed a stipulation +for dismissal of all claims and counterclaims. We have entered into settlement agreements with D. Myers & Sons, Inc. pursuant to which the U.S. District Court entered a consent judgment +against D. Myers & Sons, Inc on May 23, 2007. We do not expect the ultimate resolution of this matter will have a material adverse impact on our business. +Starting +in November 2007, certain shareholders filed several purported shareholder class actions in the U.S. District Court for the District of Colorado alleging violation of +Sections 10(b) and 20(a) of the Exchange Act based on alleged statements made by us between July 27, 2007 and October 31, 2007. Plaintiffs seek compensatory damages on behalf of +the alleged class in an unspecified amount, interest, and an award of attorney's fees and costs of litigation. These actions were subsequently consolidated. The Court is currently considering motions +for the appointment of lead plaintiff and lead counsel. After the Court appoints lead plaintiff and lead counsel, an amended consolidated complaint will be filed. Thereafter, we will respond. We +believe that the lawsuit lacks merit and intend to vigorously defend the suit. +In +January 2008 plaintiffs served us with a shareholder derivative action in the Colorado District Court for the City and County of Boulder alleging that certain officers and directors +breached their fiduciary +duties, wasted corporate assets, and were unjustly enriched. This derivative action purports to state a claim on behalf of the corporation. The complaint alleges that the claims arise from the same +conduct as was alleged in the original federal shareholder class action. We are in the process of responding. We believe that the plaintiff lacks standing and intend to vigorously defend the suit. +Although +we are subject to other litigations from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, we are not +party to any other pending legal proceedings that we believe will have a material adverse impact on our business. +As +of December 31, 2007, we have not accrued any amounts related to estimated losses for legal contingencies. While there is a reasonable possibility that certain legal matters +may result in an unfavorable outcome and loss, our estimated potential losses, or range of losses, when aggregated, would be immaterial to the financial statements. +ITEM 4. Submission of Matters to a Vote of Security Holders +Not Applicable. +26 +PART II +ITEM 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock, par value $0.001, is listed on the NASDAQ Global Select Market and trades under the stock symbol CROX. Our stock was initially listed on the +NASDAQ Global Select Market on February 8, 2006, the date our shares began to trade publicly. Prior to that time, there was no public market for our stock. The following table sets forth, for +each of the quarterly periods indicated, the high and low sales prices of our common stock as reported on the NASDAQ Global Select Market. Amounts prior to June 14, 2007 have been adjusted to +reflect the 2-for-1 stock split, which was effected as a 100% common stock dividend distributed on that date. +Fiscal Year 2007 Quarters Ended +High +Low +March 31, 2007 +$ +29.29 +$ +21.43 +June 30, 2007 +47.40 +23.41 +September 30, 2007 +68.12 +41.18 +December 31, 2007 +75.21 +33.75 +Fiscal Year 2006 Quarters Ended +High +Low +March 31, 2006 +$ +16.25 +$ +10.16 +June 30, 2006 +18.50 +10.78 +September 30, 2006 +17.53 +11.33 +December 31, 2006 +25.13 +15.83 +The +following table presents a summary of share repurchases made by us during the quarter ended December 31, 2007 under the share repurchase program authorized by our board of +directors and announced in November 2007. +Period +Total Number of Shares Purchased +Average Price Paid per Share +Total Number of Shares Purchased as Part of Publicly Announced Plan +Maximum Number of Shares that May Yet be Purchased Under the Plan +Oct. 1-31, 2007 +— +— +— +— +Nov. 1-30, 2007 +524,000 +$ +47.75 +524,000 +(1) +476,000 +Dec. 1-31, 2007 +— +— +— +— +Total +524,000 +$ +47.75 +524,000 +476,000 +(1) On +November 1, 2007, our board of directors approved an authorization to repurchase up to one million shares of our common stock. Share repurchases under this authorization may +be made in the open market or in privately negotiated transactions. The timing and actual number of shares repurchased will depend on a variety of factors, including price, corporate and regulatory +requirements and other market conditions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of shares of our common stock. The +repurchase authorization may be modified, suspended or discontinued at any time. +27 +Performance Graph +The following performance graph compares the cumulative total return of our common stock with that of the NASDAQ Composite Index and the Dow Jones US Footwear +Index from February 8, 2006 through December 31, 2007. Our stock was initially listed on the NASDAQ Global Select Market on February 8, 2006, the date our shares began to trade +publicly. Prior to that time, there was no public market for our stock. The graph assumes that the value of the investment was $100 on February 8, 2006 and all dividends and other distributions +were reinvested. The comparisons in this graph are provided in accordance with SEC disclosure requirements and are not intended to forecast or be indicative of the future performance of our common +stock. +Comparison of Cumulative Total Return on Investment +Holders +The approximate number of stockholders of record of our common stock was 85 as of January 31, 2008. Because many of the shares of our common stock are held +by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial owners represented by these stockholders of record. +Dividends +We have never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future earnings for use in the +operation of our business and do not anticipate paying any cash dividends in the foreseeable future. Any future determination to declare cash dividends will be made at the discretion of our board of +directors, subject to compliance with covenants under any existing financing agreements, which may restrict or limit our ability to declare or pay dividends, and will depend on our financial +condition, results of operations, capital requirements, general business conditions, and other factors that our board of directors may deem relevant. We issued a stock dividend in connection with our +2-for-1 stock split, which was effected in the form of a 100% common stock dividend distributed on June 14, 2007. +28 +ITEM 6. Selected Financial Data +The following table presents selected historical financial data of Crocs, Inc. and its subsidiaries for each of the years in the five-year +period ended December 31, 2007. This data was derived from our audited consolidated financial statements and reflects our operations and financial position at the dates and for the periods +indicated. The information in this table should be read with the consolidated financial statements and accompanying notes and other financial data included herein. +Year Ended December 31, +2007 +2006 +2005 +2004 +2003 +(in thousands, except share and per share data) +Consolidated Statements of Operations Data +Revenues +$ +847,350 +$ +354,728 +$ +108,581 +$ +13,520 +$ +1,1655 +Cost of sales +349,701 +154,158 +47,773 +7,162 +891 +Gross profit +497,649 +200,570 +60,808 +6,358 +274 +Selling, general and administrative expenses +259,882 +105,224 +33,916 +7,929 +1,471 +Income (loss) from operations +237,767 +95,346 +26,892 +(1,571 +) +(1,197 +) +Interest expense +438 +567 +611 +47 +3 +Other (income) expenses—net +(2,997 +) +(1,847 +) +(8 +) +19 +— +Income (loss) before income taxes +240,326 +96,626 +26,289 +(1,637 +) +(1,200 +) +Income tax expense (benefit)(1)(2) +72,098 +32,209 +9,317 +(143 +) +— +Net income (loss) +168,228 +64,417 +16,972 +(1,494 +) +(1,200 +) +Dividend on redeemable convertible preferred shares(3) +— +33 +275 +142 +— +Net income (loss) attributable to common stockholders +$ +168,228 +$ +64,384 +$ +16,697 +$ +(1,636 +) +$ +(1,200 +) +Income (loss) per common share: +Basic +$ +2.08 +$ +0.87 +$ +0.26 +$ +(0.04 +) +$ +(0.03 +) +Diluted +$ +2.00 +$ +0.81 +$ +0.26 +$ +(0.04 +) +$ +(0.03 +) +Weighted average common shares:(4) +Basic +80,759,077 +74,598,400 +50,987,154 +49,283,906 +41,710,770 +Diluted +84,194,883 +80,170,512 +67,140,000 +49,283,906 +41,710,770 +As of December 31, +2007 +2006 +2005 +2004 +2003 +(in thousands) +Consolidated Balance Sheets Data +Cash, cash equivalents, and marketable securities +$ +36,335 +$ +64,981 +$ +4,787 +$ +1,054 +$ +326 +Total assets +627,425 +299,457 +78,032 +16,224 +1,304 +Long term obligations +15,864 +3,290 +5,513 +3,660 +400 +Redeemable common shares +— +— +1,800 +1,800 +1,800 +Redeemable convertible preferred stock +— +— +5,500 +5,500 +— +Total stockholders' equity (deficit) +444,113 +208,258 +18,914 +(3,591 +) +(1,642 +) +(1) On +January 4, 2005, we converted from a limited liability company to a taxable corporation. For the tax years beginning on January 1, 2005 and afterward, we are subject +to corporate-level U.S. federal, state and foreign income taxes. The statement of operations for the year ended December 31, 2005 reflects a one-time income tax benefit of +$797,000 to record the net deferred tax assets at the date of conversion. +(2) The +income tax benefit recognized in 2004 represents the tax benefit recognized by Crocs Canada subsequent to its acquisition. +29 +(3) Dividends +accrued in 2004 were paid to holders of our Class C convertible preferred membership units. Our Class C membership units were converted into shares of our +Series A preferred stock in connection with our conversion from a limited liability company to a corporation on January 4, 2005. +(4) We +issued a stock dividend in connection with our 2-for-1 stock split, which was effected in the form of a 100% common stock dividend distributed on +June 14, 2007. All share and per share amounts prior to June 14, 2007 have been adjusted to reflect the 2-for-1 stock split. +ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations +This annual report on Form 10-K contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of +1995. In addition, we may make other written and oral communications from time to time that contain such statements. Forward-looking statements include statements as to industry trends and future +expectations and other matters that do not relate strictly to historical facts and are based on certain assumptions by management. These statements are often identified by the use of words such as +"may," "will," "expect", "believe," "anticipate," intend," "could," "estimate," or "continue," and similar expressions or variations. These statements are based on the beliefs and assumptions of our +management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ +materially from future results expressed or implied by such forward looking statements including risks such as "our limited operating history," "our significant recent expansion," "changing fashion +trends," "our reliance on market acceptance of the small number of products we sell," "our ability to develop and sell new products," "our limited manufacturing capacity and distribution channels," +"our reliance on third party manufacturing and logistics providers for the production and distribution of our products," "our reliance on two vendors for certain raw materials," "our management and +information systems infrastructure," "our ability to obtain and protect intellectual property rights," "the effect of competition in our industry," "the effects of seasonality on our sales," "our +ability to attract, assimilate and retain management talent," and other similar statements. These forward-looking statements include statements in this Item 7, "Management Discussion and +Analysis of Financial Condition and Results of Operations." Important factors that could cause actual results to differ materially from the forward-looking statements include, among others, the risks +described in the section entitled "Risk Factors" under Item 1A. We caution the reader to carefully consider such factors. Furthermore, such forward-looking statements speak only as of the date +of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. The following discussion should be read in +conjunction with our consolidated financial statements and notes thereto included elsewhere in this report. +Overview +We are a rapidly growing designer, manufacturer, distributor, worldwide marketer and brand manager of footwear for men, women, and children. We design and sell a +broad offering of footwear, apparel, gear and accessories that utilize our proprietary closed cell-resin, called Croslite. In the past several years, we realized high demand for our +Croslite products, specifically, classic Beach and Cayman models. Croslite is a unique material that enables us to produce an innovative, soft, lightweight, non-marking, slip and +odor-resistant shoe. Crocs shoes combine fun colors and innovative designs to provide a new level of comfort, functionality and style in the casual lifestyle footwear category. +Since +the initial introduction and popularity of our Beach and Cayman models, we have expanded our Croslite products to include a variety of new styles and products and have extended our +product reach through the acquisitions of new brand platforms such as Jibbitz, Fury, Ocean Minded, Bite, and through various licensing agreements. +30 +We +currently sell our Crocs-branded products throughout the U.S. and in over 90 countries worldwide. We sell our products through quality domestic and international retailers and +distributors and directly to end-user consumers through our webstores, Company-operated retail stores and kiosks. The broad appeal of our footwear has allowed us to market our products to +a wide range of distribution channels, including department stores and traditional footwear retailers as well as a variety of specialty channels. As of December 31, 2007, our customer base +domestically and internationally expanded to over 13,000 and 19,000 customer locations selling our products, respectively. +We +have achieved significant growth since our inception, driven largely by the popularity of our footwear products and our ability to significantly expand the breadth and depth of our +distribution network. For the year ended December 31, 2007, we recorded revenues of $847.4 million and net income of $168.2 million, compared to $354.7 million of revenues +and net income of $64.4 million for the year ended December 31, 2006. We have achieved strong gross profit margins on sales of our Crocs footwear. For the year ended December 31, +2007, our gross profit was $497.6 million, or 58.7% of revenues, compared to $200.6 million, or 56.6% of revenues, for the year ended December 31, 2006. We believe a number of +factors have contributed to our ability to achieve gross profit margins at these levels. Additionally, our use of third-party manufacturers as well as Company-operated manufacturing facilities +has allowed us to maintain a relatively low cost structure while enabling us to achieve significant production flexibility. +We +currently manufacture our footwear products at our Company-operated facilities located in North America, Brazil and Italy in addition to contracting with third-party manufacturers in +China, Bosnia, Vietnam, Romania and the U.S. for production of our footwear products and accessories. We believe our in-house production capabilities enable us to make rapid changes to +manufacturing schedules and provide us the flexibility to quickly ship in-demand models and colors, while outsourcing allows us to lower our capital investment and retain the +cost-effectiveness of using third-party manufacturing. +On +November 1, 2007, our board of directors approved an authorization to repurchase up to one million shares of our common stock. Share repurchases under this authorization may be +made in the open market or in privately negotiated transactions. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory +requirements and other market conditions. The repurchase authorization does not have an expiration date and does not obligate us to acquire any particular amount of shares of our common stock. The +repurchase authorization may be modified, suspended or discontinued at any time. On November 7, 2007, we repurchased approximately 524,000 shares of our common stock for a total of +approximately $25.0 million. +General +Revenues are recorded when products are shipped and the customer takes title and assumes risk of loss, collection of related receivables are probable, persuasive +evidence of an arrangement exists, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer depending on the country of the sale and the agreement with the +customer. Allowances for estimated returns and discounts are recognized when related revenue is recorded. Because we use both internal manufacturing and contract with third parties to manufacture our +products, our cost of sales represents our costs to manufacture products in our Company-operated facilities, including raw materials costs and all overhead expenses related to production, as well as +the cost to purchase finished products from our third-party manufacturers. Cost of sales also includes the cost to transport these products to our facilities and all warehouse and outbound freight +expenses. Our selling, general and administrative expense consists primarily of selling, marketing, wages and related payroll and employee benefit costs for selling, marketing and administrative +employees, travel and insurance expenses, depreciation, amortization, professional fees, facility expenses, bank charges and non-cash charges for share-based compensation. +31 +Share-Based Compensation Expenses +In December 2004, the Financial Accounting Standards Board ("FASB") issued a revision to Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Share-Based Compensation ("SFAS 123"), which requires the calculation of the fair value of share-based compensation, estimation of +future forfeitures and income taxes, and recognition of the fair value as a non-cash expense over the vesting period of the underlying instruments. SFAS No. 123R, Share-Based Payment +("SFAS 123R"), eliminates the ability to account for share-based compensation transactions using the footnote +disclosure-only provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Shares Issued to Employees +("APB 25"), and instead requires that such transactions be recognized and reflected in our financial statements using a fair-value-based method. +We +adopted SFAS 123R effective as of January 1, 2006 using the prospective method for option grants and restricted stock issued prior to August 15, 2005, which was +the date we filed our initial Registration Statement on Form S-1 in connection with our initial public offering and the modified prospective method for option grants issued after +August 15, 2005. The adoption of the SFAS 123R fair-value-based method had a significant impact on our results of operations, although it will have no impact on our overall +cash flow. The effect of applying SFAS 123R for the year ended December 31, 2006 was a decrease of $5.4 million of pre-tax income. We recognized additional share-based +compensation expense in 2007 based on the fair value of any share based payments made in 2007. The amount of compensation expense recognized depends on numerous factors and estimates, including the +number and vesting period of option grants, the publicly traded price of our common stock, estimated volatility of the stock price, estimates of the timing and volume of exercises and forfeitures of +the options, and fluctuations in future interest and income tax rates. Share based compensation expense was $21.7 million for the year ended December 31, 2007, compared to +$10.3 million for the year ended December 31, 2006 and $4.8 million for the year ended December 31, 2005. +Effects of Initial Public Offering +In February 2006, we completed an initial public offering of our common stock. As a part of the initial public offering, we issued 9,900,000 shares of our common +stock, adjusted to reflect the two-for-one stock split distributed on June 14, 2007, and received net proceeds of approximately $94.5 million. In connection with +the initial public offering, all of our then-outstanding shares of redeemable convertible preferred stock, which was not included in stockholders' equity in our balance sheet, converted +into 14,904,984 shares of our common stock, of which a portion was sold in our initial public offering, and accrued dividends aggregating $171,000 were paid with a portion of our net proceeds from the +offering. In addition, the put options on our redeemable shares of common stock terminated and such shares were also not previously included in stockholders' equity in our balance sheet. Therefore, +the immediate result of our initial public offering was a significant increase in cash and stockholders' equity on our balance sheet, and the elimination of the accrual of dividends on the preferred +stock. In addition, our common stock outstanding increased significantly because of the conversion of the preferred stock, the termination of +the put options on the redeemable shares of common stock and our issuance of shares of common stock. As a result, the basis for the calculation of net income per share on both a basic and diluted +basis has changed significantly. +Acquisitions +On January 31, 2007, we acquired substantially all of the assets of Ocean Minded for $1.75 million in cash, plus a potential earn-out of +up to $3.75 million based on Ocean Minded achieving certain earnings targets over a three year period. Ocean Minded is a designer and manufacturer of high quality leather and EVA (Ethylene +Vinyl Acetate) based sandals primarily for the beach, adventure and action sports markets. We recorded $600,000 in customer relationships and other identifiable intangible assets and $953,000 in +goodwill on the date we acquired Ocean Minded. +32 +On +June 26, 2007, we amended the Purchase Agreement with Jibbitz to amend the terms of the potential earn-out consideration included in the Purchase Agreement. The +amendment removed the earnings targets for payment of the earn-out with $3.5 million payable on the effective date of the amended Purchase Agreement and the remaining +$6.5 million payable in equal monthly installments of $500,000 due on the first business day of each month until July 2008. We recorded the additional $9.77 million, net of discounting +on future payments, to goodwill in the second quarter of 2007 as an additional cost of the acquisition. As of December 31, 2007, we have $3.4 million, net of discounting on future +payments, in remaining accrued additional purchase price for Jibbitz. +On +July 27, 2007, we acquired all of the assets of Bite for $1.75 million in cash and the assumption of $1.3 million in debt, plus a potential earn out of up to +$1.75 million based on Bite achieving certain earnings targets over a three year period. Bite is a designer and manufacturer of comfortable and supportive performance shoes and sports sandals +sold worldwide in five categories including, golf, adventure, healthy lifestyle, travel and watersports. We recorded $512,000 in customer relationships and $530,000 in goodwill on the date of +acquisition for Bite. +Our +goodwill balance of $23.8 million and $11.6 million as of December 31, 2007 and December 31, 2006, respectively, relates predominately to the acquisitions +of Bite and Ocean Minded in 2007, Jibbitz, Fury and EXO in 2006 as well as the acquisition of Crocs Canada in 2004. +Results of Operations +Comparison of the Years Ended December 31, 2007 and 2006 +Set forth below are the results of operations for the year ended December 31, 2007, as compared to the year ended December 31, 2006 (in thousands, +except for percentages). In the comparative tables below, increases in revenue/income or decreases in expense (favorable variances) are shown without brackets while decreases in revenue/income or +increases in expense (unfavorable variances) are shown with brackets in the "$ Change" and "% Change" columns. +Year Ended December 31, +2007 +2006 +$ Change +% Change +Revenues +$ +847,350 +$ +354,728 +$ +492,622 +% +138.9 +Cost of sales +349,701 +154,158 +(195,543 +) +(126.8 +) +Gross profit +497,649 +200,570 +297,079 +148.1 +Selling, general and administrative expenses +259,882 +105,224 +(154,658 +) +(147.0 +) +Income (loss) from operations +237,767 +95,346 +142,421 +149.4 +Interest expense +438 +567 +129 +22.8 +Other (income) expenses—net +(2,997 +) +(1,847 +) +1,150 +62.3 +Income (loss) before income taxes +240,326 +96,626 +143,700 +148.7 +Income tax expense (benefit) +72,098 +32,209 +(39,889 +) +(123.8 +) +Net income (loss) +168,228 +64,417 +103,811 +161.2 +Dividend on redeemable convertible preferred shares +— +33 +33 +100.0 +Net income (loss) attributable to common stockholders +$ +168,228 +$ +64,384 +$ +103,844 +% +161.3 +Revenues. Revenues increased 138.9%, or $492.6 million, to $847.4 million, in the year ended +December 31, 2007, from $354.7 million in the year ended December 31, 2006. Our revenues from sales outside of the U.S. were $407.8 million in the year ended +December 31, 2007 compared to $112.5 million in the year ended December 31, 2006. This increase was primarily a result of significantly higher unit sales of our footwear products +in our Asian and European markets driven by growing awareness and increased acceptance of our brands and products. Sales in Europe increased +33 +473.3% +or $143.4 million, to $173.7 million in the year ended December 31, 2007, from $30.3 million in the year ended December 31, 2006. Asia sales increased 199.8% +or $108.7 million in the year ended December 31, 2007, from $54.4 million in the year ended December 31, 2006. Sales in Asia were led by Japan where sales increased 579.2% +or $69.5 million, to $81.5 million in the year ended December 31, 2007, from $12.0 million in the year ended December 31, 2006. Unit sales of footwear products +increased 117.1% or 25.3 million pairs, to 46.9 million pairs in the year ended December 31, 2007, from 21.6 million pairs in the year ended December 31, 2006. The +higher unit sales primarily resulted from: +• an +increase in the number of customer doors selling our products, +• new +product offerings, +• increased +sales at Company-operated retail locations and +• business +acquisitions. +Domestic +and international customer doors selling our products totaled over 13,000 and 19,000, respectively, at December 31, 2007 compared to approximately 11,000 and 8,000, +respectively, at December 31, 2006. Sales of our classic models increased by approximately 46.3% during the year ended December 31, 2007 when compared to sales in the year ended +December 31, 2006 and now amounts to approximately 30% of total sales, compared to 50% during the year ended December 31, 2006. Sales of footwear product styles introduced in 2007 +represented approximately 18.2% or $154.1 million of our overall revenues for the year ended December 31, 2007. +Our +Company-operated retail locations, including retail stores, kiosks and outlets, increased to over 200 at December 31, 2007 from over 95 at December 31, 2006. Total +revenue from Company-operated retail locations was $74.2 million in the year ended December 31, 2007, compared to $22.2 million in the year +ended December 31, 2006. We expect revenues from our Company-operated retail stores to increase in the future as we continue to expand the number of Company-operated retail locations. Sales +from Company-operated retail stores have higher margins than wholesale. +We +have experienced rapid revenue growth since inception. We expect our revenue growth to continue as we enter new markets and introduce new footwear and other product offerings. +Additionally, our revenues may grow as a result of future acquisitions. Businesses acquired in 2006 and 2007 contributed approximately $78.6 million to our revenues during the year ended +December 31, 2007. +Gross profit. Gross profit increased 148.1%, or $297.1 million, to $497.6 million, in the year ended +December 31, 2007, from $200.6 million in the year ended December 31, 2006 due primarily to higher revenues. Our gross profit margin increased to 58.7% in the year ended +December 31, 2007, compared to 56.6% in the year ended December 31, 2006. This increase in margin was primarily attributable to increases in direct and international sales and the +addition of Jibbitz, where we recognize higher margins on sales. We have historically experienced margins that exceed those of our competitors. As we expand our product lines and introduce new +products and materials to our manufacturing processes, we may incur higher costs on duties, material and labor and face increasing competition which could result in a decrease to our gross margin. +Selling, general and administrative expenses. Selling, general and administrative expenses ("SG&A") increased 147.0% or +$154.7 million, to $259.9 million, or 30.7% of sales, in the year ended December 31, 2007, from $105.2 million, or 29.7% of sales in the year ended December 31, +2006. The increase in SG&A as a percentage of sales is a result of our strategic decision to increase our global marketing spend and increased expenses associated with developing market opportunities +in Brazil, China, Russia and India. This increase was also a result of higher costs associated with increased sales volumes, company growth and expanding operations, including an increase in selling +and marketing expenses of $40.4 million and increases in personnel expenses of $70.9 million. In addition, professional and consulting fees increased approximately $20.8 million, +primarily as a result of increased legal fees related to defending our intellectual property, accounting fees, contract labor and consultants. In addition, share-based compensation expense was +$21.7 million for the year ended December 31, 2007, compared to $10.3 million for the year ended December 31, 2006. +34 +Interest expense. Interest expense was approximately $438,000 in the year ended December 31, 2007, compared to +approximately $567,000 in the year ended December 31, 2006. Interest expense decreased due to our use of a portion of the proceeds from our initial public offering to retire bank loans. This +debt retirement led to a decrease in average borrowings outstanding on our line of credit and long term debt during the year ended December 31, 2007 compared to average borrowings outstanding +under those arrangements during the year ended December 31, 2006. +Other income/expense, net. Other income was $3.0 million in the year ended December 31, 2007, compared to +income of $1.8 million in the year ended December 31, 2006. The increase primarily resulted from a refund due to a change in our tax filing position related to value added taxes in our +international locations. +Income tax expense. In the year ended December 31, 2007, income tax expense was $72.1 million, representing an +effective income tax rate of 30.0%, compared to income tax expense of $32.2 million in the year ended December 31, 2006, representing an effective income tax rate of 33.3%. The decrease +relates primarily to an increase in the pre-tax earnings in jurisdictions with lower relative income tax rates as a percentage of total pre-tax earnings. +Comparison of the Years Ended December 31, 2006 and 2005 +Set forth below are the results of operations for the year ended December 31, 2006, as compared to the year ended December 31, 2005 (in thousands, +except for percentages). In the comparative tables below, increases in revenue/income or decreases in expense (favorable variances) are shown without brackets while decreases in revenue/income or +increases in expense (unfavorable variances) are shown with brackets in the "$ Change" and "% Change" columns. +Year Ended December 31, +2006 +2005 +$ Change +% Change +Revenues +$ +354,728 +$ +108,581 +$ +246,147 +% +226.7 +Cost of sales +154,158 +47,773 +(106,385 +) +(222.7 +) +Gross profit +200,570 +60,808 +139,762 +229.8 +Selling, general and administrative expenses +105,224 +33,916 +(71,308 +) +(210.2 +) +Income (loss) from operations +95,346 +26,892 +68,454 +254.6 +Interest expense +567 +611 +44 +7.2 +Other (income) expenses—net +(1,847 +) +(8 +) +1,839 +— +Income (loss) before income taxes +96,626 +26,289 +70,337 +267.6 +Income tax expense (benefit) +32,209 +9,317 +(22,892 +) +(245.7 +) +Net income (loss) +64,417 +16,972 +47,445 +279.5 +Dividend on redeemable convertible preferred shares +33 +275 +242 +88.0 +Net income (loss) attributable to common stockholders +$ +64,384 +$ +16,697 +$ +47,687 +% +285.6 +Revenues. Revenues increased 226.7%, or $246.1 million, to $354.7 million, in the year ended +December 31, 2006, from $108.6 million in the year ended December 31, 2005. This increase was primarily a result of significantly higher unit sales of our footwear products. +Revenues from sales outside of the U.S. were $112.5 million for the year ended December 31, 2006, compared to $8.1 million in the year ended December 31, 2005. Sales in +Europe increased 2,920% or $29.2 million, to $30.3 million in the year ended December 31, 2006, from $1.0 million in the year ended December 31, 2005. Asia sales +increased 1,057.4% or $49.7 million in the year ended December 31, 2006, from $4.7 million in the year ended December 31, 2005. Sales in Asia were led by Japan where +35 +sales +increased 252.9% or $8.6 million, to $12.0 million in the year ended December 31, 2006, from $3.4 million in the year ended December 31, 2005. Unit sales of +footwear products increased to 21.6 million pairs in the year ended December 31, 2006. The higher sales primarily resulted from: +• an +increase in the number of customer doors selling our products, +• new +product offerings and +• increased +sales at Company-operated retail locations +Domestic +and international customer doors selling our products totaled over 11,000 and 8,000 respectively, at December 31, 2006 compared to over 6,500 domestic customer doors at +December 31, 2005. +Businesses +acquired subsequent to December 31, 2005 contributed approximately $1.9 million to our revenues during the year ended December 31, 2006. +Gross profit. Gross profit increased 229.8%, or $139.8 million, to $200.6 million, in the year ended +December 31, 2006, from $60.8 million in the year ended December 31, 2005 due primarily to higher revenues. Our gross profit margin improved to 56.5% in the year ended +December 31, 2006, from 56.0% in the year ended December 31, 2005. During 2006, we increased the percentage of orders shipped factory direct reducing average order fulfillment costs. +This increase was partially offset by a decrease in margin related to product mix. +Selling, general and administrative expenses. SG&A expenses increased 210.3% or $71.3 million, to +$105.2 million in the year ended December 31, 2006, from $33.9 million in the year ended December 31, 2005. This increase was primarily a result of higher costs associated +with increased sales volumes, including an increase in selling and marketing expenses of $10 million, increases in personnel expenses of $40.9 million due to our growth and expanding +operations. In addition, professional and consulting fees increased approximately $14.5 million, primarily as a result of increased legal fees related to our secondary offering and defending +our intellectual property, accounting, contract labor and consultants. In addition, share-based compensation expense was $10.3 million for the year ended December 31, 2006, compared to +$4.8 million for the year ended December 31, 2005. As a percentage of revenues, selling, general and administrative expense decreased to 29.7% in the year ended December 31, 2006, +from 31.2% in the year ended December 31, 2005, primarily due to the effect of the improved leverage of operating expenses resulting from higher sales. +Interest expense. Interest expense was approximately $567,000 in the year ended December 31, 2006, compared to +approximately $611,000 in the year ended December 31, 2005. Interest expense decreased due to our use of a portion of the proceeds from our initial public offering to retire certain bank loans. +This debt retirement led to a decrease in average borrowings outstanding on our line of credit and long term debt during the year ended December 31, 2006 compared to average borrowings +outstanding under those arrangements during the year ended December 31, 2005. +Other income/expense, net. Other income was $1.8 million in the year ended December 31, 2006, compared to +income of approximately $8,000 in the year ended December 31, 2005. The increase resulted from an increase in interest income related to an increase in interest bearing cash and cash +equivalents and short-term investments resulting from proceeds received upon completion of our initial public offering in February 2006. +Income tax expense. In the year ended December 31, 2006, income tax expense was $32.2 million, representing an +effective income tax rate of 33.3%, compared to income tax expense of $9.3 million in the year ended December 31, 2005, representing an effective income tax rate of 35.4%. The decrease +relates primarily to an increase in the pre-tax earnings in jurisdictions with lower relative income tax rates as a percentage of total pre-tax earnings. +36 +Dividends on redeemable convertible preferred stock. Dividends on our outstanding redeemable convertible preferred stock were +$33,000 for the year ended December 31, 2006 compared to $275,000 for the year ended December 31, 2005. Our Class C membership units, issued in June 2004, had preferred +liquidation and dividend rights. In connection with our conversion from a limited liability company to a corporation, our Class C membership units converted into shares of our Series A +preferred stock. Our Series A preferred stock provided for a dividend at the rate of five percent per annum on the initial investment amount per share. All of our Series A preferred +stock converted into shares of our common stock in connection with the closing of the initial public offering on February 13, 2006. +Liquidity and Capital Resources +As of December 31, 2007, we had $36.3 million in cash and cash equivalents and short-term investments compared to $65.0 million +as of December 31, 2006. +The +significant components of our working capital are cash, accounts receivable and inventory, reduced by accounts payable and accrued expenses. Capital requirements related to +manufacturing include compounding and injection molding equipment for facilities we operate, as well as footwear molds used in facilities operated by us or purchased for our third-party manufacturers. +We have experienced rapid growth in our revenues and earnings over the past three years, and as a result have made substantial investments in our inventory, global infrastructure and property plant +and equipment, such as molds, tooling and manufacturing equipment. Additionally, we have made key acquisitions of businesses that are complimentary to our own, such as Jibbitz, Fury, Ocean Minded and +Bite. +Cash +provided by operating activities consists primarily of net income or net loss adjusted for certain non-cash items including depreciation, amortization, deferred income +taxes, provision for bad debts, stock compensation expense and for the effect of changes in working capital and other activities. Cash provided by operating activities for the year ended +December 31, 2007 was $8.9 million, primarily related to net income of $168.2 million plus non-cash items of depreciation and amortization of $20.9 million and +share-based compensation expense of $21.7 million, which was offset by increases in working capital resulting from increases in accounts receivable of $79.3 million, increase in +inventory of $151.6 million, and a increase in accounts payable and accrued expenses and other +liabilities of $106.3 million. Cash provided by operating activities for the year ended December 31, 2006 was $12.3 million, primarily related to net income of +$64.4 million plus non-cash items of depreciation and amortization of $8.1 million and share-based compensation expense of $10.3 million, which was offset by increases +in working capital resulting from increases in accounts receivable of $44.0 million, inventory of $55.0 million, and a increase in accounts payable and accrued expenses and other +liabilities of $53.8 million, all related to our sales growth and expanded operations. +Our +inventories increased to $248.4 million at December 31, 2007 from $86.2 million as of December 31, 2006. During the quarter ended December 31, +2007, we increased our inventory positions in order to meet anticipated demand for the six months ending June 30, 2008 and, at the same time, made available production capacity for new product +lines for delivery in the quarters ending March 31, 2008 and June 30, 2008. We intend to continue to expand our footwear product line by adding innovative products that keep pace with or +set fashion trends while leveraging the comfort characteristics of Croslite. We also intend to continue to expand our product line into other categories including apparel, gear, sports equipment and +accessories. We expect that new product introductions, limitations on production capacities and seasonal variations may cause our inventory to increase or decrease materially in the future as we +adjust to meeting changing conditions resulting from our rapid growth and ongoing expansion. +We +anticipate that operating activities will provide cash in future periods. However, seasonal variations in product demand and the associated changes in operating assets and liabilities +in response +37 +to +such seasonal variations may directly affect our cash flows from operating activities. Accordingly, cash flows from operating activities for any year are not necessarily indicative of cash flows +from operating activities to be expected for any other year. +Cash +used in investing activities for the year ended December 31, 2007 was $62.2 million, which was primarily related to capital expenditures for molds, machinery and +equipment of $57.4 million, acquisitions of $12.4 million and $16.5 million related to the upgrade and expansion of our information technology systems, offset by +$22.3 million in net proceeds from short term investments. Cash used in investing activities for the year ended December 31, 2006 was $69.5 million, which was primarily related to +the net purchases of investments of $22.3 million, capital expenditures for molds, machinery and equipment of $23.8 million, acquisitions of $15.4 million and $5.2 million +related to the upgrade and expansion of our information technology systems. +We +intend to grow our business by continuing to expand our product line. Expansion of our product line will require us to make ongoing capital investments in molds and other tooling +equipment related to manufacturing new products. The rapid growth of our sales in both domestic and international markets has, in the past, placed substantial demands on our warehousing and +distribution operations and we expect that these demands will continue. In December 2007, we entered into an agreement with Manhattan Associates to provide warehouse management systems within +all of our Company-operated distribution centers. We plan to continue to invest in information technology systems that will support our growth and increase the operating effectiveness of our +manufacturing, warehousing, and +distribution operations. Additionally, we expect to continue to invest in our global information systems infrastructure to further strengthen our management information and financial reporting +capabilities. +Over +the past two years we have acquired key businesses, such as Jibbitz, Fury, Bite and Ocean Minded, and we may acquire other business in the future that we believe are complementary +to our own. On June 26, 2007 we amended the Purchase Agreement with Jibbitz to amend the terms of the potential earn-out consideration included in the Purchase Agreement. The +amendment removed the earnings targets for payment of the earn-out with $3.5 million payable on the effective date of the amended Purchase Agreement and the remaining +$6.5 million payable over the following thirteen months, for a total payment of $10.0 million. We have $3.4 million, net of discounting on future payments, in remaining accrued +additional purchase price for Jibbitz as of December 31, 2007, which is to be paid out in monthly payment installments ending July 2008. The agreements for the acquisitions of Ocean +Minded and Bite, contain contingent earn-out amounts of up to $3.75 million and $1.75 million, respectively, that are required to be paid as an additional cost of the +acquisition if the business units achieve certain specified earnings targets in future periods. +We +have entered into various sponsorship agreements and operating leases that require cash payments on a specified scheduled. Over the next five years we will make payments of +$70.6 million related to our operating lease agreements and $31.9 million related to our corporate sponsorship agreements. See the contractual obligation table below. We plan to continue +to enter into operating leases related to our retail stores, kiosks, distribution, warehouse and manufacturing facilities in order to support the growth of our business. We also plan to continue to +enter into corporate sponsorship agreements that we believe are complimentary to our business and will help promote our brand awareness. +Cash +provided by financing activities was $43.2 million for the year ended December 31, 2007 compared to cash provided by financing activities of $94.6 million for +the year ended December 31, 2006. On November 1, 2007, our board of directors approved an authorization to repurchase up to one million shares of our common stock. Share +repurchases under this authorization may be made in the open market or in privately negotiated transactions. The timing and actual number of shares repurchased will depend on a variety of factors +including price, corporate and regulatory requirements +38 +and +other market conditions. The repurchase authorization may be modified, suspended or discontinued at any time. On November 7, 2007, we repurchased approximately 524,000 shares for a total of +approximately $25.0 million. +As +of December 31, 2007, we had a $25.0 million revolving loan agreement which expires on May 1, 2009. As of December 31, 2007 we had $7.0 million +outstanding under the facility. At our option, the loan agreement unpaid principal balance of the loan bears interest at either a base interest rate of LIBOR plus 0.875% or a variable interest rate of +the lender's applicable reference rate minus 0.50%. The line of credit contains financial and other covenants as well as customary events of default. As of December 31, 2007, we were in +compliance with the covenants required by the loan agreement. On January 4, 2008 we entered into a second amendment on our revolving loan agreement that provides for an increase in our +borrowing facility from $25.0 million to $50.0 million. +We +anticipate that cash flows from operations will be sufficient to meet or exceed the ongoing needs of our existing business during the next 12 months. However, we may enter into +additional borrowing arrangements, or modify existing borrowing arrangements, should additional liquidity be required to fund working capital requirements, to make additional investments in capital +assets and our global infrastructure, or to fund business acquisitions. +There +is a degree of uncertainty in forecasting our future cash requirements as a result of our rapid growth since inception. Substantial increases in accounts receivable and inventory +are commonly associated with rapid growth and could unexpectedly strain our cash resources in the future. There can be no assurance that any such capital will be available to us on acceptable terms or +at all. Our ability to fund working capital needs, planned capital expenditures and scheduled debt payments, depends on our future operating performance and cash flow, which in turn are subject to +prevailing economic conditions and to financial, business and other factors, some of which are beyond our control. +Off-Balance Sheet Arrangements +Our operating lease obligations, which include various building and equipment transactions, are not reflected on our balance sheet. See "Contractual Obligations" +below for further detail. +We +also guarantee the payment of its third-party manufacturer in China for purchases of material for the manufacture of finished shoe products, which is also not reflected on our balance +sheet. The maximum potential amount of future payments we could be required to make under the guarantee is € 2.1 million, approximately $3.1 million. See +Note 14 in the consolidated financial statements for further discussion. +We +do not believe that these arrangements are material to our current or future financial condition, results of operations, liquidity, capital resources or capital expenditures. +39 +Contractual Obligations +The following table discloses aggregate information about our contractual cash obligations as of December 31, 2007 and the periods in which payments are +due (in thousands): +Payments due by period +Total +Less than +1 year +1-3 +years +3-5 +years +More than +5 years +Operating Lease Obligations +70,623 +19,025 +27,072 +16,233 +8,293 +Corporate Sponsorships(1) +31,985 +10,397 +10,983 +10,605 +— +Contingent Income Tax Liabilities +11,715 +— +1,946 +8,383 +1,386 +Line of Credit(2) +7,669 +473 +7,196 +— +— +Minimum Licensing Royalties(3) +3,813 +2,078 +1,683 +52 +— +Additional Purchase Price related to Jibbitz +3,500 +3,500 +— +— +— +Contractual Severance Commitment +146 +146 +— +— +— +Capital Lease Obligations +119 +110 +9 +— +— +Total +129,570 +35,729 +48,889 +35,273 +9,679 +(1) Includes +sponsorships such as AVP, NASCAR, and collegiate sports teams. +(2) Includes +interest at an estimated Prime rate of 7.25% less 50 basis points. +(3) Includes +royalties to organizations such as Disney, MLB, NBA and Nickelodeon. +Excluded +from the table above is the contingent cash purchase price of up to $3.75 million for Ocean Minded and $1.75 million for Bite, related to the earn-out +provisions of their respective purchase agreements, see Note 3 in the consolidated financial statements for further discussion. These amounts were excluded from the above contractual +obligations table as Ocean Minded and Bite have not achieved the earnings targets for the earn-out payments as of December 31, 2007. +We +also guarantee the payment of one of our third-party manufacturer in China for purchases of material for the manufacture of finished shoe products, which is also excluded from the +table. The maximum potential amount of future payments we could be required to make under the guarantee is € 2.1 million, approximately $3.1 million. See +Note 14 in the consolidated financial statements for further discussion. +Critical Accounting Policies and Estimates +Our financial statements have been prepared in accordance with accounting principles generally accepted in the U.S., which require us to make estimates and +judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure at the date of our financial statements. On an ongoing basis, we evaluate our estimates +and judgments, including those related to revenue, intangible assets, and stock compensation. We base our estimates and judgments on historical experience and on various other factors that we believe +to be reasonable under the circumstances, the results of which form the basis of our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. +Actual results or changes in the estimates or other judgments of matters inherently uncertain that are included within these accounting policies could result in a significant change to the information +presented in the consolidated financial statements. We believe that the estimates and assumptions below are among those most important to an understanding of our consolidated financial statements +contained in this report. +We +consider certain accounting policies related to revenue recognition, reserves for uncollectible accounts receivable and inventories, share-based compensation and goodwill and other +intangible assets to be critical policies due to the estimates and judgments involved in each. +40 +Revenue Recognition. Our revenues are derived principally from wholesale sales to retailers. Our standard arrangement for our +customers includes a valid purchase order or contract with no customer acceptance provisions. We recognize revenues from sales of products when: +• we +enter into an agreement with a customer or persuasive evidence of an arrangement exists; +• delivery +has occurred; +• customer +payment is deemed fixed or determinable and free of contingencies or significant uncertainties; and +• collection +is reasonably assured. +Title +passes on shipment or on receipt by the customer depending on the arrangement with the customer. +Reserves and Write-Downs Allowances for estimated returns and claims are provided for when related revenue is recorded. We +base our estimates on historical rates of product returns and claims, and specific identification of outstanding claims and outstanding returns not yet received from customers. Actual returns and +claims in any future period are inherently uncertain and thus may differ from our estimates. If actual returns and claims exceed reserves, we would need to reduce our revenues at the time of such +determination. +We +also make ongoing estimates relating to the collectibility of our accounts receivable and maintain a reserve for estimated losses resulting from the inability of our customers to make +required payments. In determining the amount of the reserve, we consider our historical level of credit losses and make judgments about the creditworthiness of significant customers based on ongoing +credit evaluations. Since we cannot predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates. If the financial +condition of some of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the event we determine that a smaller or larger reserve is +appropriate, we would record a credit or a charge to selling, general and administrative expenses in the period in which we made such a determination. +We +also make ongoing estimates relating to the net realizable value of inventories based on our assumptions about future demand and market conditions. If we estimate that the net +realizable value of our inventory is less than the cost of the inventory recorded on our books, we record a write-down equal to the difference between the cost of the inventory and the +estimated net realizable value. This write-down is recorded to cost of sales. If changes in market conditions result in reductions in the estimated net realizable value of our inventory +below our previous estimate, we would increase our write-down in the period in which we made such a determination and record it to cost of sales. +Stock-Based Compensation. Effective January 1, 2006, we adopted SFAS 123R which requires recognition of the +fair value of share-based compensation over the vesting period of the option. We adopted the prospective method for all stock option grants issued prior to August 15, 2005, which was the date +we initially filed a Registration Statement on Form S-1 with the SEC in connection with our initial public offering. Prior to August 15, 2005, we used the minimum value +method of measuring equity share options and similar instruments for either recognition or pro forma disclosure purposes. We continue to account for any portion of awards outstanding at the date of +initial application using the accounting principles originally applied to those awards which were the provisions of APB 25 and its related interpretive guidance. +For +stock option grants issued after the filing of our initial Registration Statement on Form S-1 on August 15, 2005, we applied the modified prospective +method. Under this method we use the Black-Scholes valuation model to determine the fair value of our stock options, which requires assumptions to be made regarding our stock price volatility, the +expected life of the option and expected dividend +41 +rates. +The volatility assumptions were derived from our historical volatilities and historical volatilities of competitors whose shares are traded in the public markets. If factors change and we use +different assumptions for estimating share-based compensation in future periods, share-based compensation expense may differ materially in the future from that recorded in the current period. +Income Taxes. In July 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation +No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"). FIN 48 clarifies the +accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, Accounting for Income +Taxes . FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to +be taken in a tax return. Significant judgment is required in determining whether the recognition threshold has been met for recording an uncertain tax benefit and in determining the appropriate +measurement of the uncertain benefit under FIN 48. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and +transition and was effective beginning January 1, 2007. There was no cumulative effect of the adoption of FIN 48. +Tax +laws require items to be included in our tax returns at different times than when these items are reflected in the consolidated financial statements. As a result, the annual tax rate +reflected in our consolidated financial statements is different than that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not +deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and +liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities +are the enacted tax rates in effect for the year in which the differences are expected to reverse. Based on the evaluation of all available information, we recognize future tax benefits, such as net +operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. +We +evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating +results, the reversal of existing temporary differences, taxable income in prior carryback years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to be +established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. +Undistributed +earnings of our foreign subsidiaries are deemed to be indefinitely reinvested in foreign jurisdictions, accordingly, no U.S. income taxes are provided on these earnings. We +have specific plans for reinvestment of these undistributed earnings in our foreign operations. Should we change our plans and remit these earnings as dividends to the U.S. affiliates, we would be +required to record the related U.S. income tax attributes which would impact our earnings in the year of such repatriation and would impact the related deferred U.S. income tax assets and liabilities. +Goodwill and Other Intangible Assets. In accordance with SFAS No. 142, Goodwill and Other +Intangible Assets ("SFAS 142"), goodwill and intangible assets with indefinite lives are not amortized but are instead measured for impairment at least annually, or when +events indicate that an impairment exists. As required by SFAS 142, in our impairment tests for goodwill and other indefinite-lived intangible assets, we compare the estimated fair value of +goodwill and other intangible assets to the carrying value. If the carrying value exceeds our estimate of fair value, we calculate impairment as the excess of the carrying value over our estimate of +fair value. Our estimates of fair value utilized in goodwill and other indefinite-lived intangible asset tests may be based upon a number of factors, including our assumptions about the expected +future operating performance of our reporting units. Our estimates may change in future periods due to, among other things, technological change, economic +42 +conditions, +changes to our business operations or inability to meet business plans. Such changes may result in impairment charges recorded in future periods. Any impairment charge related to goodwill +would be classified as a separate line item on our consolidated statement of income for amounts necessary to reduce the carrying value of the asset to fair value. +Intangible +assets that are determined to have definite lives, such as customer relationships, core technology, capitalized software, patents and non-compete agreements are +amortized over their useful lives and are measured for impairment only when events or circumstances indicate the carrying value may be impaired. In these cases, we estimate the future undiscounted +cash flows to be derived from the asset to determine whether or not a potential impairment exists. If the carrying value exceeds our estimate of future undiscounted cash flows, we then calculate the +impairment as the excess of the carrying value of the asset over our estimate of its fair value. +Acquisitions. We account for business acquisitions under the purchase method of accounting as required by SFAS +No. 141, Business Combinations ("SFAS 141"). The total cost of acquisitions is allocated to the underlying net assets, based on their +respective estimated fair values. The excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. Determining the fair value of assets acquired and +liabilities assumed requires judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, asset +lives and market multiples, among other items. These estimates and assumptions affect future amortization expense and gains or losses recorded on any future sale of operating or other assets and +acquisitions of properties. +Recent Accounting Pronouncements +In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement , which defines fair value, +establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for +financial statements issued for the first annual or interim reporting period beginning after November 15, 2007. We will adopt SFAS 157 effective January 1, 2008. We are currently +evaluating the impact this new +standard will have on our future results of operations and financial position and do not expect that the adoption will have a material impact on our consolidated financial position or results of +operations. +In +February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities +("SFAS 159"). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 will be effective at the beginning of +fiscal 2008. We are currently evaluating the impact this new standard will have on our future results of operations and financial position and do not expect that the adoption will have a material +impact on our consolidated financial position or results of operations. +In +December 2007, the FASB issued FASB Statement No. 141(R), Business Combinations ("SFAS 141(R)"), which amends +SFAS 141, and provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any noncontrolling interest in the acquiree. It also +provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for our fiscal +year beginning January 1, 2009 and is to be applied prospectively. We are currently evaluating the potential impact of adopting this statement on our consolidated financial position, results of +operations and cash flows and do not expect that the adoption will have a material impact on our consolidated financial position or results of operations. +In +December 2007, the FASB issued FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of +ARB No. 51 ("SFAS 160"), which establishes accounting and reporting standards pertaining to ownership interests in subsidiaries held by parties +43 +other +than the parent, the amount of net income attributable to the parent and to the noncontrolling interest, changes in a parent's ownership interest, and the valuation of any retained +noncontrolling equity investment when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent +and the interests of the noncontrolling owners. SFAS 160 is effective for our fiscal year beginning January 1, 2009. We are currently evaluating the impact this new standard will have on +our consolidated financial position, results of operations and cash flows and do not expect that the adoption will have a material impact on our consolidated financial position or results of +operations. +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Credit and Interest Rate Risk +We are exposed to interest rate risk to the extent that United States interest rates change due to inflation or other factors. This exposure is directly related +to our normal operating and funding activities. The interest payable on our line of credit is determined based on either a base interest rate of LIBOR plus 0.875% or a variable interest rate of the +lender's applicable reference rate minus 0.5%, and, therefore, is affected by changes in market interest rates. Interest rates on our capital leases are dependent on interest rates in effect at the +time the lease is drawn upon. Total liabilities outstanding at December 31, 2007 under the line of credit and capital leases were approximately $7.1 million. Based on amounts borrowed as +of December 31, 2007, we would have a resulting decline in future annual earnings and cash flows of approximately $50,000 for every 1% increase in prime lending rates. +We +earn interest income on our cash and cash equivalents. We have performed a sensitivity analysis to estimate our exposure to market risk of interest rates, and if the weighted average +rate of return on cash and cash equivalents, and restricted cash, were to increase or decrease by 1%, the impact on interest income would be $264,000, net of tax during the year ended +December 31, 2007. +Foreign Currency Exchange Risk +We pay the majority of our overseas third-party manufacturers in U.S. dollars and have had significant revenues from foreign sales in recent periods. Our ability +to sell our products in foreign markets and the U.S. dollar value of the sales made in foreign currencies can be significantly influenced by foreign currency fluctuations. A decrease in the value of +foreign currencies relative to the U.S. dollar could result in downward price pressure for our products or losses from currency exchange rates. We have performed a sensitivity analysis to estimate our +exposure to market risk of foreign exchange rates. If the U.S. dollar were to increase or decrease in value by 10%, the impact on international sales of $407.5 million during the year ended +December 31, 2007 would have been an increase or decrease in consolidated revenues by $2.9 million, net of tax. The volatility of the applicable rates and prices are dependent on many +factors that cannot be forecast with reliable accuracy. In the event our foreign sales and purchases increase and are denominated in currencies other than the U.S. dollar, our operating results may be +affected by fluctuations in the exchange rate of currencies we receive for such sales. +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the "Index To Consolidated Financial Statements" on page F-1. +ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure +None. +44 +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our chief executive officer and chief financial officer, we conducted an +evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange +Act, as of the end of the period covered by this annual report (the "Evaluation Date"). Based on this evaluation, our chief executive officer and chief financial officer concluded that as of the +Evaluation Date, our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be disclosed in our Securities and +Exchange Commission ("SEC") reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated +to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. +Management's Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate control over financial reporting, pursuant to the Exchange Act +Rules 13a-15(f) and 15d-15(f). Because of the inherent limitations, internal control over financial reporting may not prevent or detect +misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate due to changes in conditions, or that the degree of +compliance with the policies or procedures may deteriorate. Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2007, using the +criteria set forth in the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway +Commission (COSO). Based on this assessment, management has concluded that our internal control over financial reporting is effective as of December 31, 2007. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting, which is +included herein. +Changes in Internal Control Over Financial Reporting +During the three months ended December 31, 2007, we made changes to our internal control over financial reporting that have materially affected, or are +reasonably likely to materially affect, our internal control over financial reporting. Certain processes and controls were changed to accommodate the needs and requirements of our growth and our +financial reporting system. +45 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2007, based on criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's +management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the +accompanying "Management Report on Internal Control Over +Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control +over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or +persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting +and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those +policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material +misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to +future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In +our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year +ended December 31, 2007 of the Company and our report dated February 29, 2008 expressed an unqualified opinion on those financial statements and included an explanatory paragraph +regarding the Company's adoption on January 1, 2007 of the Financial Accounting Standards Board's Interpretation No. 48, Accounting for Uncertainty in Income +Taxes , and the adoption on January 1, 2006 of Statement of Financial Accounting Standard No. 123(R), Share-Based +Payments . +/s/ DELOITTE & TOUCHE LLP +Denver, Colorado +February 29, 2008 +46 +ITEM 9B. Other Information +Not applicable. +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated by reference to our definitive proxy statement for the 2008 Annual Meeting of Shareholders to be filed with +the SEC within 120 days after the end of the fiscal year ended December 31, 2007. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer, principal financial officer, and +controller. A copy of our business code of conduct and ethics is available on our website: www.crocs.com. We are required to disclose any change to, or waiver from, our business code of conduct and +ethics for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our business code of conduct ethics as permitted by applicable SEC +rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated by reference to our definitive proxy statement for the 2008 Annual Meeting of Shareholders to be filed with +the SEC within 120 days after the end of the fiscal year ended December 31, 2007. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2008 Annual Meeting of Stockholders to be +filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2007. +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, as of December 31, 2007, we reserved 8,292,497 shares of common stock for future issuance on exercise of outstanding options +under equity compensation plans. +Plan Category +Number of Securities +to be Issued on Exercise +of Outstanding Options +Weighted Average +Exercise Price of +Outstanding Options +Number of Securities +Remaining Available +for Future Issuance +Under Plans, Excluding +Securities Available +in First Column +Equity compensation plans approved by stockholders(1)(2) +7,567,286 +$ +18.28 +9,240,155 +Equity compensation plans not approved by stockholders(3) +725,211 +0.62 +— +Total +8,292,497 +9,240,155 +(1) On +July 9, 2007, our stockholders approved the 2007 Equity Incentive Plan (the "2007 Plan"), which previously had been approved by our board of directors. The 2007 Plan was +effective as of July 9, 2007. The total number of shares of our common stock available for distribution under the +47 +2007 +Plan is 9,000,000, subject to adjustment for future stock splits, stock dividends and similar changes in our capitalization. +(2) On +April 27, 2005, our board of directors adopted the 2005 Equity Incentive Plan, ("the 2005 Plan"). On January 10, 2006, our board of directors amended the 2005 Plan to +increase the number of shares of our common stock available for issuance under the 2005 Plan from 11,681,000 shares to 14,017,200 shares. +(3) Represents +non-plan stock options granted to our officers, directors and employees prior to the adoption of the 2005 Equity Incentive Plan. +ITEM 13. Certain Relationships and Related Transactions, and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2008 Annual Meeting of Stockholders to be +filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2007. +ITEM 14. Principal Accounting Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2008 Annual Meeting of Stockholders to be +filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2007. +PART IV +ITEM 15. Exhibits, Financial Statement Schedules +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to financial statements on page F-1. +(2) Financial Statement Schedules +All financial statement schedules have been omitted because they are not required, are not applicable or the information is included in the Financial Statements +or Notes thereto. +(3) Exhibit list +Exhibit +Number +Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (Incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File +No. 333-132312)). +3.2 +Certificate of Amendment to the Restated Certificate of Incorporation of Crocs, Inc. (Incorporated herein by reference to Exhibit 3.1 to Crocs, Inc. Current Report on Form 8-K, filed on July 12, 2007 (File No. 000-51754) +). +3.3 +Amended and Restated Bylaws of Crocs, Inc. (Incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +4.1 +Specimen common stock certificate (Incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +48 +10.1* +Form of Indemnity Agreement between Crocs, Inc. and each of its directors and executive officers (Incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 +(File No. 333-127526)). +10.2* +Crocs, Inc. 2005 Equity Incentive Plan (the "2005 Plan") (Incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.3* +Amendment No. 1 to the 2005 Plan (Incorporated herein by reference to Exhibit 10.2.2 to Crocs, Inc.'s Registration Statement on Form S-1/A [Amendment No. 4], filed on January 19, 2006 (File No. 333-127526) +). +10.4* +Form of Notice of Grant of Stock Option under the 2005 Plan (Incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.5* +Form of Notice of Grant of Stock Option for Non-Exempt Employees under the 2005 Plan (Incorporated herein by reference to Exhibit 10.4 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.6* +Form of Stock Purchase Agreement under the 2005 Plan (Incorporated herein by reference to Exhibit 10.5 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.7* +Form of Stock Option Agreement under the 2005 Plan (Incorporated herein by reference to Exhibit 10.6 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.8* +Form of Restricted Stock Award Grant Notice under the 2005 Plan (Incorporated herein by reference to Exhibit 10.7 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526) +). +10.9* +Form of Restricted Stock Award Agreement under the 2005 Plan (Incorporated herein by reference to Exhibit 10.8 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.10* +Form of Non-Statutory Stock Option Agreement under the 2005 Plan (Incorporated herein by reference to Exhibit 10.9 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526) +). +10.11 +Stock Purchase Agreement among 4246519 Canada, Inc., Finproject Group S.p.A., 3107019 Canada, Inc. and Daniel J. Hunter dated as of June 29, 2004 (Incorporated herein by reference to Exhibit 10.14 to Crocs, Inc.'s +Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.12 +Asset Purchase and Property Transfer Agreement between Hana Phylon Tech S.A. de C.V. and Crocs Mexico, S.de.R.L de C.V. dated as of April 23, 2005 (Incorporated herein by reference to Exhibit 10.15 to Crocs, Inc.'s Registration +Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.13. +Asset Purchase and Property Transfer Agreement between St. Vrain Trading, LLC, d/b/a Crocs Hawaii, LLC and the Registrant dated May 19, 2005 (Incorporated herein by reference to Exhibit 10.16 to Crocs, Inc.'s +Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +49 +10.14 +Amended and Restated Credit Agreement between the Registrant and Bank of America, N.A., dated as of October 26, 2005 (Incorporated herein by reference to Exhibit 10.17 to Crocs, Inc.'s Registration Statement on Form S-1/A +[Amendment No. 3], filed on January 9, 2006 (File No. 333-127526)). +10.15 +Amended and Restated Security Agreement between the Registrant and Bank of America, N.A., dated as of October 26, 2005 (Incorporated herein by reference to Exhibit 10.18 to Crocs, Inc.'s Registration Statement on Form S-1/A +[Amendment No. 3]. filed on January 9, 2006 (File No. 333-127526)). +10.16 +Distribution Agreement between Crocodile Distribution and the Registrant dated as of April 1, 2005 (Incorporated herein by reference to Exhibit 10.19 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, +2005 (File No. 333-127526)). +10.17 +Kiosk Agreement between Crocodile Kiosk, LLC and the Registrant dated as of July 1, 2005 (Incorporated herein by reference to Exhibit 10.20 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 +(File No. 333-127526)). +10.18† +Amended and Restated Agreement for Supply between Finproject S.p.A. and the Registrant dated as of July 26, 2005 (Incorporated herein by reference to Exhibit 10.21 to Crocs, Inc.'s Registration Statement on Form S-1, filed on +August 15, 2005 (File No. 333-127526)). +10.19 +File Amendment to Amended and Restated Credit Agreement, dated as of January 18, 2006 among Crocs, Inc., Crocs Retail, Inc., Western Brands Holding Company, Inc. and Bank of America, N.A. (Incorporated herein by reference to +Exhibit 10.26 to Crocs, Inc.'s Registration Statement on Form S-1/A [Amendment No. 4], filed on January 19, 2006 (File No. 333-127526)). +10.20* +Offer Letter between Peter Case and the Registrant dated as of February 2, 2006 (Incorporated herein by reference to Exhibit 10.27 to Crocs, Inc.'s Registration Statement on Form S-1/A [Amendment No. 5], filed on +February 6, 2006 (File No. 333-127526)). +10.21* +Nonstatutory Stock Option Agreement between the Registrant and Raymond D. Croghan dated September 1, 2004 (Incorporated herein by reference to Exhibit 99.9 to Crocs, Inc.'s Registration Statement on Form S-8, filed on +March 9, 2006 (File No. 333-132312)). +10.22* +Nonstatutory Stock Option Agreement between the Registrant and Michael E. Marks dated September 1, 2004 (Incorporated herein by reference to Exhibit 99.10 to Crocs, Inc.'s Registration Statement on Form S-8, filed on +March 9, 2006 (File No. 333-132312)). +10.23* +Nonstatutory Stock Option Agreement between the Registrant and Ronald R. Snyder dated September 1, 2004 (Incorporated herein by reference to Exhibit 99.12 to Crocs, Inc.'s Registration Statement on Form S-8, filed on +March 9, 2006 (File No. 333-132312)). +10.24* +2006 Executive Incentive Bonus Plan (Incorporated herein by reference to Exhibit 10.38 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on August 14, 2006 (File No. 000-51754)). +10.25* +Board of Directors Compensation Plan (Incorporated herein by reference to Exhibit 10.39 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 13, 2006 (File No. 000.51754)). +10.26 +Membership Interest Purchase Agreement among Crocs, Inc. and the Members of Jibbitz, LLC, dated September 13, 2006 (Incorporated herein by reference to Exhibit 10.40 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed +on November 13, 2006 (File No. 000-51754)). +50 +10.27* +2008 Cash Incentive Plan (Incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 12, 2007 (File No. 000-51754)). +10.28* +2007 Equity Incentive Plan (Incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 12, 2007 (File No. 000-51754)). +10.29* +Form of Incentive Stock Option Agreement under the 2007 Plan (Incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007 (File No. 000-51754)). +10.30* +Form of Non-Statutory Stock Option Agreement under the 2007 Plan (Incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007 (File No. 000-51754)). +10.31* +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (Incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007 (File +No. 000-51754)). +21†† +Subsidiaries of the Registrant. +23†† +Consent of Deloitte & Touche LLP. +31.1†† +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2†† +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +32†† +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +* Management +Contract or Compensatory Plan or Arrangement. +† The +Registrant has been granted confidential treatment with respect to portions of these exhibits. +†† Filed +herewith. +51 +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its +behalf by the undersigned, thereunto duly authorized, as of February 29, 2008. +CROCS, INC. +a Delaware Corporation +By: +/s/ RONALD R. SNYDER Name: Ronald R. Snyder +Title: President and Chief Executive Officer +Pursuant +to the requirements of the Securities Exchange Act of 1934, this report has been signed below as of February 29, 2008 by the following persons on behalf of the registrant +and in the capacities indicated. +Signature +Title +/s/ RONALD R. SNYDER Ronald R. Snyder +President, Chief Executive Officer and Director +(Principal Executive Officer) +/s/ RUSSELL C. HAMMER Russell C. Hammer +Senior Vice President of Finance, Treasurer +and Chief Financial Officer +(Principal Financial and Accounting Officer) +/s/ RAYMOND D. CROGHAN Raymond D. Croghan +Director +Ronald L. Frasch +Director +/s/ MARIE HOLMAN-RAO Marie Holman-Rao +Director +/s/ MICHAEL E. MARKS Michael E. Marks +Director +/s/ RICHARD L. SHARP Richard L. Sharp +Chairman of the Board +/s/ THOMAS J. SMACH Thomas J. Smach +Director +52 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2007 and 2006, and the related consolidated +statements of operations, stockholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the responsibility of +the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. +We +conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in +the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement +presentation. We believe that our audits provide a reasonable basis for our opinion. +In +our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Crocs, Inc. and subsidiaries as of December 31, +2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally +accepted in the United States of America. +As +discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for uncertain tax positions on January 1, 2007 in accordance +with the Financial Accounting Standards Board's Interpretation No. 48, Accounting for Uncertainty in Income Taxes , and for share-based payments +on January 1, 2006 in accordance with the Statement of Financial Accounting Standard No. 123(R), Share-Based Payments . +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of +December 31, 2007, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring +Organizations of the Treadway Commission and our report dated February 29, 2008 expressed an unqualified opinion on the Company's internal control over financial reporting. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +February 29, 2008 +F-1 +CROCS, INC. +CONSOLIDATED BALANCE SHEETS +(In thousands, except share and per share data) +December 31, +2007 +2006 +ASSETS +Current assets: +Cash and cash equivalents +$ +36,335 +$ +42,656 +Restricted cash +300 +2,890 +Short-term investments +— +22,325 +Accounts receivable, less allowance for doubtful accounts of $3,795 and $1,690, respectively +152,919 +65,588 +Inventories +248,391 +86,210 +Deferred tax assets—net +12,140 +3,690 +Prepaid income taxes +— +4,715 +Prepaid expenses and other current assets +17,865 +9,617 +Total current assets +467,950 +237,691 +Property and equipment—net +88,184 +34,849 +Restricted cash +1,014 +— +Goodwill +23,759 +11,552 +Intangible assets—net +31,634 +12,210 +Deferred tax assets—net +8,051 +1,280 +Other assets +6,833 +1,875 +Total Assets +$ +627,425 +$ +299,457 +LIABILITIES AND STOCKHOLDERS' EQUITY +Current liabilities: +Accounts payable +$ +82,979 +$ +43,794 +Accrued expenses and other current liabilities +57,246 +31,109 +Deferred tax liabilities +265 +— +Income taxes payable +19,851 +12,465 +Notes payable and current installments of long-term debt +7,107 +541 +Total current liabilities +167,448 +87,909 +Long-term debt, less current installments of long-term debt +9 +116 +Deferred tax liabilities—net +1,858 +1,688 +Other liabilities +13,997 +1,486 +Total liabilities +183,312 +91,199 +Commitments and contingencies (Notes 3, 14 and 15) +Stockholders' equity: +Common shares, par value $0.001 per share; 250,000,000 authorized, 82,722,426 and 82,198,426 shares issued and outstanding in 2007 and 78,681,418 issued and outstanding in 2006 +83 +79 +Treasury Stock, 524,000 shares, at cost +(25,022 +) +— +Additional paid-in capital +211,936 +131,794 +Deferred compensation +(2,402 +) +(5,702 +) +Retained earnings +249,309 +81,081 +Accumulated other comprehensive income +10,209 +1,006 +Total stockholders' equity +444,113 +208,258 +Total Liabilities and Stockholders' Equity +$ +627,425 +$ +299,457 +See notes to consolidated financial statements. +F-2 +CROCS, INC. +CONSOLIDATED BALANCE SHEETS +(In thousands, except share and per share data) +CROCS, INC. +CONSOLIDATED STATEMENTS OF OPERATIONS +(In thousands, except share and per share data) +Year Ended December 31, +2007 +2006 +2005 +Revenues +$ +847,350 +$ +354,728 +$ +108,581 +Cost of sales +349,701 +154,158 +47,773 +Gross profit +497,649 +200,570 +60,808 +Selling, general and administrative expenses +259,882 +105,224 +33,916 +Income from operations +237,767 +95,346 +26,892 +Interest expense +438 +567 +611 +Other (income)—net +(2,997 +) +(1,847 +) +(8 +) +Income before income taxes +240,326 +96,626 +26,289 +Income tax expense +72,098 +32,209 +9,317 +Net income +168,228 +64,417 +16,972 +Dividends on redeemable convertible preferred shares +— +33 +275 +Net income attributable to common stockholders +$ +168,228 +$ +64,384 +$ +16,697 +Income per common share: +Basic +$ +2.08 +$ +0.87 +$ +0.26 +Diluted +$ +2.00 +$ +0.81 +$ +0.26 +Weighted average common shares: +Basic +80,759,077 +74,598,400 +50,987,154 +Diluted +84,194,883 +80,170,512 +67,140,000 +See +notes to consolidated financial statements. +F-3 +CROCS, INC. +CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT) +(In Thousands) +Members' Interest +Common Stock +Treasury Stock +Additional Paid in Capital +Deferred +Compensation +Retained Earnings (Accumulated Deficit) +Accummulated Other Comprehensive Income +Total Stock Holders Equity (Deficit) +Comprehensive Income (Loss) +Class A +Class B +Total +Shares +Amount +Shares +Amount +BALANCE—December 31, 2004 +$ +14 +$ +1,905 +$ +1,919 +— +$ +— +— +$ +— +$ +— +$ +(2,358 +) +$ +(3,672 +) +$ +520 +$ +(3,591 +) +Conversion to C corporation +(14 +) +(1,905 +) +(1,919 +) +33,492 +34 +— +— +(1,787 +) +— +3,672 +— +— +Deferred stock compensation +— +— +— +— +— +— +— +14,516 +(14,516 +) +— +— +— +Amortization of stock compensation +— +— +— +— +— +— +— +320 +4,437 +— +— +4,757 +Forfeitures +— +— +— +— +— +— +— +(73 +) +73 +— +— +— +Excess tax benefit on share-based compensation +— +— +— +1,406 +— +— +— +983 +— +— +— +983 +Accrued preferred dividend +— +— +— +— +— +— +— +— +— +(275 +) +— +(275 +) +Net income +— +— +— +— +— +— +— +— +— +16,972 +— +16,972 +$ +16,972 +Foreign currency translation +— +— +— +— +— +— +— +— +— +— +68 +68 +68 +Total comprehensive income +$ +17,040 +BALANCE—December 31, 2005 +$ +— +$ +— +$ +— +34,898 +$ +34 +— +$ +— +$ +13,959 +$ +(12,364 +) +$ +16,697 +$ +588 +$ +18,914 +Issuance of common stock in connection with initial public offering, net of offering costs +— +— +— +9,900 +10 +— +— +94,445 +— +— +— +94,455 +Conversion of redeemable convertible preferred shares to common shares +— +— +— +31,726 +32 +— +— +7,268 +— +— +— +7,300 +Adjustment for adoption of SFAS 123R (note 5) +— +— +— +— +— +— +— +(1,442 +) +1,442 +— +— +— +Amortization of stock compensation +— +— +— +— +— +— +— +6,233 +4,022 +— +— +10,255 +Exercises of stock options and vesting of share-based awards +— +— +— +2,158 +3 +— +— +2,281 +— +— +— +2,284 +Forfeitures +— +— +— +— +— +— +— +(1,198 +) +1,198 +— +— +— +Excess tax benefit on share-based compensation +— +— +— +— +— +— +— +10,248 +— +— +— +10,248 +Accrued preferred dividend +— +— +— +— +— +— +— +— +— +(33 +) +— +(33 +) +Net income +— +— +— +— +— +— +— +— +— +64,417 +— +64,417 +$ +64,417 +Foreign currency translation +— +— +— +— +— +— +— +— +— +— +418 +418 +418 +Total comprehensive income +$ +64,835 +BALANCE—December 31, 2006 +$ +— +$ +— +$ +— +78,682 +$ +79 +— +$ +— +$ +131,794 +$ +(5,702 +) +$ +81,081 +$ +1,006 +$ +208,258 +Amortization of stock compensation +— +— +— +— +— +— +— +18,578 +3,105 +— +— +21,683 +Excess tax benefit stock based compensation +— +— +— +— +— +— +— +43,216 +— +— +— +43,216 +Exercises of stock options and vesting of share-based awards +— +— +— +4,040 +4 +— +— +18,543 +— +— +— +18,547 +Forfeitures +— +— +— +— +— +— +— +(195 +) +195 +— +— +— +Treasury Stock +— +— +— +(524 +) +— +524 +(25,022 +) +— +— +— +— +(25,022 +) +Net income +— +— +— +— +— +— +— +— +— +168,228 +— +168,228 +$ +168,228 +Foreign currency translation +— +— +— +— +— +— +— +— +— +— +9,203 +9,203 +9,203 +Total comprehensive income +$ +177,431 +BALANCE—December 31, 2007 +$ +— +$ +— +$ +— +82,198 +$ +83 +524 +$ +(25,022 +) +$ +211,936 +$ +(2,402 +) +$ +249,309 +$ +10,209 +$ +444,113 +F-4 +CROCS, INC. +CONSOLIDATED STATEMENTS OF CASH FLOWS +(In thousands) +Year Ended December 31, +2007 +2006 +2005 +Cash flows from operating activities: +Net income +$ +168,228 +$ +64,417 +$ +16,972 +Adjustments to reconcile net income to net cash provided by operating activities: +Depreciation and amortization +20,949 +8,053 +3,334 +Loss (gain) on disposal of fixed assets +199 +137 +(7 +) +Foreign exchange gains +(8,583 +) +— +— +Deferred tax benefit +(14,866 +) +(2,037 +) +(3,090 +) +Share based compensation +21,683 +10,255 +4,757 +Excess tax benefit on share-based compensation +(43,216 +) +(10,248 +) +983 +Changes in operating assets and liabilities—net of effect of acquired businesses: +Accounts receivable-net +(79,277 +) +(43,983 +) +(14,700 +) +Inventories +(151,590 +) +(54,960 +) +(26,035 +) +Prepaid expenses and other assets +(10,912 +) +(13,049 +) +(3,472 +) +Accounts payable +27,149 +19,959 +17,711 +Accrued expenses and other liabilities +79,174 +33,799 +14,049 +Cash provided by operating activities +8,938 +12,343 +10,502 +Cash flows from investing activities: +Purchases of short-term investments +(64,880 +) +(52,600 +) +— +Sales of short-term investments +87,205 +30,275 +— +Cash paid for purchases of property and equipment +(57,379 +) +(23,828 +) +(11,531 +) +Proceeds from disposal of property and equipment +— +155 +— +Cash paid for intangible assets +(16,525 +) +(5,216 +) +— +Restricted cash +1,753 +(2,890 +) +— +Acquisition of non-competition agreement +— +— +(636 +) +Acquisition of businesses, net of cash acquired +(12,391 +) +(15,399 +) +— +Cash used in investing activities +(62,217 +) +(69,503 +) +(12,167 +) +Cash flows from financing activities: +Proceeds from note payable, net +7,000 +1,808 +6,949 +Proceeds from long-term debt +— +— +2,009 +Payments on long-term debt +(541 +) +(14,072 +) +(158 +) +Proceeds from initial public offering, net of offering costs +— +94,454 +— +Distribution payment to members +— +— +(3,000 +) +Payment of preferred dividends +— +(171 +) +(275 +) +Excess tax benefit on share-based compensation +43,216 +10,248 +— +Exercise of stock options +18,547 +2,284 +— +Purchase of Treasury Stock +(25,022 +) +— +— +Repurchase of members' investments +— +— +— +Proceeds from equity issuances +— +— +— +Payments on member loan +— +— +— +Cash provided by financing activities +43,200 +94,551 +5,525 +Effect of exchange rate changes on cash +3,758 +478 +(127 +) +Net (decrease) increase in cash and cash equivalents +(6,321 +) +37,869 +3,733 +Cash and cash equivalents—beginning of year +42,656 +4,787 +1,054 +Cash and cash equivalents—end of year +$ +36,335 +$ +42,656 +$ +4,787 +Supplemental disclosure of cash flow information—cash paid during the year for: +Interest +$ +44 +$ +353 +$ +252 +Income taxes +$ +19,991 +$ +24,789 +$ +2,510 +Supplemental disclosure of non-cash, investing, and financing activities: +In conjunction with the acquisitions made, liabilities were assumed as follows: +Fair value of assets acquired +$ +7,074 +$ +21,566 +$ +— +Cash paid +5,093 +15,399 +— +Liabilities assumed +$ +1,981 +$ +6,167 +$ +— +Accrued purchase price related to acquisitions +3,429 +2,890 +— +Accrued preferred stock dividends +— +$ +— +$ +161 +Assets acquired under capitalized leases +— +$ +282 +$ +307 +Accrued purchases of property and equipment and intangibles +$ +11,165 +$ +1,011 +$ +836 +See notes to consolidated financial statements. +F-5 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. FORMATION AND BUSINESS OF THE COMPANY +Crocs, Inc. and its subsidiaries (collectively, the "Company") are engaged in the design, development, and manufacturing of consumer products from +specialty resins. The Company was organized as a limited liability company in Colorado in 1999 under the name of Western Brands, LLC. In January 2005, the Company changed its name to +Crocs, Inc. and converted to a Colorado corporation. The Company reincorporated in Delaware in June 2005. +The +Company's wholly owned subsidiary, Crocs Canada, Inc. ("Crocs Canada"), formerly Foam Creations, Inc., formerly Finproject N.A. Inc., located in Quebec, Canada, +has designed, developed, and manufactured consumer products from specialty resins since 1995. In 2000, Crocs Canada completed the formulation of, and began manufacturing, a footwear model made from +the proprietary closed-cell resin the Company currently uses in its footwear product line, which it refers to as Croslite. In 2002, the Company established a business relationship with +Crocs Canada to distribute footwear in the U.S. In October 2002, the Company modified and improved the design of this shoe and began marketing and distributing it under the Crocs brand in the U.S. In +June 2004, Crocs, Inc. acquired Crocs Canada, including its manufacturing operations, product lines and rights to the trade secrets for Croslite. +In +October 2006, the Company acquired Fury Hockey Inc., formerly 55 Hockey Products Inc. ("Fury"), and EXO Italia ("EXO") as part of the Company's effort to expand into new +markets and expand the Company's internal design capabilities. Fury, produces and distributes hockey, soccer and lacrosse equipment for adults and children. EXO, headquartered in Padova, Italy, +designs and develops EVA (Ethylene Vinyl Acetate) based finished products, primarily for the footwear industry. Since 1993, EXO has worked with several leading branded consumer companies to produce +high quality EVA based footwear for the global marketplace. +In +December 2006, the Company acquired Jibbitz, LLC ("Jibbitz"), a unique accessory brand with colorful snap-on charms specifically suited for Crocs footwear. Today +over 1,600 Jibbitz designs are available to consumers for personalizing and customizing their Crocs footwear through over 12,000 customer locations worldwide. +In +January 2007, the Company acquired substantially all of the assets of Ocean Minded, LLC ("Ocean Minded"). Ocean Minded is a designer and manufacturer of high quality leather +and EVA based sandals primarily for the beach, adventure and action sports markets. Ocean Minded utilizes recycled and recyclable materials whenever possible and is well known in the action sports +industry as a leading advocate for environmental awareness and responsibility. +In +July 2007, the Company acquired all of the assets of Bite, LLC ("Bite"), an adventure driven designer and manufacturer of comfortable and supportive performance shoes and +sports sandals sold worldwide in five categories, including, golf, adventure, healthy lifestyle, travel and watersports. Bite shoes are designed to provide comfort when participating in activities +such as golfing, running, hiking, fishing, going to the beach and everyday casual wear. Bite produces some of the lightest golf shoes in the market, golf sandals and will be introducing the Ace, the +first Crocs golf shoe made of Croslite material in order to fuse comfort and sport. +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Basis of Consolidation —The consolidated financial statements include the accounts of +Crocs, Inc. and all of its subsidiaries. All intercompany transactions and balances are eliminated in consolidation. The consolidated financial statements include the accounts of the Company +and all entities that are +F-6 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +wholly-owned +by the Company, variable interest entities for which the Company is the primary beneficiary, and entities that are not variable interest entities but are voting-controlled subsidiaries of +the Company. +Management Estimates —Management of the Company has made certain estimates and assumptions relating to the reporting of assets, +liabilities, net sales 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 U.S. Significant areas requiring the use of management estimates relate to the allowance for doubtful accounts, returns and discounts, impairment assessments and charges, deferred +taxes, uncertain tax positions, share-based compensation expense, fair value of acquired intangibles, assessment of lower of cost or market on inventory, and useful lives assigned to +long-lived assets. Actual results could differ from these estimates and the differences could be material. +Concentration of Risk —The Company's cash and cash equivalents are maintained in several different financial institutions in +amounts that typically exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to significant credit risk. +The +Company considers its concentration risk related to accounts receivable to be mitigated by the Company's credit policy, the significance of outstanding balances owed by each +individual customer at any point in time and the geographic dispersion of these customers. +The +Company relies on both internal and external manufacturers for its products. Establishing a replacement source for the Company's product offerings could require significant +additional time and expense. +Variable Interest Entities —Under Financial Accounting Standards Board ("FASB") Interpretation No. 46 (revised December +2003), Consolidation of Variable Interest Entities ("FIN 46R") , once an entity is determined to be a variable interest entity, the party with the +controlling financial interest, the primary beneficiary, is required to consolidate it. In connection with the acquisition of Crocs Canada in 2004 the Company has an interest in Les Plastiques +Fintech Inc. ("Fintech") in which the Company is the primary beneficiary under FIN 46R. Fintech is a joint venture with the President of Crocs Canada, in which the Company holds a 50% +interest. Fintech carries out research and development for Crocs and produces the raw materials for the Company's products. At December 2007 and 2006, this entity was consolidated and the effect on +the Company's financial statements is immaterial. +Fair Value of Financial Instruments —The carrying value of financial instruments, including cash equivalents, accounts +receivable, accounts payable and accrued liabilities, approximate fair value due to their short maturities. Based on borrowing rates currently available to the Company, with similar terms, the +carrying values of the capital lease obligations and the line of credit approximate their fair values. The fair values of the Company's investments are determined using quoted market prices for those +securities. +Cash and Cash Equivalents —Cash and cash equivalents represent cash and short-term, highly liquid investments with +maturities of three months or less at date of purchase. The Company considers receivables from credit card companies to be cash equivalents. The carrying amounts reflected in the consolidated balance +sheet for cash and cash equivalents approximate fair value due to the short maturities. +F-7 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Restricted Cash —Restricted cash represents cash commitments related to building and lease deposits. The classification of +restricted cash on the consolidated balance sheet as current or noncurrent is dependent on the duration of the restriction and the purpose for which the restriction exists. +Investments —The Company accounts for investments in accordance with FASB Statement of Financial Accounting Standards ("SFAS") +No. 115, Accounting for Certain Investments in Debt and Equity Securities ("SFAS 115"). The Company invests in certain investments, which +consist primarily of short to intermediate-term fixed income securities issued by U.S. government agencies and municipalities. The Company also invests in certain auction rate debt +securities that have been +classified as short-term investments in the accompanying balance sheets. All investments are classified as available-for-sale and are reported at fair value with +unrealized gains and losses, net of tax, included in accumulated other comprehensive income as a separate component of stockholders' equity. The specific-identification method is used to determine the +cost of all investments and the basis by which amounts are reclassified from accumulated other comprehensive income into earnings. There were no unrealized gains or losses recorded as of +December 31, 2007. See Note 7 for further discussion. +Accounts Receivable —Accounts receivable represents amounts due from customers. Accounts receivable is recorded at invoiced +amounts, net of reserves and allowances, and does not bear interest. The Company uses its best estimate to determine the required allowance for doubtful accounts based on a variety of factors, +including the length of time receivables are past due, economic trends and conditions affecting the Company customer base, significant one-time events and historical write-off +experience. Specific provisions are recorded for individual receivables when the Company becomes aware of a customer's inability to meet its financial obligations. +Inventories —Raw materials and supplies are valued at the lower of cost, replacement cost, or net realizable value. Work in +process and finished goods are valued at the lower of cost and net realizable value. Cost is determined on the first in, first out basis. The cost of work in process and finished goods consists of the +cost of raw materials and an applicable share of the cost of labor and manufacturing overhead. See Note 8 for further discussion. +Property and Equipment —Depreciation of machinery and equipment is computed using the straight-line method based on +estimated useful lives ranging from three to seven years. Leasehold improvements are amortized on the straight-line basis over their estimated economic useful lives or the lease term, +whichever is shorter. See Note 9 for further discussion. +Impairment of Long-Lived Assets —In accordance with SFAS 144, the Company estimates the future undiscounted +cash flows to be derived from an asset to assess whether or not a potential impairment exists when events or circumstances indicate the carrying value of a long-lived asset may be +impaired. If the carrying value exceeds the estimate of future undiscounted cash flows, the Company calculates the impairment as the excess of the carrying value of the asset over the estimate of its +fair value. There were no impairments recorded during 2007 or 2006. +Goodwill —In accordance with SFAS 142, goodwill represents the excess purchase price paid over the fair value of assets +acquired and liabilities assumed in the acquisitions. The Company assesses goodwill for impairment annually on the last day of the fourth quarter, or more frequently if events and circumstances +indicate impairment may have occurred. If the carrying value of goodwill exceeds its +F-8 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +implied +fair value, the Company records an impairment loss equal to the difference. There was no impairment of goodwill at December 31, 2007 or 2006. See Note 4 for further discussion. +Intangible Assets Finite-Lived —SFAS No. 142, Goodwill and Other Intangible +Assets , ("SFAS 142") requires that intangible assets with finite lives be amortized over their estimated useful lives and reviewed for impairment in accordance with SFAS +No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets , ("SFAS 144"). The Company is currently amortizing its +acquired intangible assets with finite lives over periods ranging from five to 10 years. Intangible assets are comprised of capitalized software, core technology, customer relationships, a +non-competition agreement entered into in connection with the acquisition of assets in Mexico, and capitalized costs related to pending patents that the Company is pursuing related to its +technology. Patents are amortized on approval of the patent registration application over their estimated useful lives. See Note 4 for further discussion. +Capitalized Software —The Company capitalizes certain internal and external software acquisition and development costs that +benefit future years in accordance with SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. For software developed for internal use, the +Company expenses the costs of developing computer software until the software has reached the application development stage and then capitalizes all costs incurred from that time until the software +has been installed at which time amortization of the capitalized costs begins. Determination of when the software has reached the application development stage is based on completion of conceptual +designs, evaluation of alternative designs and performance requirements. Costs of major enhancements to internal use software are capitalized while routine maintenance of existing software is charged +to expense as incurred. The determination of when the software is in the application development stage and the ongoing assessment of the recoverability of capitalized computer software development +costs requires considerable judgment by management with respect to certain factors, including but not limited to, estimated economic life and changes in software and hardware technology. The Company +also contracts with third parties to help develop or test internal use software and generally capitalizes these costs. Internal-use capitalized software costs are amortized over their +expected useful life, which is generally seven years. See Note 4 for further discussion. +Earnings per Share —Basic earnings per common share ("EPS") is computed by dividing the net income 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. +Anti-dilutive securities are excluded from diluted EPS. +On +May 2, 2007, the Board of Directors of the Company declared a two-for-one stock split of the Company's common stock, which was effected in the form of a +100% common stock dividend distributed on June 14, 2007 to shareholders of record on May 31, 2007. All references to share and per share amounts in the consolidated financial statements +and accompanying notes to the consolidated financial statements have been retroactively restated to reflect the two-for-one stock split. +In +January 2005, in connection with the change from a limited liability company to a corporation, the Company converted the Class A and B units into common stock on a one for one +basis. On January 10, 2006, the Board of Directors approved a 233.62-for-1 stock split of the Company's common stock and preferred stock. All 2005 share and per share +amounts related to common stock, preferred stock and stock options included in the accompanying financial statements and footnotes have been restated to reflect the stock splits. See Note 6 for +further discussion. +F-9 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Recognition of Revenues —Revenues are recognized when the customer takes title and assumes risk of loss, collection of related +receivables is probable, persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer depending on the country of +the sale and the agreement with the customer. Allowances for estimated returns and discounts are recognized as a reduction of the related revenue when it is recorded. +Shipping and Handling Costs —Shipping and handling costs are expensed as incurred and included in cost of sales. +Share-Based Compensation —The Company issues restricted stock and stock option grants to employees and +non-employees with vesting schedules of varying lengths. Typically, these grants range from immediate vesting to vesting periods of up to four years. Effective January 1, 2006, the +Company adopted SFAS No. 123R, Share-Based Payment ("SFAS 123R"), which establishes accounting guidelines for share-based awards exchanged +for employee services, using the prospective method for option grants and restricted stock issued prior to August 15, 2005, the date which the Company filed its initial Registration Statement +on Form S-1, and the modified prospective method for option grants issued after August 15, 2005. The Company was required to adopt the prospective method for grants prior to +August 15, 2005 as the Company had elected to value employee grants using the minimum value method under SFAS No. 123, Accounting for Share-based +Compensation ("SFAS 123"). For option grants and restricted stock accounted for under the prospective method, the Company will continue to account for the grants under +the intrinsic value-based method prescribed by Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees +("APB 25"), and the related interpretations in accounting for employee stock options. Therefore, the Company does not record any compensation expense for stock options granted to employees, +prior to August 15, 2005, if the exercise price equaled the fair market value of the stock +option on the date of grant, and the exercise price, number of shares eligible for issuance under the options and vesting periods were fixed. +Compensation +expense is recognized over the vesting term for employees and non-employees on a straight-line basis. Deferred compensation represents the unvested +portion of employee grants made prior to August 15, 2005 and is recorded as a reduction of equity. The fair value of employee grants is fixed at date of grant, or the measurement date, if +later, while grants to non-employees are remeasured to fair value at each reporting period until vesting occurs. The related compensation expense is recognized over the vesting period. See +Note 5 for further discussion. +Advertising —Advertising costs are expensed as incurred and production costs are generally expensed when the advertising is +first run. Advertising expenses were $5.5 million, $1.2 million, and $0.5 million for the years ended December 31, 2007, 2006, and 2005, respectively and are included in +selling, general, and administrative expenses. +Research and Development —Research and development costs are expensed as incurred. Research and development expenses amounted +to $5.3 million, $1.8 million, and $0.5 million for the years ended December 31, 2007, 2006, and 2005, respectively and are included in selling, general, and administrative +expenses. +Foreign Currency Translation and Foreign Currency Transactions —The U.S. dollar is the Company's reporting currency. Assets and +liabilities of 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 applicable period. Adjustments resulting from +F-10 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +translating +foreign functional currency financial statements into U.S. dollars are included in the foreign currency translation adjustment, a component of accumulated other comprehensive income in +stockholders' equity. Gains and losses generated by transactions denominated in a currency different from the functional currency of the applicable entity are recorded in selling, general and +administrative expense in the period in which they occur. +Net +realized gains and losses on foreign currency transactions was a $1.5 million gain for the year ended December 31, 2007, a $747,000 loss for the year ended +December 31, 2006 and was immaterial for the year ended December 31, 2005. Net unrealized gains for foreign currency transactions was $8.6 million for 2007 and immaterial for the +years ended December 31, 2006, and 2005. +Derivative Foreign Currency Contracts —The Company is exposed to global market risks, including the effect of changes in +foreign currency exchange rates. During the year ended December 31, 2007, the Company used derivatives to manage financial exposures that occur in the normal course of business. The Company +does not hold or issue derivatives for trading purposes. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management +objective and strategy for undertaking hedge transactions. This process includes linking all derivatives to either specific assets and liabilities on the balance sheet, specific firm commitments or +forecasted transactions. The Company has entered into forward exchange contracts to hedge certain portions of future cash flows denominated in foreign currencies. These contracts were not designated +as hedges under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"). The futures contracts were marked +to market and gains and losses were recognized in earnings. The net realized gains and losses for these contracts were not material for the years ended December 31, 2007, 2006 and 2005. +The Company has no other unsettled derivative contracts as of December 31, 2007. +Income Taxes —The Company accounts for income taxes using the asset and liability method. This approach requires the +recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. The +Company provides for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. Prior to the Company's conversion to a C corporation on +January 4, 2005, the Company was not a taxpaying entity for U.S. federal and state income tax purposes. +In +July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxe s ("FIN 48"). FIN 48 +requires the use of a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax +positions. FIN 48 is effective for fiscal years beginning after December 15, 2006. Only tax positions that meet the more likely than not recognition threshold at the effective date may +be recognized on adoption of FIN 48. The adoption of FIN 48 did not have a material impact on the Company's condensed consolidated balance sheet, statement of operations or cash flows. +See Note 13 for further details. +Recent Accounting Pronouncements —In September 2006, the FASB issued SFAS No. 157, Fair Value +Measurement ("SFAS 157"), which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and +expands disclosures about fair value measurements. The Statement is effective for financial statements issued for the first annual or interim reporting period beginning after November 15, 2007. +The Company will adopt SFAS 157 effective +F-11 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +January 1, +2008. The Company is currently evaluating the impact this new standard will have on its future results of operations and financial position and does not expect that the adoption will +have a material impact on the Company's consolidated financial position or results of operations. +In +February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities +("SFAS 159"). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 will be effective at the beginning of +fiscal 2008. The Company is currently evaluating the impact this new standard will have on its future results of operations and financial position and does not expect that the adoption will have a +material impact on the Company's consolidated financial position or results of operations. +In +December 2007, the FASB issued SFAS No. 141(R), Business Combinations ("SFAS 1411(R)"), which amends SFAS No. 141, +and provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any non-controlling interest in the acquiree. It also +provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for the fiscal +year beginning January 1, 2009 and is to be applied prospectively. The Company is currently evaluating the potential impact of adopting this statement on its consolidated financial position, +results of operations and cash flows and does not expect that the adoption will have a material impact on the Company's consolidated financial position or results of operations. +In +December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements- an amendment of ARB +No. 51 ("SFAS 160") which establishes accounting and reporting standards pertaining to ownership interests in subsidiaries held by parties other than the parent, +the amount of net income attributable to the parent and to the non-controlling interest, changes in a parent's ownership interest, and the valuation of any retained +non-controlling equity investment when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests +of the parent and the interests of the non-controlling owners. SFAS 160 is effective for the fiscal year beginning January 1, 2009. The Company is currently evaluating the +impact this new standard will have on its consolidated financial position, results of operations and cash flows, and does not expect that the adoption will have a material impact on the Company's +consolidated financial position or results of operations. +3. ACQUISITIONS +On January 31, 2007, the Company acquired substantially all of the assets of Ocean Minded for $1.75 million in cash, plus a potential +earn-out of up to $3.75 million based on Ocean Minded achieving certain earnings targets over a three year period. The Company recorded $600,000 in customer relationships and other +identifiable intangible assets and $953,000 in goodwill on the date of acquisition for Ocean Minded. +On +June 26, 2007, the Company amended the membership interest purchase agreement ("Purchase Agreement") with Jibbitz to amend the terms of the potential earn-out +consideration included in the Purchase Agreement. The amendment removed the earnings targets for payment of the earn-out with $3.5 million payable on the effective date of the +amended Purchase Agreement and the remaining $6.5 million payable in equal monthly installments of $500,000 due on the first business day for the following thirteen months. The Company recorded +the additional $9.77 million, net of discounting on future payments, to goodwill in the second quarter of 2007 as an additional cost of the acquisition. +F-12 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +3. ACQUISITIONS (Continued) +On +July 27, 2007, the Company acquired all of the assets of Bite for $1.75 million in cash and the assumption of $1.3 million in debt, plus a potential earn out of +up to $1.75 million based on Bite achieving certain earnings targets over a three year period. The Company recorded $512,000 in customer relationships and other identifiable intangible assets +and $530,000 in goodwill on the date of acquisition for Bite. +Pro Forma Financial Information (Unaudited) +The following table summarizes supplemental statement of operations information for the years ended December 31, 2007 and 2006 on a pro forma basis as if +all acquisitions had occurred on January 1, 2007 and 2006. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations +that would have been achieved if the acquisitions had taken place at the beginning of each of the periods presented. +December 31, +2007 +2006 +(in thousands, except per share data) +Net sales +$ +851,344 +$ +380,456 +Gross profit +499,292 +213,666 +Income from operations +237,970 +100,007 +Net income +168,637 +66,620 +Net income per common share: +Basic +$ +2.09 +$ +0.89 +Diluted +$ +2.00 +$ +0.83 +4. GOODWILL AND INTANGIBLE ASSETS +The following table summarizes the activity in the Company's goodwill account during the years ended December 31, 2007 and 2006 (in thousands): +Balance at January 1, 2006 +$ +336 +Jibbitz acquisition +8,164 +Other acquisitions +3,052 +Balance at December 31, 2006 +11,552 +Bite acquisition +530 +Ocean Minded acquisition +953 +Jibbitz earn out +10,191 +Foreign currency translation adjustment +533 +Balance at December 31, 2007 +$ +23,759 +F-13 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +4. GOODWILL AND INTANGIBLE ASSETS (Continued) +The +following table summarizes the Company's identifiable intangible assets as of December 31, 2007 and 2006 (in thousands): +2007 +2006 +Gross +Carrying +Amount +Accumulated +Amortization +Net Carrying +Amount +Gross +Carrying +Amount +Accumulated +Amortization +Net Carrying +Amount +Finite lived assets: +Patents +$ +4,344 +$ +201 +$ +4,143 +$ +1,441 +$ +12 +$ +1,429 +Customer relationships +5,437 +2,437 +3,000 +3,547 +657 +2,889 +Core technology +4,931 +3,455 +1,476 +4,154 +2,082 +2,073 +Non-competition agreement +636 +339 +297 +636 +212 +424 +Capitalized software +24,177 +1,612 +22,565 +5,516 +274 +5,242 +Total finite lived assets +$ +39,525 +$ +8,044 +$ +31,481 +$ +15,294 +$ +3,237 +$ +12,057 +Indefinite lived intangible assets: +Jibbitz trade name +$ +153 +— +$ +153 +$ +153 +— +$ +153 +Total intangible assets +$ +39,678 +$ +8,044 +$ +31,634 +$ +15,447 +$ +3,237 +$ +12,210 +Certain +software held under a capital lease in the amount of $642,000 at December 31, 2007 is classified as capitalized software and amortized using the straight-line +method over the lease term. Amortization of capitalized software under capitalized leases is included in amortization expense. +Intangible +assets that are determined to have finite lives are amortized over their useful lives on a straight-line basis for patents, core technology, +non-competition agreement and capitalized software. Customer relationships are amortized on a straight-line basis or an accelerated basis. Amortization expense of intangible +assets with finite lives, which is included in selling, general and administrative expense, was $4.1 million, $1.6 million and $1.1 million for the years ended December 31, +2007, 2006 and 2005, respectively. For amortizable intangible assets denominated in a foreign currency, the Company translates the ending asset and accumulated amortization at the balance sheet rate +and records amortization expense using the weighted average rate of exchange for the applicable period. A difference between the recorded amortization expense and the change in accumulated +amortization exists, and should not be amortized. Below are the weighted average amortization period by major intangible asset class for the Company as of December 31, 2007. +Intangible Asset Class +Weighted Average +Amortization Period +Patents +10 years +Customer Relationships +5.7 years +Core Technology +5.0 years +Non-competition Agreement +5.0 years +Capitalized Software +7.0 years +F-14 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +4. GOODWILL AND INTANGIBLE ASSETS (Continued) +Estimated +future annual amortization of intangible assets is as follows (in thousands): +Fiscal years ending December 31, +Amortization +2008 +$ +5,560 +2009 +5,159 +2010 +4,504 +2011 +4,236 +2012 +4,010 +Thereafter +8,012 +Total +$ +31,481 +5. EQUITY +On November 1, 2007, the Company's board of directors approved an authorization to repurchase up to one million shares of its common stock. Share +repurchases under this authorization may be made in the open market or in privately negotiated transactions. The timing and actual number of shares repurchased will depend on a variety of factors +including price, corporate and regulatory requirements and other market conditions. The repurchase authorization does not have an expiration date and does not obligate the Company to acquire any +particular amount of shares of its common stock. The repurchase authorization may be modified, suspended or discontinued at any time. On November 7, 2007, the Company repurchased approximately +524,000 shares for a total of approximately $25.0 million. +On +May 2, 2007, the Board of Directors of the Company declared a two-for-one stock split of the Company's common shares, which was effected in the form of +a 100% common stock dividend distributed on June 14, 2007. All references to share and per share amounts in the consolidated financial statements and accompanying notes to the consolidated +financial statements have been retroactively restated to reflect the two-for-one stock split. +On +February 13, 2006, the Company issued 9,900,000 shares of common stock on the closing of its initial public offering for $94.5 million, net of underwriting discounts and +commissions and related offering costs of $2.5 million. In connection with the completion of the offering, the Company's redeemable common and preferred stock were converted into common shares +and those balances were reclassified to permanent equity. +Share-Based Compensation +Under the modified prospective method, compensation expense recognized in the year ended December 31, 2007, includes: (i) compensation expense of +all share-based payments granted after August 15, 2005 but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the +provisions of SFAS 123R and (ii) compensation expense for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in +accordance with the provisions of SFAS 123R. Results for prior periods have not been retrospectively adjusted. The Company records compensation expense related to non-employees +under the provisions of SFAS 123R and Emerging Issues Task Force EITF 96-18, Accounting for Equity Instruments that are Issued to Other than Employees +for Acquiring, or in conjunction with Selling, Goods or Services +F-15 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +5. EQUITY (Continued) +("EITF 96-18"), +and recognizes compensation expense over the vesting periods of such awards. Total pre-tax share-based compensation expense recognized was +$21.7 million, $10.3 million, and $4.8 million for the years ended December 31, 2007, 2006, and 2005 with associated tax benefits of approximately $6.4 million, and +$3.8 million and $1.8 million, respectively. Capitalization of the stock based compensation into inventory and intangibles as part of the overhead allocation was $3.3 million and +$160,000 respectively for 2007. The amounts capitalized in 2006 were not material. The cumulative effect of applying the modified prospective method was to reduce deferred compensation by +$1.4 million and the effect on the statement of operations was immaterial. The effect of applying SFAS 123R was to reduce pre-tax income by $5.4 million for the year +ended December 31, 2006. +SFAS 123R +also required the Company to change the classification, in its consolidated statement of cash flows, of any excess tax benefits realized on the exercise of stock options +or issuance of restricted stock unit awards in excess of that which is associated with the expense recognized for financial reporting purposes. These amounts are presented as a financing cash inflow +rather than as a reduction of income taxes paid in the consolidated statement of cash flows. +The +Company has computed the fair value of options granted using the Black-Scholes option pricing model. In order to calculate the fair value of the options, certain assumptions are made +regarding components of the model, including risk-free interest rate, volatility, expected dividend yield rate, and expected option life. Changes to the assumptions could cause significant +adjustments to the valuation. For options granted before August 15, 2005, expected volatility was not considered for employee grants as the Company was a non-public entity at the +grant date of these options. For stock option grants issued after the filing of the Company's initial Registration Statement on Form S-1 on August 15, 2005, the minimum value +method is no longer used and the Company used a volatility rate of 50% and began to include estimated forfeiture rates. The Company estimated the volatility of its common stock at the date of grant +based on the historical volatility of comparable companies. The Company factored in expected retention rates combined with vesting periods to determine the average expected life. The +risk-free interest rate for periods within the contractual life of the options is based on the U.S. Treasury yield curve in effect at the time +of each grant. Accordingly, the Company has computed the fair values of all options granted during the year ended December 31, 2007, 2006 and in 2005 subsequent to August 15, using the +Black-Scholes option pricing model and the following weighted average assumptions: +2007 +2006 +Period from +August 15 to +December 31 +2005 +Expected volatility +50 +% +50 +% +50 +% +Dividend yield +— +— +— +Risk-free interest rate +4.58 +% +4.71 +% +4.11 +% +Expected life (in years) +5 +5 +5 +Because +the Company applied the minimum value method of valuing employee stock options prior to becoming a public company, as allowed by SFAS 123, the Company is precluded from +presenting pro forma historical statement of operations information under SFAS 123R. +F-16 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +5. EQUITY (Continued) +Stock Option Activity +The following summarizes stock option transactions for the year ended December 31, 2007: +Options +Shares +Weighted +Average Exercise Price +Weighted Average +Remaining +Contractual Life +(Years) +Aggregate +Intrinsic Value +(in thousands) +Outstanding at December 31, 2006 +9,085,436 +$ +7.96 +7.9 +Granted +2,895,800 +31.68 +Exercised +(3,246,230 +) +5.71 +Forfeited or expired +(442,509 +) +14.53 +Outstanding at December 31, 2007 +8,292,497 +$ +16.76 +7.8 +$ +176,911 +Exercisable at December 31, 2007 +4,325,554 +$ +8.54 +7.8 +$ +122,287 +Vested at December 31, 2007 +1,239,850 +$ +7.00 +6.5 +$ +36,949 +Vested and expected to vest at December 31, 2007 +6,811,787 +$ +16.72 +7.8 +$ +145,615 +Options +awarded under the Company's 2005 Equity Incentive Plan (the "Plan") prior to September 30, 2006 are exercisable immediately on the date of grant with the exception of +467,248 shares granted to members of the Board of Directors. In order to preserve the vesting provisions of the immediately exercisable options, the options that are exercised early are subject to a +repurchase right by the Company at the lower of exercise price or fair market value of the underlying stock at the date of repurchase. This repurchase right expires on vesting of the underlying +option. Immediately exercisable stock options outstanding under the Plan were 3,830,397 at December 31, 2007 of which 744,693 are fully vested and no longer subject to the repurchase right. +Options awarded after October 1, 2006 are exercisable as they vest. To date, no options have been exercised early. +The +weighted average fair value of options granted during the years ended December 31, 2007 and 2006 and the period August 15, 2005 through December 31, 2005 was +approximately $15.83, $6.49 and $3.70, respectively. +The +aggregate intrinsic value of all options exercised during 2007 and 2006 was $113.7 million and $15.2 million respectively. No options were exercised in 2005. Cash +received and the income tax benefit from stock option exercises for fiscal year 2007 was $18.5 million and $5.4 million, respectively. The total grant date fair value of stock options +vested during 2007, 2006, and 2005 was $19.2 million, $8.5 million, and $1.4 million respectively. +F-17 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +5. EQUITY (Continued) +The +status of total stock options outstanding at December 31, 2007 was as follows: +Options Outstanding +Options Exercisable +Exercise Prices +Number of +Shares +Weighted +Average Remaining +Contractual Life +(Years) +Weighted +Average +Exercise +Price +Number +Exercisable +Weighted +Average +Exercise Price +Fair Value +Determination +$0.51 - 1.69 +1,405,099 +5.0 +$ +1.14 +986,871 +$ +1.36 +Black-Scholes +$2.85 - 10.50 +2,139,208 +7.7 +7.98 +2,051,596 +8.14 +Black-Scholes +$13.00 - 16.99 +1,427,916 +8.2 +14.43 +1,190,252 +14.19 +Black-Scholes +$19.61 - 22.92 +1,547,074 +8.5 +22.19 +96,835 +20.69 +Black-Scholes +$23.93 - 47.88 +1,428,100 +9.0 +32.13 +— +— +Black-Scholes +$56.13 - 59.98 +345,100 +9.6 +56.63 +— +— +Black-Scholes +8,292,497 +7.8 +$ +16.76 +4,325,554 +$ +8.54 +As +of December 31, 2007, the Company issued unvested options to purchase 7.1 million shares of the Company's common stock with a weighted average grant date fair value of +$9.58. As of December 31, 2007, the Company had $67.4 million of total unrecognized share-based compensation expense related to unvested options, net of expected forfeitures, which is +expected to be amortized over the weighted average period of 3.97 years. +Non-vested Stock Awards +The following summarizes restricted stock transactions for the year ended December 31, 2007: +Non-vested +Shares +Weighted Average Grant Date Fair Value +Outstanding at December 31, 2006 +882,196 +$ +1.68 +Granted +— +— +Vested +(794,638 +) +1.54 +Forfeited or expired +— +— +Outstanding at December 31, 2007 +87,558 +$ +2.96 +At +December 31, 2007, the Company had $259,000 of total unrecognized share-based compensation expense related to non-vested stock awards. The non-vested +stock awards are expected to be amortized over the weighted average period of 0.4 years. +6. EARNINGS PER SHARE +In April 2005, the Company amended its articles of incorporation to allow the holders of its redeemable preferred stock to participate in dividends paid on the +Company's common stock. Under the amended articles, if the Company were to pay a dividend on any share of common stock, the Company must pay a dividend on all outstanding shares of its redeemable +preferred stock on an as if converted basis in a per share amount equal to the amount paid on each share of common stock. In accordance with Emerging Issues Task Force No. 03-6, +"Participating Securities and the Two Class Method Under SFAS 128," the Company has presented basic and diluted earnings per share for +F-18 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +6. EARNINGS PER SHARE (Continued) +common +shares using the two class method for the year ended December 31, 2005 (in thousands, except share and per share data). For purposes of computing income (loss) per common share, the +Company has reflected the conversion of the membership interests into units, and the subsequent conversion of units into shares of the Company's stock. +Basic +income per common share ("EPS") is computed by dividing the net income available to common stockholders by the weighted average number of common shares outstanding for the period. +Diluted EPS reflects the potential dilution from securities that could share in the earnings of the Company. Anti-dilutive securities are excluded from diluted EPS. +December 31, +2007 +2006 +2005 +(in thousands, except share and per share data) +Reconciliation of net income attributable to common stockholders for basic computation: +Net income attributable to common stockholders +$ +168,228 +$ +64,384 +$ +16,697 +Less: Undistributed net income allocated to redeemable convertible preferred stockholders +— +— +(3,736 +) +Undistributed net income allocated to common stockholders +$ +168,228 +$ +64,384 +$ +12,961 +Reconciliation of net income for dilutive computation: +Net income attributable to common stockholders +$ +168,228 +$ +64,384 +$ +16,697 +Preferred dividend +— +33 +275 +Net income for dilutive computation +$ +168,228 +$ +64,417 +$ +16,972 +Basic income per common share: +Weighted average common shares outstanding +80,759,077 +74,598,400 +50,987,154 +Basic income per common share +$ +2.08 +$ +0.87 +$ +0.26 +Diluted income per common share: +Weighted average common shares outstanding +80,759,077 +74,598,400 +50,987,154 +Dilutive effect of preferred stock +— +1,592,652 +14,904,984 +Dilutive effect of stock options +3,144,607 +2,998,156 +440,068 +Dilutive effect of unvested stock +291,199 +981,304 +807,794 +Weighted average diluted common shares outstanding +84,194,883 +80,170,512 +67,140,000 +Diluted income per common share +$ +2.00 +$ +0.81 +$ +0.26 +For +the year ended December 31, 2007 there were options outstanding to purchase 906,700 shares of the Company's common stock with a weighted-average exercise price per share of +$48.35, which could potentially dilute basic earnings per share in the future, but which were not included in diluted +F-19 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +6. EARNINGS PER SHARE (Continued) +earnings +per share as their effect was anti-dilutive. There were no anti-dilutive securities in the year ended December 31, 2005. The following table summarizes the +anti-dilutive securities: +December 31, +2007 +2006 +Anti-dilutive effect: +Preferred stock +— +— +Stock options +906,700 +654,350 +Unvested stock +— +— +906,700 +654,350 +7. SHORT-TERM INVESTMENTS +At December 31, 2006, the Company's short-term investments consisted exclusively of auction rate securities. The Company did not hold any +short-term investments at December 31, 2007. Auction rate securities are variable rate bonds of States and joint municipal agencies tied to short-term interest rates +with maturities on the face of the underlying securities in excess of 90 days. Auction rate securities have interest rate resets through a modified Dutch auction, at pre-determined +short-term intervals, usually every 7, 28, or 35 days. They trade at par and are callable at par on any interest payment date at the option of the issuer. Interest paid during a +given period is based on the interest rate determined during the prior auction. The Company records such securities as short-term investments based on the short-term nature and +structure, the frequency with which the interest rate resets, and the ability to sell auction rate securities at par and at the Company's discretion with the intent of meeting the Company's +short-term working capital requirements. +Investments +in auction rate securities are classified as available-for-sale and are reported at fair value in the Company's consolidated balance sheets. There +were no unrealized gains or losses as of December 31, 2006. +8. INVENTORIES +Inventories by major classification are as follows (in thousands): +December 31, +2007 +2006 +Finished goods +$ +224,658 +$ +78,938 +Work-in-progress +3,346 +445 +Raw materials +20,387 +6,827 +$ +248,391 +$ +86,210 +F-20 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. PROPERTY AND EQUIPMENT +Property and equipment includes the following (in thousands): +December 31, +2007 +2006 +Machinery and equipment +$ +103,049 +$ +40,195 +Leasehold improvements +12,322 +3,529 +Subtotal +115,371 +43,724 +Less accumulated depreciation and amortization +(27,187 +) +(8,875 +) +$ +88,184 +$ +34,849 +Depreciation +expense of $17.0 million, $6.2 million and $2.0 million was recorded for the years ended December 31, 2007, 2006 and 2005, respectively. As the +Company translates the ending fixed assets and accumulated depreciation at the balance sheet rate and records depreciation expense using the weighted average rate of exchange for the applicable +period, a difference between the recorded depreciation expense and the change in accumulated depreciation exists. Certain equipment held under capital leases in the amounts of $116,000 and +$322,000 million at December 31, 2007 and 2006, respectively, are classified as equipment and amortized using the straight-line method over the lease term. Amortization of +assets under capitalized leases is included in depreciation expense. +10. ACCRUED EXPENSES AND CURRENT OTHER LIABILITIES +Accrued expenses and other liabilities include the following (in thousands): +December 31, +2007 +2006 +Accrued compensation and benefits +$ +22,416 +$ +9,724 +Professional services +5,625 +2,866 +Fulfillment and freight and duties +4,065 +4,374 +Sales/Use tax payable +2,573 +2,300 +Accrued purchase price related to Jibbitz +3,429 +2,890 +Other +19,138 +8,955 +$ +57,246 +$ +31,109 +11. NOTES PAYABLE +Notes Payable includes the following (in thousands): +December 31, +2007 +2006 +Westland note payable +— +122 +Revolving credit facility +7,000 +— +$ +7,000 +$ +122 +F-21 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +11. NOTES PAYABLE (Continued) +On +May 14, 2007 the Company entered into a credit agreement with Union Bank of California, N.A. ("Revolving Credit Facility"). The Revolving Credit Facility, consists of a +$15.0 million revolving loan facility, included within the Revolving Credit Facility is $10.0 million available for the issuance of letters of credit. On November 21, 2007, the +Company amended the Revolving Credit Facility, increasing the available borrowing amount to $25.0 million. +The +Revolving Credit Facility matures on May 1, 2009 and may be extended in one year increments. Borrowings under the Revolving Credit Facility are unsecured and bear an interest +rate based, at the option of the Company, on (i) a base rate defined as the higher of the Fed Funds rate less 0.50%, or the rate of interest most recently announced by the lender, or +(ii) the Libor rate plus 0.875%. The Prime rate as of December 31, 2007 was 7.25% less 50 basis points. +On +January 4, 2008 the Company entered into a second amendment of the Revolving Credit Facility increasing the borrowing amount to $50.0 million. See Note 20 for +details. +12. ALLOWANCES +The changes in the Company's allowance for doubtful accounts and reserve for sales returns and allowances for the years ended December 31, 2007, 2006 and +2005, are as follows (in thousands): +Balance at +Beginning +of Year +Charged to +costs and +expenses +Deductions and +write-offs +Balance at +End of Year +Year ended December 31, 2005: +Allowance for doubtful accounts +159 +594 +187 +566 +Reserve for sales returns and allowances +46 +2,977 +2,461 +562 +Year ended December 31, 2006: +Allowance for doubtful accounts +566 +1,719 +595 +1,690 +Reserve for sales returns and allowances +562 +3,266 +1,014 +2,814 +Year ended December 31, 2007: +Allowance for doubtful accounts +1,690 +4,671 +2,566 +3,795 +Reserve for sales returns and allowances +2,814 +7,168 +3,991 +5,991 +F-22 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES +The provision for income taxes consisted of the following (in thousands): +December 31, +2007 +2006 +2005 +Current—U.S. federal +$ +38,399 +$ +20,196 +$ +10,223 +Current—U.S. state +3,646 +1,009 +1,451 +Current—foreign +44,919 +13,041 +733 +Total current income taxes +86,964 +34,246 +12,407 +Deferred—U.S. federal +(5,269 +) +(1,741 +) +(2,779 +) +Deferred—U.S. state +(727 +) +(8 +) +(244 +) +Deferred—foreign +(8,870 +) +(288 +) +(67 +) +Total deferred income taxes +(14,866 +) +(2,037 +) +(3,090 +) +Total income tax expense +$ +72,098 +$ +32,209 +$ +9,317 +Pretax +income is as follows (in thousands): +December 31, +2007 +2006 +2005 +U.S. +$ +95,048 +$ +52,429 +$ +25,138 +Foreign +145,278 +44,197 +1,151 +Total +$ +240,326 +$ +96,626 +$ +26,289 +Reconciliations +of the statutory federal income tax rate to the Company's actual rates based on income or loss before income tax are summarized as follows: +December 31, +2007 +2006 +2005 +Consolidated pre tax book income +35.0 +% +35.0 +% +35.0 +% +Permanent items +0.3 +— +— +State taxes +0.8 +1.1 +2.8 +Deferred tax benefit from conversion to C Corporation +— +— +(3.0 +) +Foreign rate differential +(6.7 +) +(2.8 +) +(0.3 +) +Permanent portion of equity compensation +0.7 +— +— +Other +(0.1 +) +— +0.9 +30.0 +% +33.3 +% +35.4 +% +F-23 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES (Continued) +The +Company's deferred income tax assets and liabilities are as follows (in thousands): +December 31, +2007 +2006 +Current deferred tax assets: +Accrued expenses +$ +2,733 +$ +1,487 +Inventory +9,087 +2,206 +Total current deferred tax assets +$ +11,820 +$ +3,693 +Long-term deferred tax assets: +Accrued expenses +$ +158 +$ +— +Stock compensation expense +2,439 +2,643 +Inventory +496 +— +Long term accrued expenses +506 +— +Net operating loss carryovers +1,349 +— +Other +6,436 +311 +Total non-current deferred tax assets +$ +11,384 +$ +2,954 +Long-term deferred tax liabilities: +Property and equipment +$ +3,932 +$ +2,343 +Intangible assets +1,088 +995 +Other +116 +27 +Total non-current deferred tax liabilities +$ +5,136 +$ +3,365 +On +January 3, 2005, the Company converted from a limited liability company to a C corporation. For tax years beginning and subsequent to January 1, 2005, the Company +is subject to corporate-level U.S. federal and state income taxes. The Company recognized an income tax benefit of $797,000 in 2005 related to the net deferred tax assets of the partnership +existing as of December 31, 2004. +At +December 31, 2007, U.S. income taxes have not been provided on approximately $143.8 milion of unremitted earnings of subsidiaries operating outside of the U.S. These earnings, +which are considered to be indefinitely reinvested, would become subject to U.S. income tax if they were remitted to the U.S. The amount of unrecognized deferred U.S. income tax liability on the +unmerited earnings has not been determined because the hypothetical calculation is not practicable. +The +Company adopted the provisions of FIN 48 effective January 1, 2007. The adoption of FIN 48 did not have a material impact on the Company's consolidated balance +sheet, statement of operations or cash flows. FIN 48 requires the use of a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return +and disclosures regarding uncertainties in income tax positions. Only positions that meet the more likely than not threshold are recognized for financial reporting purposes. As required by +FIN 48, the Company has classified the amounts recorded for uncertain tax positions in the consolidated balance sheet as a long term liability to the extent that +F-24 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +13. INCOME TAXES (Continued) +payment +or settlement is not anticipated within one year. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows: +(in thousands) +Balance at January 1, 2007 +$ +— +Additions based on tax positions for the current year +6,877 +Additions for tax positions of prior years +4,838 +Reductions for tax positions of prior years +— +Settlements +— +Balance at December 31, 2007 +$ +11,715 +The +unrecognized tax benefits of $11.7 million at December 31, 2007, if recognized, would reduce the Company's annual effective tax rate. +Interest +and penalties related to income tax liabilities are included in income tax expense. During 2007, the Company recorded approximately $500,000 of penalties and interest in income +tax expense which resulted in a cumulative accrued balance of penalties and interest of $500,000. +The +Company's unrecognized benefits consist primarily of tax positions related to intercompany transfer pricing in multiple jurisdictions. The Company is currently negotiating with tax +authorities to obtain rulings regarding its transfer pricing policies. The conclusion of these negotiations could result in an increase or decrease in the amount of unrecognized tax benefits during +the next twelve months. The Company estimates the possible change to be immaterial or $0. +As +of December 31, 2007, the following tax years remain subject to examination for the major jurisdictions where the Company conducts business: +United States +2005 to 2007 +Canada +2003 to 2007 +Netherlands +2005 to 2007 +Singapore +2004 to 2007 +State +income tax returns are generally subject to examination for a period of 3 to 5 years after filing of the respective return. The state impact of any federal changes remains +subject to examination by various state jurisdictions for a period up to 2 years after formal notification to the states. +14. COMMITMENTS AND CONTINGENCIES +The Company leases space for certain of its offices, warehouses, vehicles and equipment under leases expiring at various dates through 2026. Certain leases also +contain rent escalation clauses (step rents) that require additional rental amounts in the later years of the term. Rent expense for leases with step +rents is recognized on a straight-line basis over the minimum lease term. These items are factored into the minimum lease payment and recognized on a straight-line basis over +the minimum lease term. Deferred rent is included in the balance sheet in accrued expenses. Rent expense was $26.0 million, $8.3 million, and $1.9 million for the years ended +December 31, 2007, 2006, and 2005, respectively. +F-25 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. COMMITMENTS AND CONTINGENCIES (Continued) +Minimum +future annual rental commitments under non-cancelable operating leases for each of the five succeeding years as of December 31, 2007, are as follows (in +thousands): +Fiscal years ending December 31, +2008 +$ +19,025 +2009 +15,677 +2010 +11,395 +2011 +9,193 +2012 +7,040 +Thereafter +8,293 +Total +$ +70,623 +On +July 26, 2005, the Company entered into an amended and restated four year supply agreement with Finproject S.P.A., the former majority owner of Crocs Canada, where the Company +has the exclusive right to purchase the material for the manufacture of finished shoe products, except for certain current customer dealings (including boot manufacturers). Based on the supply +agreement, the Company has +contractual purchase requirements to maintain exclusivity throughout the agreement. The pricing is to be agreed on each quarter and fluctuates based on order volume, currency fluctuations, and raw +material prices. +The +Company indemnifies certain of its vendors and its directors and executive officers for specified claims. To date, the Company has not paid or been required to defend any +indemnification claims, and accordingly, has not accrued any amounts for its indemnification obligations. +The +Company guarantees the payment of one of its third-party manufacturer in China for purchases of material for the manufacture of finished shoe products. The maximum potential amount +of future payments the Company could be required to make under the guarantee is €2.1 million (approximately $3.1 million). The Company evaluates the estimated loss for +the guarantee under SFAS No. 5, Accounting for Contingencies ("SFAS 5"), as interpreted by FIN No. 45, Guarantor's Accounting and Disclosure Requirements for +Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45"). The +Company considers such factors as the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. The Company has recourse as a matter of +common law. To date, the Company has not made any payments under the guarantee and as of December 31, 2007, has not recorded a liability related to the guarantee in its financial statements as +the Company does not believe the potential obligation under this guarantee is material. +15. CAPITALIZED LEASE OBLIGATIONS +The Company had capitalized lease obligations due on various dates through 2009 of $116,000 as of December 31, 2007. The interest rates range from 4.25% to +8.97% per annum. These lease +F-26 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. CAPITALIZED LEASE OBLIGATIONS (Continued) +obligations +are collateralized by the related assets with a net book value of $659,000 as of December 31, 2007. +December 31, +2007 +2006 +Capital lease obligations for equipment due on various dates through 2009 with interest rates ranging from 4.25% to 8.97% per annum +116 +218 +Capital lease obligations for capitalized software due on December 1, 2007 with an effective interest rate of 6.75% per annum +— +317 +— +535 +Less current portion +107 +419 +Total long-term debt +9 +116 +Maturities +of capital lease obligations as of December 31, 2007, are as follows (in thousands): +2008 +$ +110 +2009 +9 +Total minimum lease payments +$ +119 +Less—amount related to interest +3 +Principal portion of future obligations +116 +Less—current portion +107 +$ +9 +The +following table summarizes the assets recorded in intangible assets (Note 4) and property and equipment (Note 9) that are recorded as capital leases (in thousands): +December 31, +Classes of property +2007 +2006 +Capitalized software +$ +642 +$ +642 +Equipment +322 +322 +Less accumulated amortization/depreciation +(305 +) +(149 +) +$ +659 +$ +815 +16. RELATED PARTIES +The Company entered into the following related party transactions (in thousands): +December 31, +2007 +2006 +2005 +Flextronics: +Rent Expense +$ +111 +$ +159 +$ +91 +Crocs Hawaii (owned by a former director): +Sales +— +— +250 +F-27 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. RELATED PARTIES (Continued) +In +May 2005, the Company subleased an office building from Flextronics USA, Inc. Two of our directors, Messrs. Marks and Sharp, served as directors of Flextronics +and Mr. Smach serves as Flextronics' Chief Financial Officer. The Company paid Flextronics $111,000, $159,000 and $91,000 for lease payments for the years ended December 31, 2007, 2006 +and 2005, respectively. This lease expired on March 31, 2007 and was not renewed. +The +Company executed a separation agreement with its former Chief Executive Officer and Director on January 1, 2005. The terms of the arrangement were agreed to by the Company and +the former Chief Executive Officer as of December 31, 2004, consequently, the Company has recorded the present value of the severance and health insurance continuation in the 2004 financial +statements. The total amount recorded was $606,000, which has been reflected in selling, general and administrative expenses. The amount recorded has been discounted over the future payment terms at +6%. The corresponding liability is recorded in other current and non-current liabilities, for amounts due in 2007 and beyond, and accrued expenses and other liabilities for amounts due in +2006. +In +connection with the separation agreement discussed above, the Company and former Chief Executive Officer entered into an exclusive distribution agreement that commenced July 1, +2005. The distribution agreement is for specified territories in Central America and has an initial term of two years. The agreement provides for renewal periods at the former Chief Executive +Officer's option, if specified sales volumes are attained. Pricing under this agreement is set at a discount off the Company's then current wholesale pricing. Additionally, effective July 1, +2005, the Company and the former Chief Executive Officer entered into an agreement providing him the right to license and/or +franchise airport kiosks selling the Company's products for a period of 10 years, subject to the Company's right to terminate the agreement if specified numbers of kiosks are not opened in +timeframes specified. +17. OPERATING SEGMENTS AND RELATED INFORMATION +The Company operates in the consumer products industry in which the Company designs, manufactures, markets and distributes footwear, apparel and accessories. +Operating results are assessed on an aggregate basis to make decisions about necessary resources and in assessing performance. Consequently, under the provisions of SFAS No. 131, Disclosure About Segments of an Enterprise +and Related Information ("SFAS 131"), and based on the nature of the financial information that is +received by the chief executive officer as chief operating decision maker, the Company has one reportable segment for financial statement purposes. +The +Company's sales by product line are as follows (in thousands): +December 31, +2007 +2006 +2005 +Footwear +$ +763,303 +$ +342,437 +$ +102,490 +Other +84,047 +12,291 +6,091 +$ +847,350 +$ +354,728 +$ +108,581 +F-28 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +17. OPERATING SEGMENTS AND RELATED INFORMATION (Continued) +Geographic +information about the U.S. and international territories is presented below, the Company has allocated revenues to the geographic locations based on the location of the +customer (in thousands): +December 31, +Revenue +2007 +2006 +2005 +United States +$ +439,586 +$ +242,227 +$ +100,475 +Canada +41,113 +21,779 +2,214 +Mexico +6,995 +1,499 +79 +North America Total +487,694 +265,505 +102,768 +Asia-Pacific +163,046 +54,382 +4,671 +Europe +173,671 +30,286 +1,042 +All other +22,939 +4,555 +100 +$ +847,350 +$ +354,728 +$ +108,581 +Total for countries outside the United States +$ +407,764 +$ +112,501 +$ +8,106 +December 31, +Long-lived assets +2007 +2006 +United States +$ +47,144 +$ +36,146 +Canada +14,111 +13,636 +Mexico +2,988 +1,204 +North America Total +64,243 +50,986 +Asia-Pacific +7,793 +3,132 +Europe +12,379 +4,494 +Other +3,769 +— +$ +88,184 +$ +58,612 +Total for countries outside the United States +$ +41,040 +$ +22,466 +There +were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2007 and 2006. Revenues from one customer totaled approximately +12% of consolidated revenues during the year ended December 31, 2005. +18. LEGAL PROCEEDINGS +On March 31, 2006, Crocs filed a complaint with the ITC against Acme Ex-Im, Inc., Australia Unlimited, Inc., Cheng's +Enterprises, Inc., Collective Licensing International, LLC, D. Myers & Sons, Inc., Double Diamond Distribution, Ltd., Effervescent, Inc., Gen-X +Sports, Inc., Holey Soles, Inter-Pacific Trading Corporation, and Shaka Holdings, Inc., alleging patent and trade dress infringement and seeking an exclusion order banning the +importation and sale of infringing products. The utility and design patents asserted in the complaint were issued to Crocs on February 7, 2006 and March 28, 2006 respectively, by the +United States Patent and Trademark Office. The ITC has issued final determinations terminating Shaka Holdings, Inc., Inter-Pacific Trading Corporation, Acme Ex-Im, Inc., D. +Myers & Sons, and Australia Unlimited, Inc. from the ITC investigation No. 337-TA-567 +F-29 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +18. LEGAL PROCEEDINGS (Continued) +on +the basis of settlement and Cheng's Enterprises, Inc. on the suspension of accused activities. A trial was held before the ALJ from September 2007. After post-trial briefing was +completed, the ALJ has set a target date of April 11, 2008 for completion of the Investigation. The Company does not expect that the ultimate resolution of this matter to have a material +adverse impact on its business. +On +April 3, 2006, Crocs filed a complaint in the U.S. District Court for the District of Colorado alleging patent and trade dress infringement and seeking injunctive relief +against Acme EX-IM, Inc., Australia Unlimited, Inc., Cheng's Enterprises, Inc., Collective Licensing International, LLC, D. Myers & Sons, Inc., +Double Diamond Distribution, Ltd., Effervescent, Inc., Gen-X Sports, Inc., Holey Soles, Inter-Pacific Trading Corporation, Shaka Holdings, Inc., and Does +1-10. The utility and design patents asserted in the complaint were issued to Crocs on February 7, 2006 and March 28, 2006 respectively, by the United States Patent and +Trademark Office. This case has been administratively stayed pending resolution of the ITC proceeding above. Consent judgments have been entered against Shaka Holdings, Inc., Interpacific +Trading Corporation and Acme Ex-Im, Inc. Crocs has entered into a settlement agreement with Australia Unlimited, Inc., and on January 25, 2007, we filed a stipulation +for dismissal of all claims and counterclaims. Crocs has entered into settlement agreements with D. Myers & Sons, Inc. pursuant to which the U.S. District Court entered a consent +judgment against D. Myers & Sons, Inc on May 23, 2007. The Company does not expect the ultimate resolution of this matter will have a material adverse impact on its business. +Starting +in November 2007, certain shareholders filed several purported shareholder class actions in the US District Court for the District of Colorado alleging violation of +Sections 10(b) and 20(a) of the +Exchange Act based on alleged statements made between July 27, 2007 and October 31, 2007. Plaintiffs seek compensatory damages on behalf of the alleged class in an unspecified amount, +interest, and an award of attorney's fees and costs of litigation. These actions were subsequently consolidated. The Court is currently considering motions for the appointment of lead plaintiff and +lead counsel. After the Court appoints lead plaintiff and lead counsel, an amended consolidated complaint will be filed. Thereafter, Crocs will respond. Crocs believes that the lawsuit lacks merit and +intends to vigorously defend itself. +In +January 2008 plaintiffs served the Company with a shareholder derivative action in the Colorado District Court for the City and County of Boulder alleging that certain officers and +directors breached their fiduciary duties, wasted corporate assets, and were unjustly enriched. This derivative action purports to state a claim on behalf of the corporation. The complaint alleges +that the claims arise from the same conduct as was alleged in the original federal shareholder class action. Crocs is in the process of responding. Crocs believes that the plaintiff lacks standing and +intends to vigorously defend the suit. +Although +the Company is subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, the +Company is not party to any other pending legal proceedings the Company believes will have a material adverse impact on its business. +As +of December 31, 2007, the Company has not accrued any amounts related to estimated losses for legal contingencies. While there is a reasonable possibility that certain legal +matters may result in an unfavorable outcome and loss, the Company's estimated potential losses, or range of losses, when aggregated, would be immaterial to the financial statements. +F-30 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +19. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +Quarter Ended +March 31 +Quarter Ended +June 30 +Quarter Ended +September 30 +Quarter Ended +December 31 +Year Ended December 31, 2007 +Revenues +$ +142,002 +$ +224,273 +$ +256,275 +$ +224,800 +Gross profit +84,485 +131,944 +155,392 +125,828 +Income from operations +37,158 +68,472 +78,236 +53,901 +Net income +24,945 +48,451 +56,548 +38,284 +Net income attributable to common stockholders +24,945 +48,451 +56,548 +38,284 +Basic income per common share +$ +0.32 +$ +0.60 +$ +0.69 +$ +0.47 +Diluted income per common share +$ +0.31 +$ +0.58 +$ +0.66 +$ +0.45 +Year Ended December 31, 2006 +Revenues +$ +44,844 +$ +85,635 +$ +111,345 +$ +112,904 +Gross profit +23,681 +46,970 +64,824 +65,095 +Income from operations +9,992 +23,658 +31,480 +30,216 +Net income +6,440 +15,666 +21,526 +20,785 +Net income attributable to common stockholders +6,407 +15,666 +21,526 +20,785 +Basic income per common share +$ +0.10 +$ +0.21 +$ +0.28 +$ +0.27 +Diluted income per common share +$ +0.09 +$ +0.20 +$ +0.27 +$ +0.26 +20. SUBSEQUENT EVENTS +On January 4, 2008 the Company entered into a second amendment of the Revolving Credit Facility increasing the borrowing amount to $50.0 million and +reduces the available amount for the issuance of letters of credit to $4.5 million. Under the amended Revolving Credit Facility, the Company must satisfy specified financial covenants, such as +a minimum level of consolidated EBITDA and a minimum adjusted quick ratio. +In +January and February 2008, the Company received additional proceeds of $38.7 million and made payments of $2.0 million under the Revolving Credit Facility. +F-31 \ No newline at end of file diff --git a/raw/filings/0001334036/2007/0001047469-08-002093/filing_metadata.csv b/raw/filings/0001334036/2007/0001047469-08-002093/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..597b14306374bec801bd2f58790bf42c1cdd1c59 --- /dev/null +++ b/raw/filings/0001334036/2007/0001047469-08-002093/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2008-02-29,2007-12-31,2008-02-29T21:55:06.000Z,0001047469-08-002093,a2183219z10-k.htm,FORM 10-K,1075577,0,0,https://www.sec.gov/Archives/edgar/data/1334036/000104746908002093/a2183219z10-k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000104746908002093/,2007,2007,1 diff --git a/raw/filings/0001334036/2007/0001047469-08-002093/item1.txt b/raw/filings/0001334036/2007/0001047469-08-002093/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..b5aec00506aaddf8278e3c16f0e111fe20e198b8 --- /dev/null +++ b/raw/filings/0001334036/2007/0001047469-08-002093/item1.txt @@ -0,0 +1,2 @@ +Item 1. +Business \ No newline at end of file diff --git a/raw/filings/0001334036/2007/0001047469-08-002093/item13.txt b/raw/filings/0001334036/2007/0001047469-08-002093/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..ad239fae0c1579ed2ba2c0b8e3f4176fd349f81c --- /dev/null +++ b/raw/filings/0001334036/2007/0001047469-08-002093/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. Certain Relationships and Related Transactions, and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2008 Annual Meeting of Stockholders to be +filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2007. \ No newline at end of file diff --git a/raw/filings/0001334036/2007/0001047469-08-002093/item9a.txt b/raw/filings/0001334036/2007/0001047469-08-002093/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..18b3ac6778ab60293be064ce9c481cbdf1945e42 --- /dev/null +++ b/raw/filings/0001334036/2007/0001047469-08-002093/item9a.txt @@ -0,0 +1,64 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our chief executive officer and chief financial officer, we conducted an +evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange +Act, as of the end of the period covered by this annual report (the "Evaluation Date"). Based on this evaluation, our chief executive officer and chief financial officer concluded that as of the +Evaluation Date, our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be disclosed in our Securities and +Exchange Commission ("SEC") reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated +to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. +Management's Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate control over financial reporting, pursuant to the Exchange Act +Rules 13a-15(f) and 15d-15(f). Because of the inherent limitations, internal control over financial reporting may not prevent or detect +misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate due to changes in conditions, or that the degree of +compliance with the policies or procedures may deteriorate. Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2007, using the +criteria set forth in the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway +Commission (COSO). Based on this assessment, management has concluded that our internal control over financial reporting is effective as of December 31, 2007. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting, which is +included herein. +Changes in Internal Control Over Financial Reporting +During the three months ended December 31, 2007, we made changes to our internal control over financial reporting that have materially affected, or are +reasonably likely to materially affect, our internal control over financial reporting. Certain processes and controls were changed to accommodate the needs and requirements of our growth and our +financial reporting system. +45 +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2007, based on criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's +management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the +accompanying "Management Report on Internal Control Over +Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control +over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or +persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting +and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those +policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material +misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to +future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In +our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year +ended December 31, 2007 of the Company and our report dated February 29, 2008 expressed an unqualified opinion on those financial statements and included an explanatory paragraph +regarding the Company's adoption on January 1, 2007 of the Financial Accounting Standards Board's Interpretation No. 48, Accounting for Uncertainty in Income +Taxes , and the adoption on January 1, 2006 of Statement of Financial Accounting Standard No. 123(R), Share-Based +Payments . +/s/ DELOITTE & TOUCHE LLP +Denver, Colorado +February 29, 2008 +46 \ No newline at end of file diff --git a/raw/filings/0001334036/2007/0001047469-08-002093/rp_note.txt b/raw/filings/0001334036/2007/0001047469-08-002093/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..ff04c09965c8e55989f6c34819a80d699bfe4a9b --- /dev/null +++ b/raw/filings/0001334036/2007/0001047469-08-002093/rp_note.txt @@ -0,0 +1,40 @@ +16. RELATED PARTIES +The Company entered into the following related party transactions (in thousands): +December 31, +2007 +2006 +2005 +Flextronics: +Rent Expense +$ +111 +$ +159 +$ +91 +Crocs Hawaii (owned by a former director): +Sales +— +— +250 +F-27 +CROCS, INC. +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. RELATED PARTIES (Continued) +In +May 2005, the Company subleased an office building from Flextronics USA, Inc. Two of our directors, Messrs. Marks and Sharp, served as directors of Flextronics +and Mr. Smach serves as Flextronics' Chief Financial Officer. The Company paid Flextronics $111,000, $159,000 and $91,000 for lease payments for the years ended December 31, 2007, 2006 +and 2005, respectively. This lease expired on March 31, 2007 and was not renewed. +The +Company executed a separation agreement with its former Chief Executive Officer and Director on January 1, 2005. The terms of the arrangement were agreed to by the Company and +the former Chief Executive Officer as of December 31, 2004, consequently, the Company has recorded the present value of the severance and health insurance continuation in the 2004 financial +statements. The total amount recorded was $606,000, which has been reflected in selling, general and administrative expenses. The amount recorded has been discounted over the future payment terms at +6%. The corresponding liability is recorded in other current and non-current liabilities, for amounts due in 2007 and beyond, and accrued expenses and other liabilities for amounts due in +2006. +In +connection with the separation agreement discussed above, the Company and former Chief Executive Officer entered into an exclusive distribution agreement that commenced July 1, +2005. The distribution agreement is for specified territories in Central America and has an initial term of two years. The agreement provides for renewal periods at the former Chief Executive +Officer's option, if specified sales volumes are attained. Pricing under this agreement is set at a discount off the Company's then current wholesale pricing. Additionally, effective July 1, +2005, the Company and the former Chief Executive Officer entered into an agreement providing him the right to license and/or +franchise airport kiosks selling the Company's products for a period of 10 years, subject to the Company's right to terminate the agreement if specified numbers of kiosks are not opened in +timeframes specified. \ No newline at end of file diff --git a/raw/filings/0001334036/2007/0001047469-08-002093/rpt_disclosure.txt b/raw/filings/0001334036/2007/0001047469-08-002093/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..d45da885b8638fffb835219ff05f160cb061e757 --- /dev/null +++ b/raw/filings/0001334036/2007/0001047469-08-002093/rpt_disclosure.txt @@ -0,0 +1,22 @@ +CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS +Related Party Transactions +In 2008, we sponsored Germain Racing Truck #9 in the NASCAR Craftsman Truck Series. Justin Marks is employed by Germain Racing as the driver of Truck #9. Justin +Marks is the son of our director, Michael Marks. The total amount of our sponsorship commitment to Germain Racing for 2008 is $600,000. We believe that a related person, Justin Marks, has a material +interest in the sponsorship by virtue of his employment with Germain Racing as the driver of Truck #9. The sponsorship is part of our larger auto racing sponsorship and sports marketing efforts and +was negotiated at an arms-length basis with terms similar to those of our other auto racing sponsorships. +Policy on Transactions with Related Persons +Our Business Code of Conduct and Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive officers, or +greater than five percent stockholders, or their immediate family members, have a material interest be approved or ratified by the Audit Committee if the amount involved exceeds $100,000. The full +Board reviews ordinary course of business transactions in which directors have an interest as part of the Board's annual director independence review, and our Business Code of Conduct and Ethics +requires the full board to waive any conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, +in addition to other factors it deems appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. +All +transactions disclosed above were reviewed and approved in accordance with this policy. +Director and Officer Indemnification +We have entered into agreements to indemnify our directors and executive officers, in addition to the indemnification provided for in our certificate of +incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain +23 +expenses +(including attorneys' fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by or in the right of the Company, arising +out of such person's services as a director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We believe +that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. \ No newline at end of file diff --git a/raw/filings/0001334036/2010/0001047469-11-001395/filing.txt b/raw/filings/0001334036/2010/0001047469-11-001395/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..bb30f0b154a9d5379e2f2bb945679df944a7698e --- /dev/null +++ b/raw/filings/0001334036/2010/0001047469-11-001395/filing.txt @@ -0,0 +1,5898 @@ +10-K +1 +a2202205z10-k.htm +10-K +Use these links to rapidly review the document +Table of Contents +INDEX TO FINANCIAL STATEMENTS +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +ý +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2010 +or +o +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission File No. 0-51754 +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware +(State or other jurisdiction of +incorporation or organization) +20-2164234 +(I.R.S. Employer +Identification No.) +6328 Monarch Park Place +Niwot, Colorado 80503 +(303) 848-7000 +(Address, including zip code and telephone number, including area code, of registrant's principal executive offices) +Securities +registered pursuant to Section 12(b) of the Act: +Title of each class: +Name of each exchange on which registered: +Common Stock, par value $0.001 per share +The NASDAQ Global Select Market +Securities +registered pursuant to Section 12(g) of the Act: None +Indicate +by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes o No ý +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the +Act. Yes o No ý +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 ý No o +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be +submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the +registrant was required to submit and post such files). Yes o No o +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained +herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the +Form 10-K or any amendment to the Form 10-K. ý +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting +company. See the definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer ý +Accelerated filer o +Non-accelerated filer o +(do not check if a +smaller reporting company) +Smaller reporting company o +Indicate +by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the +Act). Yes o No ý +The aggregate market value of the voting common stock held by non-affiliates of the registrant as of June 30, 2010 was $915.0 million. +For the purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 5% of the registrant's common stock are assumed to be affiliates of +the registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The +number of shares of the registrant's common stock outstanding as of January 31, 2011 was 88,690,768. +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by reference from the registrant's proxy statement for the 2011 annual meeting of stockholders to be filed no +later than 120 days after the end of the registrant's fiscal year ended December 31, 2010. +Table of Contents +Crocs, Inc. +2010 Annual Report on Form 10-K +Table of Contents +PART I +Item 1. +Business +1 +Item 1A. +Risk Factors +9 +Item 1B. +Unresolved Staff Comments +18 +Item 2. +Properties +18 +Item 3. +Legal Proceedings +19 +Item 4. +Reserved +20 +PART II +Item 5. +Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +21 +Item 6. +Selected Financial Data +23 +Item 7. +Management's Discussion and Analysis of Financial Condition and Results of Operations +24 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +44 +Item 8. +Financial Statements and Supplementary Data +45 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +45 +Item 9A. +Controls and Procedures +45 +Item 9B. +Other Information +47 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +47 +Item 11. +Executive Compensation +47 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +47 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +47 +Item 14. +Principal Accountant Fees and Services +47 +PART IV +Item 15. +Exhibits and Financial Statement Schedules +48 +Signatures +51 +Table of Contents +PART I +ITEM 1. BUSINESS +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the "Company," "we," "our" or "us") is a designer, manufacturer, +distributor, worldwide marketer and brand manager of footwear and accessories for men, women and children. We strive to be the global leader in molded footwear design and development which feature +fun, comfort and functionality. Our products include footwear and accessories that utilize our proprietary closed cell-resin, called Croslite. The use of this unique material allows us to +produce innovative, lightweight, non-marking and odor-resistant footwear. Certain shoes made with the Croslite material have been certified by U.S. Ergonomics to reduce peak +pressure on the foot, reduce muscular fatigue while standing and walking and to relieve the musculoskeletal system. We currently sell our products in more than 90 countries through domestic and +international retailers and distributors, and directly to end-user consumers through our company-operated retail stores, outlets, kiosks and webstores. +We +were organized in 1999 as a limited liability company. Shortly after completing our first footwear design produced by Foam Creations, Inc. (now known as Crocs +Canada Inc., "Crocs Canada,") and Finproject N.A., Inc. in 2002, we launched the marketing and distribution footwear products under the Crocs brand in the United States. The unique +characteristics of Croslite, which was developed by Crocs Canada, enabled us to offer consumers a shoe unlike any other footwear model then available. In 2004, we acquired Crocs Canada, including its +manufacturing operations, product lines, and rights to the trade secrets for the Croslite material. In January 2005, we converted to a Colorado corporation and subsequently re-incorporated +as a Delaware corporation in June 2005. In February 2006, we completed our initial public offering and trading of our common stock on NASDAQ commenced. Our business has grown both organically and +through acquisitions which have enabled us to expand the Croslite product-line as well as to include a variety of new products and styles. We aim to continue to expand our +product-line and bring a unique and original perspective to the consumer in styles that may be unexpected from Crocs. +We +are advocates of our global community and environment. We introduced a shoe donation program currently operating under our "Crocs Cares" program. We have donated millions of Crocs +shoes to those in need in both the local and global communities we serve. In addition to the donation program, Crocs Cares aims to establish a comprehensive program focused on internal team building +and community awareness by providing Crocs employees the opportunity to volunteer in their community. Also, our wholly-owned subsidiary Ocean Minded takes an active role in protecting the oceans, +rivers and beaches through beach clean-ups, support of the Surfrider Foundation and through various other charitable efforts. +Products +While the majority of our products consist of footwear, we also offer accessories which generated approximately 4.0% of our total +revenues during the year ended December 31, 2010, and to a much smaller extent, apparel which generated approximately 0.1%. Our footwear products are divided into four product offerings: Core, +Active, Casual and Style. The Core product offering primarily includes molded products that are derivatives of the original Crocs Classic designs and is targeted toward a wide range of consumers. The +Active product offering is comprised of footwear intended for healthy living and includes sport-inspired products and footwear suited for activities such as boating, walking, hiking and even recovery +after workouts. The Casual product offering includes sporty and relaxed styles appealing to a broad range of customers. The Style product offering includes stylish products which are intended to +broaden the wearing occasion for Crocs lovers. +1 +Table of Contents +In +2010, we extended licensing agreements with Disney, Nickelodeon, Marvel, Dreamworks, HIT Entertainment, Mario Batali, and The Collegiate Licensing Company among others, for Crocs +branded footwear and/or Jibbitz shoe charms (discussed below). In addition, we entered into new licensing agreements with LEGO and Mattel (Barbie) in 2010. We also offer a line of footwear and Jibbitz +charms featuring such popular characters as Mickey and Minnie Mouse, Ariel, Sponge Bob Square Pants, Dora the Explorer, Scooby-Doo and Hello Kitty, as well as characters from motion +pictures including Toy Story and Cars. In addition, we are exploring opportunities to license out the Crocs brand name as part of a strategy to extend Crocs into new product types including +accessories and children's apparel. +Footwear +Our footwear product offering has grown significantly since we first introduced the Crocs single style clog in six colors, in 2002. We +currently offer a wide product line of footwear, some of which include boots, sandals, sneakers, mules and flats which are made of materials like leather and textile fabrics as well as Croslite. In +addition to the Crocs brand, some of our market specific product lines include the following. +• Crocs Work is a product offering targeted at the hospital, restaurant, hotel and hospitality markets and includes both +molded and leather footwear styles of which various have been industry certified for slip-resistance and electro-static discharge. The Crocs Work products have an established distribution +channel with a leading uniform supply company thus providing us marketing access to large hospitality chains, laboratories and clean-rooms. In 2010, the Bistro style received the 2010 Gold Medal Seal +from Chef's of America. Also in 2010 the Bistro, Specialist, Specialist Vent, Juniper and Lavender styles were certified by the American Podiatric Medical Association ("APMA"). +• Crocs Rx is a medical-needs product offering targeted at the general foot care and diabetic-needs markets. In 2009 and +2010, Crocs Rx out-sold its competitors in terms of unit volume in the U.S. with a distribution to approximately 1,780 podiatry offices and medical shoe stores. In 2009, we expanded our +Crocs Rx sales in Europe, Asia and India with low-cost, lightweight footwear appropriate for people with diabetes. Each of the Crocs Rx styles has been certified by the APMA. In addition, +we were the first shoe company to receive the APMA's "2008 Company of the Year" award for "greatest impact on the field of podiatry." +• Ocean Minded is a product offering featuring high quality leather and EVA (Ethylene Vinyl Acetate) footwear, sandals and +printed apparel primarily for the beach, action and adventure markets. +• YOU by Crocs is a women's fashion line that combines comfort with fashionable styles. +A +key differentiating feature of our footwear products is the Croslite material, which is uniquely suited for comfort and functionality. We have carefully formulated the Croslite +material to be of a density that creates extremely lightweight, comfortable and non-marking footwear which conforms to the shape of the foot, often reducing pressure points on the foot to +increase comfort. Croslite is a closed cell resin material which is water resistant, virtually odor free, and allows many of our footwear styles to be cleaned simply with water. As we have expanded +our product offering, we have incorporated traditional materials such as textile fabric and leather into many new styles. However, we continue to utilize the Croslite material for the foot bed, sole +and other key structural components for the majority of these styles. +Footwear +sales made up 95.5%, 94.6%, and 91.6% of total revenues for the years ended December 31, 2010, 2009, and 2008, respectively. During the years ended December 31, +2010, 2009 and 2008, approximately 75.5%, 77.5% and 77.9% of unit sales consisted of products geared towards adults, +2 +Table of Contents +respectively, +compared to 24.5%, 22.5% and 22.1% of unit sales of products geared towards children, respectively. Sales of our Crocs Classic models accounted for 9.9%, 15.8%, and 24.8% of total unit +sales for the years ended December 31, 2010, 2009 and 2008, respectively. We believe that the declining percentage of our original styles is reflective of our continued efforts to diversify our +product-line and reduce reliance on original styles. +Accessories +In addition to our footwear brands, we own the Jibbitz brand, a unique accessory product-line with colorful +snap-on charms specifically suited for Crocs shoes. We acquired Jibbitz, LLC ("Jibbitz") in December 2006 and have expanded the product-line to include a wide variety of +charms in varying shapes and sizes, with designs such as flowers, sports gear, seasonal and holiday designs, animals, symbols, letters and rhinestones. Crocs licensing agreements also extend to +Jibbitz, which allows Jibbitz to create designs bearing logos and emblems of Disney, Nickelodeon and the Crocs collegiate line, among others. Jibbitz designs allow Crocs consumers to personalize their +footwear to creatively express their individuality. As of December 31, 2010, approximately 700 unique Jibbitz charm designs were available to consumers for personalizing their Crocs footwear. +Sales from Jibbitz designs made up 3.5%, 3.9%, and 6.5% of total revenues for the years ended December 31, 2010, 2009, and 2008, respectively. +Sales and Marketing +While the broad appeal of our footwear has allowed us to market our products in a wide range of distribution channels, including +department stores, traditional footwear retailers and a variety of specialty and independent retail channels, our marketing approach has become significantly target defined. Our marketing efforts +center on specific product launches and employ a fully integrated approach utilizing a variety of media outlets, including print, the internet and television. We have three primary sales channels: +wholesale, retail and internet. Our marketing efforts drive business to both our wholesale partners and our company-operated retail and internet stores, ensuring that our presentation and story are +first class and drive purchasing at the point of sale. +Wholesale Channel +During the years ended December 31, 2010, 2009 and 2008, approximately 61.0%, 62.6% and 76.5% of net revenues, respectively, +were derived from sales through the wholesale channel which consists of sales to distributors and third-party retailers. Wholesale customers include national and regional retail chains, department +stores, sporting goods stores and family footwear retailers, such as Nordstrom, Journeys, Dillard's, Dick's Sporting Goods, The Sports Authority, The Forzani Group, Famous Footwear, DSW and Xebio, as +well as on-line retailers such as Zappos, Amazon and Shoebuy.com. No single customer accounted for 10% or more of revenues for the year ended December 31, 2010, 2009 or 2008. +We +use third-party distributors in select markets where we believe such arrangements are preferable to direct sales. These third-party distributors purchase products pursuant to a price +list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to four years, are +generally terminable on 30 days prior notice and have minimum sales requirements. At our discretion, we may accept returns from wholesale customers for defective products, quality issues, and +shipment errors on an exception basis or, for certain wholesale customers, extend pricing discounts in lieu of defective product returns. Also at our discretion, we may accept returns from our +wholesale customers, on an exception basis, for the purpose of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, we may provide +markdown allowances to key wholesale customers to facilitate in-channel product markdowns where sell-through is less than anticipated. +3 +Table of Contents +Consumer-Direct Channels +Consumer-direct sales channels include retail and internet channels and serve as an important and effective means to enhance our +product and brand awareness as they provide direct access to our consumers and an opportunity to showcase our entire line of footwear and accessory offerings. We view the consumer-direct channels to +be complementary to our wholesale channel. +Retail Channel +During the years ended December 31, 2010, 2009 and 2008, approximately 29.5%, 28.0%, and 17.4%, of our net revenues were derived +from sales through our retail channel, which consists of company-operated kiosks, retail and outlet stores. +Kiosks As of December 31, 2010 and 2009, we operated 164 and 170 global retail kiosks, respectively, located in malls and other +high foot traffic +areas. Due to their efficient use of retail space and limited initial capital investment, kiosks are an effective outlet for marketing our products. +Retail Stores As of December 31, 2010 and 2009, we operated 138 and 84 global retail stores, respectively, in a variety of +locations, including: Maui, +Hawaii; Yokohama City, Japan; and Hong Kong, China. Company-operated retail stores allow us to effectively market the full breadth and depth of our new and existing products and interact with +customers in order to enhance brand awareness. +Outlet Stores As of December 31, 2010 and 2009, we operated 76 and 63 global outlet stores, respectively in a variety of +locations, including: Orlando, +Florida; Nasushiobara, Japan; and Metzingen, Germany. Outlet stores help us move older products in an orderly fashion. We also sell full priced products in our outlet stores. +Internet Channel +As of December 31, 2010 and 2009, we offered our products through 46 and 23 company-operated webstores, respectively worldwide. +During the years ended December 31, 2010, 2009 and 2008, approximately 9.5%, 9.4%, and 6.1% respectively, of our net revenues were derived from sales through our internet channel. Our internet +presence enables us to educate consumers about our products and brand. We continue to expand our web-based marketing efforts to increase consumer awareness of our full product range. +Business Segments and Geographic Information +We have three reportable segments: Americas, Europe and Asia. We also have an Other segment category which aggregates insignificant +operating segments that do not meet the reportable threshold. Each of our reportable segments derives its revenues from the sale of footwear, apparel and accessories. The composition of our reportable +segments is consistent with that used by our chief operating decision maker ("CODM") to evaluate performance and allocate resources. During the fourth quarter of 2010, we changed the internal segment +reports used by our CODM to separately illustrate performance metrics of certain operating segments which provide manufacturing support, located in Mexico and Italy. These operating segments make up +our Other segment category. Segment information for all periods presented has been restated to reflect this change. +Within +each segment, we sell our products through our wholesale, retail and internet channels. We occasionally utilize sales agents and buying groups in our international locations to +service our wholesale customers. We established a direct sales presence in most major international markets rather than relying on distributors which enables us to obtain better margins and allows us +to better control +4 +Table of Contents +our +marketing and distribution. Financial information relating to our operating segments as well as foreign country revenues and long-lived assets is provided in +Note 15—Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements. +Americas +The Americas segment consists of revenues and expenses related to product sales in the North and South America geographic regions. +Regional wholesale channel customers consist of a broad range of sporting goods and department stores as well as specialty retailers. The regional retail channel sells directly to the consumer through +197 company-operated store locations, including kiosks and retail stores in such locations as Orlando, Maui, Boston, New York, Quebec and Montreal, as well as through webstores. During the years ended +December 31, 2010, 2009 and 2008, the regional revenues constituted approximately 47.8%, 46.7% and 50.7% of our consolidated revenues, respectively. +Asia +The Asia segment consists of revenues and expenses related to product sales throughout Asia, Australia, New Zealand, the Middle East +and South Africa. The Asia wholesale channel consists of sales to a broad range of retailers, similar to the wholesale channel we have established in the Americas wholesale channel. We also sell +products directly to the consumer through 159 company-operated stores including kiosks and retail stores in locations such as Yokohama City, Hong Kong, Singapore and Brisbane, as well as through our +webstores. During the years ended December 31, 2010, 2009 and 2008, revenues from the Asia segment constituted 36.1%, 36.8% and 28.4% of our aggregate consolidated revenues, respectively. +Europe Segment +The Europe segment consists of revenues and expenses related to product sales throughout Europe and Russia. Europe segment wholesale +channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in our Americas segment. We also sell our products directly to the consumer through 22 +company-operated stores including kiosks and retail stores in locations such as Moscow, Russia; Metzingen, Germany; and London, England, as well as through our webstores. During the years ended +December 31, 2010, 2009 and 2008, revenues from the Europe segment constituted 16.2%, 16.4% and 20.7% of our aggregate consolidated revenues, respectively. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network so as to further streamline our supply chain, increase +our speed to market and lower costs. In 2008, we consolidated our distribution and logistics network to leverage resources and simplify our fulfillment processes while driving down costs in our +operations. During 2009, we continued to streamline our distribution strategy based upon projected economic conditions and demand for our products to further consolidate global distribution centers +and warehousing thereby decreasing fixed costs. +During +the year ended December 31, 2010, we stored our raw material and finished goods inventories in company-operated warehouse and distribution facilities located in, +California, Puerto Rico, Mexico, the Netherlands, Japan, China and South Africa. We also utilized distribution centers which were operated by third parties located in Brazil, Finland, Australia, +Dubai, Hong Kong, Korea, Singapore, India, Taiwan and China. Throughout 2010, we continued to engage in efforts to consolidate our global warehouse and distribution facilities to maintain a lean cost +structure. As of December 31, 2010 and 2009, our company-operated warehouse and distribution facilities provided us with 1.3 million square feet and 1.5 million square feet, +respectively, and our third-party operated distribution facilities provided us with 0.3 million square feet and 0.2 million square feet, respectively. We also ship a portion +5 +Table of Contents +of +our products directly to our customers from our internal and third-party manufacturers. We are actively pursuing initiatives aimed at shipping more of our product directly to our customers, which, +if successful, is expected to lower our cost of sales in the future. +Raw Materials +Croslite material, our proprietary closed-cell resin, is the primary raw material used in the majority of our footwear and +some of our accessories. Croslite material is soft and durable and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and +development in order to refine our materials to enhance these properties and to target the development of new properties for specific applications. +Croslite +material is produced by compounding elastomer resins that we or one of our third-party processors purchase from major chemical manufacturers together with certain other +production inputs such as color dyes. At this time, we have identified two suppliers that produce the particular elastomer resins used in the Croslite material. We may, however, in the future identify +and utilize materials produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use +to produce the Croslite material are readily available for purchase from multiple suppliers. +Since +our inception, we have substantially increased the number of footwear products that we offer. Many of our new products are constructed using leather, textile fabrics or other +non-Croslite materials. We or our third-party manufacturers obtain these materials from a number of third-party sources and we believe these materials are broadly available. We compound +Croslite material internally in Mexico utilizing subcomponent materials produced by a third party in the U.S. We also outsource the compounding of Croslite material and continue to purchase a portion +of our compounded raw materials from a third party in Europe. +Design and Development +We have expanded into new footwear categories by designing new footwear styles using both internal designers and external recognized +footwear design experts. As part of this strategy, we acquired EXO Italia ("EXO") in 2006, which expanded our internal design capabilities. EXO is based in Padova, Italy and is an Italian producer of +EVA (Ethylene Vinyl Acetate) based finished products, primarily for the footwear industry. By introducing outside sources to the design process, we are able to capture a variety of different design +perspectives on a cost-efficient basis and anticipate trends more quickly. +We +continue to dedicate significant resources to product design and development as we develop footwear styles based on opportunities we identify in the marketplace. Our design and +development process is highly collaborative, as members of the design team frequently meet with sales and marketing staff, production and supply managers and certain of our retail customers to further +refine our products to meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs while +maintaining product quality. We spent $7.8 million, $7.7 million and $6.4 million in research, design and development activities for the years ended December 31, 2010, +2009, and 2008, respectively. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have +company-operated production facilities in Mexico and Italy. We also contract with third-party manufacturers to produce certain of our footwear styles or provide support to our internal production +processes. We believe that our internal manufacturing capabilities enable us to rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high demand +models and colors throughout the year, while outsourcing allows us to capitalize on the efficiencies and +6 +Table of Contents +cost +benefits of using contracted manufacturing services. We believe this strategy will continue to minimize our production costs, increase overall operating efficiencies and shorten production and +development times. +In +the years ended December 31, 2010, 2009 and 2008, we manufactured approximately 21.0%, 26.4% and 16.6%, respectively, of our footwear products internally and sourced the +remaining footwear +production from multiple third-party manufacturers in China and Bosnia. During the years ended December 31, 2010, 2009 and 2008, our largest third-party supplier in China produced approximately +38.8%, 35.7%, and 48.8%, respectively, of our footwear unit volume. We do not have written supply agreements with our primary third-party manufacturers in China. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress, and patent protection to establish, protect, and enforce +our intellectual property rights in our product designs, brand, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material +trademarks used in connection with the marketing, distribution and sale of all of our products, both domestically and internationally, where our products are currently either sold or manufactured. Our +major trademarks include the Crocs logo and design and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China and Canada among +other places. We also have registrations or pending registrations for trademark rights or have pending trademark applications for the marks Jibbitz, Jibbitz Logo, YOU by Crocs, YOU by Crocs Logo, +Ocean Minded, Tail Logo, Bite, Bite Logo, Crocband, Crocs Tone and Crocs Littles, as well as for our proprietary material Croslite and the Croslite logo, globally. We intend to continue to +strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the future. We will also continue to aggressively police our +trademarks and copyrights and pursue those who infringe, both domestically and internationally as we deem necessary. +In +the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks registered within and outside of the U.S. +are generally valid as long as they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks are crucial to the successful +marketing and sale of our products, and we intend to vigorously prosecute and defend our intellectual property rights throughout the world. +We +consider the formulation of the Croslite material used to produce our products to be a valuable trade secret. Prior to our acquisition of Crocs Canada in June 2004, Crocs Canada +developed the formula for the Croslite material, and we believe that it did not publish or otherwise make the formula available to third parties without the protection of confidentiality or similar +agreements. Post acquisition, we continue to protect the formula by using confidentiality agreements with our third-party processors and by requiring our employees who have access to the formula to +execute confidentiality agreements or to be bound by similar agreements concerning the protection of our confidential information. Neither we nor Crocs Canada have attempted to seek patent protection +for the formula. We are not aware of any third party that has independently developed the formula or that otherwise has the right to use the formula in their products other than Finproject, our +third-party supplier of Croslite in Italy and another third-party licensee. Under the terms of our supply agreement with Finproject, Finproject has certain limited rights to use the Croslite material, +which were originally negotiated in connection with our purchase of Crocs Canada from Finproject's parent company. We believe the comfort and utility of our products depend on the properties achieved +from the +compounding of the Croslite material and constitute a key competitive advantage for us, and we intend to vigorously protect this trade secret. +7 +Table of Contents +We +also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers to police against infringing +products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives are also educated on our patents, pending patents, trademarks and +trade dress and assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or +in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain jurisdictions. +Seasonality +Due to the seasonal nature of our footwear which is more heavily focused on styles suitable for warm weather, revenues generated during +our first and fourth quarters are typically less than revenues generated during our second and third quarters, when the northern hemisphere is experiencing warmer weather. We continue to expand our +product line to include more winter-oriented styles to mitigate some of the seasonality of our revenues. Our quarterly results of operations may also fluctuate significantly as a result of a variety +of other factors, including the timing of new model introductions or general economic or consumer conditions. Accordingly, results of operations and cash flows for any one quarter are not necessarily +indicative of results to be expected for any other quarter or for any other year. +Backlog +We receive a significant portion of orders as preseason orders, generally four to five months prior to shipment date. We provide +customers with price incentives to participate in such preseason programs to enable us to better plan our production schedule, inventory and shipping needs. Unfulfilled customer orders as of any date, +are referred to as backlog and represent orders scheduled to be shipped at a future date. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing +schedule and the timing of product shipments. Further, the mix of future and immediate delivery orders can vary significantly from period over period. Due to +these factors and since the unfulfilled orders can be canceled at any time prior to shipment by our customers, backlog may not be reliable measure of future sales and comparisons of backlog from +period to period may be misleading. In addition, our historical cancellation experience may not be indicative of future cancellation rates. Backlog as of December 31, 2010 and 2009 was +$258.4 million and $165.0 million, respectively. +Competition +The global casual, athletic and fashion footwear markets are highly competitive. Although we believe that we do not compete directly +with any single company with respect to the entire spectrum of our products, we believe portions of our business compete with companies such as, but not limited to, Nike Inc., +Heelys Inc., Deckers Outdoor Corp., Skechers USA Inc. and Wolverine World Wide, Inc. Our company-operated retail locations also compete with footwear retailers such as +Nordstrom Inc., Dillards, Dick's Sporting Goods Inc. and Collective Brands Inc. +The +principal elements of competition in these markets include brand awareness, product functionality, design, quality, pricing, customer service, marketing and distribution. We believe +that our unique footwear designs, the Croslite material, our prices, expanded product-line and our distribution network continue to position us well in the marketplace. However, some +companies in the casual footwear and apparel industry have greater financial resources, more comprehensive product lines, broader market presence, longer-standing relationships with wholesalers, +longer operating histories, greater distribution capabilities, stronger brand recognition and greater marketing resources than we currently have. Furthermore, we face competition from new players who +have been attracted to the market with imitation products similar to ours as the result of the unique design and success of our footwear products. +8 +Table of Contents +Employees +As of December 31, 2010, we had approximately 4,000 full-time, part-time and seasonal employees, none of +which were represented by a union. +Available Information +Our internet address is www.crocs.com on which we post the following filings, free of charge, as soon as reasonably practicable after +they are electronically filed with or furnished to the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our +current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended +(the "Exchange Act"). Also available on our website are the charters of the committees of our board of directors and our code of ethics. Copies of any of these +documents will be provided in print to any stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. +ITEM 1A. Risk Factors +Special Note Regarding Forward-Looking Statements +Statements in this Form 10-K and in documents incorporated by reference herein (or otherwise made by us or on our +behalf) contain "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications from time to +time that contain such statements. Forward looking statements include statements as to industry trends and our future expectations and other matters that do not relate strictly to historical facts and +are based on certain assumptions of our management. These statements are often identified by the use of words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "strive," +"will," and variations of such words or similar expressions. These statements are based on the beliefs and assumptions of management based on information currently available. Such forward looking +statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from future results expressed or implied by such forward looking statements. +Important factors that could cause actual results to differ materially from the forward looking statements include, without limitation, the risk factors mentioned below. Furthermore, such forward +looking statements speak only as of the date of this report. We undertake no obligation to update any forward looking statements to reflect events or circumstances after the date of such statements. +The +risks included here are not exhaustive. Other sections of this Form 10-K may include additional factors which could adversely affect our business and financial +performance. Since we operate in a very competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for management to predict all such risk factors, +nor can it assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained +in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. +Current economic conditions may adversely affect consumer spending and the financial health of our customers and others with whom we do business which may adversely affect +our financial condition, results of operations and cash resources. +Uncertainty about the current and future global economic conditions may cause consumers and retailers to defer purchases or cancel +purchase orders for our products in response to tighter credit, decreased cash availability and weakened consumer confidence. Our financial success is sensitive to changes in general economic +conditions, both globally and nationally. Recessionary economic cycles, +9 +Table of Contents +higher +interest borrowing rates, higher fuel and other energy costs, inflation, increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other +changes in tax laws or other economic factors that may affect consumer spending could continue to adversely affect the demand for our products. As a result, we may not be able to maintain or increase +our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain or increase our international operations on a profitable basis, or maintain or improve our +earnings from operations as a percentage of net sales. +In +addition, the decrease in available credit that has resulted from the weakened economy may result in financial difficulties for our wholesale and retail customers, product suppliers, +insurers, other service providers and the financial institutions that are counterparties to our credit facility and derivative transactions. In particular, our customers may experience diminished +liquidity that could result in reduced orders for our products, order cancellations, extended payment terms, higher accounts receivable, reduced cash flows, greater expense associated with collection +efforts and increased bad debt expense. If credit pressures or other financial difficulties result in insolvency for these third parties it could adversely impact our estimated reserves and financial +results. +We face significant competition. +The footwear industry is highly competitive. Recent growth in the market for casual footwear has encouraged the entry of new +competitors into the marketplace and has increased competition from established companies. Our competitors include most major athletic and footwear companies, branded apparel companies, and retailers +with their own private labels. A number of our competitors have: significantly greater financial resources than us, more comprehensive product lines, a broader market presence, longer-standing +relationships with wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition, and spend substantially more than we do on product advertising and sales. Our +competitors' greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and production, and +more quickly develop new products. Further, some of our competitors are offering products that are substantially similar, in design and materials, to +Crocs-branded footwear. In addition, access to offshore manufacturing is also making it easier for new companies to enter the markets in which we compete. If we fail to compete successfully in the +future, our sales and profits may decline, we may lose market share, our financial condition may deteriorate, and the market price of our common stock is likely to fall. +We may be unable to successfully execute our long-term growth strategy or maintain our current revenue levels. +Although we exhibited significant growth from our inception through 2007, revenues were significantly lower in 2008, 2009 and 2010, +relative to the peak levels achieved in 2007. We may experience similar decreases in revenues in the future. Our ability to maintain our revenue levels or to grow in the future depends upon, among +other things, the continued success of our efforts to maintain our brand image and bring compelling and revenue-enhancing footwear offerings to market and our ability to expand within our current +distribution channels and increase sales of our products into new locations internationally. Likewise, in order to effectively execute our long-term growth strategy, we will need to +continue to streamline our supply chain to increase operating efficiencies and decrease costs. Successfully executing our long-term growth strategy will depend on many factors, including +the strength of the Crocs brand and competitive conditions in new markets that we attempt to enter, our ability to attract and retain qualified distributors or agents or to develop direct sales +channels, our ability to secure strategic retail store locations, our ability to use and protect the Crocs brand and our other intellectual property, in these new markets and territories, and our +ability to consolidate our network to leverage resources and simplify our fulfillment process. If we are unable to successfully +10 +Table of Contents +maintain +our brand image, expand distribution channels, streamline our supply chain and sell our products in new markets abroad, our business may fail to grow, our brand may suffer and our results of +operations may be adversely impacted. +Expanding our footwear product line may be difficult and expensive. If we are unable to successfully continue such expansion, our brand may be adversely affected and we may +not be able to maintain or grow our current revenue levels or our revenues may continue to decline. +The footwear industry is subject to rapidly changing consumer demands, preferences and fashion trends, and our footwear may not remain +popular or we may fail to develop additional footwear designs that appeal to consumers. To successfully expand our footwear product line, we must anticipate, understand, and react to the rapidly +changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with consumers or our brand may fall out of favor with +consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may +decline further, our brand image may suffer, our operating performance may decline and we may not be able to execute upon our growth plans. +In +producing new footwear models, we may encounter difficulties that we did not anticipate during the development stage. Our development schedules for new products are difficult to +predict and are subject to change in response to consumer preferences and competing products. If we are not able to efficiently manufacture newly developed products in quantities sufficient to support +retail and wholesale distribution, we may not be able to recover our investment in the development of new models and product lines and we would continue to be subject to the risks inherent in having a +limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new model may depend on our pricing. We have a limited history +of introducing new products in certain target markets; as such, we may set the prices of new models too high for the market to bear or we may not provide the appropriate level of marketing in order to +educate the market and potential consumers about new products. Achieving market acceptance will require us to exert substantial product development and marketing efforts, which could result in a +material increase in our selling, general, and administrative expense, and there can be no assurance that we will have the resources necessary to undertake such efforts effectively. Failure to gain +market acceptance for new products that we introduce could impede our ability to maintain or grow our current revenues, reduce our profits, adversely affect the image of our brands, erode our +competitive position and result in long-term harm to our business. +If we do not accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers' orders, either of which could +adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction, and closings, as well as fashion trends, rapid +changes in consumer preferences, the effects of weather, general economic conditions, and other factors affecting demand and possibly impairing our brand image. These factors make it difficult to +forecast consumer demand and, if we overestimate demand for our products, we may be forced to liquidate excess inventories at a discount to customers, resulting in markdowns and lower gross margins. +Conversely, if we underestimate consumer demand, we could have inventory shortages, which can result in lower sales, delays in shipments to customers, strains on our relationships with customers and +diminished brand loyalty. A decline in demand for our products, or any failure on our part to satisfy increased demand for our products, could adversely affect our business and results of operations. +11 +Table of Contents +Opening and operating additional retail stores are subject to numerous risks, and declines in revenue of such retail stores could adversely affect our profitability. +In recent years, we have significantly expanded and intend to continue the expansion of our retail sales channel. Opening global retail +stores involve substantial investments, including constructing leasehold improvements, furniture and fixtures, equipment, information systems, inventory and personnel. Operating global retail stores +incurs fixed costs, and if we have insufficient sales, we may be unable to reduce expenses in order to avoid losses or negative cash flows. Due to the high fixed cost structure associated with the +retail segment, negative cash flows or the closure of a store could result in write-downs of inventory and leasehold improvements, severance costs, significant lease termination costs, impairment +losses on long-lived assets or loss of our working capital, which could adversely impact our financial position, results of operations or cash flows. Our ability to recover the investment +in and expenditures of our retail operations can be adversely affected if sales at our retail stores are lower than anticipated. +We have substantial cash requirements in the U.S.; however, a majority of our cash is generated and held outside of the U.S. The risks attendant to holding cash abroad could +adversely affect our financial condition and results of operations. +We have substantial cash requirements in the U.S., but the majority of our cash is generated and held abroad. We generally consider +unremitted earnings of subsidiaries operating outside of the U.S. to be indefinitely reinvested and it is not our current intent to change this position. Cash held outside of the U.S. is primarily +used for the ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., but under current law, would be +subject to U.S. federal and state income taxes, less applicable foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax +consequences if we were to move the cash to another country. Certain countries, including China, may have monetary laws which may limit our ability to utilize cash resources in those countries for +operations in other countries. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our liquidity. Since +repatriation of such cash is subject to limitations and may be subject to significant taxation, we cannot be certain that we will be able to repatriate such cash on favorable terms or in a timely +manner. If we continue to incur operating losses and require cash held in international accounts for use in our U.S. operations, a failure to repatriate such cash in a timely and +cost-effective manner could adversely affect our business, financial condition and results of operations. +Our asset-backed revolving credit facility contains financial covenants that require us to maintain certain financial metrics and ratios and restrictive covenants that limit +our flexibility. A breach of those covenants may cause us to be in default under the facility, and our lenders could foreclose on our assets. +The credit agreement for our asset-backed revolving credit facility requires us to maintain a certain level of tangible net worth and a +minimum fixed-charge coverage ratio on a quarterly basis. A lack of revenue growth, a failure to meet our tangible net worth level or an inability to control costs could negatively impact our ability +to meet these financial covenants and, if we breach such covenants or any of the restrictive covenants described below, the lenders could either refuse to lend funds to us or accelerate the repayment +of any outstanding borrowings under the revolving credit facility. We might not have sufficient assets to repay such indebtedness upon a default. If we are unable to repay the indebtedness, the +lenders could initiate a bankruptcy proceeding against us or collection proceedings with respect to our assets, all of which secure our indebtedness under the revolving credit facility. +The +credit agreement also contains certain restrictive covenants that limit, and in some circumstances prohibit, our ability to, among other things incur additional debt, sell, lease or +transfer our assets, pay dividends, make capital expenditures and investments, guarantee debt or obligations, +12 +Table of Contents +create +liens, enter into transactions with our affiliates, and enter into certain merger, consolidation or other reorganizations transactions. These restrictions could limit our ability to obtain +future financing, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business or the economy in general, conduct operations or otherwise take advantage +of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors that have less debt and are not subject to such restrictions. +We manufacture a portion of our products which causes us to incur greater fixed costs. Any difficulties or disruptions in our manufacturing operations could adversely affect +our sales and results of operations. +We produce a portion of our footwear products at our internal manufacturing facilities in Mexico and Italy. Ownership of these +facilities adds fixed costs to our cost structure which are not as easily scalable as variable costs. The manufacture of our products from Croslite requires the use of a complex process and we may +experience difficulty in producing footwear that meets our high quality control standards. We will be required to absorb the costs of manufacturing and disposing of products that do not meet our +quality standards. Any increases in our manufacturing costs could adversely impact our margins. Furthermore, our manufacturing capabilities are subject to many of the same risks and challenges noted +below with respect to our third-party manufacturers, including our ability to scale our production capabilities to meet the needs of our customers, and our +manufacturing may be disrupted for reasons beyond our control, including work stoppages, fires, earthquakes, floods, or other natural disasters. Any disruption to our manufacturing operations will +hinder our ability to deliver products to our customers in a timely manner, and could have a material and adverse effect on our business. +We depend heavily on third-party manufacturers located outside the U.S. +Third-party manufacturers located outside of the U.S. (China and Bosnia) produce most of our footwear products. We depend on these +manufacturers' ability to finance the production of goods ordered, maintain adequate manufacturing capacity and meet our quality standards. We compete with other companies for the production capacity +of our third-party manufacturers, and we do not exert direct control over the manufacturers' operations. As such, we have experienced at times, specifically in China, delays or inabilities to fulfill +customer demand and orders. While we are increasing our communication and relationships with our third-party manufacturers, we cannot guarantee that any third-party manufacturer will have sufficient +production capacity, meet our production deadlines or meet our quality standards. +In +addition, we do not have long-term supply contracts with these third-party manufacturers and any of them may unilaterally terminate their relationship with us at any time +or seek to increase the prices they charge us. As a result, we are not assured of an uninterrupted supply of products of an acceptable quality and price from our third-party manufacturers. Foreign +manufacturing is subject to additional risks, including transportation delays and interruptions, work stoppages, political instability, expropriation, nationalization, foreign currency fluctuations, +changing economic conditions, changes in governmental policies and the imposition of tariffs, import and export controls and other non-tariff barriers. We may not be able to offset any +interruption or decrease in supply of our products by increasing production in our internal manufacturing facilities due to capacity constraints, and we may not be able to substitute suitable +alternative third-party manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third-party manufacturers may harm our business and could result in +a loss of sales and an increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or unexpected demand for our products may require us to +use faster, but more expensive, transportation methods such as aircraft, which could adversely affect our profit margins. The cost of fuel is a significant component in transportation costs, so +increases in the price of petroleum products can adversely affect our profit margins. +13 +Table of Contents +China +Because a large portion of our footwear products are manufactured in China, the possibility of adverse changes in trade or political +relations between the U.S. and China, political instability in China, increases in labor costs, or adverse weather conditions could significantly interfere with the production and shipment of our +products, which would have a material adverse affect on our operations and financial results. +Compliance with standards and laws +We require our third-party foreign manufacturers to meet our quality control standards and footwear-industry standards for working +conditions and other matters, including compliance with applicable labor, environmental and other laws. However, we do not control our third-party manufacturers or their respective labor practices. A +failure by any of our third-party manufacturers to adhere to quality standards or labor, environmental and other laws could cause us to incur additional costs for our products and could cause negative +publicity, damage to our reputation and the value of our brand, and discourage retail customers and consumers from buying our products. We also require our third-party foreign manufacturers to meet +both our and industry standards for product safety. A failure by any of our third-party manufacturers to adhere to product safety standards could lead to a product recall, which could result in +critical media coverage and harm our business and reputation and could cause us to incur additional costs. +Trade laws and regulations +In addition, if we or our third-party foreign manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to +extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import or the loss of our import privileges. Possible violations of U.S. or foreign +laws or regulations could include inadequate record keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported +products, fraudulent visas or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our +operating results. We cannot predict whether additional U.S. or foreign customs quotas, duties, taxes or other changes or restrictions will be imposed upon the importation of foreign produced products +in the future or what effect such actions could have on our business, financial condition or results of operations. +We conduct significant business activity outside the U.S. which exposes us to foreign currency and other risks. +Our ability to maintain the current level of operations in our existing international markets is subject to risks associated with +international sales operations as well as the difficulties associated with promoting products in unfamiliar cultures. +We +may be adversely affected by currency exchange rate fluctuations. We purchase products and supplies from third parties in U.S. dollars and receive payments from certain of our +international customers in foreign currencies. The cost of these products and supplies sourced overseas, and payments received from customers, may be affected by changes in the value of the relevant +currencies. Price increases caused by currency exchange rate fluctuations could make our products less competitive or have an adverse effect on our profitability. Currency exchange rate fluctuations +could also disrupt the business of the third-party manufacturers that produce our products by making their purchases of raw materials more expensive and more difficult to finance. Foreign currency +fluctuations could have a material adverse effect on our results of operations and financial condition. +In +addition to foreign manufacturing, we operate retail stores and sell our products to retailers outside of the U.S. We have had significant revenues from foreign sales. Foreign +manufacturing and +14 +Table of Contents +sales +activities are subject to numerous risks, including tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas and local +content rules; delays associated with the manufacture, transportation and delivery of foreign-sourced products; increased transportation costs due to distance, energy prices, or other factors; delays +in the transportation and delivery of goods due to increased security concerns; restrictions on the transfer of funds; restrictions, due to privacy laws, on the handling and transfer of consumer and +other personal information; changes in governmental policies and regulations; political unrest, changes in law, terrorism, or war, any of which can interrupt commerce; expropriation and +nationalization; difficulties in managing foreign operations effectively and efficiently from the U.S.; and difficulties in understanding and complying with local laws, regulations, and customs in +foreign jurisdictions. +Our financial success may be limited to the strength of our relationships with our wholesale customers and to the success of such wholesale customers. +Our financial success is significantly related to the willingness of our current and prospective wholesale customers to carry our +products and the expansion to new wholesale customers, We do not have long term contracts with any of our wholesale customers, and sales to our wholesale customers are generally on an +order-by-order basis and are +subject to rights of cancellation and rescheduling by the customer. If we cannot fill our customers' orders in a timely manner, the sales of our products and our relationships with those customers may +suffer, and this could have a material adverse effect on our product sales and ability to grow our product line. +Our +financial success is also significantly related to the success of our wholesale customers who are directly impacted by fluctuations in the broader economy, including the recent +global economic downturn which reduced foot traffic in shopping malls and lessened consumer demand for our products. Changes in the global credit market could also affect our customers' liquidity and +capital resources and their ability to meet their payment obligations to us which could have a material adverse impact on our cash flows and capital resources. We continue to monitor our accounts +receivable aging and have recorded appropriate reserves as we deem appropriate. Additionally, many of our wholesale customers compete with each other and if they perceive that we are offering their +competitors better pricing and support, they may reduce purchases of our products. In addition, we compete directly with our wholesale customers by selling our products to consumers via the internet +and through our company-operated retail locations. If our wholesale customers believe that our direct sales to consumers divert sales from their stores, this may weaken our relationships with such +customers and cause them to reduce purchases of our products. Furthermore, we continue to grow our consumer-direct channels (company-operated retail and internet) which could exacerbate this issue. +We depend on a limited number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product manufacturing and +increase product costs. +We depend on a limited number of sources for the primary materials used to make our footwear. We source the elastomer resins that +constitute the primary raw materials used in compounding Croslite, which we use to produce our footwear products, from two suppliers. If the suppliers we rely on for elastomer resins were to cease +production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production cycle, if at all. We may also have to pay materially higher +prices in the future for the elastomer resins or any substitute materials we use, which would increase our production costs and could have a materially adverse impact on our margins and results of +operations. If we are unable to obtain suitable elastomer resins or if we are unable to procure sufficient quantities of the Croslite material, we may not be able to meet our production requirements +in a timely manner. Such failure could result in lost potential sales, delays in shipments to customers, strained relationships with customers and diminished brand loyalty. +15 +Table of Contents +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our brand image and adversely +affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending patents and trade dress and designs on nearly all of +our products and believe that having distinctive marks that are readily identifiable is important to our brand, our success and our competitive position. The laws of some countries, +e.g., China, do not protect intellectual property rights to the same extent as do U.S. laws. We periodically discover products that are counterfeit reproductions of our products or that +otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party's products on the basis of trademark or design or utility patent infringement, particularly +in some foreign countries, or if we are required to change our name or use a different logo, continued sales of such competing products by third parties could harm our brand and adversely impact our +business, financial condition, and results of operations by resulting in the shift of consumer preference away from our products. If our brands are associated with inferior counterfeit reproductions, +the integrity of our brands could be adversely affected. Furthermore, our efforts to enforce our intellectual property rights are typically met with defenses and counterclaims attacking the validity +and enforceability of our intellectual property rights. We may face significant expenses and liability in connection with the protection of our intellectual property rights outside the U.S., and if we +are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial condition could be adversely affected. +We +also rely on trade secrets, confidential information, and other unpatented proprietary information related to, among other things, the formulation of the Croslite material and product +development, particularly where we do not believe patent protection is appropriate or obtainable. Using third-party manufacturers and compounding facilities may increase the risk of misappropriation +of our trade secrets, confidential information and other unpatented proprietary information. The agreements we use in an effort to protect our intellectual property, confidential information and other +unpatented proprietary information may be ineffective and may be insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may +breach the agreement and we may not have adequate remedies for such breach. As a result, our trade secrets, confidential information, and other unpatented proprietary information may become known to +others, including our competitors. Furthermore, as with any trade secret, confidential information or other proprietary information, others, including our competitors, may independently develop or +discover such trade secrets and information, which would render them less valuable to us. +We have been named as a defendant in a securities class action lawsuit that may result in substantial costs and could divert management's attention. +Starting in November 2007, certain stockholders filed several purported shareholder class actions in the U.S. District Court for the +District of Colorado alleging violations of Sections 10(b) and 20(a) of the Exchange Act based on alleged statements made by us between July 27, 2007 and October 31, 2007. We and +certain of our current and former officers and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of Colorado. The first +complaint was filed in November 2007; several other complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the Court appointed a lead plaintiff and counsel. +An amended consolidated complaint was filed in December 2008. The amended complaint purports to state claims under Section 10(b), 20(a), and 20A of the Exchange Act on behalf of a class of all +persons who purchased our stock between April 2, 2007 and April 14, 2008 (the "Class Period"). The amended complaint alleges that, during the Class Period, defendants made false and +misleading public statements about us and our business and prospects and that, as a result, the market price of our stock was artificially inflated. The amended complaint also claims that certain +current and former officers and directors traded our stock on the basis of material non-public information. The amended complaint +16 +Table of Contents +seeks +compensatory damages on behalf of the alleged class in an unspecified amount, interest, and an award of attorneys' fees and costs of litigation. The Company believe the claims lack merit and +intends to defend the action vigorously. Motions to dismiss are currently pending with the Court. Due to the inherent uncertainties of litigation and because the litigation is at a preliminary stage, +we cannot at this time accurately predict the ultimate outcome of the matter, or of the amount or range of potential loss, if any. It is possible that this action could be resolved adversely to us. +Risks associated with legal liability are often difficult to assess or quantify, and their existence and magnitude can remain unknown for significant periods of time. While we maintain director and +officer insurance, the amount of insurance coverage may not be sufficient to cover a claim, and the continued availability of this insurance cannot be assured. We may, in the future, be the target of +additional proceedings, and the +present or future proceedings may result in substantial costs and divert management's attention and resources that are needed to successfully run our business. +We depend on key personnel, the loss of whom would harm our business. +The loss of the services and expertise of any key employee could harm our business. Our future success depends on our ability to +identify, attract and retain qualified personnel on a timely basis. We have experienced significant management turnover in recent years. Turnover of senior management can adversely impact our stock +price, our results of operations and our client relationships and may make recruiting for future management positions more difficult. In some cases, we may be required to pay significant amounts of +severance to terminated management employees. In addition, we must successfully integrate any new management personnel that we hire within our organization in order to achieve our operating +objectives, and changes in other key management positions may temporarily affect our financial performance and results of operations as new management becomes familiar with our business. +Our current management information systems may not be sufficient for our business and planned system improvements may not be successfully implemented on a timely basis or be +sufficient for our business. +We are in the process of implementing numerous information systems designed to support several areas of our business, including +warehouse management, order management, retail point-of-sale and internet point-of-sale as well as various systems that provide interfaces between these +systems. These systems are intended to assist in streamlining our operational processes and eliminating certain manual processes. However, for certain business planning, finance and accounting +functions, we still rely on manual processes that are difficult to control and are subject to human error. We may experience difficulties in transitioning to our new or upgraded systems, including +loss of data and decreases in productivity as our personnel become familiar with new systems. In addition, our management information systems will require modification and refinement as our business +needs change, which could prolong difficulties we experience with systems transitions, and we may not always employ the most effective systems for our purposes. If we experience difficulties in +implementing new or upgraded information systems or experience significant system failures, or if we are unable to successfully modify our management information systems to respond to changes in our +business needs, our ability to properly run our business could be adversely affected. +Our financial results may be adversely affected if substantial investments in businesses and operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, acquisitions of new businesses, and expansion of existing businesses, such +as our retail operations, which require substantial cash investments and management attention. We believe cost effective investments are essential to business growth and profitability. However, +significant investments are subject to typical risks and uncertainties inherent in acquiring or expanding a business. The failure of any significant investment to provide the +17 +Table of Contents +returns +or profitability we expect could have a material adverse effect on our financial results and divert management attention from more profitable business operations. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of factors, including seasonal variations, which could increase the +volatility of the price of our common stock. +Sales of our products are subject to seasonal variations and are sensitive to weather conditions. The majority of our revenues are +attributable to footwear styles that are more suitable for fair weather and typically experience our highest sales activity during the second and third quarters of the calendar year, when there is a +revenue concentration in countries in the northern hemisphere. While we continue to create more footwear models that are more suitable for cold weather, the effects of favorable or unfavorable weather +on sales can be significant enough to affect our quarterly results, with a resulting effect on our common stock price. Quarterly results may also fluctuate as a result of other factors, including new +model introductions, general economic conditions or changes in consumer preferences. Results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for +any year, and revenues for any particular period may fluctuate. This could lead to results outside of analyst and investor expectations, which could cause the volatility in our stock price to +increase. +We may fail to meet analyst expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly and various securities analysts follow our financial results and frequently issue reports on us. +These reports include information about our historical financial results as well as the analysts' estimates of our future performance. The analysts' estimates are based upon their own opinions and are +often different from our estimates or expectations +of our business. If our operating results are below the estimates or expectations of public market analysts and investors, our stock price could decline. +Our restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could discourage a third party from acquiring us and +consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could +delay, defer, or prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and +take other corporate actions, which may prevent a change of control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General +Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change of control or change in management that stockholders might otherwise consider to be +favorable could cause the market price of our common stock to decline. +ITEM 1B. Unresolved Staff Comments +None. +ITEM 2. Properties +Our principal executive and administrative offices are located at 6328 Monarch Park Place, Niwot, Colorado. We lease, rather than own, +all of our facilities. We enter into short-term and long-term leases for kiosks, office, retail, manufacturing and warehouse space domestically and internationally. The terms +of these leases include fixed monthly rents and/or contingent rents based on percentage of +18 +Table of Contents +revenues +and have expirations between 2011 and 2026. The general location, use and approximate size of our principal properties are given below. +Location +Use +Approximate +Square Feet +Ontario, California +Warehouse +399,000 +Narita, Japan(1) +Warehouse +289,000 +Aurora, Colorado(2) +Warehouse +264,000 +Leon, Mexico +Manufacturing/offices +226,000 +Leon, Mexico +Warehouse/offices +214,000 +Rotterdam, the Netherlands +Warehouse +183,000 +Shanghai, China +Warehouse +76,000 +Niwot, Colorado +Corporate headquarters +69,000 +Niwot, Colorado +Regional offices +60,000 +Tampere, Finland(3) +Warehouse/offices +60,000 +Melbourne, Australia +Warehouse +48,000 +Shenzen, China +Manufacturing/offices +32,000 +Den Haag, the Netherlands +Regional offices +27,000 +Padova, Italy +EXO's Regional offices/manufacturing facility +28,000 +Singapore +Regional offices +26,000 +Gordon's Bay, South Africa +Warehouse/offices +24,000 +Niwot, Colorado +Warehouse +15,000 +Shanghai, China +Regional offices +13,000 +(1) The +space we lease related to our facility in Narita, Japan will be reduced to 156,000 square feet in stages over the first half of 2011. +(2) We +intend to sublease our facility in Aurora, Colorado which is currently vacant. +(3) Our +facility in Tampere, Finland is partially subleased. +In +addition to the properties listed above, we maintain small branch sales offices in Hong Kong, Taiwan, Korea, Australia, Brazil and India. We also lease retail space for 63 domestic +and 75 international retail stores and 61 domestic and 15 international outlet stores. +ITEM 3. Legal Proceedings +On March 31, 2006, we filed a complaint with the International Trading Commission ("ITC") against Acme +Ex-Im, Inc., Australia Unlimited, Inc., Cheng's Enterprises, Inc., Collective Licensing International, LLC, D. Myers & Sons, Inc., Double Diamond +Distribution, Ltd., Effervescent, Inc., Gen-X Sports, Inc., Holey Soles Holdings, Ltd., Inter-Pacific Trading Corporation, and Shaka Holdings, Inc. +(collectively, the "respondents"), alleging, among other things infringement of United States Patent Nos. 6,993,858 (the "'858 Patent") and D517,789 (the "'789 Patent") and seeking an exclusion +order banning the importation and sale of infringing products. During the course of the investigation, the ITC issued final determinations terminating Shaka Holdings, Inc., Inter-Pacific +Trading Corporation, Acme Ex-Im, Inc., D. Myers & Sons, Inc., Australia Unlimited, Inc. and Gen-X Sports, Inc. from the ITC investigation due +to a settlement being reached with each of those entities. Cheng's Enterprises, Inc. was removed from the ITC investigation because they ceased the accused activities. After a trial in the +matter in September 2007, the ITC Administrative Law Judge ("ALJ") issued an initial determination on April 11, 2008, finding the '858 patent infringed by certain accused products, but also +finding the patent invalid as obvious. The ALJ found that the '789 patent was valid, but was not infringed by the accused products. On July 25, 2008, the ITC notified us of its decision to +terminate the investigation with a finding of no violation as to either patent. We filed a Petition for +19 +Table of Contents +Review +of the decision with the United States Court of Appeals for the Federal Circuit on September 22, 2008. On October 4, 2009, a settlement was reached between us and Collective +Licensing International, LLC. Collective Licensing International, LLC agreed to cease and desist infringing on our patents and to pay us certain monetary damages, which was recorded upon +receipt. On February 24, 2010, the Federal Circuit found that the ITC erred in finding that the utility patent was obvious and also reversed the ITC's determination of +non-infringement of the design patent. The case has been remanded back to the ITC. On July 6, 2010, the ITC ordered the matter to be assigned to an ALJ for a determination on +enforceability. On February 9, 2011, the ALJ issued a determination that the utility and design patents were both enforceable against the remaining respondents. The ALJ's decision becomes final +on April 11, 2011, unless the Commission determines to review it. +On +December 8, 2009, Columbia Sportswear Company ("Columbia") filed an amended complaint adding us as a defendant in a case between Columbia and Brian P. O'Boyle and 1 +Pen. Inc. in the Multnomah County Circuit Court in the State of Oregon. Columbia asserted claims against us for misappropriation of trade secrets, aiding and abetting breach of fiduciary duty, +intentional interference with contract, injunctive relief, disgorgement and an accounting. The amended complaint sought damages in an unspecified amount, return of patent rights, reasonable attorney's +fees and costs and expenses against us. On July 29, 2010, all issues between us and Columbia were settled and Columbia dismissed with prejudice all claims against us in exchange for certain +monetary and other considerations. +We +and certain current and former officers and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of Colorado. +The first complaint was filed in November 2007 and several other complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the district court appointed a lead +plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purports to state claims under Section 10(b), 20(a), and 20A of the Exchange Act on +behalf of a class of all persons who purchased our common stock between April 2, 2007 and April 14, 2008 (the "Class Period"). The +amended complaint also added our independent auditor as a defendant. The amended complaint alleges that, during the Class Period, the defendants made false and misleading public statements about us +and our business and prospects and, as a result, the market price of our common stock was artificially inflated. The amended complaint also claims that certain current and former officers and +directors traded in our common stock on the basis of material non-public information. The amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified +amount, including interest, and also added attorneys' fees and costs of litigation. We believe the claims lack merit and intend to defend the action vigorously. Motions to dismiss are currently +pending with the district court. Due to the inherent uncertainties of litigation and because the litigation is at a preliminary stage, we cannot at this time accurately predict the ultimate outcome, +or any potential liability, of the matter. +ITEM 4. Reserved +20 +Table of Contents +PART II +ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock, par value $0.001, is listed on the NASDAQ Global Select Market and trades under the stock symbol "CROX". The +following table shows the high and low sales prices of our common stock for the periods indicated. +Fiscal Year 2010 Three Months Ended +High +Low +March 31, 2010 +$ +9.00 +$ +5.81 +June 30, 2010 +$ +12.28 +$ +8.38 +September 30, 2010 +$ +14.08 +$ +9.88 +December 31, 2010 +$ +19.54 +$ +12.88 +Fiscal Year 2009 Three Months Ended +High +Low +March 31, 2009 +$ +1.63 +$ +1.00 +June 30, 2009 +$ +4.50 +$ +1.19 +September 30, 2009 +$ +7.45 +$ +2.55 +December 31, 2009 +$ +8.20 +$ +4.33 +Performance Graph +The following performance graph compares the cumulative total return of our common stock with that of the NASDAQ Composite Index and +the Dow Jones U.S. Footwear Index from February 8, 2006 through December 31, 2010. Our common stock was initially listed on NASDAQ on February 8, 2006, the date it commenced +trading publicly. Prior to that time, there was no public market for our stock. The graph assumes an investment of $100 on February 8, 2006, reinvestment of all dividends and other +distributions, and reflects our stock prices post-stock split. +Comparison of Cumulative Total Return on Investment +2/8/2006 +12/29/2006 +12/31/2007 +12/31/2008 +12/31/2009 +12/31/2010 +Crocs, Inc. +$ +100.00 +$ +144.00 +$ +245.40 +$ +8.27 +$ +38.33 +$ +114.13 +Nasdaq Composite Index +$ +100.00 +$ +106.86 +$ +117.35 +$ +69.77 +$ +100.40 +$ +117.37 +Dow Jones US Footwear Index +$ +100.00 +$ +114.93 +$ +143.58 +$ +102.81 +$ +131.46 +$ +172.12 +21 +Table of Contents +The +Dow Jones U.S. Footwear Index consists of Crocs, Inc., NIKE, Inc., Deckers Outdoor Corp., Timberland Co. and Wolverine World Wide, Inc. Because +Crocs, Inc. is part of the Dow Jones U.S. Footwear Index, the price and returns of our stock have an effect on this index. The Dow Jones U.S. Footwear Index includes companies in the major line +of business in which we compete. This index does not encompass all of our competitors or all of our product categories and lines of business. +The +stock performance shown on the performance graph above is not necessarily indicative of future performance. We do not make nor endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 213 as of January 31, 2011. Because many of the shares +of our common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial owners represented by these stockholders of record. +Dividends +We have never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future +earnings for use in the operation of our business and do not anticipate paying any cash dividends in the foreseeable future. Our financing arrangements also contain restriction on our ability to pay +cash dividends. Any future determination to declare cash dividends will be made at the discretion of our board of directors, subject to compliance with covenants under any then existing financing +agreements. +22 +Table of Contents +ITEM 6. Selected Financial Data +The following table presents selected historical financial data of the Company for each of the last five fiscal years. The information +in this table should be read in conjunction with the consolidated financial statements and accompanying notes beginning on page F-1 and with "Management's Discussion and Analysis of +Financial Conditions and Results of Operations" included in Item 7 of this Form 10-K. +For the Years Ended December 31, +($ thousands, except per share data) +2010 +2009 +2008 +2007 +2006 +Consolidated Statements of Operations Data +Revenues +$ +789,695 +$ +645,767 +$ +721,589 +$ +847,350 +$ +354,728 +Cost of sales +364,631 +337,720 +486,722 +349,701 +154,158 +Restructuring charges +1,300 +7,086 +901 +— +— +Gross profit +423,764 +300,961 +233,966 +497,649 +200,570 +Selling, general and administrative expenses +342,121 +311,592 +341,518 +268,978 +104,172 +Foreign currency transaction losses (gains), net +(2,912 +) +(665 +) +25,438 +(10,055 +) +776 +Charitable contributions +840 +7,510 +1,844 +959 +276 +Restructuring charges +2,539 +7,623 +7,664 +— +— +Impairment charges +141 +26,085 +45,784 +— +— +Income (loss) from operations +81,035 +(51,184 +) +(188,282 +) +237,767 +95,346 +Gain on charitable contributions +(223 +) +(3,163 +) +— +— +— +Interest expense +657 +1,495 +1,793 +438 +567 +Other income, net +(191 +) +(895 +) +(565 +) +(2,997 +) +(1,847 +) +Income (loss) before income taxes +80,792 +(48,621 +) +(189,510 +) +240,326 +96,626 +Income tax expense (benefit) +13,066 +(6,543 +) +(4.434 +) +72,098 +32,209 +Net income (loss) +67,726 +(42,078 +) +(185,076 +) +168,228 +64,417 +Dividend on redeemable convertible preferred shares +— +— +— +— +33 +Net income (loss) attributable to common stockholders +$ +67,726 +$ +(42,078 +) +$ +(185,076 +) +$ +168,228 +$ +64,384 +Income (loss) per common share: +Basic +$ +0.78 +$ +(0.49 +) +$ +(2.24 +) +$ +2.08 +$ +0.87 +Diluted +$ +0.76 +$ +(0.49 +) +$ +(2.24 +) +$ +2.00 +$ +0.81 +Weighted average common shares:(1) +Basic +85,482,055 +85,112,461 +82,767,540 +80,759,077 +74,598,400 +Diluted +87,595,618 +85,112,461 +82,767,540 +84,194,883 +80,170,512 +As of December 31, +($ thousands) +2010 +2009 +2008 +2007 +2006 +Consolidated Balance Sheets Data +Cash, cash equivalents, and marketable securities +$ +145,583 +$ +77,343 +$ +51,665 +$ +36,335 +$ +64,981 +Total assets +549,481 +409,738 +455,999 +627,425 +299,457 +Long term obligations +35,613 +35,462 +35,303 +15,864 +3,290 +Total stockholders' equity +$ +376,106 +$ +287,620 +$ +287,163 +$ +444,113 +$ +208,258 +(1) Our +2-for-1 stock split was effected in the form of a 100% common stock dividend distributed on June 14, 2007. All share and +per share amounts prior to June 14, 2007 have been adjusted to reflect the 2-for-1 stock split. +23 +Table of Contents +ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations +Overview +We are a designer, manufacturer, distributor, worldwide marketer and brand manager of footwear, apparel and accessories for men, women +and children. We strive to be the global leader in molded footwear design and development. We design, manufacture and sell a broad product offering that provides new and exciting molded footwear +products that feature fun, comfort +and functionality. Our products include footwear and accessories that utilize our proprietary closed cell-resin, called Croslite. Our Croslite material is unique in that it enables us to +produce an innovative, lightweight, non-marking, and odor-resistant shoe. Certain shoes made with the Croslite material have been certified by U.S. Ergonomics to reduce peak +pressure on the foot, reduce muscular fatigue while standing and walking and to relieve the musculoskeletal system. +Since +the initial introduction and popularity of our Beach and Crocs Classic designs, we have expanded our Croslite products to include a variety of new styles and products and have +extended our product reach through the acquisition of brand platforms such as Jibbitz, LLC ("Jibbitz") and Ocean Minded, Inc. ("Ocean Minded"). We intend to continue branching out into +other types of footwear, bringing a unique and original perspective to the consumer in styles that may be unexpected from Crocs. In part, we believe this will help us to continue to build a stable +year-round business as we look to offer more winter-oriented styles. Our marketing efforts surround specific product launches and employ a fully integrated approach utilizing a variety of +media outlets, including print and online media and television. Our marketing efforts drive business to both our wholesale partners and our company-operated retail and internet stores, ensuring that +our presentation and story are first class and drive purchasing at the point of sale. +We +currently sell our Crocs-branded products throughout the U.S. and in more than 90 countries. We sell our products through domestic and international retailers and distributors and +directly to end-user consumers through our webstores, company-operated retail stores, outlets and kiosks. The broad appeal of our footwear has allowed us to market our products to a wide +range of distribution channels, including department stores and traditional footwear retailers as well as a variety of specialty and independent retail channels. +Financial Highlights +During the year ended December 31, 2010, revenues increased $143.9 million, or 22.3%, compared to the same period in +2009, as a result of stronger sales in each of our geographic operating segments. Diluted earnings per share for the year ended December 31, 2010 improved to $0.76 compared to diluted losses +per share of $0.49 during the same period in 2009, primarily due to the following: +• improved global economic conditions; +• stronger global demand for our products as a result of market acceptance of our expanded product-line and more +effective marketing and merchandising programs; +• on-going investment in the growth of our retail and internet channels which have historically yielded higher +margins; and +• the residual impact of our turnaround strategy as further described below. +Turnaround Strategy +Having experienced rapid revenue growth and difficulty meeting demand for our footwear products since inception, our revenue growth +moderated in the first half of 2008 and decreased through the balance of 2008 and through the year ended December 31, 2009. During this time, our total revenues declined from +$847.4 million in the year ended December 31, 2007 to $645.8 million during the year +24 +Table of Contents +ended +December 31, 2009. Accordingly, we implemented a turnaround strategy in 2008, which continued through 2010, aimed at aligning production and distribution capacities with revised demand +projections, reducing costs and streamlining processes. As a result, we consolidated our global manufacturing facilities and distribution centers, reduced warehouse and office space, cut global +workforce by 33% and reduced other discretionary spending. During 2009, we sold excess discontinued and impaired product inventories, much of which had been written down in 2008 to a level that we had +considered realizable, at prices substantially higher than previously estimated. The consequential net effect of these sales was accretive to our gross profit in 2009. As a result of these and other +actions taken as part of our turnaround strategy, we achieved improved year-over-year gross margin in 2009 as well as improved operating margin and net loss, despite weakened +economic conditions during 2009. The benefits of our turnaround strategy continued through the year ended December 31, 2010, during which sales of discontinued and impaired product were at more +normal levels. +Presentation of Reportable Segments +We have three reportable segments: Americas, Europe and Asia. We also have an Other segment category which aggregates insignificant +operating segments that do not meet the reportable threshold. Each of our reportable segments derives its revenues from the sale of footwear, apparel and accessories. The composition of our reportable +segments is consistent with that used by our CODM to evaluate performance and allocate resources. During the fourth quarter of 2010, we changed the internal segment reports used by our CODM to +separately illustrate performance metrics of certain operating segments which provide manufacturing support, located in Mexico and Italy. These operating segments make up our Other segment category. +Segment information for all periods presented has been restated to reflect this change. +Segment +operating income (loss) is the primary measure used by our CODM to evaluate segment operating performance and to decide how to allocate resources to segments. Segment performance +evaluation is based primarily on segment results without allocating corporate expenses, or indirect general, administrative and other expenses. Segment profits or losses of our reportable segments +include adjustments to eliminate intersegment profit or losses on intersegment sales. Segment operating income (loss) is defined as operating income before asset impairment charges and restructuring +costs not included in cost of sales. Segment assets consist of cash, accounts receivable and inventory as these assets make up the asset information used by the CODM. Revenues of each of our +reportable segments represent sales to external customers. Revenues of the Other segment are made up of intersegment sales only. See Note 15—Operating Segments and Geographic +Information in the accompanying notes to the financial statements for further details. +Results of Operations +Our turnaround strategy as previously discussed had a considerable impact on our operating results for the years ended +December 31, 2010, 2009 and 2008. The following summarizes specific significant items related to the implementation of this strategy as well as other material events which should be considered +in evaluating the comparability of such results. +• Revenues and gross profit for the year ended December 31, 2009 were impacted by the effect of the sale of excess +discontinued and impaired product inventories (much of which had been written down in 2008 to a level that we had considered realizable) at prices substantially higher than previously estimated. The +net effect of these sales accretive to our gross profit during the year ended December 31, 2009 was $49.8 million. Although we were able to sell $58.3 million of this impaired +product at higher than anticipated price levels, such sales were deeply discounted and consequently drove down average selling price and revenues in 2009. During 2010 and 2008, sales of discontinued +and impaired product were at more normal levels given seasonality and historical fluctuations in our business. +25 +Table of Contents +• Cost of sales and selling, general and administrative costs for the year ended December 31, 2009 were negatively +impacted by $16.3 million due to our stock option tender offer (the "2009 Tender Offer"). In April 2009, we offered to purchase stock options with exercise prices equal to or greater than +$10.50 per share for cash from certain eligible employees in order to restore the incentive value of our long-term performance award programs and in response to the fact that the exercise +prices of a substantial number of outstanding stock options held by our employees far exceeded the market price of our common stock. As part of the 2009 Tender Offer, we repurchased 2.3 million +stock options from employees and non-employee directors and recorded a charge of $16.3 million related to previously unrecognized share-based compensation expense for these tendered +and cancelled options. Of this $16.3 million charge, $13.3 million was recorded to selling, general and administrative expenses and $3.0 million was recorded to cost of sales. +• Selling, general and administrative costs for the year ended December 31, 2009 were negatively impacted by +$3.9 million due to an error in our calculation of stock-based compensation expense for prior periods. This error resulted in an accumulated $6.0 million understatement of stock-based +compensation expense, with a corresponding understatement of additional paid in capital, of which $2.0 million was partially offset as a consequence of adjustments made pursuant to the 2009 +Tender Offer. Consequently, we recorded an additional $3.9 million in stock-based compensation during the fourth quarter of 2009 to correct the balance of this error. We do not believe that +these errors or related corrections are material to our previously issued historical consolidated financial statements for 2008 or our quarterly or annual results for 2009. +• Revenues and gross profit for the year ended December 31, 2008 were impacted by historically high sales returns and +allowances. In 2008, we received a substantial number of return and allowance requests from our wholesale customers which we believed were primarily due to wholesaler response to rapid declines in +consumer spending on a macroeconomic level as a result of the global economic downturn as well as less-than-anticipated sell-through during the spring/summer season +in 2008. We granted certain return requests and allowances to customers that we believed were strategically important to our ongoing business. Consequently, sales returns and allowances for the year +ended December 31, 2008 were significantly higher than historical estimates. However, we believed that the granting of return requests and allowances to customers in response to the severe +economic downturn was strategically important to our business. We experienced significant improvement in our sell-through in the wholesale channel during 2009 and 2010 and do not expect to +grant return requests and allowances to customers in the future to the extent that we did during 2008. +• During 2008 and 2009, the implementation of our turnaround strategy resulted in significantly higher restructuring costs +and asset impairment charges as we consolidated global distribution centers, warehouse and office space and assessed the useful life and carrying value recoverability of certain assets we no longer +intended to utilize, including molds, tooling, equipment and other assets. These costs decreased during 2010 as our turnaround strategy implementation came to an end. The portions of restructuring and +impairment related to manufacturing assets are recognized in cost of sales on the consolidated statements of operations. The portions related to non-product, non-manufacturing +assets are reflected in restructuring charges and asset impairment charges as appropriate, on the consolidated statements of operations. +26 +Table of Contents +Comparison of the Years Ended December 31, 2010 and 2009 +Year Ended +December 31, +Change +($ thousands, except per share data) +2010 +2009 +$ +% +Revenues +$ +789,695 +$ +645,767 +$ +143,928 +22.3 +% +Cost of sales +365,931 +344,806 +21,125 +6.1 +% +Gross profit +423,764 +300,961 +122,803 +40.8 +% +Selling, general and administrative expenses and foreign currency (gains)/losses +339,209 +310,927 +28,282 +9.1 +% +Restructuring charges +2,539 +7,623 +(5,084 +) +(66.7 +)% +Impairment charges +141 +26,085 +(25,944 +) +(99.5 +)% +Charitable contributions +840 +7,510 +(6,670 +) +(88.8 +)% +Income (loss) from operations +81,035 +(51,184 +) +132,219 +258.3 +% +Interest expense +657 +1,495 +(838 +) +(56.1 +)% +Other, net +(414 +) +(4,058 +) +3,644 +89.8 +% +Income (loss) before income taxes +80,792 +(48,621 +) +129,413 +266.2 +% +Income tax (benefit) expense +13,066 +(6,543 +) +19,609 +299.7 +% +Net income (loss) +$ +67,726 +$ +(42,078 +) +$ +109,804 +261.0 +% +Net income (loss) per basic share +$ +0.78 +$ +(0.49 +) +$ +1.27 +N/M +Net income (loss) per diluted share +$ +0.76 +$ +(0.49 +) +$ +1.25 +N/M +Gross margin +53.7 +% +46.6 +% +Operating margin +10.3 +% +(7.9 +)% +N/M—Not +meaningful +Revenues Revenues increased $143.9 million, or 22.3%, during the year ended December 31, 2010 compared to the same +period in 2009, due +to a 15.8% increase in unit sales and a 6.6% increase in average selling price per pair of shoes, as shown in the table below, both of which were driven by increased demand and improvements in the +global economy. During the year ended December 31, 2009, we sold $58.3 million in end of life and impaired products as we disposed of excess and impaired inventory as previously +mentioned. The following table sets forth revenue by channel and by region as well as other revenue information for the years ended December 31, 2010 and 2009. +Year ended +December 31, +Change +($ millions, except average selling price) +2010 +2009 +$ +% +Wholesale channel revenue +$ +481.8 +$ +404.5 +$ +77.3 +19.1 +% +Retail channel revenue +232.9 +180.9 +52.0 +28.7 +% +Internet channel revenue +75.0 +60.4 +14.6 +24.2 +% +Americas revenue +$ +377.1 +$ +301.4 +$ +75.7 +25.1 +% +Asia revenue +284.8 +237.5 +47.3 +19.9 +% +Europe revenue +127.7 +106.0 +21.7 +20.5 +% +Footwear unit sales +42.6 +36.8 +5.8 +15.8 +% +Average selling price +$ +17.69 +$ +16.60 +$ +1.09 +6.6 +% +Wholesale Channel Revenues During the year ended December 31, 2010, revenues from our wholesale channel grew by $77.3 million, +or +19.1%, compared to the same period in 2009, particularly +27 +Table of Contents +in +the Americas and Asia, as demand for product continued to grow resulting from a stronger global economy, on-going efforts made to improve our wholesale customer relationships and market +acceptance of our new product line. +Consumer-Direct Channel Revenues Revenues from our consumer-direct sales channels increased to 39.0% of revenue during the year ended +December 31, 2010 compared to 37.4% during the same period in 2009. As consumer-direct channel sales continue to grow as a percentage of our total sales, we expect to realize growth in total +revenues and gross margin since these channels have historically achieved higher average selling prices than the wholesale channel. +Retail Channel Revenues from our company-operated retail locations increased $52.0 million, or 28.7%, during the year ended +December 31, 2010 compared +to the same period in 2009, which was driven by the expanded availability of product to our retail customer due to the increase in retail locations where we can better merchandise the full breadth and +depth of our product line and improved pricing year over year. The table below illustrates the overall growth in the number of our company-operated retail locations as of December 31, 2010 and +2009. +As of December 31, +2010 +2009 +Change +Type: +Crocs Kiosk/Store in Store +164 +170 +(6 +) +Crocs Retail Stores +138 +84 +54 +Crocs Outlet Stores +76 +63 +13 +Total +378 +317 +61 +Geography: +Americas +197 +182 +15 +Asia +159 +119 +40 +Europe +22 +16 +6 +Internet Channel Revenues from our internet channel increased by $14.6 million, or 24.2%, primarily due to increased sales in our +Europe segment, resulting +from the addition of local language internet sites for France, Germany, Spain and Italy as well as stronger consumer demand. These increases were partially offset by revenue declines from our internet +channel in Asia where we saw a drop in demand due to prolonged cold weather and an increase in imitation products in the region, particularly in Japan. The internet channel enables us to showcase our +entire product offering directly to the consumer, which we believe to be advantageous to us in terms of sales volume and brand awareness. +Product Revenue Concentration Revenues from non-classic footwear models made up the majority of our revenues during the year ended +December 31, 2010, as our classic models and core products (defined below) have become a smaller portion of our total revenue in recent quarters. The following +28 +Table of Contents +table +sets forth sales of our classic models, core products and new footwear products as a percentage of our total unit sales. +Years Ended +December 31, +2010 +2009 +Classic models (Beach and Crocs Classic) +9.9 +% +15.8 +% +Core products(1) +19.7 +% +33.5 +% +New footwear products +31.0 +% +17.3 +% +(1) Core +products include Classic models, Kids Crocs Classic, Athens, Kids Athens, Mary Jane, Girls Mary Jane, Mammoth and Kids Mammoth. +Impact on Revenues due to Foreign Exchange Rate Fluctuations Changes in average foreign currency exchange rates during the year ended +December 31, 2010 increased revenues by $22.2 million compared to the same period in 2009. We expect that sales in international markets in foreign currencies will continue to represent +a substantial portion of our overall revenues. Accordingly, changes in foreign currency exchange rates could materially affect our overall revenues or the comparability of those revenues from period +to period as a result of translating our financial statements into our reporting currency, the U.S. dollar. +Americas Segment Revenues Revenues from the Americas segment increased $75.7 million, or 25.1%, during the year ended +December 31, 2010 +compared the same period in 2009, as a result of increased revenue in all channels. Revenues from company-operated retail locations in the region increased $35.6 million, or 33.5%, to +$141.9 million for the year ended December 31, 2010 compared to the same period in 2009 primarily due to increased unit sales resulting from an increase in the number of company-operated +retail locations in the region, as discussed above, and increases in average selling price. Regional wholesale revenues grew $34.7 million, or 23.2%, to $184.4 million for the year ended +December 31, 2010 compared to the same period in 2009 primarily due to increased unit sales. +Asia Segment Revenues Revenues in Asia increased $47.3 million, or 19.9%, during the year ended December 31, 2010 compared to +the same +period in 2009, due to increased wholesale and retail channel revenues. Regional wholesale channel revenues increased $33.3 million, or 20.0%, primarily due to continued strong demand and +improvements in average selling price. Regional revenues from company-operated retail locations increased $13.8 million, or 21.7%, to $77.3 million during the year ended +December 31, 2010 compared to the same period in 2009, due to an increases in average selling price and company-operated retail locations in the region, as discussed above, partially offset by +the negative impact of a prolonged cold weather season in parts of the region and a rise in imitation products in Japan. +Europe Segment Revenues Revenues in Europe increased $21.7 million, or 20.5%, during the year ended December 31, 2010 +compared to the +same period in 2009 which was driven by growth in all sales channels. Regional internet channel revenues increased by $8.8 million to $16.5 million during the year ended +December 31, 2010, which was more than twice the internet channel revenues earned during the same period in 2009, primarily due to the addition of local language internet sites for France, +Germany, Spain and Italy, as previously mentioned. Wholesale channel revenues increased $9.5 million, or 10.8%, to $97.7 million during the year ended December 31, 2010 compared +to the same period in 2009, due to increased demand. +29 +Table of Contents +Gross Profit During the year ended December 31, 2010 gross profit increased $122.8 million, or 40.8%, compared to the +same period in +2009. Gross margin increased 15.1% to 53.7% during the year ended December 31, 2010 compared to the same period in 2009. These increases are primarily attributable to a 15.8% increase in sales +volume, a 6.6% increase in average selling price and favorable shifts in product mix within the consumer-direct channels toward higher margin products. The increase is also attributable to a decrease +of $5.8 million in restructuring charges due to higher 2009 restructuring costs associated with the closures and consolidation our distribution spaces in the Americas and Europe segments. +Additionally, we continue to increase shipments made directly from the factories to our wholesale customers and our retail channel which lower distribution costs. We realized improvements in gross +profit during 2010 as factory-direct shipment volume increased. Offsetting these increases was the accretive effect of impaired unit sales that took place during 2009 as previously discussed. The net +effect of these sales during the year ended December 31, 2009 was $49.8 million. During 2010, retail and internet sales continued to increase as a percentage of total revenue. This trend +contributed to higher gross margins as we were able to achieve a higher average selling price in these channels while many of the fixed costs associated with operating our company-operated retail +stores are included in selling, general and administrative expenses. Also during 2010, we sold a wide range of products which required additional materials, such as canvas, cloth lining and suede, and +additional processes, such as stitching, to manufacture, thereby increasing our direct costs and lowering our gross margins on those products. As we continue to expand our portfolio and +non-classic models become a larger portion of our business, we expect that our profit margins will be adversely affected. +Impact on Gross Profit due to Foreign Exchange Rate Fluctuations Changes in average foreign currency exchange rates during the year +ended +December 31, 2010 increased our gross profit by $13.0 million compared to the same period in 2009. We expect that sales at subsidiary companies with functional currencies other than the +U.S. dollar will continue to generate a substantial portion of our overall gross profit. Accordingly, changes in foreign currency exchange rates could materially affect our overall gross profit or the +comparability of our gross profit from period to period as a result of translating our financial statements into our reporting currency, the U.S. dollar. +Selling, General and Administrative Expenses and Foreign Currency Transaction (Gains)/Losses Selling, general and administrative +expense increased +$28.3 million, or 9.1%, in the year ended December 31, 2010 compared to the same period in 2009, primarily due to: +• an increase of approximately $28.6 million in salaries, rent and other retail-related costs largely driven by the +expansion of our retail sales channel and +• an increase of approximately $15.9 million in costs related to our 2010 marketing campaign; +• which were partially offset by a decrease of $20.7 million in share-based compensation, $13.3 million of +which was due to the acceleration of share-based compensation expense from the 2009 Tender Offer; and +• an increase of $2.2 million gains on transactions denominated in foreign currencies. +Impact on Selling, General, and Administrative Expenses due to Foreign Exchange Rate Fluctuations Changes in average foreign currency +exchange rates +used to translate expenses from our functional currencies to our reporting currency, the U.S. dollar, during the year ended December 31, 2010 increased selling, general and administrative +expenses by approximately $5.0 million as compared to the same period in 2009. +Restructuring Charges We recorded $3.8 million in restructuring charges in the year ended December 31, 2010, of which +$1.3 million was recorded to cost of sales. These restructuring charges consisted of $2.0 million in severance costs related to the departure of a former Chief Executive +30 +Table of Contents +Officer, +and $1.8 million due to a change in estimate of our original accruals for lease termination costs for our Canadian office and our distribution facilities in North America and Europe. +During +the year ended December 31, 2009, we recorded $14.7 million in restructuring charges, of which $7.1 million was included in costs of sales. These charges +primarily consisted of: +• $5.6 million in costs associated with the consolidation of our warehousing, distribution and office space +worldwide; +• $3.8 million related to the termination of our manufacturing agreement with a third party in Bosnia and our +sponsorship agreement with the Association of Volleyball Professionals; +• $3.7 million in severance costs; and +• $1.1 million related to the release from further obligations under the earn-out provisions of our +acquisition of Bite, LLC. +Asset Impairment Charges During the year ended December 31, 2010, we recorded $0.1 million in impairment charges +compared to +$26.1 million in impairment charges recorded during the same period in 2009 due to the implementation of our turnaround strategy in 2009, as previously discussed. The +2009 charges primarily consisted of $18.1 million related to the write-off of obsolete molds, tooling, manufacturing and distribution equipment, sales and marketing assets and other +distribution and manufacturing assets, largely associated with the consolidation of warehouse and distribution space; and $7.6 million related to the write-off of capitalized +software, patents, trade names and other intangible assets that we no longer intended to utilize. +Segments—Operating Income (Loss) Total segment operating income increased $82.0 million, or 90.5%, during the year +ended +December 31, 2010 compared to the same period in 2009, primarily due to increased revenue in each of our operating segments and a decrease of $5.8 million in restructuring charges which +were partially offset by the accretive effect of impaired unit sales that took place during 2009, and increased costs related to the expansion of our retail selling channel and our 2010 +fully-integrated marketing campaign, as previously discussed. The following table summarizes operating income (loss) by segment for the year ended December 31, 2010 and +2009. +Year Ended December 31, +($ thousands) +2010 +2009 +Operating income (loss): +Americas +$ +67,259 +$ +21,598 +Asia +80,955 +57,836 +Europe +24,654 +11,087 +Other +(281 +) +76 +Total segment operating income (loss) +172,587 +90,597 +Corporate, intersegment eliminations and other +(88,872 +) +(108,073 +) +SG&A restructuring +(2,539 +) +(7,623 +) +Asset impairment +(141 +) +(26,085 +) +Total consolidated operating income (loss) +$ +81,035 +$ +(51,184 +) +Interest Expense Interest expense decreased $0.8 million, or 56.1%, during the year ended December 31, 2010 compared +to same period in +2009 primarily due to lower borrowing rates and lower borrowing balances under our current asset-backed credit facility. +Income Tax (Benefit) Expense Income tax expense increased $19.6 million during the year ended December 31, 2010 +compared to the same +period in 2009 which was primarily due to an increase of $129.4 million in income before taxes. Our 2010 effective tax rate of 16.2% differs from the federal +31 +Table of Contents +U.S. +statutory rate because of differences in the statutory rates of foreign subsidiaries, certain items of revenue and/or expense for which there is a permanent difference in taxability treatment for +financial reporting and tax purposes, and changes in the amount of valuation allowances resulting from changes in the company's judgments about whether certain deferred tax assets are more likely than +not to be realized. For a reconciliation between the federal U.S. statutory rate and our effective tax rate, see Note 12—Income Taxes in the accompanying notes to the consolidated +financial statements. +Comparison of the Years Ended December 31, 2009 and 2008 +Year Ended December 31, +Change +($ millions, except average selling price) +2009 +2008 +$ +% +Revenues +$ +645,767 +$ +721,589 +$ +(75,822 +) +(10.5 +)% +Cost of sales +344,806 +487,623 +(142,817 +) +(29.3 +)% +Gross profit +300,961 +233,966 +66,995 +28.6 +% +Selling, general and administrative expenses and foreign currency (gains)/losses +310,927 +366,956 +(56,029 +) +(15.3 +)% +Restructuring charges +7,623 +7,664 +(41 +) +(1.0 +)% +Asset impairment charges +26,085 +45,784 +(19,699 +) +(43.0 +)% +Charitable contributions +7,510 +1,844 +5,666 +307.3 +% +Loss from operations +(51,184 +) +(188,282 +) +137,098 +72.8 +% +Interest expense +1,495 +1,793 +(298 +) +(16.6 +)% +Gain on charitable contributions +(3,163 +) +— +(3,163 +) +N/M +Other income, net +(895 +) +(565 +) +(330 +) +(58.4 +)% +Loss before income taxes +(48,621 +) +(189,510 +) +140,889 +74.3 +% +Income tax benefit +(6,543 +) +(4,434 +) +(2,109 +) +(47.6 +)% +Net loss +$ +(42,078 +) +$ +(185,076 +) +$ +142,998 +77.2 +% +Net loss per basic share +$ +(0.49 +) +$ +(2.24 +) +$ +1.75 +78.1 +% +Net loss per diluted share +$ +(0.49 +) +$ +(2.24 +) +$ +1.75 +78.1 +% +Gross margin +46.6 +% +32.4 +% +Operating margin +(7.9 +)% +(26.1 +)% +N/M—Not +meaningful +Revenues Revenues decreased $75.8 million, or 10.5%, during the year ended December 31, 2009 as compared to same +period 2008, primarily +due to a decrease of $1.75 in average selling price which was partially offset by an increase of 1.5 million in units sold. The lower average selling price in 2009 was primarily attributable to +the sale of discontinued and impaired product which was sold at deeply discounted prices. Sales of our Jibbitz products decreased 46.6% to $25.2 million in the year ended December 31, +2009, from $47.2 million in the year ended December 31, 2008. The following table sets +32 +Table of Contents +forth +revenue by channel and by region as well as other revenue information for the years ended December 31, 2009 and 2010. +Year ended +December 31, +Change +($ millions, except average selling price) +2009 +2008 +$ +% +Wholesale channel revenue +$ +404.5 +$ +552.1 +$ +(147.6 +) +26.7 +% +Retail channel revenue +180.9 +125.8 +55.1 +43.8 +% +Internet channel revenue +60.4 +43.7 +16.7 +38.2 +% +Americas revenue +$ +301.4 +$ +365.9 +$ +(64.5 +) +(17.6 +)% +Asia revenue +237.5 +204.9 +32.6 +15.9 +% +Europe revenue +106.0 +149.3 +(43.3 +) +(29.0 +)% +Footwear unit sales +36.8 +35.3 +1.5 +4.2 +% +Average selling price +$ +16.60 +$ +18.35 +$ +(1.75 +) +(9.5 +)% +Wholesale Channel Revenues During the year ended December 31, 2009, revenues from the wholesale channel decreased by +$147.6 million, or +26.7%, compared to the same period in 2008, primarily due by weakened consumer demand in Americas and Europe business segments resulting from the global economic downturn which also caused some +retailers to choose to operate at leaner inventory levels. In addition, during the latter portion of 2009, we implemented a more disciplined wholesale approach and reduced the number of wholesalers +merchandising our product so as to better position our products in the marketplace. Wholesale channel revenues also suffered as we faced challenges selling our expanded product lines to existing +wholesale channels, weakened consumer demand for certain of our products which had reached a mature stage in their product life, and the impact of competitors entering the market with imitation +products sold at substantially lower prices. +Retail Channel Revenues During the year ended December 31, 2009, revenues from the retail channel increased $55.1 million, or +43.8%, +which was primarily driven by an increase in the number of stores as well as the fact that we are able to merchandise the full breadth and depth of our product line. The +table below sets forth information about the number of company-operated retail locations as of December 31, 2009 and 2008. +As of December 31, +2009 +2008 +Change +Type: +Crocs Kiosk/Store in Store +170 +177 +(7 +) +Crocs Retail Stores +84 +70 +14 +Crocs Outlet Stores +63 +32 +31 +Total +317 +279 +38 +Geography: +Americas +182 +157 +25 +Asia +119 +107 +12 +Europe +16 +15 +1 +Internet Channel Revenues During the year ended December 31, 2009, revenues from the internet channel increased $16.7 million, +or +38.2%, primarily due to increased web-based and other marketing efforts aimed at driving consumer awareness of our webstores as well as the launches of several new sites serving +international markets. +33 +Table of Contents +Product Revenue Concentration Revenues from non-classic footwear models made up the majority of our revenues during the year ended +December 31, 2009, as our classic models and core products (defined below) have become a smaller portion of our total revenue in recent quarters. The following table sets forth sales of our +classic models, core products and new footwear products as a percentage of our total unit sales. +Years Ended +December 31, +2009 +2008 +Classic models (Beach and Crocs Classic) +16 +% +25 +% +Core products(1) +33 +% +57 +% +New 2009 footwear products +17 +% +— +(1) Core +products include Classic models, Kids Crocs Classic, Athens, Kids Athens, Mary Jane, Girls Mary Jane, Mammoth and Kids Mammoth. +Impact on Revenues due to Foreign Exchange Rate Fluctuations Changes in average foreign currency exchange rates during the year ended +December 31, 2009 decreased revenues by $14.9 million compared to the same period in 2008. We expect that sales in international markets in foreign currencies will continue to represent +a substantial portion of our overall revenues. Accordingly, changes in foreign currency exchange rates could materially affect our overall revenues or the comparability of those revenues from period +to period as a result of translating our financial statements into our reporting currency, the U.S. dollar. +Americas Segment Revenues Revenues from the Americas segment decreased $64.5 million, or 17.6%, during the year ended +December 31, 2009 +compared the same period in 2008, which was largely driven by lower regional wholesale channel sales, partially offset by higher regional retail and internet channel sales. The net decrease in +revenues was primarily due to weakened consumer demand resulting from deteriorated U.S. economic conditions, the challenges of selling our expanded product line, lessened demand for our more mature +core products, and by sales of deeply discounted end of life and impaired units. See "Financial Highlights" above. In 2009, we implemented plans to re-invigorate the region's wholesale +channel revenues, which included investments in cooperative advertising and merchandising assistance for select locations at our largest U.S. wholesale accounts. Revenue from company-operated retail +locations in the Americas increased $37.6 million, or 54.7%, to $106.3 million in the year ended December 31, 2009, from $68.7 million for the year ended +December 31, 2008. +During +the year ended December 31, 2009, sales returns and allowances, which are included as a net adjustment to revenue, decreased $24.6 million, or 59.1%, to +$17.0 million in the year ended December 31, 2009 from $41.6 million for the year ended December 31, 2008 which was primarily due to a higher 2008 balance, when, in light +of then-prevailing economic conditions, we granted certain return requests and allowances to a number of customers it believed were strategically important to our ongoing business. Sales +returns and allowances for the year ended December 31, 2008 were significantly higher than historical estimates as a result of specific reserves related to those granted return and allowance +requests. +Asia Segment Revenues Revenues in Asia increased $32.6 million, or 15.9%, during the year ended December 31, 2009 +compared to the same +period in 2008, as a result of strong demand in all channels, particularly in the wholesale and retail channels, partially offset by a lower average selling price resulting from the sales of +lower-priced end of life and impaired units, as discussed in "Recent Events" above. Revenues from company-operated retail locations in Asia increased $13.7 million, or 27.5%, to +$63.6 million in the year ended December 31, 2009, from $49.9 million for the year ended December 31, 2008. +34 +Table of Contents +We +experienced a decline in sales returns and allowances of $6.9 million, or 43.4%, to $9.0 million in the year ended December 31, 2009 from $15.9 million for +the year ended December 31, 2008. The decrease in sales returns and allowances is primarily related to a higher 2008 balance, when management, in light of then-prevailing economic +conditions, granted certain returns and allowances to some of our wholesale customers to properly balance their portfolios of our products with respect to size, color and style. +Europe Segment Revenues Revenues in Europe decreased $43.3 million, or 29.0%, during the year ended December 31, 2009 +compared to the +same period in 2008 due to a decline in regional wholesale revenues resulting from weakened consumer demand due to regional economic conditions and an increased number of imitation products in the +region. This decrease was partially offset by increased revenues from our company-operated retail locations, partially driven by an additional retail location, and an increase in revenue from our +internet channel. Revenue from company-operated retail locations was $11.0 million in the year ended December 31, 2009 versus $7.2 million for the year ended December 31, +2008. +Sales +returns and allowances, which are recorded as a net adjustment to revenue, decreased $18.6 million, or 71%, to $7.6 million in the year ended December 31, 2009 +from $26.2 million in the year ended December 31, 2008, due to a higher 2008 balance, when, in light of then-prevailing economic conditions, we granted certain return +requests and allowances to a number of customers it believed were strategically important to our ongoing business. Sales returns and allowances for the year ended December 31, 2008 were +significantly higher than historical estimates as a result of specific reserves related to those granted return and allowance requests. +Gross Profit During the year ended December 31, 2009, gross profit increased $67.0 million, or 28.6%, compared to the +same period in +2008. Gross margin increased 43.8% to 46.6% during the year ended December 31, 2009 compared to the same period in 2008. During 2009, we sold $58.3 million of impaired product as +previously discussed in "Financial Highlights." Much of this product had been written down to a level that we considered realizable; however, we were able to sell this product at prices substantially +higher than what we had previously estimated. The gross profit amount related to these units was accretive to our gross profit percentage during the year ended December 31, 2009. The net effect +of these sales on our gross profit during the year ended December 31, 2009 was $49.8 million. During 2009, we also experienced an increase in retail and internet sales as a percentage of +our total revenue. This trend contributed to higher gross margins as we were able to achieve a higher average selling price in these channels while many of the fixed costs associated with operating +our company-operated retail stores are included in selling, general and administrative expenses. +Partially +offsetting these increases in gross profit were restructuring charges of $7.1 million associated with the consolidation of our warehouse and distribution space and +cancellation of our warehousing agreement. See "Restructuring" below for further discussion. In addition, as a result of the 2009 Tender Offer, we recognized $3.0 million in additional +share-based compensation expense through cost of sales during 2009. Also, during 2009, we sold a wide range of products which required additional materials, such as canvas, cloth lining and suede, and +additional processes, such as stitching, to manufacture, thereby increasing our direct costs and lowering our gross margins on those products. By comparison, during 2008, we recorded charges of +$76.3 million related to inventory write-downs and $4.2 million related to losses on future purchase commitments. We also recorded $0.9 million in restructuring costs in cost of +sales as a result of the closure of our Canadian manufacturing operation. +Impact on Gross Profit due to Foreign Exchange Rate Fluctuations Changes in average foreign currency exchange rates during the year +ended +December 31, 2009 decreased our gross profit by $4.4 million compared to the same period in 2008. +35 +Table of Contents +Selling, General and Administrative Expenses and Foreign Currency Transaction (Gains)/Losses During the 2009 and 2008, we took +certain actions to +reduce our selling, general and administrative expenses. Those actions included, but were not limited to, reductions in certain discretionary spending such as the discontinuation of certain +sponsorship and consulting arrangements. Selling, general and administrative expense and foreign currency transaction losses decreased $56.0 million, or 15.3%, in the year ended +December 31, 2009 compared to the same period in 2008, which was primarily attributable to the following: +• a decrease of $27.9 million in advertising and marketing expense of which $11.1 million was related to +corporate sponsorships and $16.8 million was related to advertising expenses, as we exited corporate sponsorships and changed our approach to marketing our products towards a more integrated, +consumer-focused program; +• a decrease of $24.1 million in legal expense; +• an increase of $26.1 million in net gains on changes in currency exchange rates for transactions denominated, and +settled or to be settled, in a currency other than the functional currency of the consolidated entity; +• which were partially offset by increases in stock compensation due to the 2009 Tender Offer of $13.3 million and +$4.5 million due to the equity accounting software error, as previously discussed, +• an increase of $7.4 million in rent expense; and +• an increase of $4.1 million in salaries and wages. +Impact on Selling, General, and Administrative Expenses due to Foreign Exchange Rate Fluctuations Changes in average foreign currency +exchange rates +used to translate expenses from our functional currencies to our reporting currency, the U.S. dollar, during the year ended December 31, 2010 decreased selling, general and administrative +expenses by approximately $4.0 million as compared to the same period in 2009. +Restructuring Charges During the years ended December 31, 2009 and 2008, we incurred restructuring charges as a result of +our turnaround +strategy, previously discussed in "Financial Highlights." Specifically, we recorded $14.7 million in restructuring charges in the year ended December 31, 2009, of which +$7.1 million was reflected in cost of sales and which primarily consisted of: +• $5.6 million related to the termination of operating leases and other costs associated with the consolidation of +our warehousing, distribution and office space worldwide; +• $3.8 million related to the termination of our manufacturing agreement with a third party in Bosnia and our +sponsorship agreement with the Association of Volleyball Professionals; +• $3.7 million in severance costs; and +• $1.1 million related to the release from further obligation under the earn-out provisions of our +acquisition of Bite, LLC. +In +2008, we recorded $8.5 million in restructuring charges related to the closure of our facilities in Canada and Brazil, $7.6 million of which was recorded in +restructuring charges and $0.9 million of which was reflected in cost of sales. +We +established reserves covering future known obligations related to the consolidation of our global distribution facilities. Reserves at December 31, 2009 were +$3.1 million and have been included in the line items accrued restructuring charges and other liabilities in our consolidated balance sheets. +36 +Table of Contents +Asset Impairment Charges During the years ended December 31, 2009 and 2008, we incurred asset impairment charges as a +result of our turnaround +strategy, previously discussed in "Financial Highlights." The $26.1 million impairment charges recorded in 2009 primarily consisted of: $18.1 million related to the write-off +of obsolete molds, tooling, manufacturing and distribution equipment, sales and marketing assets and other distribution and manufacturing assets, primarily associated with the consolidation of +warehouse and distribution space as well as other cost-savings initiatives undertaken during the year; and $7.6 million related to the write-off of capitalized software, +patents, trade names and other intangible assets that we no longer intend to utilize. +The +$45.8 million impairment charges recorded in 2008 primarily consisted of: $20.9 million related to the write-down of fixed assets, primarily related to +equipment and shoe molds for shoes we no longer intended to manufacture or styles for which we had more molds on hand than necessary to meet projected demand; and $23.8 million related to the +write-off of goodwill and other indefinite lived intangible assets, see Note 4—Intangible assets in the accompanying notes to the consolidated financial statements for +additional information. +Segments Operating Margin. Total segment operating income increased $116.2 million during the year ended December 31, +2009 compared to +the same period in 2008. The following table summarizes operating income (loss) by segment for the year ended December 31, 2009 and 2008. +Year Ended December 31, +($ thousands) +2009 +2008 +Operating loss: +Americas +$ +21,598 +$ +(38,430 +) +Asia +57,836 +16,634 +Europe +11,087 +2,703 +Other +76 +(6,480 +) +Total segment operating income (loss) +90,597 +(25,573 +) +Corporate, intersegment eliminations and other +(108,073 +) +(109,261 +) +SG&A restructuring +(7,623 +) +(7,664 +) +Asset impairment +(26,085 +) +(45,784 +) +Total consolidated operating loss +$ +(51,184 +) +$ +(188,282 +) +During +2008, the operating loss in our Americas segment was driven primarily inventory write-downs and excess capacity in our company-operated manufacturing and distribution facilities. +In addition, we experienced foreign currency exchange losses related to fluctuations in the Canadian dollar, Mexican peso and Brazilian real in 2008. During 2009, we implemented a plan to reduce and +consolidate our global warehouse footprint, which increased our Americas gross margin compared to 2008, and we experienced declines in marketing and advertising expenses as we exited corporate +sponsorships and changed our approach to marketing our products. +During +2008, our Asia operating income was affected by foreign exchange losses and inventory impairments. In 2009, we experienced higher gross margins in Asia, driven largely by growth +in our Asia retail channel as well as an overall increase in total revenues from the Asia segment. We also experienced an increase in gains from fluctuations in foreign currency exchange rates during +2009 in our Asia segment. +During +2008, our Europe operating income was affected by foreign exchange losses and inventory impairments. In 2009, we experienced higher gross margins in Europe as a result of the +reduction and consolidation of our global warehouse and distribution footprint; however, these higher margins were achieved at lower sales volumes. We also experienced a lower loss from fluctuations +in foreign currency exchange rates during 2009 in our Europe segment. +37 +Table of Contents +Interest Expense Interest expense decreased $0.3 million, or 16.6%, during the year ended December 31, 2009 when +compared to the same +period in 2008 which was primarily driven by lower debt balances which was partially offset by higher interest rates year over year as well as additional interest expense on a new capitalized lease +obligation which financed certain equipment and internally developed software during 2009. +Income Tax Benefit During the year ended December 31, 2009, we recognized an income tax benefit of $6.5 million on a +pre-tax loss of $48.6 million, compared to income tax benefit of $4.4 million on pre-tax loss of $189.5 million for the year ended December 31, +2008. The effective tax benefit rate was 13.5% during the year ended December 31, 2009 compared to 2.3% during the year ended December 31, 2008, primarily due to the impact of +restructuring our international operations and cost-sharing arrangements. +Liquidity and Capital Resources +At December 31, 2010, we had $145.6 million in cash and cash equivalents. We anticipate that cash flows from operations +will be sufficient to meet the ongoing needs of our business for the next 12 months. In order to provide additional liquidity in the future and to help support our strategic goals, we also have +an asset-backed revolving credit facility with PNC Bank, N.A. ("PNC") (further discussed below), which provides us with up to $30.0 million in borrowings and matures on September 24, +2014. Additional future financing may be necessary; however, due to current macroeconomic conditions and their affect on the global credit markets, there can be no assurance that we will be able to +secure additional debt or equity financing on terms acceptable to us or at all. +Credit Facility +On September 30, 2010, we amended our Revolving Credit and Security Agreement with PNC, originally dated September 25, +2009, (the "Credit Agreement"). Based on the amended terms, the Credit Agreement provides for an asset-backed revolving credit facility (the "Credit Facility") of up to $30.0 million in total, +which includes a $20.0 million sublimit for borrowings against our eligible inventory, a $2 million sublimit for borrowings against our eligible inventory in-transit, and a +$10 million sublimit for letters of credit, and matures on September 24, 2014. Total borrowings available under the Credit Facility at any given time are subject to customary reserves +and reductions to the extent our asset borrowing base changes. Borrowings under the Credit Facility are secured by all of our assets including all receivables, equipment, general intangibles, +inventory, investment property, subsidiary stock and leasehold interests. The terms of the Credit Agreement require us to prepay borrowings in the event of certain dispositions of property. With +respect to domestic rate loans, principal amounts outstanding bear interest at 1.5% plus the greater of either (i) PNC's published reference rate, (ii) the Federal Funds Open Rate (as +defined in the Credit Agreement) in effect on such day plus 0.5% or, (iii) the sum of the daily LIBOR rate and 1.0%. Eurodollar denominated principal amounts outstanding bear interest at 3.0% +plus the Eurodollar rate (as defined in the Credit Agreement). The Credit Agreement requires monthly interest payments with respect to domestic rate loans and at the end of each interest period with +respect to Eurodollar rate loans and contains certain customary restrictive and financial covenants. We were in compliance with these financial covenants as of December 31, 2010. As of +December 31, 2010 and 2009, we had an immaterial amount of outstanding borrowings under the Credit Facility. At December 31, 2010 and 2009, we had issued and outstanding letters of +credit of $1.0 million and $1.1 million, respectively, which were reserved against the borrowing base. +Working Capital +As of December 31, 2010, accounts receivable increased $13.8 million when compared to December 31, 2009, primarily +due to higher sales in the fourth quarter of 2010 compared to the fourth +38 +Table of Contents +quarter +of 2009. Days sales outstanding improved slightly to 33.0 at December 31, 2010 compared to 34.1 at December 31, 2009. +Inventories +increased $27.8 million as of December 31, 2010 when compared to December 31, 2009, due to multiple factors including: the growth associated with the +addition of 61 new retail locations; the addition of component raw material inventory, as we continue to manufacture more of our hybrid product which provides savings on costs incurred with importing +these products from China; and a significant increase in order backlog. +Capital Assets +During the years ended December 31, 2010 and 2009, we had net capital expenditures of $43.8 million and +$24.6 million, respectively. The $19.2 million increase in net capital expenditures was primarily due to ongoing investments in new retail stores as well as new molds and other tooling +equipment related to new product manufacturing. +We +have entered into various operating leases that require cash payments on a specified schedule. Over the next five years we are committed to make payments of approximately +$153.9 million related to our operating leases. We plan to continue to enter into operating leases related to our retail stores. We also continue to evaluate cost reduction opportunities. Our +evaluation of cost reduction opportunities will include an evaluation of contracts for sponsorships, operating lease contracts and other contracts that require future minimum payments resulting in +fixed operating costs. Any changes to these contracts may require early termination fees or other charges that could result in significant cash expenditures. +Repatriation of Cash +We are a global business with operations in many different countries, which requires cash accounts to be held in various currencies. +The global market has recently experienced many fluctuations in foreign currency exchange rates which impacts our results of operations and cash positions. The future fluctuations in foreign +currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries have additional restrictions and covenants associated with them, which adds +increased strains on our liquidity and ability to timely access and transfer cash balances between entities. +We +generally consider unremitted earnings of subsidiaries operating outside of the U.S. to be indefinitely reinvested and it is not our current intent to change this position. However, +most of the cash held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal and state income taxes, less applicable foreign tax credits. In some +countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. Certain countries, including +China, have monetary laws which may limit our ability to utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully utilize our cash +resources for needs in the U.S. or other countries and may adversely affect our liquidity. As of December 31, 2010, we held $135.0 million of our total $145.6 million in cash in +international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the $135.0 million, $32.2 million could +potentially be restricted, as described above. If the remaining $102.8 million were to be repatriated to the U.S., we would be required to pay approximately $6.8 million in international +withholding taxes with no offsetting credit. We believe that we have sufficient U.S. net operating losses ("NOLs") to absorb any future increases to U.S. taxable income (and therefore, U.S. federal +income tax) brought about by potential cash repatriation up to the lesser of the total U.S. NOL balances or the current foreign subsidiaries' earnings. There are full valuation allowances on the NOLs +that would be released to result in no tax effect or cash tax payments for the +39 +Table of Contents +U.S. +up to the aforementioned limitation. As of December 31, 2010, we anticipate repatriating approximately $50.0 million of foreign subsidiary earnings in 2011 and the release of +$17.5 million in NOL valuation allowances. +Contractual Obligations and Off-Balance Sheet Arrangements +In February 2011, we renewed and amended our supply agreement with Finproject S.r.l. which provides us the exclusive right to +purchase certain raw materials used to +manufacture our products. The agreement also provides that we meet minimum purchase requirements to maintain exclusivity throughout the term of the agreement, which expires December 31, 2014. +Historically, the minimum purchase requirements have not been onerous and we do not expect them to become onerous in the future. Depending on the material purchased, pricing is either based on +contracted price or is subject to quarterly reviews and fluctuates based on order volume, currency fluctuations and raw material prices. Pursuant to the agreement, we guarantee the payment for certain +third-party manufacturer purchases of these raw materials up to a maximum potential amount of €3.5 million (approximately $4.6 million as of December 31, 2010), +through a letter of credit that was issued to Finproject S.r.l.. +The +following table summarizes aggregate information about our contractual cash obligations as of December 31, 2010, excluding the guarantee and supply agreement mentioned above. +Payments due by period +($ thousands) +Total +Less than +1 year +1 - 3 +years +4 - 5 +years +More than +5 years +Operating lease obligations +$ +220,083 +$ +48,891 +$ +64,454 +$ +40,587 +$ +66,151 +Inventory purchase obligations with third-party manufacturers +84,121 +84,121 +— +— +— +Estimated liability for uncertain tax positions +33,042 +— +25,988 +4,181 +2,873 +Capital lease obligations +2,643 +1,923 +713 +7 +— +Minimum licensing royalties +458 +311 +147 +— +Corporate sponsorships +140 +95 +45 +— +— +Long-term debt obligations +3 +3 +— +— +— +Total +$ +340,490 +$ +135,344 +$ +91,347 +$ +44,775 +$ +69,024 +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of operations is based on the consolidated financial statements which +have been prepared in accordance +with United States generally accepted accounting principles ("GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of +assets, liabilities and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our assumptions and +estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of +which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under +different assumptions or conditions. The following discussion pertains to accounting policies management believes are most critical to the portrayal of our financial condition and results of +operations that require management's most difficult, subjective or complex judgments. +Reserves for Uncollectible Accounts Receivable We make ongoing estimates related to the collectability of our accounts +receivable and maintain a +reserve for estimated losses resulting from the inability of our customers to make required payments. Our estimates are based on a variety of factors, +40 +Table of Contents +including +the length of time receivables are past due, economic trends and conditions affecting our customer base, significant one-time events and historical write-off +experience. Specific provisions are recorded for individual receivables when we become aware of a customer's inability to meet its financial obligations. Since we cannot predict future changes in the +financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates and we may experience changes in the amount of reserves we recognize for accounts +receivable that we deem uncollectible. If the financial condition of some of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In +the event we determine that a smaller or larger reserve is appropriate, we would record a credit or a charge to selling, general and administrative expenses in the period in which we made such a +determination. +Sales Returns, Allowances and Discounts We record reductions to revenue for estimated customer returns, allowances and +discounts. Our estimated sales +returns and allowances are based on customer return history and actual outstanding returns yet to be received. Provisions for customer specific discounts based on contractual obligations with certain +major customers are recorded as reductions to net sales. We may accept returns from our wholesale and distributor customers, on an exception basis at the sole discretion of management for the purpose +of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, at the sole discretion of management, we may provide markdown allowances to key +wholesale and distributor customers to facilitate the "in-channel" markdown of products where we have experienced less than anticipated sell-through. We also record reductions +to revenue for estimated customer credits as a result of price mark-downs in certain markets. Fluctuations in our estimates for sales returns, allowances and discounts may be caused by +many factors, including, but not limited to, fluctuations in our sales revenue, changes in demand for our products. Our judgment in determining these estimates is impacted by various factors including +customer acceptance of our new styles, +customer inventory levels, shipping delays or errors, known or suspected product defects, the seasonal nature of our products and macroeconomic factors affecting our customers. Since we cannot predict +or control certain of these factors, the actual amounts of customer returns and allowances may differ from our estimates. +Inventory Valuation Inventories are valued at the lower of cost or market. Inventory cost is determined using the moving average +cost method. At +least quarterly, we evaluate our inventory for possible impairment using standard categories to classify inventory based on the degree to which we believe that the products may need to be discounted +below cost to sell within a reasonable period. We base inventory fair value on several subjective and unobservable assumptions including estimated future demand and market conditions, as well as other +observable factors such as current sell-through of our products, recent changes in demand for our product as well as shifting demand between the products we offer, global and regional +economic conditions, historical experience selling through liquidation and "off-price" channels and the amount of inventory on hand. If the estimated inventory fair value is less than its +carrying value, the carrying value is adjusted to market value and the resulting impairment charge is recorded in cost of sales on the consolidated statements of operations. The ultimate results +achieved in selling excess and discontinued products in future periods may differ significantly from management's fair value estimates. See Note 2—Inventories in the accompanying +notes to the consolidated financial statements for additional information regarding inventory and impaired product. +Impairment of Long-Lived Assets We test long-lived assets to be held and used for impairment when events or circumstances +indicate the carrying value of a long-lived asset may not be fully recoverable. Events that may indicate the impairment of a long-lived asset (or asset group, as defined below) +include; (i) a significant decrease in its market price, (ii) a significant adverse change in the extent or manner in which it is being used or in its physical condition, (iii) a +significant adverse change in legal factors or business climate that could affect its value, including an adverse action or assessment by a regulator, (iv) an accumulation of costs +significantly in excess of the amount originally expected for its acquisition or construction, (v) its current period operating or cash flow losses combined with +41 +Table of Contents +historical +operating or cash flow losses or a forecast of its cash flows demonstrate continuing losses associated with its use, and (vi) a current expectation that, more likely than not, it +will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. If such facts indicate a potential impairment of a long-lived asset (or asset +group), we assess the recoverability by determining if its carrying value exceeds the sum of its projected undiscounted cash flows expected to result from its use and eventual disposition over its +remaining economic life. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Fair value is determined by independent third-party appraisals, the +net present value of expected cash flows, or other valuation techniques as appropriate. Assets to be abandoned or from which no further benefit is expected are written down to zero at the time that +the determination is made and the assets are removed entirely from service. +An +asset group is the lowest level of assets and liabilities for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Beginning in +2009, we determined that the lowest level of assets and liabilities for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities is at the retail store +level for assets involved in our retail business. Our estimates of future cash flows over the remaining useful life of the asset group are based on management's operating budgets and forecasts. These +budgets and forecasts take into consideration inputs from our regional management related to growth rates, pricing, new markets and other factors expected to affect the business, as well as +management's forecasts for inventory, receivables, capital spending, and other cash needs. These considerations and expectations are inherently uncertain, and estimates included in our operating +forecasts beyond a three to six month future period are extremely subjective. Accordingly, actual cash flows may differ significantly from our estimated future cash flows. +Impairment +charges are driven by, among other things, changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product or +shifting demand between different products we offer and other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived +assets and result in impairment charges in future periods. Significant impairment charges recognized during a reporting period could have an adverse affect on our reported financial results +Impairment of Intangible Assets Goodwill and intangible assets with indefinite lives are evaluated for impairment when events or +changes in +circumstances indicate that the carrying value may not be fully recoverable and at least annually. Intangible assets that are determined to have definite lives, such as customer relationships, core +technology, capitalized software, patents and non-compete agreements are amortized over their useful lives and are evaluated for impairment only when events or circumstances indicate a +carrying value may not be fully recoverable. Recoverability is based on the estimated future undiscounted cash flows of an asset. If the asset is not supported on an undiscounted cash flow basis, the +amount of impairment is measured as the difference between its carrying value and its fair value. Determination of the fair value of goodwill and other indefinite-lived intangible asset involves a +number of management assumptions including the expected future operating performance of our reporting units which may change in future periods due to technological changes, economic conditions, +changes to our business operations, or the inability to meet business plans, among other things. The valuation is sensitive to the actual results of any of these uncertain factors which could be +negatively affected and may result in additional impairment charges should the actual results differ from management's estimates. See Note 4—Intangible Assets, in the accompanying +notes to the consolidated financial statements for additional information regarding our intangible assets. +Share-Based Compensation We estimate the fair value of our stock option awards using a Black-Scholes valuation model, the inputs +of which require +various assumptions including the expected volatility of our stock price and the expected life of the option. The expected volatility assumptions are derived using our historical stock price +volatility and the historical volatilities of competitors whose shares are traded in the public markets. These assumptions reflect our best estimates, but they involve +42 +Table of Contents +inherent +uncertainties based on market conditions generally outside of our control. If factors change and we use a different methodology for deriving the Black-Scholes assumptions, our stock-based +compensation expense may differ materially in the future from that recorded in the current period. Additionally, we make certain estimates about the number of awards which will be made under +performance-based incentive plans. As a result, if other assumptions or estimates had been used, stock-based compensation expense could have been materially impacted. Furthermore, if we use different +assumptions in future periods, stock-based compensation expense could be materially impacted in future periods. See Note 9—Equity in the accompanying notes to the consolidated +financial statements for additional information regarding our stock-based compensation. +Income Taxes We account for income taxes using the asset and liability method which requires the recognition of deferred tax +assets and liabilities +for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future +enacted tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and +disclosures regarding uncertainties in income tax positions. The impact of an uncertain tax position that is more likely than not of being sustained upon examination by the relevant taxing authority +must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of +being sustained. Interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a matter of tax law, the body of +statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. +Our +annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is +required in determining our annual tax expense and in evaluating our tax positions. Tax laws require items to be included in our tax returns at different times than when these items are reflected in +the consolidated financial statements. As a result, the annual tax rate reflected in our consolidated financial statements is different than that reported in our tax return (our cash tax rate). Some +of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These timing differences create +deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax basis of assets and liabilities. The tax +rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year in which the differences are expected to reverse. Based on the evaluation of all available +information, we recognize future tax +benefits, such as net operating loss carry forwards, to the extent that realizing these benefits is considered more likely than not. +We +evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating +results, the reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to +be established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred tax asset. Undistributed earnings of a subsidiary +are accounted for as a temporary difference, except that deferred tax liabilities are not recorded for undistributed earnings of a foreign subsidiary that are deemed to be indefinitely reinvested in +the foreign jurisdiction. We have operated under a specific plan for reinvestment of undistributed earnings of our foreign subsidiaries which demonstrates that such earnings will be indefinitely +reinvested in the applicable tax jurisdictions. Should we change our plans, we would be required to record a significant amount of deferred tax liabilities. We recognize interest and penalties related +to unrecognized tax benefits within the income +43 +Table of Contents +tax +expense line in the accompanying consolidated statement of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheets. +Recent Accounting Pronouncements See Note 1—Summary of Significant Accounting Policies in the accompanying notes to the +consolidated financial statements for recently adopted accounting pronouncements. +ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +Our exposure to market risk includes interest rate fluctuations in connection with our revolving credit facility, see +Note 8—Notes Payable and Capital Lease Obligations in the accompanying notes to the consolidated financial statements for additional +information. Borrowings under the revolving credit facility bear interest at variable rates which are based on either the lender's published rate, the Federal Funds Open Rate, LIBOR or the Eurodollar +Rate (as defined in the revolving credit facility), and are subject to risk based upon prevailing market interest rates. Interest rate risk may result from many factors, including governmental +monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control. As of December 31, 2010, the amount of total +borrowings outstanding under the revolving credit facility was immaterial. If the prevailing market interest rates relative to these borrowings increased by 10%, our interest expense during the year +ended December 31, 2010 would have increased by $0.1 million. +Fluctuations +in the prevailing market interest rates, earned on our cash and cash equivalents and restricted cash balances during the year ended December 31, 2010, would have an +immaterial impact on the consolidated statements of operations. +Foreign Currency Exchange Risk +We have significant revenues from foreign sales in recent periods. While the majority of expenses attributable to our foreign +operations are paid in the functional currency of the country in which such operations are conducted, we pay the majority of our overseas third-party manufacturers in U.S. dollars. Our ability to sell +our products in foreign markets and the U.S. dollar value of the sales made in foreign currencies can be significantly influenced by foreign currency fluctuations. A decrease in the value of foreign +currencies relative to the U.S. dollar could result in downward price pressure for our products and increase losses from currency exchange rates. A decrease of 1% in value of U.S. dollar relative to +foreign currencies would have increased income before taxes during the year ended December 31, 2010 by approximately $2.6 million. The volatility of the applicable exchange rates is +dependent on many factors that cannot be forecasted with reliable accuracy. In the event our foreign sales and purchases increase and are denominated in currencies other than the U.S. dollar, our +operating results may be affected by fluctuations in the exchange rate of currencies we receive for such sales. See Item 7, "Management's Discussion and Analysis of Financial Condition and +Results of Operations," for a discussion of the impact of foreign exchange rate variances experienced during the year ended December 31, 2010. +We +enter into foreign currency exchange forward contracts to reduce our exposure to changes in exchange rates. As of December 31, 2010, the total notional value of outstanding +foreign currency exchange forward contracts was $12.3 million. The following table summarizes the notional amounts of the outstanding derivatives at December 31, 2010 (in thousands). The +notional amounts of the +44 +Table of Contents +derivative +financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the foreign currency exchange risks. +Currency Purchased +Currency Sold +Maturity Date +Contract Type +USD +2,000 +JPY +162,960 +January 2011 +Foreign currency exchange forward +USD +2,000 +JPY +161,940 +February 2011 +Foreign currency exchange forward +USD +2,000 +JPY +161,920 +March 2011 +Foreign currency exchange forward +USD +1,752 +EUR +1,300 +February 2011 +Foreign currency exchange forward +USD +1,751 +EUR +1,300 +March 2011 +Foreign currency exchange forward +USD +952 +GBP +600 +February 2011 +Foreign currency exchange forward +USD +952 +GBP +600 +March 2011 +Foreign currency exchange forward +USD +481 +GBP +300 +January 2011 +Foreign currency exchange forward +USD +418 +EUR +300 +January 2011 +Foreign currency exchange forward +ITEM 8. Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the "Index to Consolidated Financial Statements" on +page 52. +ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Acting Principal +Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and +15d-15(e) under the Exchange Act, as of December 31, 2010 (the "Evaluation Date"). Based on this evaluation, our Chief Executive Officer and Acting Principal Financial Officer +concluded that as of the Evaluation Date, our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be +disclosed in our Securities and Exchange Commission ("SEC") reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and +(ii) is accumulated and communicated to our management, including our Chief Executive Officer and Acting Principal Financial Officer, as appropriate to allow timely decisions regarding required +disclosure. +Management's Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange +Act Rules 13a-15(f) and 15d-15(f). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2010, using the +criteria set forth in the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway +Commission (COSO). Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2010. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued a report on our internal control over financial reporting, which is included herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially +affected, or is reasonable likely to materially affect, our internal control over financial reporting. +45 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2010, based on criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's +management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the +accompanying "Management's Annual Report on Internal Control Over Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial reporting based on +our audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control +over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or +persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting +and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those +policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material +misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to +future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In +our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year +ended December 31, 2010 of the Company and our report dated February 25, 2011 expressed an unqualified opinion on those financial statements. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +February 25, 2011 +46 +Table of Contents +ITEM 9B. Other Information +None. +PART III +ITEM 10. Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2011 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2010. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer, principal +financial officer and controller. A copy of our business code of conduct and ethics policy is available on our website: www.crocs.com. We are required to disclose any change to, or waiver from, our +code of ethics for our senior financial officers. We intend to use our website as a method of disseminating any change to, or waiver from, our business code of conduct and ethics policy as permitted +by applicable SEC rules. +ITEM 11. Executive Compensation +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2011 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2010. +ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2011 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2010, with the exception of those items listed below. +ITEM 13. Certain Relationships and Related Transactions, and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2011 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2010. +ITEM 14. Principal Accountant Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2011 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2010. +47 +Table of Contents +PART IV +ITEM 15. Exhibits and Financial Statement Schedules +(1) Financial Statements +The financial statements filed as part of this report are listed on the index to financial statements on page 52. +(2) Financial Statement Schedules +All financial statement schedules have been omitted because they are not required, are not applicable or the information is included in the Financial Statements +or Notes thereto. +(3) Exhibit list +Exhibit +Number +Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 +(File No. 333-132312)). +3.1 +Certificate of Amendment to Restated Certificate of Incorporate of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc. Current Report on Form 8-K, filed on July 12, +2007). +3.2 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-8, filed on March 9, 2006 (File No. 333-132312)). +4.1 +Specimen common stock certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.'s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +10.1 +* +Form of Indemnity Agreement between Crocs, Inc. and each of its directors and executive officers (Incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Registration Statement on Form S-1, +filed on August 15, 2005 (File No. 333-127526)). +10.2 +* +Crocs, Inc. 2005 Equity Incentive Plan (the "2005 Plan") (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.3 +* +Amendment No.1 to the 2005 Plan (incorporated herein by reference to Exhibit 10.2.2 to Crocs, Inc.'s Registration Statement on Form S-1/A, filed on January 19, 2006 (File No. 333-127526)). +10.4 +* +Form of Notice of Grant of Stock Option under the 2005 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.5 +* +Form of Notice of Grant of Stock Option for Non-Exempt Employees under the 2005 Plan (incorporated herein by reference to Exhibit 10.4 to Crocs, Inc.'s Registration Statement on Form S-1, filed on +August 15, 2005 (File No. 333-127526)). +10.6 +* +Form of Stock Purchase Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.5 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +48 +Table of Contents +Exhibit +Number +Description +10.7 +* +Form of Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.6 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.8 +* +Form of Restricted Stock Award Grant Notice under the 2005 Plan (incorporated herein by reference to Exhibit 10.7 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.9 +* +Form of Restricted Stock Award Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.8 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.10 +* +Form of Non Statutory Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.9 to Crocs, Inc.'s Registration Statement on Form S-1, filed on August 15, 2005 (File +No. 333-127526)). +10.11 +*†† +Crocs, Inc. 2010 Board of Directors Compensation Plan. +10.12 +* +Crocs, Inc. Amended and Restated 2007 Senior Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.15 to Crocs, Inc.'s Annual Report on Form 10-K, filed on March 17, +2009). +10.13 +† +Amended and Restated Agreement for Supply, dated July 26, 2005, between Finproject S.p.A. and Crocs, Inc. (incorporated herein by reference to Exhibit 10.21 to Crocs, Inc.'s Registration Statement +on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.14 +* +2008 Cash Incentive Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 12, 2007). +10.15 +* +2007 Equity Incentive Plan (the "2007 Plan") (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Current Report on Form 8-K, filed on July 12, 2007). +10.16 +* +Form of Incentive Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.17 +* +Form of Non-Statutory Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on November 14, +2007). +10.18 +* +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on +November 14, 2007). +10.19 +* +Employment Agreement, dated January 16, 2008, between Crocs, Inc. and Russell Hammer (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on +May 12, 2008). +10.20 +* +Employment Agreement, dated February 9, 2009, between Crocs, Inc. and John McCarvel (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on +February 13, 2009). +10.21 +* +Employment Agreement, dated February 9, 2009, between Crocs, Inc. and John Duerden (incorporated herein by reference to Crocs, Inc.'s Current Report on Form 8-K, filed on March 2, +2009). +49 +Table of Contents +Exhibit +Number +Description +10.22 +* +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Crocs, Inc.'s Quarterly Report on Form 10-Q, filed on August 5, +2010). +10.23 +* +Separation Agreement, dated March 31, 2010, between Crocs. Inc. and John Duerden (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.'s Current Report on Form 8-K, filed on +April 6, 2010). +10.24 +Revolving Credit and Security Agreement, dated September 25, 2009, among Crocs, Inc., Crocs Retail, Inc., Crocs Online, Inc., Ocean Minded, Inc., Jibbitz LLC, Bite, Inc. and PNC Bank, +N.A. (incorporated herein by reference to Crocs, Inc.'s Current Report on Form 8-K, filed on September 30, 2009). +10.25 +First Amendment to Revolving Credit and Security Agreement, dated October 14, 2009, among Crocs, Inc., Crocs Retail, Inc., Crocs Online, Inc., Ocean Minded, Inc., Jibbitz LLC, Bite, Inc. +and PNC Bank, N.A. (incorporated herein by reference to Crocs, Inc.'s Current Report on Form 8-K, filed on October 15, 2009). +10.28 +Second Amendment to Revolving Credit and Security Agreement, dated September 30, 2010, among Crocs, Inc., Crocs Retail, Inc., Crocs Online, Inc., Ocean Minded, Inc., Jibbitz LLC, Bite, +Inc. and PNC Bank, N.A. (incorporated herein by reference to Crocs, Inc.'s Current Report on Form 8-K, filed on October 4, 2010). +21 +†† +Subsidiaries of the registrant. +23.1 +†† +Consent of Deloitte & Touche LLP. +31.1 +†† +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act. +31.2 +†† +Certification of the Acting Principal Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley +Act. +32 +†† +Certification of the Chief Executive Officer and Acting Principal Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act. +* Compensatory +plan or arrangement +† The +registrant has been granted confidential treatment with respect to portions of these exhibits. +†† Filed +herewith. +50 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this +report to be signed on its behalf by the undersigned, thereunto duly authorized, as of February 25, 2011. +CROCS, INC. +a Delaware Corporation +By: +/s/ JOHN P. MCCARVEL +Name: +John P. McCarvel +Title: +President and Chief Executive Officer +Pursuant +to the requirements of the Securities Exchange Act of 1934, this report has been signed below as of February 25, 2011 by the following persons on behalf of the registrant +and in the capacities indicated. +Signature +Title +Date +/s/ JOHN P. MCCARVEL +John P. McCarvel +President, Chief Executive Officer and Director (Principal Executive Officer) +February 25, 2011 +/s/ JEFFREY J. LASHER +Jeffrey J. Lasher +Corporate Controller and Chief Accounting Officer (Acting Principal Financial Officer and Principal Accounting Officer) +February 25, 2011 +/s/ W. STEPHEN CANNON +W. Stephen Cannon +Director +February 25, 2011 +/s/ RAYMOND D. CROGHAN +Raymond D. Croghan +Director +February 25, 2011 +/s/ RONALD L. FRASCH +Ronald L. Frasch +Director +February 25, 2011 +/s/ PETER A. JACOBI +Peter A. Jacobi +Director +February 25, 2011 +/s/ THOMAS J. SMACH +Thomas J. Smach +Acting Chairman of the Board +February 25, 2011 +Richard L. Sharp* +Director +* On +leave of absence as previously disclosed. +51 +Table of Contents +INDEX TO FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm +F-1 +Consolidated Statements of Operations for the Years Ended December 31, 2010, 2009 and 2008 +F-2 +Consolidated Balance Sheets as of December 31, 2010 and 2009 +F-3 +Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss) for the Years Ended December 31, 2010, +2009 and 2008 +F-4 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2010, 2009 and 2008 +F-5 +Notes to Consolidated Financial Statements +F-6 +52 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2010 and 2009, and the related consolidated +statements of operations, stockholders' equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are +the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. +We +conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in +the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement +presentation. We believe that our audits provide a reasonable basis for our opinion. +In +our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Crocs, Inc. and subsidiaries as of December 31, +2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally +accepted in the United States of America. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of +December 31, 2010, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring +Organizations of the Treadway Commission and our report dated February 25, 2011 expressed an unqualified opinion on the Company's internal control over financial reporting. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +February 25, 2011 +F-1 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +Year Ended December 31, +($ thousands, except per share amounts) +2010 +2009 +2008 +Revenues +$ +789,695 +$ +645,767 +$ +721,589 +Cost of sales +364,631 +337,720 +486,722 +Restructuring charges (Note 6) +1,300 +7,086 +901 +Gross profit +423,764 +300,961 +233,966 +Selling, general and administrative expenses +342,121 +311,592 +341,518 +Foreign currency transaction losses (gains), net +(2,912 +) +(665 +) +25,438 +Restructuring charges (Note 6) +2,539 +7,623 +7,664 +Goodwill impairment charges (Note 4) +— +— +23,867 +Asset impairment charges (Note 3) +141 +26,085 +21,917 +Charitable contributions +840 +7,510 +1,844 +Income (loss) from operations +81,035 +(51,184 +) +(188,282 +) +Interest expense +657 +1,495 +1,793 +Gain on charitable contribution (Note 2) +(223 +) +(3,163 +) +— +Other income, net +(191 +) +(895 +) +(565 +) +Income (loss) before income taxes +80,792 +(48,621 +) +(189,510 +) +Income tax expense (benefit) +13,066 +(6,543 +) +(4,434 +) +Net (loss) income +$ +67,726 +$ +(42,078 +) +$ +(185,076 +) +Income (loss) per common share (Note 13): +Basic +$ +0.78 +$ +(0.49 +) +$ +(2.24 +) +Diluted +$ +0.76 +$ +(0.49 +) +$ +(2.24 +) +The +accompanying notes are an integral part of these consolidated financial statements. +F-2 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +($ thousands, except number of shares) +December 31, +2010 +December 31, +2009 +ASSETS +Current assets: +Cash and cash equivalents +$ +145,583 +$ +77,343 +Accounts receivable, net of allowance for doubtful accounts of $10,249 and $9,839, respectively +64,260 +50,458 +Inventories (Note 2) +121,155 +93,329 +Deferred tax assets, net +15,888 +7,358 +Income tax receivable +9,062 +8,611 +Other receivables +11,637 +16,140 +Prepaid expenses and other current assets +13,429 +14,015 +Total current assets +381,014 +267,254 +Property and equipment, net (Note 3) +70,014 +71,084 +Intangible assets, net (Note 4) +45,461 +35,984 +Deferred tax assets, net +34,711 +18,479 +Other assets +18,281 +16,937 +Total assets +$ +549,481 +$ +409,738 +LIABILITIES AND STOCKHOLDERS' EQUITY +Current liabilities: +Accounts payable +$ +35,669 +$ +23,434 +Accrued expenses and other current liabilities (Note 5) +59,049 +53,580 +Accrued restructuring charges (Note 6) +439 +2,616 +Deferred tax liabilities, net +17,620 +9 +Income taxes payable +23,084 +6,377 +Note payable, current portion of long-term debt and capital lease obligations (Note 8) +1,901 +640 +Total current liabilities +137,762 +86,656 +Deferred tax liabilities, net +847 +2,192 +Long term income tax payable +29,861 +27,890 +Other liabilities +4,905 +5,380 +Total liabilities +173,375 +122,118 +Commitments and contingencies (Note 14) +Stockholders' equity: +Preferred shares, par value $0.001 per share, 5,000,000 shares authorized, none outstanding +— +— +Common shares, par value $0.001 per share, 250,000,000 shares authorized, 88,600,860 and 88,065,859 shares issued and outstanding, respectively, at +December 31, 2010 and 86,224,760 and 85,659,581 shares issued and outstanding, respectively, at December 31, 2009 +88 +85 +Treasury stock, at cost, 535,001 and 565,179 shares, respectively +(22,008 +) +(25,260 +) +Additional paid-in capital +277,293 +266,472 +Retained earnings +89,881 +22,155 +Accumulated other comprehensive income +30,852 +24,168 +Total stockholders' equity +376,106 +287,620 +Total liabilities and stockholders' equity +$ +549,481 +$ +409,738 +The +accompanying notes are an integral part of these consolidated financial statements. +F-3 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME (LOSS) +Common Stock +Treasury Stock +Accumulated +Other +Comprehensive +Income +Additional +Paid in +Capital +Deferred +Compensation +Retained +Earnings +Total Stock +Holders +Equity +Comprehensive +Income (Loss) +($ thousands) +Shares +Amount +Shares +Amount +BALANCE—December 31, 2007 +82,198 +$ +83 +524 +$ +(25,022 +) +$ +211,936 +$ +(2,402 +) +$ +249,309 +$ +10,209 +$ +444,113 +Amortization of stock compensation (Note 9) +— +— +— +— +16,951 +1,388 +— +— +18,339 +Forfeitures +— +— +— +— +(131 +) +131 +— +— +— +Exercises of stock options and issuance of restricted stock awards (Note 9) +821 +1 +— +— +3,281 +637 +— +— +3,919 +Net loss +— +— +— +— +— +— +(185,076 +) +— +(185,076 +) +$ +(185,076 +) +Foreign currency translation +— +— +— +— +— +— +— +5,868 +5,868 +5,868 +Total comprehensive loss +$ +(179,208 +) +BALANCE—December 31, 2008 +83,019 +$ +84 +524 +$ +(25,022 +) +$ +232,037 +$ +(246 +) +$ +64,233 +$ +16,077 +$ +287,163 +Amortization of stock compensation (Note 9) +— +— +17,189 +208 +— +— +17,397 +Tender offer (Note 9) +— +— +16,197 +— +— +— +16,197 +Forfeitures +(116 +) +— +— +— +(199 +) +38 +— +— +(161 +) +Exercises of stock options and issuance of restricted stock awards (Note 9) +1,858 +1 +— +— +1,248 +— +— +— +1,249 +Adjustment for prior period RSA grants +939 +— +— +— +— +— +— +— +— +Repurchase of common stock for tax withholding +(41 +) +— +41 +(238 +) +— +— +— +— +(238 +) +Net loss +— +— +— +— +(42,078 +) +— +(42,078 +) +$ +(42,078 +) +Foreign currency translation +— +— +— +— +— +8,091 +8,091 +8,091 +Total comprehensive loss +$ +(33,987 +) +BALANCE—December 31, 2009 +85,659 +$ +85 +565 +$ +(25,260 +) +$ +266,472 +$ +— +$ +22,155 +$ +24,168 +$ +287,620 +Amortization of stock compensation (Note 9) +— +— +7,594 +— +— +7,594 +Forfeitures +(454 +) +— +— +— +(288 +) +— +— +(288 +) +Exercises of stock options and issuance of restricted stock awards (Note 9) +2,908 +3 +(77 +) +3,673 +3,515 +— +— +— +7,191 +Repurchase of common stock for tax withholding +(47 +) +— +47 +(421 +) +— +— +— +— +(421 +) +Net income +— +— +— +— +67,726 +— +67,726 +$ +67,726 +Foreign currency translation +9,048 +9,048 +9,048 +Reclassification of cumulative foreign exchange translation adjustments to net income (Note 1) +— +— +— +— +— +(2,364 +) +(2,364 +) +(2,364 +) +Total comprehensive income +$ +74,410 +BALANCE—December 31, 2010 +88,066 +$ +88 +535 +$ +(22,008 +) +$ +277,293 +$ +— +$ +89,881 +$ +30,852 +$ +376,106 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +($ thousands) +2010 +2009 +2008 +Cash flows from operating activities: +Net income (loss) +$ +67,726 +$ +(42,078 +) +$ +(185,076 +) +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Depreciation and amortization +37,059 +36,671 +37,450 +Unrealized loss (gain) on foreign exchange +1,334 +(11,267 +) +21,570 +Deferred income taxes +(4,999 +) +5,399 +(5,429 +) +Goodwill impairment +— +— +23,837 +Asset impairment +141 +26,027 +21,927 +Inventory write-down charges +— +2,568 +76,258 +Charitable contributions +840 +7,424 +1,844 +Non-cash restructuring charges +196 +2,196 +— +Bad debt expense +2,204 +1,316 +3,153 +Share based compensation +7,109 +15,237 +18,976 +Share based compensation from 2009 Tender Offer +— +16,197 +— +Other non-cash items +942 +(3,924 +) +4,833 +Changes in operating assets and liabilities—net of effect of acquired businesses: +Accounts receivable +(13,165 +) +(13,251 +) +111,318 +Inventories +(27,908 +) +44,828 +16,395 +Prepaid expenses and other assets +2,230 +(13,914 +) +(4,342 +) +Accounts payable +12,689 +(17,387 +) +(60,168 +) +Accrued expenses and other liabilities +20,344 +(19,304 +) +11,553 +Accrued restructuring +(2,696 +) +1,208 +2,398 +Income taxes receivable +228 +23,163 +(23,634 +) +Cash provided by operating activities +104,274 +61,109 +72,863 +Cash flows from investing activities: +Purchases of marketable securities +(5,654 +) +(1,502 +) +— +Sales of marketable securities +7,369 +— +— +Cash paid for purchases of property and equipment +(31,257 +) +(20,054 +) +(55,559 +) +Proceeds from disposal of property and equipment +1,274 +2,476 +2,383 +Cash paid for intangible assets +(13,848 +) +(6,973 +) +(10,659 +) +Restricted cash +38 +322 +(1,624 +) +Acquisition of businesses, net of cash acquired +— +— +(7,977 +) +Cash used in investing activities +(42,078 +) +(25,731 +) +(73,436 +) +Cash flows from financing activities: +Proceeds from note payable, net +83,100 +293 +76,024 +Repayment of note payable and capital lease obligations +(84,625 +) +(23,078 +) +(60,707 +) +Debt issuance costs +— +(458 +) +— +Exercise of stock options +7,191 +1,290 +3,283 +Repurchase of common stock for tax withholding +(421 +) +(238 +) +— +Cash provided by (used in) financing activities +5,245 +(22,191 +) +18,600 +Effect of exchange rate changes on cash +799 +12,491 +(2,697 +) +Net increase in cash and cash equivalents +68,240 +25,678 +15,330 +Cash and cash equivalents—beginning of year +77,343 +51,665 +36,335 +Cash and cash equivalents—end of year +$ +145,583 +$ +77,343 +$ +51,665 +Supplemental disclosure of cash flow information—cash paid during the year for: +Interest +$ +639 +$ +1,491 +$ +1,581 +Income taxes +$ +11,048 +$ +12,392 +$ +16,367 +Supplemental disclosure of non-cash, investing, and financing activities: +Assets acquired under capitalized leases +$ +2,606 +$ +1,760 +— +Accrued purchases of property and equipment +$ +1,826 +$ +2,826 +$ +10,331 +Accrued purchases of intangibles +$ +3,786 +$ +2,411 +$ +2,265 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Organization —Crocs, Inc. and its subsidiaries (collectively the "Company," "we," "our" or "us") are engaged in the design, development, +manufacturing, marketing and distribution of consumer products, primarily casual and athletic shoes and shoe charms, manufactured from specialty resins referred to as Croslite. Our wholly-owned +subsidiaries include, among others, EXO Italia ("EXO"), which designs and develops EVA (Ethylene Vinyl Acetate) based finished products, primarily for the footwear industry; Jibbitz, LLC +("Jibbitz"), a unique accessory brand with colorful snap-on charms specifically suited for the Company's shoes; and Ocean Minded, LLC ("Ocean Minded"), which designs, manufactures, +markets and distributes high quality leather and EVA based sandals primarily for the beach, adventure and action sports markets. +Basis of Consolidation —The consolidated financial statements include the accounts of our wholly-owned and majority owned subsidiaries as well as a +variable interest entity ("VIE") for which we are the primary beneficiary after the elimination of intercompany accounts and transactions. The primary beneficiary of a VIE is the entity that absorbs +the majority of the entity's expected losses, receives a majority of the VIE's expected residual returns or both. See Note 10—Variable Interest Entities for further discussion. +Noncontrolling Interests —With the exception of Crocs India Private Limited ("Crocs India") all of our subsidiaries are, in substance, +wholly-owned. +Effective January 1, 2010, we sold our interests in Crocs India. During the years ended December 31, 2009 and 2008, the non-controlling interests in Crocs India were +immaterial and were included in other (income) expenses on the consolidated statements of income and in other liabilities on the consolidated balance sheets. +Change in Accounting Principle —Effective January 1, 2010, we changed our inventory valuation method for all inventories from the +first-in, first-out ("FIFO") cost method to the moving average cost method, which approximates FIFO. We believe the change to the moving average cost method is preferable +because it results in better alignment with the physical flow of inventory than the FIFO methodology; it is calculated by our inventory information system which incorporates automated controls; and it +is the method management uses when preparing budgets, reviewing actual and forecasted financial information and determining incentive management compensation. The moving average cost method results in +substantially the same results of operations in each reporting period. Financial statements for periods ending on or before December 31, 2009 have not been retroactively adjusted due to +immateriality. The impact of the change for the year ended December 31, 2010 was also immaterial. +Management Estimates —The preparation of financial statements in conformity with generally accepted accounting principles in the United States of +America ("GAAP") requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported +amounts of revenue and expenses during the reporting period. Management believes that the estimates, judgments and assumptions made when accounting for items and matters such as, but not limited to, +the allowance for doubtful accounts, sales returns, impairment assessments and charges, recoverability of assets (including deferred tax assets), uncertain tax positions, share-based compensation +expense, the fair value of acquired intangibles, the assessment of lower of cost or market on inventory, useful lives assigned to long-lived assets, depreciation and provisions for +contingencies are reasonable based on information available at the time they are made. Management also makes estimates in the assessments of potential losses in relation to +F-6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +threatened +or pending legal and tax matters. See Note 16—Legal Proceedings. Actual results could materially differ from these estimates. For matters not related to income taxes, if +a loss is considered probable and the amount can be reasonably estimated, we recognize an expense for the estimated loss. If there is the potential to recover a portion of the estimated loss from a +third party, we make a separate assessment of recoverability and reduce the estimated loss if recovery is also deemed probable. +Concentrations of Risk —We are exposed to concentrations of risks in the following categories: (1) cash and cash equivalents; +(2) accounts receivable; (3) manufacturing sources; and (4) suppliers of certain raw materials. Our cash and cash equivalents are maintained in several different financial +institutions in amounts that typically exceed U.S. federally insured limits or in financial institutions in international jurisdictions where insurance is not provided and restrictions may exist. We +have not experienced any losses in such accounts and believe we are not exposed to significant credit risk. We consider any concentration of credit risk related to accounts receivable to be mitigated +by our credit policy, the insignificance of outstanding balances owed by each individual customer at any point in time and the geographic dispersion of our customers. We rely on a limited source of +internal and external manufacturers. Establishing a replacement source could require significant additional time and expense. We source the elastomer resins that constitute the primary raw materials +used in compounding Croslite, which we use to produce our footwear products, from two suppliers. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may +not be able to obtain suitable substitute materials in time to avoid interruption of our production cycle, if at all. We may also have to pay materially higher prices in the future for the elastomer +resins or any substitute materials we use, which would increase our production costs and could have a materially adverse impact on our margins and results of operations. +Fair Value —Fair value is the price that would be received from the sale of an asset or transfer of a liability in an orderly transaction between +market participants at the measurement date. When determining the fair value measurements for assets and liabilities required to be recorded at fair value, we consider the principal or most +advantageous market in which a hypothetical sale or transfer would take place and consider assumptions that market participants would use when pricing the asset or liability, such as inherent risk, +transfer restrictions, and risk of non-performance. +The +fair value hierarchy is made up of three levels of inputs that may be used to measure fair value: Level 1—observable inputs such as quoted prices for identical +instruments in active markets; Level 2—observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in +markets that are not active and model-derived valuations, in which all significant inputs are observable in active markets; and Level 3—unobservable inputs for which there is little +or no market data, which require the reporting entity to develop its own assumptions. We categorize fair value measurements within the fair value hierarchy based upon the lowest level of the most +significant inputs used to determine such fair value measurement. +Derivative +financial instruments are required to be recorded at their fair value, on a recurring basis. The fair values of our derivative instruments are determined using a discounted +cash flow valuation model. The significant inputs used in the model are readily available in public markets or can be derived from observable market transactions, and therefore, have been classified +as Level 2. These inputs include the applicable exchange rates and forward rates, and discount rates based on the prevailing LIBOR deposit rates. +F-7 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Our +other financial instruments are not required to be carried at fair value on a recurring basis. The carrying value of these financial instruments, including cash equivalents, accounts +receivable, accounts payable and accrued liabilities, approximates fair value due to their short maturities. Based on borrowing rates currently available to us, with similar terms, the carrying values +of capital lease obligations and the line of credit approximate their fair values. +Long-lived +assets such as inventories, property, plant and equipment and intangible assets are also not required to be carried at fair value on a recurring basis. However, +when determining impairment losses, fair values of property, plant and equipment, goodwill and intangibles must be determined. For such determination, we use either an income approach with inputs that +are mainly unobservable, such as expected future cash flows, or a market approach using observable inputs such as replacement cost or third-party appraisals, as appropriate. Estimated future cash +flows are based on management's operating budgets and forecasts which take into consideration both observable and unobservable inputs including growth rates, pricing, new markets and other factors +expected to affect the business, as well as management's forecasts for inventory, receivables, capital spending, and other cash needs. For a discussion of inventory estimated fair value see "Inventory +Valuation" below. +Cash and Cash Equivalents —Cash and cash equivalents represent cash and short-term, highly liquid investments with maturities of three +months or less at the date of purchase. We consider receivables from credit card companies to be cash equivalents, if expected to be received within five days. The carrying amounts reflected in the +consolidated balance sheet for cash and cash equivalents approximate fair value due to the short maturities. +Accounts Receivable —Accounts receivable represent amounts due from customers. Accounts receivable are recorded at invoiced amounts, net of +reserves +and allowances, are not collateralized and do not bear interest. We use our best estimate to determine the required allowance for doubtful accounts based on a variety of factors, including the length +of time receivables are past due, economic trends and conditions affecting our customer base, significant one-time events and historical write-off experience. Specific +provisions are recorded for individual receivables when we become aware of a customer's inability to meet its financial obligations. +Inventory Valuation —Inventories are valued at the lower of cost or market. Inventory cost +is determined using the moving average cost method. At least quarterly, we evaluate our inventory for possible impairment using standard categories to classify inventory based on the degree to which +we believe that the products may need to be discounted below cost to sell within a reasonable period. We base inventory fair value on several subjective assumptions including estimated future demand +and market conditions, as well as other observable factors such as current sell-through of our products, recent changes in demand for our product as well as shifting demand between the +products we offer, global and regional economic conditions, historical experience selling through liquidation and price discounted channels and the amount of inventory on hand. If the estimated +inventory fair value is less than its carrying value, the carrying value is adjusted to market value and the resulting impairment charge is recorded in cost of sales on the consolidated statements of +operations. See Note 2—Inventories for further discussion. +Property and Equipment —Depreciation of property, equipment, furniture and fixtures is computed using the straight-line method based on +estimated useful lives ranging from two to five years. Leasehold improvements are amortized on the straight-line basis over their estimated economic useful lives or the +F-8 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +lease +term, whichever is shorter. For long-lived assets denominated in a foreign currency, we translate the ending asset and accumulated depreciation at rate of exchange at the balance +sheet date and record depreciation expense using the weighted average rate of exchange for the applicable period. The difference between the recorded depreciation expense and the change in accumulated +depreciation is recorded as a component of accumulated other comprehensive income in stockholders' equity on the consolidated balance sheets. Depreciation of manufacturing assets such as molds and +tooling is included in cost of sales on the consolidated statements of operations. Depreciation related to corporate, non-product and non-manufacturing assets is included in +selling, general and administrative expense on the consolidated statements of operations. +Impairment of Long-Lived Assets —Long-lived assets to be held and used are evaluated for impairment when events or +circumstances indicate the carrying value of a long-lived asset may not be fully recoverable. Events that may indicate the impairment of a long-lived asset (or asset group, as +defined below) include; (i) a significant decrease in its market price, (ii) a significant adverse change in the extent or manner in which it is being used or in its physical condition, +(iii) a significant adverse change in legal factors or business climate that could affect its value, including an adverse action or assessment by a regulator, (iv) an accumulation of +costs significantly in excess of the amount originally expected for its acquisition or construction, (v) its current period operating or cash flow losses combined with historical operating or +cash flow losses or a forecast of its cash flows demonstrate continuing losses associated with its use, and (vi) a current expectation that, more likely than not, it will be sold or otherwise +disposed of significantly before the end of its previously estimated useful life. If such facts indicate a potential impairment of a long-lived asset (or asset group), we assess the +recoverability by determining if its carrying value exceeds the sum of its projected undiscounted cash flows expected to +result from its use and eventual disposition over its remaining economic life. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Assets to be +abandoned or from which no further benefit is expected are written down to zero at the time that the determination is made and the assets are removed entirely from service. +An +asset group is the lowest level of assets and liabilities for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Beginning in +2009, we determined that the lowest level of assets and liabilities for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities is at the retail store +level for assets involved in our retail business. +Intangible Assets and Goodwill —Intangible assets that are determined to have finite lives are amortized over their useful lives on a +straight-line basis. Customer relationships are amortized on a straight-line basis or an accelerated basis. Indefinite-lived intangible assets, such as trade names, are not +amortized and are evaluated for impairment at least annually and when circumstances imply possible impairment. As of December 31, 2010 and 2009, we had no indefinite lived intangible assets. +For +amortizable intangible assets denominated in a foreign currency, we translate the ending asset and accumulated amortization at rate of exchange at the balance sheet date and record +amortization expense using the weighted average rate of exchange for the applicable period. The difference between the recorded amortization expense and the change in accumulated amortization is +recorded as a component of accumulated other comprehensive income in stockholders' equity. Amortization of manufacturing intangible assets is included in cost of sales on the consolidated statements +of operations. Amortization related to corporate, non-product and non-manufacturing assets such as our +F-9 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +global +information systems is included in selling, general and administrative expense on the consolidated statements of operations. +The +following table sets forth our definite lived intangible assets and the periods over which they are amortized. +Intangible Asset Class +Weighted Average Amortization Period +Patents +10 years +Customer Relationships +Estimated customer life +Core Technology +5 years +Non-competition Agreement +Contractual term +Capitalized Software +Shorter of 7 years or useful life +Capitalized Software —We capitalize certain internal and external software acquisition and development costs that benefit future years, including the +costs of employees and contractors devoting time to the software development projects and external direct costs for materials and services. Initial costs associated with +internally-developed-and-used software are expensed until it is determined that the project has reached the application development stage. Once in its development stage, +subsequent additions, modifications or upgrades to an internal-use software project are capitalized to the extent that they allow the software to perform a task it previously did not +perform. Software maintenance and training costs are expensed in the period in which they are incurred. Capitalized software primarily consists of our enterprise resource system software, warehouse +management software and point of sale software. At least annually, we consider the potential impairment of capitalized software by assessing the substantive service potential of the software, changes, +if any, in the extent or manner in which the software is used or is expected to be used, and the actual cost of software development or modification compared to expected cost. See +Note 4—Intangibles Assets for further discussion. +Goodwill —Goodwill represents the excess purchase price paid over the fair value of assets acquired and liabilities assumed in acquisitions. We assess +goodwill for impairment annually on the last day of the fourth quarter, or more frequently if events and circumstances indicate impairment may have occurred. If the carrying value of goodwill, +including intangibles with indefinite lives, exceeds its implied fair value, we record an impairment loss equal to the difference. As of December 31, 2009 and 2010, we had no goodwill. +Impairment of Intangible Assets —Intangible assets with indefinite lives and goodwill are evaluated for impairment when events or changes in +circumstances indicate that the carrying value may not be fully recoverable and at least annually. Intangible assets that are determined to have definite lives, such as customer relationships, core +technology, capitalized software, patents and non-compete agreements are amortized over their useful lives and are evaluated for impairment only when events or circumstances indicate a +carrying value may not be fully recoverable. Recoverability is based on the estimated future undiscounted cash flows of an asset. If the asset is not supported on an undiscounted cash flow basis, the +amount of impairment is measured as the difference between its carrying value and its fair value. +Earnings per Share —Basic and diluted earnings (loss) per common share ("EPS") is presented using the two-class method, which is an +earnings allocation formula that determines earnings per share for common stock and any participating securities according to dividend rights and participation rights +F-10 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +in +undistributed earnings. Under the two-class method, EPS is computed by dividing the sum of distributed and undistributed earnings (loss) attributable to common stockholders by the +weighted average number of shares of common stock outstanding during the period. A participating security is an unvested share-based payment award containing non-forfeitable rights to +dividends and must be included in the computation of earnings per share pursuant to the two-class method. Shares of the Company's non-vested restricted stock awards and units +are considered participating securities. Diluted EPS reflects the potential dilution from securities that could share in the earnings of the Company. Anti-dilutive securities are excluded +from diluted EPS. See Note 13—Earnings per Share for further discussion. +Recognition of Revenues —Revenues are recognized when the customer takes title and assumes risk of loss, collection of related receivables is +probable, +persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer depending on the country of the sale and the +agreement with the customer. Allowances for estimated returns and discounts are recognized when the related revenue is recorded. +Shipping and Handling Costs and Fees —Shipping and handling costs are expensed as incurred and included in cost of sales. Shipping and handling +fees +billed to customers are included in revenues. +Share-Based Compensation —We have share-based compensation plans under which certain officers, employees and members of the Board of Directors are +participants and may be granted stock options, restricted stock and stock performance awards. Awards granted under these plans are fair valued and amortized, net of estimated forfeitures over the +vesting period using the straight-line method. The fair value of stock options is calculated by using the Black-Scholes option pricing formula that requires estimates for expected +volatility, expected dividends, the risk-free interest rate and the term of the option. If any of the assumptions used in the Black-Scholes model or the anticipated number of shares to be +awarded change significantly, share-based compensation expense may differ materially in the future from that recorded in the current period. See additional information related to share-based +compensation in Note 9—Equity. Share-based compensation expense associated with our manufacturing and retail employees is included in cost of sales in the consolidated statements of +operations. Share-based compensation expense associated with selling, marketing and administrative employees is included selling, general and administrative expense in the consolidated statements of +operations. +The +classification of any excess tax benefits realized on the exercise of stock options or issuance of restricted stock unit awards in excess of that which is associated with the expense +recognized are presented as a financing cash inflow in the consolidated statement of cash flows. +Advertising —Advertising costs are expensed as incurred and production costs are generally expensed when the advertising is run. Total advertising, +marketing and promotional costs reflected in selling, general, and administrative expenses on the consolidated statement of operations were $44.1 million, $28.2 million and +$56.1 million for the years ended December 31, 2010, 2009 and 2008, respectively. As of December 31, 2010 and 2009, we had $2.2 million and $0.7 million in prepaid +advertising costs. +Research and Development —Research and development costs are expensed as incurred. Research and development expenses amounted to $7.8 million, +$7.7 million, and $6.4 million for the years ended +F-11 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +December 31, +2010, 2009, and 2008, respectively, and are included in selling, general, and administrative expenses in the consolidated statement of operations. +Foreign Currency Translation and Foreign Currency Transactions —Our functional currency is the U.S. dollar. Assets and liabilities of 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 +applicable period. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are included in the foreign currency translation adjustment, a component of +accumulated other comprehensive income in stockholders' equity. +Gains +and losses generated by transactions denominated in foreign currencies are reflected in the consolidated statement of operations in the period in which they occur and are primarily +associated with payables and receivables arising from intercompany transactions. For the year ended December 31, 2010, we recognized realized gains and unrealized losses on foreign currency +transactions of $4.2 million and $1.3 million, respectively. Included in the 2010 realized gains on foreign currency transactions was $2.4 million of realized gains recognized on +payments of intercompany balances denominated in foreign currencies for which collection had not been planned or anticipated previously. For the year ended December 31, 2009, we recognized +realized losses and unrealized gains on foreign currency transactions of $10.6 million and $11.3 million, respectively. For the year ended December 31, 2008, we recognized +realized losses and unrealized losses on foreign currency transactions of $3.8 million and $21.6 million, respectively. +Derivative Foreign Currency Contracts —We are directly and indirectly affected by fluctuations in foreign currency rates which may adversely impact +our +financial performance. To mitigate the potential impact of foreign currency exchange rate risk, we may employ derivative financial instruments including, forward contracts and option contracts. +Forward contracts are agreements to buy or sell a quantity of a currency at a predetermined future date and at a predetermined rate. An option contract is an agreement that conveys the purchaser the +right, but not the obligation, to buy or sell a quantity of a currency at a predetermined rate during a period or at a time in the future. These derivative financial instruments are viewed as risk +management tools and are not used for trading or speculative purposes. We recognize derivative financial instruments as either assets or liabilities in the consolidated balance sheets and measure +those instruments at fair value. Changes in the fair value of derivatives not designated or effective as hedges are recorded in other expense (income), net in the consolidated statements of +operations. We had no derivative instruments that qualified for hedge accounting during any of the periods presented. See Note 7—Fair Value Measurements and Financial Instruments +for further discussion. +Income Taxes —We account for income taxes using the asset and liability method which requires the recognition of deferred tax assets and +liabilities +for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future +enacted tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and +disclosures regarding uncertainties in income tax positions. We recognize interest and penalties related to income tax matters in income tax expense in the consolidated statement of operations. See +Note 12—Income Taxes for further discussion. +F-12 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) +Taxes Assessed by Governmental Authorities —Taxes assessed by governmental authorities that are directly imposed on a revenue transaction, +including +value added tax, are recorded on a net basis and are therefore excluded from sales. +Recent Accounting Pronouncements —In January 2010, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") +2010-06, Improving Disclosures About Fair Value Measurement, which amends the disclosure requirements related to recurring and +non-recurring fair value measurements. The guidance requires additional disclosures about the different classes of assets and liabilities measured at fair value, the valuation techniques +and inputs used, the activity in Level 3 fair value measurements, and the transfers between Levels 1, 2, and 3 of the fair value measurement hierarchy. We adopted this guidance at the +beginning of 2010 with the exception of the disclosure requirements relating to purchases, sales, issuances and settlements of Level 3 assets and liabilities, which will be effective beginning +January 1, 2011. As this guidance only requires expanded disclosures, its adoption did not and will not impact the consolidated financial statements. See Note 7—Fair Value +Measurements and Financial Instruments. +In +December 2009, the FASB issued ASU 2009-17, Improvements to Financial Reporting by Enterprises Involved with Variable Interest +Entities . The amendments in ASU 2009-17 replace the quantitative-based risks-and-rewards calculation for determining which reporting entity, +if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which reporting entity has (1) the power to direct the activities of a +variable interest entity that most significantly affect the entity's economic performance and (2) the obligation to absorb losses of, or the right to receive benefits from, the entity. The ASU +also requires additional disclosures about a reporting entity's involvement with variable interest entities and about any significant changes in risk exposure as a result of that involvement. We +adopted the guidance at the beginning of 2010 with no material impact to the consolidated financial statements. See Note 10—Variable Interest Entities. +2. INVENTORIES +Inventories by major classification as of December 31, 2010 and 2009 were as follows: +December 31, +($ thousands) +2010 +2009 +Finished goods +$ +111,134 +$ +88,775 +Work-in-progress +248 +220 +Raw materials +9,773 +4,334 +$ +121,155 +$ +93,329 +During +the year ended December 31, 2008, we recorded inventory write-downs of $76.3 million with an additional $4.2 million in charges related to losses on future +purchase commitments for inventory with a market value lower than cost, of which $2.1 million was included as accrued expenses. These write-downs were to a level considered realizable, however, +we were able to sell this product at prices substantially higher than what was previously estimated. During the year ended December 31, 2009, sales of this impaired product resulted in +$58.3 million of revenue for which the associated gross profit was $49.8 million. During the years ended December 31, 2010 and 2009, we did not record +F-13 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +2. INVENTORIES (Continued) +impairment +charges related to inventory. No losses on future purchase commitments were recorded during the years ended December 31, 2010 and 2009. +During +the years ended December 31, 2010 and 2009, we donated certain inventory items to charitable organizations consisting primarily of end of life units, some of which were +partially or fully impaired. +The contributions made were expensed at their fair value of $0.8 million and $7.5 million, respectively. We recognized a gain of $0.2 million and $3.2 million and a net +reduction of inventory of $0.6 million and $4.3 million, for the years ending December 31, 2010 and 2009, respectively, as the fair value of the inventory contributed exceeded its +carrying amount. +3. PROPERTY AND EQUIPMENT +Property and equipment as of December 31, 2010 and 2009 included the following: +December 31, +($ thousands) +2010 +2009 +Machinery and equipment +$ +70,962 +$ +63,889 +Leasehold improvements +49,519 +34,759 +Furniture and fixtures and other +16,587 +14,099 +Construction-in-progress +7,902 +8,422 +Subtotal(1) +144,970 +121,169 +Less accumulated depreciation and amortization(2) +(74,956 +) +(50,085 +) +Total property and equipment +$ +70,014 +$ +71,084 +(1) Includes +$0.1 million of certain equipment held under capital leases and classified as equipment as of December 31, 2010 and 2009. +(2) Includes +an immaterial amount of accumulated depreciation related to certain equipment held under capital leases, as of December 31 2010 and 2009, +respectively, which are depreciated using the straight-line method over the lease term. +During +the years ended December 31, 2010, 2009 and 2008, we recorded $29.5 million, $29.7 million, and $30.7 million, respectively, in depreciation expense of +which $14.7 million, $15.6 million, and $18.3 million, respectively, was recorded in cost of sales, with the remaining amounts recorded in selling, general and administrative +expenses in the consolidated statements of operations. +During +the years ended December 31, 2010, 2009 and 2008, we recorded $0.1 million, $18.5 million and $20.9 million, respectively, in impairment charges on +molds related primarily to: styles that we either no longer intended to manufacture or styles that we had more molds on hand than necessary to meet projected demand; and distribution facility assets +related to equipment and fixtures of warehouse and distribution centers that were closed during the period. Management evaluated the production capacity at company-operated facilities compared with +demand projections and capacity requirements and made the decision to abandon certain tooling and equipment that represented excess capacity. +F-14 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +4. INTANGIBLE ASSETS +Intangible Assets +The following table summarizes intangible assets at December 31, 2010 and 2009. +2010 +2009 +($ thousands) +Gross +Carrying +Amount +Accumulated +Amortization +Net +Carrying +Amount +Gross +Carrying +Amount +Accumulated +Amortization +Net +Carrying +Amount +Intangible assets: +Capitalized software +$ +54,489 +(1) +$ +13,674 +(2) +$ +40,815 +$ +38,741 +(1) +$ +8,185 +(2) +$ +30,556 +Customer relationships +6,361 +5,485 +876 +5,928 +4,912 +1,016 +Patents, copyrights, and trademarks +5,703 +1,933 +3,770 +5,673 +1,396 +4,277 +Core technology +4,843 +4,843 +— +4,614 +4,614 +— +Other +636 +636 +— +779 +644 +135 +Total intangible assets +$ +72,032 +$ +26,571 +$ +45,461 +$ +55,735 +$ +19,751 +$ +35,984 +(1) Includes +$4.3 million and $1.7 million of software held under a capital lease classified as capitalized software as of December 31, +2010 and 2009, respectively. +(2) Includes +$0.5 million and $0.2 million of accumulated amortization of software held under a capital lease which is amortized using the +straight-line method over the useful life as of December 31, 2010 and 2009, respectively. +During +the years ended December 31, 2010, 2009 and 2008, amortization expense recorded for intangible assets with finite lives was $7.6 million, $7.0 million and +$6.6 million, respectively, of which $2.3 million, $1.6 million and $0.9 million was recorded in cost of sales, respectively. The remaining amounts were recorded in +selling, general and administrative expenses. Estimated future annual amortization of intangible assets is as follows (in thousands): +Fiscal years ending December 31, +Amortization +2011 +$ +9,711 +2012 +9,365 +2013 +8,768 +2014 +7,240 +2015 +4,726 +Thereafter +5,651 +Total +$ +45,461 +During +the year ended December 31, 2009, we recorded $7.6 million in impairment charges related to the write-off of certain intangible assets associated the +discontinued Tagger brand and certain capitalized software no longer intended for use. During the year ended December 31, 2008, we recorded $1.1 million in impairment charges related to +the write-off of certain intangible assets the impaired Jibbitz trade name and patents no longer intended for use. No impairment charges were recorded in 2010. +F-15 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +4. INTANGIBLE ASSETS (Continued) +Goodwill +During the year ended December 31, 2008, we recognized $23.8 million in impairment charges primarily related to the +acquisitions of Ocean Minded and Bite in 2007, Jibbitz and Fury in 2006, and Crocs Canada in 2004. The goodwill balance of $1.0 million related to Fury was written off prior to its liquidation +in June 2008. The remaining goodwill balance was assessed for impairment due to the substantial decline in our stock price during the second half of 2008, which represented a triggering event for +potential impairment. Consequently, as of December 31, 2008, we determined the balance was fully impaired. We had no goodwill as of December 31, 2010 and 2009. +5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES +Accrued expenses and other liabilities as of December 31, 2010 and 2009 include the following: +December 31, +($ thousands) +2010 +2009 +Accrued compensation and benefits +$ +25,666 +$ +21,007 +Fulfillment and freight and duties +5,396 +10,765 +Professional services +4,704 +4,329 +Sales/use and VAT tax payable +6,061 +4,330 +Other +17,222 +13,149 +$ +59,049 +$ +53,580 +Asset Retirement Obligations +We record a liability equal to the fair value of the estimated future cost to retire an asset, if the liability's fair value can be +reasonably estimated. Our asset retirement obligation ("ARO") liabilities are primarily associated with the disposal of property and equipment which we are contractually obligated to remove at the end +of certain retail and office leases in order to restore the facilities back original condition as specified in the related lease agreements. We estimate the fair value of these liabilities based on +current store closing costs and discount the costs back as if they were to be performed at the inception of the lease. At the inception of such leases, we recorded the ARO as a liability and also +recorded a related asset in an amount equal to the estimated fair value of the liability. +The capitalized asset is then depreciated on a straight-line basis over the useful life of the asset. Upon retirement of the asset, any difference between the actual retirement costs +incurred and the previously recorded estimated ARO liability is recognized as a gain or loss in the consolidated statements of operations. Our ARO liability as of December 31, 2010 and 2009 was +$1.6 million and $1.1 million, respectively. +6. RESTRUCTURING ACTIVITIES +In response to declining revenues during the years ended December 31, 2009 and 2008, we implemented a turnaround strategy aimed at aligning production and distribution capacities +with revised demand projections, reducing costs and streamlining processes. As a result, we consolidated our global manufacturing facilities and distribution centers, reduced warehouse and office +space and cut global workforce. Specifically, during the year ended December 31, 2008, we closed our Canadian and Brazilian manufacturing facilities and consolidated our Canadian distribution +activities into existing +F-16 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +6. RESTRUCTURING ACTIVITIES (Continued) +North +American operations. During the year ended December 31, 2009, we pursued further restructuring efforts and made certain organizational changes in order to better align costs with revenues +which included the closure of various warehouses and office buildings as well as the settlement and termination of contracts prior to term. As of December 31, 2010, the cumulative amounts +related to one-time employee termination benefits, operating lease exit costs and other associated costs were $10.6 million, $9.1 million and $7.4 million, +respectively. As of December 31, 2010, we do not expect to incur additional related costs in the future in connection with these activities. +During +the year ended December 31, 2010, we recorded restructuring charges of $3.8 million, of which $1.3 million is reflected in cost of sales. These charges are +primarily related to a change in the estimate in lease termination costs associated with the closure of distribution facilities in North America and Europe, and $2.0 million of severance pay +and additional share-based compensation related to the departure of a former officer. See Note 9—Equity for additional information on the +separation agreement. See Note 15—Operating Segments and Geographic Information for restructuring charges incurred by segment. +Restructuring +charges are included in the following line items: cost of sales and restructuring charges on the consolidated statements of operations. The following table summarizes the +changes in the restructuring accruals during the years ended December 31, 2010 and 2009. +($ thousands) +As of +December 31, +2008 +Additions +Cash +Payments +Foreign +Currency +Translation +and Other +As of +December 31, +2009 +Additions +Cash +Payments +Foreign +Currency +Translation +and Other +As of +December 31, +2010 +Termination benefits +$ +676 +$ +1,711 +$ +(2,111 +) +$ +240 +$ +516 +$ +2,009 +$ +(2,460 +) +$ +(65 +) +$ +— +Operating lease exit costs +1,488 +5,586 +(4,089 +) +(752 +) +2,233 +1,634 +(3,565 +) +137 +439 +Other restructuring costs(1) +234 +5,306 +(5,192 +) +39 +387 +— +(391 +) +4 +— +$ +2,398 +$ +12,603 +$ +(11,392 +) +$ +(473 +) +$ +3,136 +$ +3,643 +$ +(6,416 +) +$ +76 +$ +439 +(1) Includes +costs associated with the settlement and termination of contracts prior to term. +7. FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS +Recurring Fair Value Measurements +The following table summarizes the financial instruments required to be measured at fair value on a recurring basis as of +December 31, 2010. Other financial instruments including debt are not required to be carried at fair value on a recurring basis. The carrying value of these financial instruments, including +cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximate fair value due to their short maturities. Based on borrowing rates currently available to us, with similar +terms, the carrying values of capital lease obligations and the line of credit approximate their fair values. +F-17 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +7. FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS (Continued) +Fair Value as of +December 31, 2010 +($ thousands) +Level 1 +Level 2 +Level 3 +Balance Sheet Classification +Derivative assets:(1) +Foreign currency contracts +$ +— +$ +5 +$ +— +Prepaid expenses and other current assets +Derivative liabilities(1): +Foreign currency contracts +$ +— +$ +134 +$ +— +Accrued expenses and other current liabilities +(1) We +had no outstanding derivatives at December 31, 2009. +Non-Recurring Fair Value Measurements +The majority of our non-financial instruments, which include inventories, property, plant and equipment and intangible +assets are not required to be carried at fair value on a recurring basis. However, if certain triggering events occur such that a non-financial instrument is required to be evaluated for +impairment, a resulting asset impairment would require that the non-financial instrument be recorded at the lower of cost or its fair value. See Note 1—Summary of +Significant Accounting Policies for an explanation of our fair value determinations. +Derivative Financial Instruments +The following tables present the amounts affecting the consolidated statements of operations for the year ended December 31, +2010. We did not employ the use of derivative instruments during the years ended December 31, 2009 and 2008. +($ thousands) +Year ended +December 31, 2010 +Location of Loss (Gain) Recognized +In Income on Derivatives +Derivatives not designated as hedging instruments: +Foreign currency exchange forwards +$ +587 +Other income, net +The +following table summarizes the notional amounts of the outstanding derivatives at December 31, 2010 (in thousands). We had no outstanding derivatives at +December 31, 2009. The notional amounts of the derivative financial instruments do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our +exposure to the foreign currency exchange risks. +Currency Purchased +Currency Sold +Maturity Date +Contract Type +USD +2,000 +JPY +162,960 +January 2011 +Foreign currency exchange forward +USD +2,000 +JPY +161,940 +February 2011 +Foreign currency exchange forward +USD +2,000 +JPY +161,920 +March 2011 +Foreign currency exchange forward +USD +1,752 +EUR +1,300 +February 2011 +Foreign currency exchange forward +USD +1,751 +EUR +1,300 +March 2011 +Foreign currency exchange forward +USD +952 +GBP +600 +February 2011 +Foreign currency exchange forward +USD +952 +GBP +600 +March 2011 +Foreign currency exchange forward +USD +481 +GBP +300 +January 2011 +Foreign currency exchange forward +USD +418 +EUR +300 +January 2011 +Foreign currency exchange forward +F-18 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +8. NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS +Notes payable and capital lease obligations consist of the following: +($ thousands) +December 31, +2010 +December 31, +2009 +Revolving credit facility +$ +3 +$ +— +Capital lease obligations (for certain capitalized software) bearing interest rates ranging from 8.7% to 12.4% and maturities through 2013 +2,488 +640 +Capital lease obligations (for certain equipment) bearing interest at 8.8% and maturities through 2014 +155 +912 +Total notes payable and capital lease obligations +$ +2,646 +$ +1,552 +Minimum +future annual rental commitments under capital leases for each of the five succeeding years as of December 31, 2010, are as follows (in thousands): +Fiscal years ending December 31, +2011 +$ +1,923 +2012 +658 +2013 +55 +2014 +7 +2015 +— +Thereafter +— +Total minimum lease payments +$ +2,643 +Revolving Credit Facility +On September 30, 2010, we amended our Revolving Credit and Security Agreement (the "Credit Agreement") with PNC Bank, N.A. +("PNC"), originally dated September 25, 2009. Based on the amended terms, the Credit Agreement provides for an asset-backed revolving credit facility of up to $30.0 million in total, +which includes a $20.0 million sublimit for borrowings against eligible inventory, a $2.0 million sublimit for borrowings against eligible inventory in-transit, and a +$10.0 million sublimit for letters of credit, and matures on September 24, 2014. Total borrowings available under the revolving credit facility at any given time are subject to customary +reserves and reductions to the extent our asset borrowing base changes. Borrowings under the Credit Agreement are secured by our total assets, including all receivables, equipment, general +intangibles, inventory, investment property, subsidiary stock and leasehold interests. The Credit Agreement requires us to prepay borrowings under the Credit Agreement in the event of certain +dispositions of property. +With +respect to domestic rate loans, principal amounts outstanding bear interest at 1.5% plus the greater of either (i) PNC's published reference rate, (ii) the Federal +Funds Open Rate (as defined in the Credit Agreement) in effect on such day plus 0.5% or, (iii) the sum of the Daily LIBOR Rate (as defined in the Credit Agreement) in effect on such day plus +1.0%. Eurodollar denominated principal amounts outstanding bear interest at 3.0% plus the Eurodollar Rate (as defined in the Credit Agreement). The Credit Agreement requires monthly interest payments +with respect to domestic rate loans and at the end of each interest period with respect to Eurodollar rate loans. The Credit +F-19 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +8. NOTES PAYABLE AND CAPITAL LEASE OBLIGATIONS (Continued) +Agreement +contains certain customary restrictive and financial covenants. We were in compliance with all financial covenants as of December 31, 2010. +As +of December 31, 2010 and 2009, we had issued and outstanding letters of credit of $1.0 million and $1.1 million, respectively, which were reserved against the +borrowing base under the Credit Agreement. During the year ended December 31, 2009, we capitalized $0.5 million in fees and third-party costs which were incurred in connection with the +Credit Agreement, as deferred financing costs. During the year ended December 31, 2010, no deferred financing costs were recorded. +9. EQUITY +Equity Incentive Plans +On August 15, 2005, we adopted the 2005 Equity Incentive Plan (the "2005 Plan"), which permitted the issuance of up to +14.0 million common shares in connection with the grant of non-qualified stock options, incentive stock options, and restricted stock to +eligible employees, consultants and members of our Board of Directors. As of December 31, 2010 and 2009, 2.0 million and 2.7 million stock options, respectively, were outstanding +under the 2005 Plan. No shares are available for future issuance under the 2005 Plan. +On +July 19, 2007, we adopted the 2007 Equity Incentive Plan (the "2007 Plan") which permits the issuance of up to 9.0 million shares of our common stock (subject to +adjustment for future stock splits, stock dividends and similar changes in our capitalization) in connection with the grant of non-qualified stock options, incentive stock options, +restricted stock, restricted stock units, stock appreciation rights, performance units, common stock or any other share-based award to eligible employees, consultants and members of our Board of +Directors. As of December 31, 2010 and 2009, 4.1 million and 5.9 million stock options, restricted stock awards and restricted stock units were outstanding under the 2007 Plan, +respectively. As of December 31, 2010, 1.7 million shares were available for future issuance under the 2007 Plan. +Stock +options under both the 2005 Plan and the 2007 Plan generally vest ratably over four years with the first year vesting on a "cliff" basis followed by monthly vesting for the +remaining three years. Restricted stock awards generally vest annually on a straight-line basis over three or four years depending on the terms of the award agreement. +2009 Tender Offer +Due to declines in the market price of our common stock, the exercise prices of a substantial number of outstanding stock options held +by our employees far exceeded the market price of our common stock as of April 2, 2009. This decline in our common stock price substantially eliminated the incentive and retention value of the +options previously granted to our employees. Consequently, on April 2, 2009, we offered to purchase stock options with exercise prices equal to or greater than $10.50 per share for cash from +certain eligible employees (the "2009 Tender Offer") in order to restore the incentive value of our long-term performance award programs. Individuals eligible to participate in the 2009 +Tender Offer were those employees, including officers and non-employee directors, who continued employment through the date of the offer's expiration, April 30, 2009. Participation +in the 2009 Tender Offer was voluntary. In connection with the 2009 Tender Offer, we made an aggregate cash payment of $0.1 million to repurchase the 2.3 million options tendered and +recorded a charge of $16.3 million +F-20 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. EQUITY (Continued) +related +to previously unrecognized share-based compensation expense for the tendered options. Of this $16.3 million charge, $13.3 million was recorded to selling, general and +administrative expenses and $3.0 million was recorded to cost of sales. As a result of the 2009 Tender Offer, the pool of awards available for future grant under the 2007 Plan increased by +0.8 million shares. Tendered stock options that were originally granted from the 2005 Plan are not available for future grant. +Stock Option Activity +The following table summarizes stock option transactions for the year ended December 31, 2010. +Shares +Weighted +Average +Exercise +Price +Weighted +Average +Remaining +Contractual +Life +(Years) +Aggregate +Intrinsic +Value +(in thousands) +Outstanding at December 31, 2009 +7,755,254 +$ +7.67 +7.48 +15,290 +Granted +342,250 +12.68 +Exercised +(2,133,806 +) +3.37 +Forfeited or expired +(956,361 +) +11.56 +Outstanding at December 31, 2010 +5,007,337 +$ +9.10 +6.36 +$ +47,009 +Exercisable at December 31, 2010 +2,887,500 +$ +10.94 +4.91 +$ +23,595 +Vested and expected to vest at December 31, 2010 +4,388,595 +$ +9.44 +6.06 +$ +40,437 +During +the years ended December 31, 2010, 2009 and 2008, options issued were valued using the Black-Scholes option pricing model using the following assumptions. +Year Ended December 31, +2010 +2009 +2008 +Expected volatility +60 +% +50 - 60 +% +50 +% +Dividend yield +— +— +— +Risk-free interest rate +1.64% - 2.27 +% +1.44% - 2.75 +% +2.81 +% +Expected life (in years) +5.66 - 6.49 +4.59 - 6.86 +4.59 +The +weighted average fair value of options granted during the years ended December 31, 2010, 2009 and 2008 was approximately $7.10, $2.01, and $4.90, respectively. The aggregate +intrinsic value of options exercised during the years ended December 31, 2010, 2009 and 2008 was $21.0 million, $1.0 million, and $9.4 million, respectively. During the +year ended December 31, 2010, we received $7.2 million in cash with no income tax benefit due to our domestic tax loss position (see Note 12—Income Taxes). The total +grant date fair value of stock options vested during the years ended December 31, 2010, 2009 and 2008 was $5.4 million, $13.0 million, and $22.5 million, respectively. +As +of December 31, 2010, we had $7.1 million of total unrecognized share-based compensation expense related to unvested options, net of expected forfeitures, which is +expected to be amortized over the weighted average period of 2.4 years. +F-21 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. EQUITY (Continued) +Restricted Stock Shares and Restricted Stock Units +During 2010, our Board of Directors approved grants of restricted stock awards and units to certain employees as part of a performance +incentive plan. Half of such grants vest ratably on each of the first four anniversaries of the grant date. The remaining half vest on a cliff basis on the fourth anniversary of the grant date, +provided that certain corporate performance metrics are achieved. During the year ended December 31, 2010, 0.7 million restricted stock awards and units were granted under this program. +The +following table summarizes restricted stock award and unit activity during the years ended December 31, 2010, 2009, and 2008. +Restricted Stock Awards +Restricted Stock Units +Shares +Weighted +Average +Grant Date +Fair Value +Shares +Weighted +Average +Grant Date +Fair Value +Nonvested at December 31, 2007 +87,558 +$ +2.96 +— +— +Granted +1,062,454 +4.11 +— +— +Vested +(177,012 +) +0.51 +— +— +Forfeited +(34,000 +) +10.77 +— +— +Nonvested at December 31, 2008 +939,000 +3.87 +— +— +Granted +1,282,110 +2.43 +— +— +Vested +(783,202 +) +2.88 +— +— +Forfeited +(115,668 +) +4.08 +— +— +Nonvested at December 31, 2009 +1,322,240 +3.04 +— +— +Granted +637,557 +12.10 +116,400 +$ +12.99 +Vested +(688,049 +) +3.93 +— +— +Forfeited +(318,325 +) +2.77 +— +— +Nonvested at December 31, 2010 +953,423 +$ +8.54 +116,400 +$ +12.99 +The +total grant date fair value of restricted stock vested during the years ended December 31, 2010, 2009 and 2008 was $2.7 million, $2.3 million, and +$0.1 million, respectively. At December 31, 2010, we had $7.2 million of total unrecognized share-based compensation expense related to non-vested restricted stock +awards, net of expected forfeitures. The non-vested restricted stock awards are expected to be amortized over the weighted average period of 2.4 years. At December 31, 2010, +we had $1.4 million of total unrecognized share-based compensation expense related to non-vested restricted stock units, net of expected forfeitures. The non-vested +restricted stock awards are expected to be amortized over the weighted average period of 3.5 years. +Share-Based Compensation +Total pre-tax share-based compensation expense recognized was $7.3 million for the year ended December 31, +2010 of which $0.2 million of accelerated vesting charges related to the separation agreement of a former officer is included in restructuring charges in the consolidated statements of +F-22 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. EQUITY (Continued) +operations. +No associated tax benefits were recognized in the year ended December 31, 2010, due to our domestic loss position (see Note 12—Income Taxes). +Total +pre-tax share-based compensation expense related to non-vested options, restricted stock awards and restricted stock units, was $33.6 million for the +year ended December 31, 2009 which included the following non-routine items. +• We incurred $16.3 million in charges related to the 2009 Tender Offer. +• We recorded a $3.9 million adjustment related to an error in the calculation of share-based compensation expense +which was identified after our third-party equity accounting software provider notified us that it made a change to how its software program calculates share-based compensation expense. Specifically, +the prior version of this software calculated share-based compensation expense by incorrectly continuing to apply a weighted average forfeiture rate to the vested portion of a stock option award until +the final vesting date of such award rather than reflecting actual forfeitures as vested, resulting in an understatement of share-based compensation expense in certain periods prior to the award's +final vesting. Because our stock option awards generally vest on a monthly basis after the first anniversary date of the award, our share-based compensation expense was understated in certain periods. +This error changed the timing of share-based compensation expense recognition, but did not change the total share-based compensation expense. As share-based compensation expense is a +non-cash item, this error did not impact net cash provided by operations in any period. This error resulted in an understatement of approximately $4.5 million in share-based +compensation expense, with a corresponding understatement of additional paid in capital, as of December 31, 2008 which was corrected in 2009. We do not believe that either the understatement of +share-based compensation expense in 2008 or the effect of the related correction in 2009 were material to the consolidated financial statements. +• We recorded $2.0 million of accelerated vesting charges and $0.2 million of accelerated amortization of +deferred compensation related to the separation agreements with certain former executives which were included in restructuring charges in the consolidated statements of operations. +Total +pre-tax share-based compensation expense recognized was $19.0 million for the year ended December 31, 2008. Due to our domestic tax loss positions during +the years ended December 31, 2009 and 2008, we did not recognize associated tax benefits. During the years ended December 31, 2010, 2009 and 2008, we capitalized $0.1 million, +$0.1 million and $49,000, respectively into intangibles, as capitalized software costs. +Separation Agreements +On March 31, 2010, we entered into a separation agreement with a former officer pursuant to which the vesting of +0.1 million stock options and 0.1 million shares of restricted stock were accelerated as of March 31, 2010. During the year ended December 31, 2010, we recorded +$0.2 million amount to restructuring charges related to these vesting accelerations. Also in connection with this separation agreement, 0.2 million stock options and 0.2 million +shares of restricted stock were forfeited. +During +the year ended December 31, 2009, we entered into two separation agreements with certain former officers. Pursuant to these agreements, the vesting of 0.3 million +stock options and +F-23 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +9. EQUITY (Continued) +0.1 million +restricted stock awards were accelerated during the year ended December 31, 2009 of which 0.1 million stock options vested during 2010. We recorded restructuring +charge of $2.0 million related to such vesting accelerations as well as $0.2 million in accelerated amortization of deferred compensation in 2009. Also in connection with these +separation agreements, 0.2 million stock options were forfeited. +10. VARIABLE INTEREST ENTITIES +In 2007, we established a relationship with Shanghai Shengyiguan Trade, Ltd Co ("ST") for the purpose of serving as a distributor of our products in the People's Republic of +China. We have determined that ST is a variable interest entity for which we are the primary beneficiary. We determined that we are the primary beneficiary of ST by virtue of our variable interest in +the equity of ST and because we currently control all business activities and absorb substantially all of the expected residual returns and substantially all of the expected losses of ST. All voting +rights have been assigned to us and there is a transfer agreement under which all of the equity, assets, and liabilities of ST are to be transferred to us at our sole discretion, subject to certain +conditions. +As +of December 31, 2010 and 2009, the consolidated financial statements included $7.3 million and $6.4 million in total assets of ST respectively, which primarily +consisted of cash, inventory and receivables. These amounts were partially offset by $0.2 million and $0.3 million in liabilities as of December 31, 2010 and 2009, respectively, +which primarily consisted of accounts payable and accrued expenses, excluding liabilities related to the support provided by us. ST's cash assets are restricted to the extent that the monetary laws of +the People's Republic of China limit our ability to utilize ST's cash. +11. ALLOWANCES +The changes in the allowance for doubtful accounts and reserve for sales returns and allowances for the years ended December 31, 2010, 2009 and 2008, are as follows: +($ thousands) +Balance at +Beginning of +Year +Charged to +costs and +expenses +Reversals +and +Write-offs +Balance at +End of +Year +Year ended December 31, 2008: +Allowance for doubtful accounts +$ +3,795 +$ +3,091 +$ +(1,624 +) +$ +5,262 +Reserve for sales returns and allowances +5,991 +52,597 +(39,752 +) +18,836 +Year ended December 31, 2009: +Allowance for doubtful accounts +5,262 +1,262 +(2,551 +) +3,973 +Reserve for sales returns and allowances +18,836 +8,368 +(21,338 +) +5,866 +Year ended December 31, 2010: +Allowance for doubtful accounts +3,973 +2,204 +(1,535 +) +4,642 +Reserve for sales returns and allowances +$ +5,866 +$ +4,971 +$ +(5,230 +) +$ +5,607 +F-24 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. INCOME TAXES +The following table sets forth income (loss) before taxes and the expense (benefit) for income taxes for the years ended December 31, 2010, 2009 and 2008. +December 31, +($ thousands) +2010 +2009 +2008 +Income (loss) before taxes: +U.S. +$ +(14,835 +) +$ +(63,961 +) +$ +(124,502 +) +Foreign +95,627 +15,340 +(65,008 +) +Total income (loss) before taxes +80,792 +$ +(48,621 +) +$ +(189,510 +) +Income tax expense (benefit): +Current income taxes +U.S. federal +47 +$ +(5,452 +) +$ +(9,162 +) +U.S. state +95 +— +206 +Foreign +17,923 +(6,490 +) +9,951 +Total current income taxes +18,065 +(11,942 +) +995 +Deferred income taxes: +U.S. federal +— +(1,330 +) +7,276 +U.S. state +— +— +723 +Foreign +(4,999 +) +6,729 +(13,428 +) +Total deferred income taxes +(4,999 +) +5,399 +(5,429 +) +Total income tax expense (benefit) +$ +13,066 +$ +(6,543 +) +$ +(4,434 +) +The +following table sets forth income (loss) reconciliations of the statutory federal income tax rate to our actual rates based on income or loss before income taxes as of +December 31, 2010, 2009 and 2008. +December 31, +($ thousands) +2010 +2009 +2008 +Consolidated income before taxes +35.0 +% +35.0 +% +35.0 +% +State income taxes net of federal benefit +(0.3 +) +9.0 +1.4 +Foreign tax rate differential +(22.2 +) +(12.0 +) +(11.4 +) +Permanent items +12.5 +(3.8 +) +1.7 +Permanent portion of equity compensation +1.6 +(13.6 +) +— +Charitable donations of inventory +(0.1 +) +11.1 +0.8 +Change in valuation allowance +(34.2 +) +(36.5 +) +(26.1 +) +Unremitted foreign earnings of subsidiary +21.7 +— +— +Benefit of international restructuring +— +28.7 +— +Other +2.2 +(4.5 +) +0.9 +16.2 +% +13.4 +% +2.3 +% +F-25 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. INCOME TAXES (Continued) +The following table sets forth deferred income tax assets and liabilities as of December 31, 2010 and 2009. +December 31, +($ thousands) +2010 +2009 +Current deferred tax assets: +Accrued expenses +$ +19,908 +$ +18,163 +Inventory +454 +1,391 +Intangible assets +238 +257 +Property and equipment +368 +— +Other +1,718 +1,476 +Valuation allowance +(6,918 +) +(12,858 +) +Total current deferred tax assets +$ +15,768 +$ +8,429 +Current deferred tax liabilities: +Property and equipment. +$ +— +$ +(1,080 +) +Unremitted earnings of foreign subsidiary +(17,500 +) +— +Total current deferred tax liabilities. +$ +(17,500 +) +$ +(1,080 +) +Non-current deferred tax assets: +Stock compensation expense +$ +7,409 +$ +11,348 +Inventory +— +433 +Long-term accrued expenses +2,711 +10,062 +Net operating loss and charitable contribution carryovers +39,185 +35,207 +Intangible assets +993 +1,334 +Property and equipment +— +1,722 +Future uncertain tax position offset +13,577 +13,501 +Foreign tax credit +626 +— +Valuation allowance +(28,192 +) +(51,569 +) +Other +101 +— +Total non-current deferred tax assets +$ +36,410 +$ +22,038 +Non-current deferred tax liabilities: +Accrued expenses +$ +— +$ +(4,615 +) +Intangible assets +(196 +) +— +Property and equipment +(2,350 +) +— +Other +— +(1,136 +) +Total non-current deferred tax liabilities +$ +(2,546 +) +$ +(5,751 +) +We +do not provide for deferred taxes on the excess of the financial reporting basis over the tax basis in our investments in foreign subsidiaries that are essentially permanent in +duration. In general, it is our practice and intention to reinvest the earnings of our foreign subsidiaries in those operations. Generally, the earnings of our foreign subsidiaries become subject to +U.S. taxation upon the remittance of dividends and under certain other circumstances. Exceptions may be made on a year-by-year basis to repatriate current year earnings of +certain foreign subsidiaries based on cash needs in the U.S. As of +F-26 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. INCOME TAXES (Continued) +December 31, +2010, we have provided for deferred U.S. income tax of $17.5 million on $50.0 million of foreign subsidiary earnings. No withholding tax is due with respect to the +repatriation of these earnings to the U.S. and none has been provided for. +At +December 31, 2010 and 2009, U.S. income and foreign withholding taxes have not been provided for on approximately $279.2 million and $178.7 million, respectively, +of unremitted earnings of subsidiaries operating outside of the U.S. These earnings are estimated to represent the excess of the financial reporting over the tax basis in our investments in those +subsidiaries. These earnings, which are considered to be indefinitely reinvested, would become subject to U.S. income tax if they were remitted to the U.S. The amount of unrecognized deferred U.S. +income tax liability on the unremitted earnings has not been determined because the hypothetical calculation is not practicable. +We +have deferred tax assets related to certain deductible temporary differences in various tax jurisdictions for which we have recorded a valuation allowance of $35.1 million +against these deferred tax assets because we do not believe that it is more likely than not that we will be able to realize these deferred tax assets. The significant components of the deferred tax +assets for which a valuation allowance has been applied consist of net operating losses in certain tax jurisdictions for which management believes there is not sufficient positive evidence that such +net operating losses will be realized against future income and book expenses not deductible for tax purposes in the current year such as inventory impairment reserves, equity compensation and +unrealized foreign exchange loss that would increase such net operating losses in the same jurisdictions. These temporary differences are amounts which arose in jurisdictions where (i) current +losses exist, (ii) such losses are in excess of any loss carryback potential, (iii) no tax planning strategies exist with which to overcome such losses, and (iv) no profits are +projected for the following year. For these reasons it is determined that it is more likely than not that these deferred tax assets will not be realized and a valuation allowance has been provided +with respect to these deferred tax assets. +At +December 31, 2010, we had U.S. federal net operating loss and charitable contribution carryforwards and state net operating loss carryforwards of $80.4 million and +$124.5 million which will expire at various dates between 2014 and 2030. We do not believe that it is more likely than not that the benefit from certain U.S. federal and state net operating +losses will be realized. Consequently, we have a valuation allowance of $29.9 million on the deferred tax assets relating to these federal and state net operating loss carryforwards. +At +December 31, 2010, we have a foreign deferred tax asset of $5.4 million reflecting the benefit of $30.7 million in foreign net operating loss carryforwards. Such +deferred tax assets expire at various dates between 2014 and 2030. We do not believe it is more likely than not that the benefit from certain foreign net operating loss carryforwards will be realized. +Consequently, we have provided a valuation allowance of $5.2 million on the deferred tax assets relating to these foreign net operating loss carryforwards. +We +had approximately $32.1 million in net deferred tax assets at December 31, 2010. Approximately $14.4 million of the net deferred tax assets were located in +foreign jurisdictions for which a sufficient history and expected future profits indicated that it is more likely than not that such deferred tax assets will be realized. Pre-tax profit of +approximately $42.8 million is required to realize the net deferred tax assets. +F-27 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. INCOME TAXES (Continued) +At +December 31, 2010, approximately $17.7 million of net deferred tax assets consists of deferred tax assets related to estimated liabilities for uncertain tax positions +that would be realized if such liabilities are actually incurred. The deferred tax assets represent primarily the reduction in withholding tax expense that would occur upon a disallowance of +intercompany royalty expense by various taxing authorities. Approximately $44.6 million of unrecognized tax benefits would have to be recognized to realize these deferred tax assets. +As +a result of certain accounting realization requirements, the table of deferred tax assets and liabilities shown above does not include certain deferred tax assets at +December 31, 2010 that arose directly from tax deductions related to equity compensation in excess of compensation recognized for financial reporting. Equity will be increased by +$8.5 million if and when such deferred tax assets are ultimately realized. We use tax law ordering for purposed of determining when excess tax benefits have been realized. +The +following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits during the years ended December 31, 2010, 2009 and 2008. +($ thousands) +2010 +2009 +2008 +Unrecognized tax benefit—January 1 +$ +29,163 +$ +28,210 +$ +11,264 +Gross increases—tax positions in prior period +943 +1,440 +13,063 +Gross decreases—tax positions in prior period +— +(4,868 +) +— +Gross increases—tax positions in current period +3,086 +4,381 +4,868 +Settlements +— +— +(985 +) +Lapse of statute of limitations +(150 +) +— +— +Unrecognized tax benefit—December 31 +$ +33,042 +$ +29,163 +$ +28,210 +Unrecognized +tax benefits of $33.0 million, $29.2 million and $28.2 million at December 31, 2010, 2009 and 2008, respectively, if recognized, would reduce our +annual effective tax rate. +Interest +and penalties related to income tax liabilities are included in income tax expense in the consolidated statement of operations. During 2010, 2009 and 2008, we recorded +approximately $0.1 million, $0.8 million and $1.6 million, respectively, of penalties and interest which resulted in a cumulative accrued balance of penalties and interest of +$2.9 million, $2.8 million and $2.1 million at December 31, 2010, 2009 and 2008, respectively. +Unrecognized +tax benefits consist primarily of tax positions related to intercompany transfer pricing in multiple international jurisdictions. The gross increase for tax positions in +current and prior periods in 2010 of $4.0 million primarily includes specific transfer pricing exposures in various jurisdictions. We believe that it is reasonably possible that no significant +increases or decreases to unrecognized tax benefits will occur in the next twelve months. +F-28 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +12. INCOME TAXES (Continued) +The +following table sets forth the remaining tax years subject to examination for the major jurisdictions where we conduct business as of December 31, 2010. +United States +2005 to 2010 +Singapore +2005 to 2010 +Canada +2006 to 2010 +Netherlands +2006 to 2010 +Japan +2006 to 2010 +State +income tax returns are generally subject to examination for a period of three to five years after filing of the respective return. The state impact of any federal changes remains +subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. +13. EARNINGS PER SHARE +The following table illustrates the basic and diluted EPS computations for the years ended December 31, 2010, 2009 and 2008. +Years Ended December 31, +($ thousands, except per share data) +2010 +2009(1) +2008(1) +Numerator +Net income (loss) attributable to common stockholders +$ +67,726 +$ +(42,078 +) +$ +(185,076 +) +Income allocated to participating securities +(863 +) +— +— +Adjusted net income (loss) attributable to common stockholders +$ +66,863 +$ +(42,078 +) +$ +(185,076 +) +Denominator +Weighted average common shares outstanding +85,482,055 +85,112,461 +82,767,540 +Dilutive effect of stock options +2,113,563 +— +— +Weighted average diluted common shares outstanding +87,595,618 +85,112,461 +82,767,540 +Earnings Per Share +Net income (loss) attributable to common stockholders—basic +$ +0.78 +$ +(0.49 +) +$ +(2.24 +) +Net income (loss) attributable to common stockholders—diluted +$ +0.76 +$ +(0.49 +) +$ +(2.24 +) +(1) Due +to the net loss for the years ended December 31, 2009 and 2008, the dilutive effect of stock options and participating securities were not +included in the computation of EPS, as their inclusion would have been anti-dilutive. +For +the years ended December 31, 2010, 2009 and 2008, there were 1.3 million, 4.0 million and 10.1 million stock options outstanding, respectively, which +could potentially dilute basic EPS in the future, but which were not included in diluted EPS as their effect was anti-dilutive. +F-29 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +14. COMMITMENTS AND CONTINGENCIES +We lease space for certain of our offices, warehouses, vehicles and equipment under leases expiring at various dates through 2026. Certain leases contain rent escalation clauses (step +rents) that require additional rental amounts in the later years of the term. Rent expense for leases with step rents or rent holidays is recognized on a straight-line basis over the +minimum lease term. Deferred rent is included in the consolidated balance sheet in accrued expenses. Total rent expense was $67.3 million, $59.6 million, and $52.7 million for the +years ended December 31, 2010, 2009 and 2008, respectively. Included in such amounts are contingent rents of $9.8 million, $7.1 million and $4.2 million in 2010, 2009 and +2008, respectively. +Minimum +future annual rental commitments under non-cancelable operating leases for each of the five succeeding years as of December 31, 2010, are as follows (in +thousands): +Fiscal years ending December 31, +2011 +$ +48,891 +2012 +36,150 +2013 +28,304 +2014 +21,800 +2015 +18,787 +Thereafter +66,151 +Total minimum lease payments(1) +$ +220,083 +(1) Minimum +payments have not been reduced by minimum sublease rentals of $0.8 million due in the future under non-cancelable subleases. They +also do not include contingent rentals which may be paid under certain retail leases on a basis of percentage of sales in excess of stipulated amounts. +As +of December 31, 2010, we had purchase commitments with certain third-party manufacturers for $84.1 million of which $7.9 million was for +yet-to-be-received finished product where title passes to us upon receipt. +In +February 2011, we renewed and amended our supply agreement with Finproject S.r.l. which provides us the exclusive right to purchase certain raw materials used to manufacture +our products. The agreement also provides that we meet minimum purchase requirements to maintain exclusivity throughout the term of the agreement, which expires December 31, 2014. Historically, +the minimum purchase requirements have not been onerous and we do not expect them to become onerous in the future. Depending on the material purchased, pricing is either based on contracted price or +is subject to quarterly reviews and fluctuates based on order volume, currency fluctuations and raw material prices. Pursuant to the agreement, we guarantee the payment for certain third-party +manufacturer purchases of these raw materials up to a maximum potential amount of €3.5 million (approximately $4.6 million as of December 31, 2010), through a +letter of credit that was issued to Finproject S.r.l.. +We +indemnify certain of our vendors, directors and executive officers for specified claims. As of December 31, 2010, we have not paid or been required to defend any +indemnification claims. Accordingly, we have not accrued any amounts for these indemnification obligations. +F-30 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +We have three reportable segments: Americas, Europe and Asia. We also have an Other segment +category which aggregates insignificant operating segments that do not meet the reportable threshold. Each of our reportable segments derives its revenues from the sale of footwear, apparel and +accessories. The composition of our reportable segments is consistent with that used by our chief operating decision maker ("CODM") to evaluate performance and allocate resources. During the fourth +quarter of 2010, we changed the internal segment reports used by our CODM to separately illustrate performance metrics of certain operating segments which provide manufacturing support, located in +Mexico and Italy. These operating segments make up our Other segment category. Segment information for all periods presented has been restated to reflect this change. +Segment +operating income (loss) is the primary measure used by our CODM to evaluate segment operating performance and to decide how to allocate resources to segments. Segment performance +evaluation is based primarily on segment results without allocating corporate expenses, or indirect general, administrative and other expenses. Segment profits or losses of our reportable segments +include adjustments to eliminate intersegment profit or losses on intersegment sales. Segment operating income (loss) is defined as operating income before asset impairment charges and restructuring +costs not included in cost of sales. Segment assets consist of cash, accounts receivable and inventory as these assets make up the asset information used by the CODM. Revenues of each of our +reportable segments represent sales to external customers. Revenues of the Other segment are made up of intersegment sales only. +F-31 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +The following tables set forth information related to our reportable operating business segments as of and for the years ended December 31, 2010, 2009 and 2008. +Year Ended December 31, +($ thousands) +2010 +2009 +2008 +Revenues: +Americas +$ +377,080 +$ +301,365 +$ +365,930 +Asia +284,814 +237,502 +204,943 +Europe +127,713 +105,996 +149,271 +Other +50,306 +29,164 +33,151 +Total segment revenues +839,913 +674,027 +753,295 +Corporate, intersegment eliminations and other(1) +(50,218 +) +(28,260 +) +(31,706 +) +Total consolidated revenues +$ +789,695 +$ +645,767 +$ +721,589 +Operating income (loss): +Americas +$ +67,259 +$ +21,598 +$ +(38,430 +) +Asia +80,955 +57,836 +16,634 +Europe +24,654 +11,087 +2,703 +Other +(281 +) +76 +(6,480 +) +Total segment operating income (loss) +172,587 +90,597 +(25,573 +) +Corporate, intersegment eliminations and other(1) +(88,872 +) +(108,073 +) +(109,261 +) +SG&A restructuring +(2,539 +) +(7,623 +) +(7,664 +) +Asset impairment(2) +(141 +) +(26,085 +) +(45,784 +) +Total consolidated operating income (loss)(3) +81,035 +(51,184 +) +(188,282 +) +Interest expense +657 +1,495 +1,793 +Gain on charitable contributions +(223 +) +(3,163 +) +— +Other income, net +(191 +) +(895 +) +(565 +) +Income (loss) before income taxes +$ +80,792 +$ +(48,621 +) +$ +(189,510 +) +Depreciation and amortization: +Americas +$ +8,852 +$ +9,977 +$ +9,910 +Asia +7,035 +6,659 +5,638 +Europe +2,048 +2,746 +2,754 +Other +1,324 +1,201 +1,805 +Total segment depreciation and amortization +19,259 +20,583 +20,107 +Corporate, intersegment eliminations and other(1) +17,800 +16,088 +17,343 +Total consolidated depreciation and amortization +$ +37,059 +$ +36,671 +$ +37,450 +(1) Includes +(i) a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based +compensation, research and development, brand marketing, legal, depreciation on corporate and other assets not allocated to operating segments such as molds, tooling, and IT systems, +(ii) intersegment eliminations and (iii) certain corporate holding companies. +F-32 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +(2) Impairment +charges incurred during the year ended December 31, 2009 by segment were recorded as follows: $2.0 million in the Europe segment +and $4.8 million in the Americas segment. Impairment charges incurred during the year ended December 31, 2008 by segment were recorded as follows: $18.9 million in the Americas +segment and $0.3 million in the Europe segment. See Note 2—Property and Equipment for further details on impairments on property and equipment. Included in the +$18.9 million asset impairment in the Americas segment is $7.6 million related to the write-off of certain intangible assets. See Note 3—Intangible Assets +for details. +(3) Includes +total restructuring charges incurred by segment as follows: $1.0 million in the Americas segment, $0.6 million in the Europe segment +and $0.2 million in the Asia segment, during year ended December 31, 2010; $6.3 million in the Americas segment, $3.4 million in the Europe segment and $0.4 million +in the Asia segment during the year ended December 31, 2009; and $8.6 million of restructuring charges in the Americas segments during year ended December 31, 2008. See +Note 6—Restructuring Activities for further details. +As of December 31, +($ thousands) +2010 +2009 +Assets: +Americas +$ +85,296 +$ +77,708 +Asia +164,855 +90,240 +Europe +46,712 +36,296 +Other +25,997 +16,869 +Total segment assets +322,860 +221,113 +Corporate and other(1) +8,138 +17 +Other current assets +50,016 +46,124 +Property and equipment, net +70,014 +71,084 +Intangible assets, net +45,461 +35,984 +Deferred tax assets, net +34,711 +18,479 +Other assets +18,281 +16,937 +Total consolidated assets +$ +549,481 +$ +409,738 +(1) Corporate +assets primarily consist of cash and equivalents, and assets such as molds, tooling, and IT systems not allocated to operating segments. +F-33 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +15. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION (Continued) +There +were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2010, 2009 and 2008. The following table sets forth geographical +information regarding our revenues during the years ended December 31, 2010, 2009 and 2008. +Year Ended December 31, +($ thousands) +2010 +2009 +2008 +Product: +Footwear +$ +753,951 +$ +611,138 +$ +660,734 +Other +35,744 +34,629 +60,855 +Total Revenues +$ +789,695 +$ +645,767 +$ +721,589 +Location: +United States +$ +299,026 +$ +251,487 +$ +317,932 +International +490,669 +394,280 +403,657 +Total Revenues +$ +789,695 +$ +645,767 +$ +721,589 +Foreign country revenues in excess of 10% of total revenues: +Japan +$ +111,764 +$ +99,193 +$ +97,588 +The +following table sets forth geographical information regarding our long-lived assets as of December 31, 2010, 2009 and 2008. +December 31, +($ thousands) +2010 +2009 +2008 +Location: +United States +$ +37,261 +$ +33,342 +$ +64,340 +International +32,753 +37,742 +31,552 +Total long-lived assets +$ +70,014 +$ +71,084 +$ +95,892 +Foreign countries where more than 10% of long-lived assets reside: +China +$ +8,075 +$ +11,522 +$ +1,044 +Mexico +$ +5,943 +$ +7,280 +$ +2,302 +16. LEGAL PROCEEDINGS +On March 31, 2006, we filed a complaint with the International Trading Commission ("ITC") against Acme Ex-Im, Inc., Australia Unlimited, Inc., Cheng's +Enterprises, Inc., Collective Licensing International, LLC, D. Myers & Sons, Inc., Double Diamond Distribution, Ltd., Effervescent, Inc., Gen-X +Sports, Inc., Holey Soles Holdings, Ltd., Inter-Pacific Trading Corporation, and Shaka Holdings, Inc. (collectively, the "respondents"), alleging, among other things infringement +of United States Patent Nos. 6,993,858 (the "'858 Patent") and D517,789 (the "'789 Patent") and seeking an exclusion order banning the importation and sale of infringing products. During the +course of the investigation, the ITC issued final determinations terminating Shaka Holdings, Inc., Inter-Pacific Trading Corporation, Acme Ex-Im, Inc., D. Myers & +Sons, Inc., Australia Unlimited, Inc. and Gen-X +F-34 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. LEGAL PROCEEDINGS (Continued) +Sports, Inc. +from the ITC investigation due to a settlement being reached with each of those entities. Cheng's Enterprises, Inc. was removed from the ITC investigation because they +ceased the accused activities. After a trial in the matter in September 2007, the ITC Administrative Law Judge ("ALJ") issued an initial determination on April 11, 2008, finding the '858 patent +infringed by certain accused products, but also finding the patent invalid as obvious. The ALJ found that the '789 patent was valid, but was not infringed by the accused products. On July 25, +2008, the ITC notified us of its decision to terminate the investigation with a finding of no violation as to either patent. We filed a Petition for Review of the decision with the United States Court +of Appeals for the Federal Circuit on September 22, 2008. On October 4, 2009, a settlement was reached between us and Collective Licensing International, LLC. Collective Licensing +International, LLC agreed to cease and desist infringing on our patents and to pay us certain monetary damages, which was recorded upon receipt. On February 24, 2010, the Federal Circuit +found that the ITC erred in finding that the utility patent was obvious and also reversed the ITC's determination of non-infringement of the design patent. The case has been remanded back +to the ITC. On July 6, 2010, the ITC ordered the matter to be assigned to an ALJ for a determination on enforceability. On February 9, 2011, the ALJ issued a determination that the +utility and design patents were both enforceable against the remaining respondents. The ALJ's decision becomes final on April 11, 2011, unless the Commission determines to review it. +On +December 8, 2009, Columbia Sportswear Company ("Columbia") filed an amended complaint adding us as a defendant in a case between Columbia and Brian P. O'Boyle and 1 +Pen. Inc. in the Multnomah County Circuit Court in the State of Oregon. Columbia asserted claims against us for misappropriation of trade secrets, aiding and abetting breach of fiduciary duty, +intentional interference with contract, injunctive relief, disgorgement and an accounting. The amended complaint sought damages in an unspecified amount, return of patent rights, reasonable attorney's +fees and costs and expenses against us. On July 29, 2010, all issues between us and Columbia were settled and Columbia dismissed with prejudice all claims against us in exchange for certain +monetary and other considerations. +We +and certain current and former officers and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of Colorado. +The first complaint was filed in November 2007 and several other complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the district court appointed a lead +plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purports to state claims under Section 10(b), 20(a), and 20A of the Exchange Act on +behalf of a class of all persons who purchased our common stock between April 2, 2007 and April 14, 2008 (the "Class Period"). The amended complaint also added our independent auditor as +a defendant. The amended complaint alleges that, during the Class Period, the defendants made false and misleading public statements about us and our business and prospects and, as a result, the +market price of our common stock was artificially inflated. The amended complaint also claims that certain current and former officers and directors traded in our common stock on the basis of material +non-public information. The amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified amount, including interest, and also added attorneys' fees and +costs of litigation. We believe the claims lack merit and intend to defend the action vigorously. Motions to dismiss are currently pending with the district court. Due to the inherent uncertainties of +litigation and because the litigation is at a preliminary stage, we cannot at this time accurately predict the ultimate outcome, or any potential liability, of the matter. +F-35 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) +16. LEGAL PROCEEDINGS (Continued) +Although +we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, we are not +party to any other pending legal proceedings that we believe will have a material adverse impact on its business. +17. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +($ thousands, except per share data) +Quarter +Ended +March 31 +Quarter +Ended +June 30(1) +Quarter +Ended +September 30 +Quarter +Ended +December 31(1) +Year Ended December 31, 2010 +Revenues +$ +166,852 +$ +228,046 +$ +215,605 +$ +179,192 +Cost of Sales—Restructuring Charges +10 +1,251 +91 +(53 +) +Gross profit +86,704 +131,919 +118,808 +86,333 +Restructuring charges +2,539 +— +— +— +Asset impairment charges +141 +— +— +— +Income from operations +9,395 +38,726 +27,446 +5,468 +Net income +5,717 +32,284 +24,996 +4,729 +Basic income per common share +$ +0.07 +$ +0.38 +$ +0.29 +$ +0.05 +Diluted income per common share +$ +0.07 +$ +0.37 +$ +0.28 +$ +0.05 +Year Ended December 31, 2009 +Revenues +$ +134,892 +$ +197,722 +$ +177,141 +$ +136,012 +Cost of Sales—Restructuring Charges +— +5,266 +513 +1,307 +Gross profit +49,731 +101,112 +89,850 +60,268 +Restructuring charges +38 +5,915 +17 +1,653 +Asset impairment charges +69 +23,655 +1,722 +639 +Income (loss) from operations +(22,563 +) +(24,519 +) +8,970 +(13,072 +) +Net income (loss) +(22,417 +) +(30,281 +) +22,068 +(11,448 +) +Basic income (loss) per common share +$ +(0.27 +) +$ +(0.36 +) +$ +0.26 +$ +(0.13 +) +Diluted income (loss) per common share +$ +(0.27 +) +$ +(0.36 +) +$ +0.25 +$ +(0.13 +) +(1) As +disclosed in Note 9—Equity, we identified an error during the fourth quarter of 2009 in the calculation of share-based compensation. +This error resulted in the understatement of share-based compensation expense, with a corresponding understatement of additional paid in capital, in the approximate amounts of $4.5 million as +of December 31, 2008. Additional amounts of share-based compensation of approximately $1.0 million and $0.5 million should have been recognized during the first and third quarters +of 2009, respectively. In connection with the 2009 Tender Offer during the second quarter of 2009, we inadvertently corrected approximately $2.0 million of the then existing cumulative error of +approximately $6.0 million. We recorded an additional $3.9 million in share-based compensation during the fourth quarter of 2009 to correct the balance of this error. +F-36 \ No newline at end of file diff --git a/raw/filings/0001334036/2010/0001047469-11-001395/filing_metadata.csv b/raw/filings/0001334036/2010/0001047469-11-001395/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..459bb50ed19d97c5c92021a81d42c73cc08caf67 --- /dev/null +++ b/raw/filings/0001334036/2010/0001047469-11-001395/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2011-02-25,2010-12-31,2011-02-25T21:05:35.000Z,0001047469-11-001395,a2202205z10-k.htm,10-K,1411185,0,0,https://www.sec.gov/Archives/edgar/data/1334036/000104746911001395/a2202205z10-k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000104746911001395/,2010,2010,1 diff --git a/raw/filings/0001334036/2010/0001047469-11-001395/item1.txt b/raw/filings/0001334036/2010/0001047469-11-001395/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..ec024012cf4d696aa43f46615680525e87ee4942 --- /dev/null +++ b/raw/filings/0001334036/2010/0001047469-11-001395/item1.txt @@ -0,0 +1,266 @@ +ITEM 1. BUSINESS +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the "Company," "we," "our" or "us") is a designer, manufacturer, +distributor, worldwide marketer and brand manager of footwear and accessories for men, women and children. We strive to be the global leader in molded footwear design and development which feature +fun, comfort and functionality. Our products include footwear and accessories that utilize our proprietary closed cell-resin, called Croslite. The use of this unique material allows us to +produce innovative, lightweight, non-marking and odor-resistant footwear. Certain shoes made with the Croslite material have been certified by U.S. Ergonomics to reduce peak +pressure on the foot, reduce muscular fatigue while standing and walking and to relieve the musculoskeletal system. We currently sell our products in more than 90 countries through domestic and +international retailers and distributors, and directly to end-user consumers through our company-operated retail stores, outlets, kiosks and webstores. +We +were organized in 1999 as a limited liability company. Shortly after completing our first footwear design produced by Foam Creations, Inc. (now known as Crocs +Canada Inc., "Crocs Canada,") and Finproject N.A., Inc. in 2002, we launched the marketing and distribution footwear products under the Crocs brand in the United States. The unique +characteristics of Croslite, which was developed by Crocs Canada, enabled us to offer consumers a shoe unlike any other footwear model then available. In 2004, we acquired Crocs Canada, including its +manufacturing operations, product lines, and rights to the trade secrets for the Croslite material. In January 2005, we converted to a Colorado corporation and subsequently re-incorporated +as a Delaware corporation in June 2005. In February 2006, we completed our initial public offering and trading of our common stock on NASDAQ commenced. Our business has grown both organically and +through acquisitions which have enabled us to expand the Croslite product-line as well as to include a variety of new products and styles. We aim to continue to expand our +product-line and bring a unique and original perspective to the consumer in styles that may be unexpected from Crocs. +We +are advocates of our global community and environment. We introduced a shoe donation program currently operating under our "Crocs Cares" program. We have donated millions of Crocs +shoes to those in need in both the local and global communities we serve. In addition to the donation program, Crocs Cares aims to establish a comprehensive program focused on internal team building +and community awareness by providing Crocs employees the opportunity to volunteer in their community. Also, our wholly-owned subsidiary Ocean Minded takes an active role in protecting the oceans, +rivers and beaches through beach clean-ups, support of the Surfrider Foundation and through various other charitable efforts. +Products +While the majority of our products consist of footwear, we also offer accessories which generated approximately 4.0% of our total +revenues during the year ended December 31, 2010, and to a much smaller extent, apparel which generated approximately 0.1%. Our footwear products are divided into four product offerings: Core, +Active, Casual and Style. The Core product offering primarily includes molded products that are derivatives of the original Crocs Classic designs and is targeted toward a wide range of consumers. The +Active product offering is comprised of footwear intended for healthy living and includes sport-inspired products and footwear suited for activities such as boating, walking, hiking and even recovery +after workouts. The Casual product offering includes sporty and relaxed styles appealing to a broad range of customers. The Style product offering includes stylish products which are intended to +broaden the wearing occasion for Crocs lovers. +1 +Table of Contents +In +2010, we extended licensing agreements with Disney, Nickelodeon, Marvel, Dreamworks, HIT Entertainment, Mario Batali, and The Collegiate Licensing Company among others, for Crocs +branded footwear and/or Jibbitz shoe charms (discussed below). In addition, we entered into new licensing agreements with LEGO and Mattel (Barbie) in 2010. We also offer a line of footwear and Jibbitz +charms featuring such popular characters as Mickey and Minnie Mouse, Ariel, Sponge Bob Square Pants, Dora the Explorer, Scooby-Doo and Hello Kitty, as well as characters from motion +pictures including Toy Story and Cars. In addition, we are exploring opportunities to license out the Crocs brand name as part of a strategy to extend Crocs into new product types including +accessories and children's apparel. +Footwear +Our footwear product offering has grown significantly since we first introduced the Crocs single style clog in six colors, in 2002. We +currently offer a wide product line of footwear, some of which include boots, sandals, sneakers, mules and flats which are made of materials like leather and textile fabrics as well as Croslite. In +addition to the Crocs brand, some of our market specific product lines include the following. +• Crocs Work is a product offering targeted at the hospital, restaurant, hotel and hospitality markets and includes both +molded and leather footwear styles of which various have been industry certified for slip-resistance and electro-static discharge. The Crocs Work products have an established distribution +channel with a leading uniform supply company thus providing us marketing access to large hospitality chains, laboratories and clean-rooms. In 2010, the Bistro style received the 2010 Gold Medal Seal +from Chef's of America. Also in 2010 the Bistro, Specialist, Specialist Vent, Juniper and Lavender styles were certified by the American Podiatric Medical Association ("APMA"). +• Crocs Rx is a medical-needs product offering targeted at the general foot care and diabetic-needs markets. In 2009 and +2010, Crocs Rx out-sold its competitors in terms of unit volume in the U.S. with a distribution to approximately 1,780 podiatry offices and medical shoe stores. In 2009, we expanded our +Crocs Rx sales in Europe, Asia and India with low-cost, lightweight footwear appropriate for people with diabetes. Each of the Crocs Rx styles has been certified by the APMA. In addition, +we were the first shoe company to receive the APMA's "2008 Company of the Year" award for "greatest impact on the field of podiatry." +• Ocean Minded is a product offering featuring high quality leather and EVA (Ethylene Vinyl Acetate) footwear, sandals and +printed apparel primarily for the beach, action and adventure markets. +• YOU by Crocs is a women's fashion line that combines comfort with fashionable styles. +A +key differentiating feature of our footwear products is the Croslite material, which is uniquely suited for comfort and functionality. We have carefully formulated the Croslite +material to be of a density that creates extremely lightweight, comfortable and non-marking footwear which conforms to the shape of the foot, often reducing pressure points on the foot to +increase comfort. Croslite is a closed cell resin material which is water resistant, virtually odor free, and allows many of our footwear styles to be cleaned simply with water. As we have expanded +our product offering, we have incorporated traditional materials such as textile fabric and leather into many new styles. However, we continue to utilize the Croslite material for the foot bed, sole +and other key structural components for the majority of these styles. +Footwear +sales made up 95.5%, 94.6%, and 91.6% of total revenues for the years ended December 31, 2010, 2009, and 2008, respectively. During the years ended December 31, +2010, 2009 and 2008, approximately 75.5%, 77.5% and 77.9% of unit sales consisted of products geared towards adults, +2 +Table of Contents +respectively, +compared to 24.5%, 22.5% and 22.1% of unit sales of products geared towards children, respectively. Sales of our Crocs Classic models accounted for 9.9%, 15.8%, and 24.8% of total unit +sales for the years ended December 31, 2010, 2009 and 2008, respectively. We believe that the declining percentage of our original styles is reflective of our continued efforts to diversify our +product-line and reduce reliance on original styles. +Accessories +In addition to our footwear brands, we own the Jibbitz brand, a unique accessory product-line with colorful +snap-on charms specifically suited for Crocs shoes. We acquired Jibbitz, LLC ("Jibbitz") in December 2006 and have expanded the product-line to include a wide variety of +charms in varying shapes and sizes, with designs such as flowers, sports gear, seasonal and holiday designs, animals, symbols, letters and rhinestones. Crocs licensing agreements also extend to +Jibbitz, which allows Jibbitz to create designs bearing logos and emblems of Disney, Nickelodeon and the Crocs collegiate line, among others. Jibbitz designs allow Crocs consumers to personalize their +footwear to creatively express their individuality. As of December 31, 2010, approximately 700 unique Jibbitz charm designs were available to consumers for personalizing their Crocs footwear. +Sales from Jibbitz designs made up 3.5%, 3.9%, and 6.5% of total revenues for the years ended December 31, 2010, 2009, and 2008, respectively. +Sales and Marketing +While the broad appeal of our footwear has allowed us to market our products in a wide range of distribution channels, including +department stores, traditional footwear retailers and a variety of specialty and independent retail channels, our marketing approach has become significantly target defined. Our marketing efforts +center on specific product launches and employ a fully integrated approach utilizing a variety of media outlets, including print, the internet and television. We have three primary sales channels: +wholesale, retail and internet. Our marketing efforts drive business to both our wholesale partners and our company-operated retail and internet stores, ensuring that our presentation and story are +first class and drive purchasing at the point of sale. +Wholesale Channel +During the years ended December 31, 2010, 2009 and 2008, approximately 61.0%, 62.6% and 76.5% of net revenues, respectively, +were derived from sales through the wholesale channel which consists of sales to distributors and third-party retailers. Wholesale customers include national and regional retail chains, department +stores, sporting goods stores and family footwear retailers, such as Nordstrom, Journeys, Dillard's, Dick's Sporting Goods, The Sports Authority, The Forzani Group, Famous Footwear, DSW and Xebio, as +well as on-line retailers such as Zappos, Amazon and Shoebuy.com. No single customer accounted for 10% or more of revenues for the year ended December 31, 2010, 2009 or 2008. +We +use third-party distributors in select markets where we believe such arrangements are preferable to direct sales. These third-party distributors purchase products pursuant to a price +list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to four years, are +generally terminable on 30 days prior notice and have minimum sales requirements. At our discretion, we may accept returns from wholesale customers for defective products, quality issues, and +shipment errors on an exception basis or, for certain wholesale customers, extend pricing discounts in lieu of defective product returns. Also at our discretion, we may accept returns from our +wholesale customers, on an exception basis, for the purpose of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, we may provide +markdown allowances to key wholesale customers to facilitate in-channel product markdowns where sell-through is less than anticipated. +3 +Table of Contents +Consumer-Direct Channels +Consumer-direct sales channels include retail and internet channels and serve as an important and effective means to enhance our +product and brand awareness as they provide direct access to our consumers and an opportunity to showcase our entire line of footwear and accessory offerings. We view the consumer-direct channels to +be complementary to our wholesale channel. +Retail Channel +During the years ended December 31, 2010, 2009 and 2008, approximately 29.5%, 28.0%, and 17.4%, of our net revenues were derived +from sales through our retail channel, which consists of company-operated kiosks, retail and outlet stores. +Kiosks As of December 31, 2010 and 2009, we operated 164 and 170 global retail kiosks, respectively, located in malls and other +high foot traffic +areas. Due to their efficient use of retail space and limited initial capital investment, kiosks are an effective outlet for marketing our products. +Retail Stores As of December 31, 2010 and 2009, we operated 138 and 84 global retail stores, respectively, in a variety of +locations, including: Maui, +Hawaii; Yokohama City, Japan; and Hong Kong, China. Company-operated retail stores allow us to effectively market the full breadth and depth of our new and existing products and interact with +customers in order to enhance brand awareness. +Outlet Stores As of December 31, 2010 and 2009, we operated 76 and 63 global outlet stores, respectively in a variety of +locations, including: Orlando, +Florida; Nasushiobara, Japan; and Metzingen, Germany. Outlet stores help us move older products in an orderly fashion. We also sell full priced products in our outlet stores. +Internet Channel +As of December 31, 2010 and 2009, we offered our products through 46 and 23 company-operated webstores, respectively worldwide. +During the years ended December 31, 2010, 2009 and 2008, approximately 9.5%, 9.4%, and 6.1% respectively, of our net revenues were derived from sales through our internet channel. Our internet +presence enables us to educate consumers about our products and brand. We continue to expand our web-based marketing efforts to increase consumer awareness of our full product range. +Business Segments and Geographic Information +We have three reportable segments: Americas, Europe and Asia. We also have an Other segment category which aggregates insignificant +operating segments that do not meet the reportable threshold. Each of our reportable segments derives its revenues from the sale of footwear, apparel and accessories. The composition of our reportable +segments is consistent with that used by our chief operating decision maker ("CODM") to evaluate performance and allocate resources. During the fourth quarter of 2010, we changed the internal segment +reports used by our CODM to separately illustrate performance metrics of certain operating segments which provide manufacturing support, located in Mexico and Italy. These operating segments make up +our Other segment category. Segment information for all periods presented has been restated to reflect this change. +Within +each segment, we sell our products through our wholesale, retail and internet channels. We occasionally utilize sales agents and buying groups in our international locations to +service our wholesale customers. We established a direct sales presence in most major international markets rather than relying on distributors which enables us to obtain better margins and allows us +to better control +4 +Table of Contents +our +marketing and distribution. Financial information relating to our operating segments as well as foreign country revenues and long-lived assets is provided in +Note 15—Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements. +Americas +The Americas segment consists of revenues and expenses related to product sales in the North and South America geographic regions. +Regional wholesale channel customers consist of a broad range of sporting goods and department stores as well as specialty retailers. The regional retail channel sells directly to the consumer through +197 company-operated store locations, including kiosks and retail stores in such locations as Orlando, Maui, Boston, New York, Quebec and Montreal, as well as through webstores. During the years ended +December 31, 2010, 2009 and 2008, the regional revenues constituted approximately 47.8%, 46.7% and 50.7% of our consolidated revenues, respectively. +Asia +The Asia segment consists of revenues and expenses related to product sales throughout Asia, Australia, New Zealand, the Middle East +and South Africa. The Asia wholesale channel consists of sales to a broad range of retailers, similar to the wholesale channel we have established in the Americas wholesale channel. We also sell +products directly to the consumer through 159 company-operated stores including kiosks and retail stores in locations such as Yokohama City, Hong Kong, Singapore and Brisbane, as well as through our +webstores. During the years ended December 31, 2010, 2009 and 2008, revenues from the Asia segment constituted 36.1%, 36.8% and 28.4% of our aggregate consolidated revenues, respectively. +Europe Segment +The Europe segment consists of revenues and expenses related to product sales throughout Europe and Russia. Europe segment wholesale +channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in our Americas segment. We also sell our products directly to the consumer through 22 +company-operated stores including kiosks and retail stores in locations such as Moscow, Russia; Metzingen, Germany; and London, England, as well as through our webstores. During the years ended +December 31, 2010, 2009 and 2008, revenues from the Europe segment constituted 16.2%, 16.4% and 20.7% of our aggregate consolidated revenues, respectively. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network so as to further streamline our supply chain, increase +our speed to market and lower costs. In 2008, we consolidated our distribution and logistics network to leverage resources and simplify our fulfillment processes while driving down costs in our +operations. During 2009, we continued to streamline our distribution strategy based upon projected economic conditions and demand for our products to further consolidate global distribution centers +and warehousing thereby decreasing fixed costs. +During +the year ended December 31, 2010, we stored our raw material and finished goods inventories in company-operated warehouse and distribution facilities located in, +California, Puerto Rico, Mexico, the Netherlands, Japan, China and South Africa. We also utilized distribution centers which were operated by third parties located in Brazil, Finland, Australia, +Dubai, Hong Kong, Korea, Singapore, India, Taiwan and China. Throughout 2010, we continued to engage in efforts to consolidate our global warehouse and distribution facilities to maintain a lean cost +structure. As of December 31, 2010 and 2009, our company-operated warehouse and distribution facilities provided us with 1.3 million square feet and 1.5 million square feet, +respectively, and our third-party operated distribution facilities provided us with 0.3 million square feet and 0.2 million square feet, respectively. We also ship a portion +5 +Table of Contents +of +our products directly to our customers from our internal and third-party manufacturers. We are actively pursuing initiatives aimed at shipping more of our product directly to our customers, which, +if successful, is expected to lower our cost of sales in the future. +Raw Materials +Croslite material, our proprietary closed-cell resin, is the primary raw material used in the majority of our footwear and +some of our accessories. Croslite material is soft and durable and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and +development in order to refine our materials to enhance these properties and to target the development of new properties for specific applications. +Croslite +material is produced by compounding elastomer resins that we or one of our third-party processors purchase from major chemical manufacturers together with certain other +production inputs such as color dyes. At this time, we have identified two suppliers that produce the particular elastomer resins used in the Croslite material. We may, however, in the future identify +and utilize materials produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use +to produce the Croslite material are readily available for purchase from multiple suppliers. +Since +our inception, we have substantially increased the number of footwear products that we offer. Many of our new products are constructed using leather, textile fabrics or other +non-Croslite materials. We or our third-party manufacturers obtain these materials from a number of third-party sources and we believe these materials are broadly available. We compound +Croslite material internally in Mexico utilizing subcomponent materials produced by a third party in the U.S. We also outsource the compounding of Croslite material and continue to purchase a portion +of our compounded raw materials from a third party in Europe. +Design and Development +We have expanded into new footwear categories by designing new footwear styles using both internal designers and external recognized +footwear design experts. As part of this strategy, we acquired EXO Italia ("EXO") in 2006, which expanded our internal design capabilities. EXO is based in Padova, Italy and is an Italian producer of +EVA (Ethylene Vinyl Acetate) based finished products, primarily for the footwear industry. By introducing outside sources to the design process, we are able to capture a variety of different design +perspectives on a cost-efficient basis and anticipate trends more quickly. +We +continue to dedicate significant resources to product design and development as we develop footwear styles based on opportunities we identify in the marketplace. Our design and +development process is highly collaborative, as members of the design team frequently meet with sales and marketing staff, production and supply managers and certain of our retail customers to further +refine our products to meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs while +maintaining product quality. We spent $7.8 million, $7.7 million and $6.4 million in research, design and development activities for the years ended December 31, 2010, +2009, and 2008, respectively. +Manufacturing and Sourcing +Our strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have +company-operated production facilities in Mexico and Italy. We also contract with third-party manufacturers to produce certain of our footwear styles or provide support to our internal production +processes. We believe that our internal manufacturing capabilities enable us to rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high demand +models and colors throughout the year, while outsourcing allows us to capitalize on the efficiencies and +6 +Table of Contents +cost +benefits of using contracted manufacturing services. We believe this strategy will continue to minimize our production costs, increase overall operating efficiencies and shorten production and +development times. +In +the years ended December 31, 2010, 2009 and 2008, we manufactured approximately 21.0%, 26.4% and 16.6%, respectively, of our footwear products internally and sourced the +remaining footwear +production from multiple third-party manufacturers in China and Bosnia. During the years ended December 31, 2010, 2009 and 2008, our largest third-party supplier in China produced approximately +38.8%, 35.7%, and 48.8%, respectively, of our footwear unit volume. We do not have written supply agreements with our primary third-party manufacturers in China. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress, and patent protection to establish, protect, and enforce +our intellectual property rights in our product designs, brand, materials, and research and development efforts, although no such methods can afford complete protection. We own or license the material +trademarks used in connection with the marketing, distribution and sale of all of our products, both domestically and internationally, where our products are currently either sold or manufactured. Our +major trademarks include the Crocs logo and design and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China and Canada among +other places. We also have registrations or pending registrations for trademark rights or have pending trademark applications for the marks Jibbitz, Jibbitz Logo, YOU by Crocs, YOU by Crocs Logo, +Ocean Minded, Tail Logo, Bite, Bite Logo, Crocband, Crocs Tone and Crocs Littles, as well as for our proprietary material Croslite and the Croslite logo, globally. We intend to continue to +strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the future. We will also continue to aggressively police our +trademarks and copyrights and pursue those who infringe, both domestically and internationally as we deem necessary. +In +the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks registered within and outside of the U.S. +are generally valid as long as they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks are crucial to the successful +marketing and sale of our products, and we intend to vigorously prosecute and defend our intellectual property rights throughout the world. +We +consider the formulation of the Croslite material used to produce our products to be a valuable trade secret. Prior to our acquisition of Crocs Canada in June 2004, Crocs Canada +developed the formula for the Croslite material, and we believe that it did not publish or otherwise make the formula available to third parties without the protection of confidentiality or similar +agreements. Post acquisition, we continue to protect the formula by using confidentiality agreements with our third-party processors and by requiring our employees who have access to the formula to +execute confidentiality agreements or to be bound by similar agreements concerning the protection of our confidential information. Neither we nor Crocs Canada have attempted to seek patent protection +for the formula. We are not aware of any third party that has independently developed the formula or that otherwise has the right to use the formula in their products other than Finproject, our +third-party supplier of Croslite in Italy and another third-party licensee. Under the terms of our supply agreement with Finproject, Finproject has certain limited rights to use the Croslite material, +which were originally negotiated in connection with our purchase of Crocs Canada from Finproject's parent company. We believe the comfort and utility of our products depend on the properties achieved +from the +compounding of the Croslite material and constitute a key competitive advantage for us, and we intend to vigorously protect this trade secret. +7 +Table of Contents +We +also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors, and retailers to police against infringing +products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives are also educated on our patents, pending patents, trademarks and +trade dress and assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or +in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain jurisdictions. +Seasonality +Due to the seasonal nature of our footwear which is more heavily focused on styles suitable for warm weather, revenues generated during +our first and fourth quarters are typically less than revenues generated during our second and third quarters, when the northern hemisphere is experiencing warmer weather. We continue to expand our +product line to include more winter-oriented styles to mitigate some of the seasonality of our revenues. Our quarterly results of operations may also fluctuate significantly as a result of a variety +of other factors, including the timing of new model introductions or general economic or consumer conditions. Accordingly, results of operations and cash flows for any one quarter are not necessarily +indicative of results to be expected for any other quarter or for any other year. +Backlog +We receive a significant portion of orders as preseason orders, generally four to five months prior to shipment date. We provide +customers with price incentives to participate in such preseason programs to enable us to better plan our production schedule, inventory and shipping needs. Unfulfilled customer orders as of any date, +are referred to as backlog and represent orders scheduled to be shipped at a future date. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing +schedule and the timing of product shipments. Further, the mix of future and immediate delivery orders can vary significantly from period over period. Due to +these factors and since the unfulfilled orders can be canceled at any time prior to shipment by our customers, backlog may not be reliable measure of future sales and comparisons of backlog from +period to period may be misleading. In addition, our historical cancellation experience may not be indicative of future cancellation rates. Backlog as of December 31, 2010 and 2009 was +$258.4 million and $165.0 million, respectively. +Competition +The global casual, athletic and fashion footwear markets are highly competitive. Although we believe that we do not compete directly +with any single company with respect to the entire spectrum of our products, we believe portions of our business compete with companies such as, but not limited to, Nike Inc., +Heelys Inc., Deckers Outdoor Corp., Skechers USA Inc. and Wolverine World Wide, Inc. Our company-operated retail locations also compete with footwear retailers such as +Nordstrom Inc., Dillards, Dick's Sporting Goods Inc. and Collective Brands Inc. +The +principal elements of competition in these markets include brand awareness, product functionality, design, quality, pricing, customer service, marketing and distribution. We believe +that our unique footwear designs, the Croslite material, our prices, expanded product-line and our distribution network continue to position us well in the marketplace. However, some +companies in the casual footwear and apparel industry have greater financial resources, more comprehensive product lines, broader market presence, longer-standing relationships with wholesalers, +longer operating histories, greater distribution capabilities, stronger brand recognition and greater marketing resources than we currently have. Furthermore, we face competition from new players who +have been attracted to the market with imitation products similar to ours as the result of the unique design and success of our footwear products. +8 +Table of Contents +Employees +As of December 31, 2010, we had approximately 4,000 full-time, part-time and seasonal employees, none of +which were represented by a union. +Available Information +Our internet address is www.crocs.com on which we post the following filings, free of charge, as soon as reasonably practicable after +they are electronically filed with or furnished to the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our +current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended +(the "Exchange Act"). Also available on our website are the charters of the committees of our board of directors and our code of ethics. Copies of any of these +documents will be provided in print to any stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. \ No newline at end of file diff --git a/raw/filings/0001334036/2010/0001047469-11-001395/item13.txt b/raw/filings/0001334036/2010/0001047469-11-001395/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..911623f3d32a33a0c238ceab2575953e3b425d79 --- /dev/null +++ b/raw/filings/0001334036/2010/0001047469-11-001395/item13.txt @@ -0,0 +1,3 @@ +ITEM 13. Certain Relationships and Related Transactions, and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2011 Annual Meeting +of Stockholders to be filed with the SEC within 120 days after December 31, 2010. \ No newline at end of file diff --git a/raw/filings/0001334036/2010/0001047469-11-001395/item9a.txt b/raw/filings/0001334036/2010/0001047469-11-001395/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..0730881443cfc16289eb2f53368959600b5a13ba --- /dev/null +++ b/raw/filings/0001334036/2010/0001047469-11-001395/item9a.txt @@ -0,0 +1,62 @@ +ITEM 9A. Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Acting Principal +Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and +15d-15(e) under the Exchange Act, as of December 31, 2010 (the "Evaluation Date"). Based on this evaluation, our Chief Executive Officer and Acting Principal Financial Officer +concluded that as of the Evaluation Date, our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be +disclosed in our Securities and Exchange Commission ("SEC") reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and +(ii) is accumulated and communicated to our management, including our Chief Executive Officer and Acting Principal Financial Officer, as appropriate to allow timely decisions regarding required +disclosure. +Management's Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange +Act Rules 13a-15(f) and 15d-15(f). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2010, using the +criteria set forth in the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway +Commission (COSO). Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2010. +Deloitte & +Touche LLP, our independent registered public accounting firm, has issued a report on our internal control over financial reporting, which is included herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially +affected, or is reasonable likely to materially affect, our internal control over financial reporting. +45 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To +the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We +have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the "Company") as of December 31, 2010, based on criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's +management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the +accompanying "Management's Annual Report on Internal Control Over Financial Reporting". Our responsibility is to express an opinion on the Company's internal control over financial reporting based on +our audit. +We +conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to +obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control +over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and +performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A +company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or +persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting +and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those +policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; +(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that +receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding +prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. +Because +of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material +misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to +future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In +our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control—Integrated +Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We +have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year +ended December 31, 2010 of the Company and our report dated February 25, 2011 expressed an unqualified opinion on those financial statements. +/s/ +Deloitte & Touche LLP +Denver, +Colorado +February 25, 2011 +46 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2010/0001047469-11-001395/rp_note.txt b/raw/filings/0001334036/2010/0001047469-11-001395/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2010/0001047469-11-001395/rpt_disclosure.txt b/raw/filings/0001334036/2010/0001047469-11-001395/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..9703a900fc4995e26ae349e7ed6f9582de181f65 --- /dev/null +++ b/raw/filings/0001334036/2010/0001047469-11-001395/rpt_disclosure.txt @@ -0,0 +1,18 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +We had no +transactions with related persons during 2011 which are required to be disclosed by the rules of the SEC. +Policy on Transactions with +Related Persons +Our Code of Business Conduct and Ethics requires that any transaction involving us in which one of our directors, +nominees for director, executive officers, or greater than five percent stockholders, or one of the aforementioned’s immediate family members (each, a “related person”), have a material interest be approved or ratified by the Audit +Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course of business transactions in which directors have +an interest as part of the Board’s annual director independence review, and our Code of Business Conduct and Ethics permits the full Board to waive any conflicts of interest between us and any director or officer. In determining whether to +approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. +Director and Officer Indemnification +We have entered into agreements to indemnify certain directors and executive officers in addition to the indemnification provided for in our certificate +of incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys’ fees), judgments, fines and settlement amounts incurred by any +such person in any action or proceeding, including any action by us or in our right, arising out of such person’s services as a director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person +provided services at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. +15 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2011/0001193125-12-075455/filing.txt b/raw/filings/0001334036/2011/0001193125-12-075455/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..b08921ee9930ec48a180ddf33479675d041d2f29 --- /dev/null +++ b/raw/filings/0001334036/2011/0001193125-12-075455/filing.txt @@ -0,0 +1,5465 @@ +10-K +1 +d280890d10k.htm +FORM 10-K +FORM 10-K +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2011 +or +¨ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period from +to +Commission File No. 0-51754 +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware +20-2164234 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +7477 East Dry Creek Parkway +Niwot, Colorado 80503 +(303) 848-7000 +(Address, including zip code and telephone number, +including area code, of registrant’s principal executive offices) +Securities registered pursuant to Section 12(b) of +the Act: +Title of each class: +Name of each exchange on which +registered: +Common Stock, par value $0.001 per share +The NASDAQ Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes x No ¨ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x +Indicate by check mark +whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file +such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File +required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such +files). Yes x No ¨ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and +will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to the Form 10-K. ¨ +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, +a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer x +Accelerated filer ¨ +Non-accelerated filer ¨ +Smaller reporting company ¨ +(do not check if a +smaller reporting company) +Indicate by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x +The aggregate market value of +the voting common stock held by non-affiliates of the registrant as of June 30, 2011 was $2.3 billion. For the purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of +the registrant’s common stock are assumed to be affiliates of the registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The number of shares of the registrant’s common stock outstanding as of January 31, 2012 was 89,838,840. +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by +reference from the registrant’s proxy statement for the 2012 annual meeting of stockholders to be filed no later than 120 days after the end of the registrant’s fiscal year ended December 31, 2011. +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2011 +PART I +Item 1. +Business +1 +Item 1A. +Risk Factors +8 +Item 1B. +Unresolved Staff Comments +17 +Item 2. +Properties +18 +Item 3. +Legal Proceedings +18 +Item 4. +Mine Safety Disclosures +19 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +19 +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 +39 +Item 8. +Financial Statements and Supplementary Data +40 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +40 +Item 9A. +Controls and Procedures +40 +Item 9B. +Other Information +43 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +43 +Item 11. +Executive Compensation +43 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder +Matters +43 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +44 +Item 14. +Principal Accountant Fees and Services +44 +PART IV +Item 15. +Exhibits and Financial Statement Schedules +44 +Signatures +47 +Table of Contents +PART I +ITEM 1. +BUSINESS +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the “Company,” “we,” “our” or “us”) is a +designer, manufacturer and distributor of footwear and accessories for men, women and children. We strive to be the global leader in the sale of molded footwear featuring fun, comfort and functionality. Our primary products utilize our proprietary +closed cell-resin, called Croslite. The use of this unique material allows us to produce innovative, lightweight, non-marking and odor-resistant footwear. We currently sell our products in more than 90 countries through domestic and international +retailers and distributors and directly to end-user consumers through our company-operated retail stores, outlets, kiosks and webstores. +We +were organized in 1999 as a limited liability company. In 2002, we launched the marketing and distribution of our original clog style footwear in the United States. The unique characteristics of Croslite enabled us to offer consumers a shoe unlike +any other footwear model then available. In January 2005, we converted to a Colorado corporation and subsequently re-incorporated as a Delaware corporation in June 2005. In February 2006, we completed our initial public offering and trading of our +common stock on NASDAQ commenced. +Since the initial introduction and popularity of the Beach and Crocs Classic designs, we have expanded our +Croslite products to include a variety of new styles and products and have further extended our product reach through the acquisition of brand platforms such as Jibbitz, LLC (“Jibbitz”) and Ocean Minded, Inc. (“Ocean +Minded”). We continue to branch out into other types of footwear so as to bring a unique and original perspective to the consumer in styles that may be unexpected from Crocs. We believe this will help us to continue to build a stable year-round +business as we look to offer more styles oriented for cold weather. Our marketing efforts surround specific product launches and employ a fully integrated approach utilizing a variety of media outlets, including print and online. Our marketing +efforts drive business to both our wholesale partners and our company-operated retail and internet stores, ensuring that our presentation and story are first class and drive purchasing at the point of sale. +Products +While the majority of our +products consist of footwear, we also offer accessories and apparel which generated approximately 3.7% of our total revenues during the year ended December 31, 2011. Our footwear products are divided into four product offerings: Core-Comfort, +Active, Casual and Style. The Core product offering primarily includes molded products that are derivatives of the original Crocs Classic designs and is targeted toward a wide range of consumers. The Active product offering is comprised of footwear +intended for healthy living and includes sport inspired products and footwear suited for activities such as boating, walking, hiking and even recovery after workouts. The Casual product offering includes sporty and relaxed styles appealing to a +broad range of customers. The Style product offering includes stylish products which are intended to broaden the wearing occasion for Crocs lovers. +Crocs has an active licensing program that includes licensing various marks from companies such as Disney, Marvel and Viacom, among others, for Crocs branded footwear and Jibbitz branded shoe charms. In +2011, Crocs began to license certain of its own marks to third parties in connection with a strategy to extend the Crocs brand into new product types. +Footwear +Our footwear product offering has grown significantly since we first +introduced the Crocs single style clog in six colors, in 2002. We currently offer a wide product line of footwear, some of which include boots, sandals, sneakers, mules and flats which are made of materials like leather and textile fabrics as well +as Croslite. In addition to the Crocs brand, some of our market specific product lines include the following. +• +Crocs Work is a product offering targeted at the healthcare, service/hospitality and airline markets that include both molded and leather footwear +styles that feature Crocs Lock™ tread for slip- +1 +Table of Contents +resistance that exceeds industry standards. The Crocs Work products have an established distribution channels with uniform supply companies and large Group Purchasing Organizations, thus +providing us market access to specific industry consumers and large hospitality chains. In 2010, the Bistro style received the 2010 Gold Medal Seal from Chef’s of America. Also in 2011 the Bistro, Specialist and Specialist Vent styles +received the “Seal of Acceptance” by the American Podiatric Medical Association (“APMA”), while several other work styles are currently in the same approval process. +• +Crocs Rx is a medical needs product offering targeted at the general foot care and diabetic needs markets with a distribution to 1,358 podiatry offices +and medical shoe stores. Relief, Ultimate Cloud and Custom Cloud Rx styles have also received the “Seal of Acceptance” by the APMA. +• +Ocean Minded is a product offering featuring high quality leather and EVA (Ethylene Vinyl Acetate) footwear, sandals and printed apparel primarily for +the beach, action and adventure markets. +A key differentiating feature of our footwear products is the Croslite material, +which is uniquely suited for comfort and functionality. Croslite is carefully formulated to be of a density that creates extremely lightweight, comfortable and non-marking footwear which conforms to the shape of the foot and increase comfort. +Croslite is a closed cell resin material which is water resistant, virtually odor free and allows many of our footwear styles to be cleaned simply with water. As we have expanded our product offering, we have incorporated traditional materials such +as textile fabric and leather into many new styles. However, we continue to utilize the Croslite material for the foot bed, sole and other key structural components for many of these styles. +Footwear sales made up 95.6%, 95.5% and 94.6% of total revenues for the years ended December 31, 2011, 2010 and 2009, respectively. During the years ended December 31, 2011, 2010 and 2009, +approximately 73.1%, 75.5% and 77.5% of unit sales consisted of products geared towards adults, respectively, compared to 26.9%, 24.5% and 22.5% of unit sales of products geared towards children, respectively. +Accessories +In addition to our +footwear brands, we own the Jibbitz brand, a unique accessory product-line with colorful snap-on charms specifically suited for Crocs shoes. We acquired Jibbitz, LLC (“Jibbitz”) in December 2006 and have expanded the product-line to +include a wide variety of charms in varying shapes and sizes, with designs such as flowers, sports gear, seasonal and holiday designs, animals, symbols, letters and rhinestones. Crocs licensing agreements also extend to Jibbitz, which allows Jibbitz +to create designs bearing logos and emblems of Disney, Nickelodeon and the Crocs collegiate line, among others. Jibbitz designs allow Crocs consumers to personalize their footwear to creatively express their individuality. As of December 31, +2011, more than 3,000 unique Jibbitz charm designs were sold to consumers for personalizing their Crocs footwear. Sales from Jibbitz designs made up 3.7%, 3.5% and 3.9% of total revenues for the years ended December 31, 2011, 2010 and 2009, +respectively. +Sales and Marketing +While the broad appeal of our footwear has allowed us to market our products in a wide range of distribution channels, including department stores, traditional footwear retailers and a variety of +specialty and independent retail channels, our marketing approach has become significantly target defined. Our marketing efforts center on specific product launches and employ a fully integrated approach utilizing a variety of media outlets, +including print and the internet. We have three primary sales channels: wholesale, retail and internet. Our marketing efforts drive business to both our wholesale partners and our company-operated retail and internet stores, ensuring that our +presentation and story are first class and drive purchasing at the point of sale. +2 +Table of Contents +Wholesale Channel +During the years ended December 31, 2011, 2010 and 2009, approximately 59.8%, 61.0% and 62.6% of net revenues, respectively, were derived from sales through the wholesale channel which consists of +sales to distributors and third party retailers. Wholesale customers include national and regional retail chains, department stores, sporting goods stores independent footwear retailers and family footwear retailers, such as Dick’s Sporting +Goods, Famous Footwear, Academy, DSW, Nordstrom, Murasaki Sports and Centauro, as well as on-line retailers such as Zappos and Amazon. No single customer accounted for 10% or more of revenues for the years ended December 31, 2011, 2010 or 2009. +We use third party distributors in select markets where we believe such arrangements are preferable to direct sales. These third party +distributors purchase products pursuant to a price list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to four years, are +generally terminable on 30 days prior notice and have minimum sales requirements. At our discretion, we may accept returns from wholesale customers for defective products, quality issues and shipment errors on an exception basis or, for certain +wholesale customers, extend pricing discounts in lieu of defective product returns. Also at our discretion, we may accept returns from our wholesale customers, on an exception basis, for the purpose of stock re-balancing to ensure that our products +are merchandised in the proper assortments. Additionally, we may provide markdown allowances to key wholesale customers to facilitate in-channel product markdowns where sell-through is less than anticipated. +Consumer Direct Channels +Consumer direct sales channels include retail and internet channels and serve as an important and effective means to enhance our product and brand +awareness as they provide direct access to our consumers and an opportunity to showcase our entire line of footwear and accessory offerings. Consequently, we view the consumer direct channels to be complementary to our wholesale channel. +Retail Channel +During the years ended +December 31, 2011, 2010 and 2009, approximately 30.6%, 29.5% and 28.0%, respectively, of our net revenues were derived from sales through our retail channel, which consists of kiosks/store in stores, company-operated retail and outlet stores. +Retail Stores As of December 31, 2011, 2010 and 2009, we operated 180, 138 and 84 global retail stores, +respectively. Our retail stores allow us to effectively market the full breadth and depth of our new and existing products and interact with customers in order to enhance brand awareness. +Outlet Stores As of December 31, 2011, 2010 and 2009, we operated 92, 76 and 63 global outlet stores, respectively. +Outlet stores help us move older products in an orderly fashion. We also sell full priced products in our outlet stores. +Kiosks/Store in Stores As of December 31, 2011, 2010 and 2009, we operated 158, 164 and 170 global retail kiosks and store in +stores, respectively, located in malls and other high foot traffic areas. +Of our total 430 global stores as of December 31, 2011, 180 +were located in the U.S., 51 were located in Korea, 41 were located in Taiwan, 32 were located in China, 24 were located in Japan, 21 were located in Hong Kong, 13 were located in Canada, 13 were located in Russia and the remaining were located +throughout Asia, Europe, Australia, the Middle East, South America and South Africa. +Internet Channel +As of December 31, 2011, 2010 and 2009, we offered our products through 42, 37 and 23 company-operated internet webstores, respectively, worldwide. +During the years ended December 31, 2011, 2010 and 2009, +3 +Table of Contents +approximately 9.6%, 9.5% and 9.4%, respectively, of our net revenues were derived from sales through our internet channel. Our internet presence enables us to have increased access to our +customers and provides us with an opportunity to educate them about our products and brand. We continue to expand our web-based marketing efforts to increase consumer awareness of our full product range. +Business Segments and Geographic Information +We have three reportable operating segments: Americas, Europe and Asia. Revenues of each of our reportable operating segments represent sales to external customers. We also have an “Other +businesses” category which aggregates insignificant operating segments that do not meet the reportable threshold and represent manufacturing operations located in Mexico and Italy. Revenues of the “Other businesses” category are +primarily made up of intersegment sales which are eliminated when deriving total consolidated revenues. The remaining revenues for the “Other businesses” represent non-footwear product sales to external customers. Financial information +relating to our operating segments as well as foreign country revenues and long-lived assets is provided in Note 14—Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements. +Americas +The +Americas segment consists of revenues and expenses related to product sales in the North and South America geographic regions. Regional wholesale channel customers consist of a broad range of sporting goods and department stores as well as specialty +retailers. The regional retail channel sells directly to the consumer through 197 company-operated store locations as well as through webstores. During the years ended December 31, 2011, 2010 and 2009, revenues from the Americas segment +constituted approximately 44.8%, 47.8% and 46.7% of our consolidated revenues, respectively. +Asia +The Asia segment consists of revenues and expenses related to product sales throughout Asia, Australia, New Zealand, the Middle East and South Africa. +The Asia wholesale channel consists of sales to a broad range of retailers, similar to the wholesale channel we have established in the Americas. We also sell products directly to the consumer through 198 company-operated stores as well as through +our webstores. During the years ended December 31, 2011, 2010 and 2009, revenues from the Asia segment constituted 38.1%, 36.1% and 36.8% of our consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related to product +sales throughout Europe and Russia. Europe segment wholesale channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas. We also sell our products directly to the consumer through 35 +company-operated stores including kiosks and retail stores as well as through our webstores. During the years ended December 31, 2011, 2010 and 2009, revenues from the Europe segment constituted 17.1%, 16.2% and 16.4% of our consolidated +revenues, respectively. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network so as to further streamline our supply chain, increase our speed to market and lower operating costs. During the year ended +December 31, 2011, we stored our raw material and finished goods inventories in company-operated warehouse and distribution facilities located in the United States, Mexico, the Netherlands, Japan, Finland, Australia, South Africa, Russia and +Italy. We also utilize distribution centers which are operated by third parties located in China, Japan, Hong Kong, Australia, Korea, Singapore, India, Taiwan, Russia, Mexico, Brazil, Puerto Rico and Italy. Throughout 2011, we continued to engage in +efforts to consolidate our global warehouse and distribution facilities to maintain a lean cost structure. As of December 31, 2011, 2010 and 2009, our company-operated warehouse and +4 +Table of Contents +distribution facilities provided us with 1.0 million square feet, 1.3 million square feet and 1.5 million square feet, respectively, and our third party operated distribution +facilities provided us with 0.5 million square feet, 0.3 million square feet and 0.2 million square feet, respectively. We also ship a portion of our products directly to our customers from our internal and third party manufacturers. +We are actively pursuing initiatives aimed at shipping more of our product directly to our customers in an effort to lower future cost of sales. +Raw Materials +Croslite material, our proprietary closed-cell resin, is the primary raw +material used in the majority of our footwear and some of our accessories. Croslite material is soft and durable and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and development +in order to refine our materials to enhance these properties and to target the development of new properties for specific applications. +Croslite material is produced by compounding elastomer resins that we or one of our third party processors purchase from major chemical manufacturers +together with certain other production inputs such as color dyes. At this time, we have identified multiple suppliers that produce the particular elastomer resins used in the Croslite material. We may, however, in the future identify and utilize +materials produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use to produce the Croslite material are readily available for +purchase from multiple suppliers. +Since our inception, we have substantially increased the number of footwear products that we offer. Many of +our new products are constructed using leather, textile fabrics or other non-Croslite materials. We, or our third party manufacturers, obtain these materials from a number of third party sources and we believe these materials are broadly available. +We also outsource the compounding of Croslite material and continue to purchase a portion of our compounded raw materials from a third party in Europe. +Design and Development +We have expanded into new footwear categories by designing new +footwear styles using both internal designers and external recognized footwear design experts. As part of this strategy, we acquired EXO Italia (“EXO”) in 2006, which expanded our internal design capabilities. EXO is based in Padova, Italy +and is an Italian producer of EVA (Ethylene Vinyl Acetate) based finished products, primarily for the footwear industry. By introducing outside sources to the design process, we are able to capture a variety of different design perspectives on a +cost-efficient basis and anticipate trends more quickly. +We continue to dedicate significant resources to product design and development as +we develop footwear styles based on opportunities we identify in the marketplace. Our design and development process is highly collaborative, as members of the design team frequently meet with sales and marketing staff, production and supply +managers and certain of our retail customers to further refine our products to meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs +while maintaining product quality. We spent $10.8 million, $7.8 million and $7.7 million in research, design and development activities for the years ended December 31, 2011, 2010 and 2009, respectively. +Manufacturing and Sourcing +Our +strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have company-operated production facilities in Mexico and Italy. We also contract with third party manufacturers to produce certain of our footwear +styles or provide support to our internal production processes. We believe that our internal manufacturing capabilities enable us to rapidly make changes to production, providing us with the +5 +Table of Contents +flexibility to quickly respond to orders for high demand models and colors throughout the year, while outsourcing allows us to capitalize on the efficiencies and cost benefits of using contracted +manufacturing services. We believe this strategy will continue to minimize our production costs, increase overall operating efficiencies and shorten production and development times. +In the years ended December 31, 2011, 2010 and 2009, we manufactured approximately 20.6%, 21.0% and 26.4%, respectively, of our footwear products internally. We sourced the remaining footwear +production from multiple third party manufacturers primarily in China, Vietnam, Eastern Europe and South America. During the years ended December 31, 2011, 2010 and 2009, our largest third party manufacturer in China produced approximately +33.1%, 38.8% and 35.7%, respectively, of our footwear unit volume. We do not have written supply agreements with our primary third party manufacturers in China. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, +trade secret, trade dress and patent protection to establish, protect and enforce our intellectual property rights in our product designs, brand, materials and research and development efforts, although no such methods can afford complete +protection. We own or license the material trademarks used in connection with the marketing, distribution and sale of all of our products, both domestically and internationally, where our products are currently either sold or manufactured. Our major +trademarks include the Crocs logo and design and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China and Canada among other places. We also have registrations or pending +registrations for trademark rights or have pending trademark applications for the marks Jibbitz, Jibbitz Logo, YOU by Crocs, YOU by Crocs Logo, Ocean Minded, Tail Logo, Bite, Bite Logo, Crocband, Crocs Tone and Crocs Littles, as well as for our +proprietary material Croslite and the Croslite logo, globally. +In the U.S., our patents are generally in effect for up to 20 years from +the date of the filing of the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to become generic. We +believe our trademarks are crucial to the successful marketing and sale of our products. We intend to continue to strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in +the future. We will also continue to aggressively police our patent, trademarks and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We consider the formulation of the material referred to by our trademark Croslite and used to produce our shoes to be a valuable trade secret. Croslite +material is manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formula by using +exclusive supply agreements for key components, confidentiality agreements with our third party processors and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our +third party processors and a third party licensee, we are not aware of any third party that has independently developed the formula or that otherwise has the right to use the formula. We believe the comfort and utility of our products depend on the +properties achieved from the compounding of Croslite material and constitute a key competitive advantage for us, and we intend to continue to vigorously protect this trade secret. +We also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors and retailers to police against infringing products by +encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives are also educated on our patents, pending patents, trademarks and trade dress to assist in preventing potentially infringing +products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal +protection for our intellectual property in certain jurisdictions. +6 +Table of Contents +Seasonality +Due to the seasonal nature of our footwear which is more heavily focused on styles suitable for warm weather, revenues generated during our first and fourth quarters are typically less than revenues +generated during our second and third quarters, when the northern hemisphere is experiencing warmer weather. We continue to expand our product line to include more winter oriented styles to mitigate some of the seasonality of our revenues. Our +quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of new model introductions or general economic or consumer conditions. Accordingly, results of operations and cash flows +for any one quarter are not necessarily indicative of results to be expected for any other quarter or year. +Backlog +We receive a significant portion of orders as preseason orders, generally four to five months prior to shipment date. We provide customers with price +incentives to participate in such preseason programs to enable us to better plan our production schedule, inventory and shipping needs. Unfulfilled customer orders as of any date are referred to as backlog and represent orders scheduled to be +shipped at a future date. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing schedule and the timing of product shipments. Further, the mix of future and immediate delivery orders can vary +significantly period over period. Due to these factors and since the unfulfilled orders can be canceled at any time prior to shipment by our customers, backlog may not be a reliable measure of future sales and comparisons of backlog from period to +period may be misleading. In addition, our historical cancellation experience may not be indicative of future cancellation rates. Backlog as of December 31, 2011 and 2010 was $307.4 million and $258.4 million, respectively. +Competition +The global +casual, athletic and fashion footwear markets are highly competitive. Although we believe that we do not compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale business +compete with companies such as, but not limited to, Deckers Outdoor Corp., Skechers USA Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations also compete with footwear retailers such as +Genesco, Inc., Macy’s, Dillard’s, Dick’s Sporting Goods Inc., The Finish Line, Inc and Footlocker, Inc. +The principal +elements of competition in these markets include brand awareness, product functionality, design, quality, pricing, customer service, marketing and distribution. We believe that our unique footwear designs, the Croslite material, our prices, expanded +product-line and our distribution network continue to position us well in the marketplace. However, some companies in the casual footwear and apparel industry have greater financial resources, more comprehensive product lines, broader market +presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition and greater marketing resources than we have. Furthermore, we face competition from new players who +have been attracted to the market with imitation products similar to ours as the result of the unique design and success of our footwear products. +Employees +As of December 31, 2011, we had approximately 4,157 full-time, part-time +and seasonal employees, none of which were represented by a union. +Available Information +Our internet address is www.crocs.com on which we post the following filings, free of charge, as soon as reasonably practicable after they are +electronically filed with or furnished to the Securities and Exchange +7 +Table of Contents +Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to +Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”). Copies of any of these documents will be provided in print to any stockholder who submits a request in writing to Integrated Corporate +Relations, 761 Main Avenue, Norwalk, CT 06851. +ITEM 1A. +Risk Factors +Special Note Regarding +Forward Looking Statements +Statements in this Form 10-K and in documents incorporated by reference herein (or otherwise made by us +or on our behalf) contain “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications from time to time that contain such +statements. Forward looking statements include statements as to industry trends, our future expectations and other matters that do not relate strictly to historical facts and are based on certain assumptions of our management. These statements are +often identified by the use of words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “strive,” “will,” and variations of such +words or similar expressions. Further, these statements are based on the beliefs and assumptions of management based on information currently available. Such forward looking statements are subject to risks, uncertainties and other factors that could +cause actual results to differ materially from future results expressed or implied by such forward looking statements. Important factors that could cause actual results to differ materially from the forward looking statements include, without +limitation, the risk factors mentioned below. Moreover, such forward looking statements speak only as of the date of this report. We undertake no obligation to update any forward looking statements to reflect events or circumstances after the date +of such statements. +The risks included herein are not exhaustive. Other sections of this Form 10-K may include additional factors which +could adversely affect our business and financial performance. Since we operate in a very competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for management to predict all such risk factors, +nor can it assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward looking statements. Given these +risks and uncertainties, investors should not place undue reliance on forward looking statements as a prediction of actual results. +Current global economic conditions may adversely affect consumer spending and the financial health of our customers and others with whom we do +business which may adversely affect our financial condition, results of operations and cash resources. +Uncertainty about the current +and future global economic conditions may cause consumers and retailers to defer purchases or cancel purchase orders for our products in response to tighter credit, decreased cash availability and weakened consumer confidence. Our financial success +is sensitive to changes in general economic conditions, both globally and nationally. Recessionary economic cycles, higher interest borrowing rates, higher fuel and other energy costs, inflation, increases in commodity prices, higher levels of +unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws or other economic factors that may affect consumer spending could adversely affect the demand for our products. As a result, we may not be able to maintain or +increase our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain or increase our international operations on a profitable basis, or maintain or improve our earnings from operations as a percentage +of net sales. Our financial success is also significantly related to the success of our wholesale customers who are directly impacted by fluctuations in the broader economy including the global economic downturns which reduce foot traffic in +shopping malls and lessen consumer demand for our products. +In addition, any decrease in available credit caused by a weakened global economy +may result in financial difficulties for our wholesale and retail customers, product suppliers and other service providers, as well as the financial institutions that are counterparties to our credit facility and derivative transactions. If credit +pressures or +8 +Table of Contents +other financial difficulties result in insolvency for these parties, it could adversely impact our estimated reserves, our ability to obtain future financing and our financial results. In +particular, if our customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer order cancellations and/or the need to extend customer payment terms which could lead to higher accounts +receivable balances, reduced cash flows, greater expense associated with collection efforts and increased bad debt expense. +We face +significant competition. +The footwear industry is highly competitive. Continued growth in the market for casual footwear has +encouraged the entry of new competitors into the marketplace and has increased competition from established companies. Our competitors include most major athletic and footwear companies, branded apparel companies and retailers with their own private +label footwear products. A number of our competitors have significantly greater financial resources than us, more comprehensive product lines, a broader market presence, longer standing relationships with wholesalers, a longer operating history, +greater distribution capabilities, stronger brand recognition and spend substantially more than we do on product marketing. Our competitors’ greater capabilities in these areas may enable them to better withstand periodic downturns in the +footwear industry, compete more effectively on the basis of price and production and more quickly develop new products. Additionally, some of our competitors are offering products that are substantially similar, in design and materials, to Crocs +branded footwear. In addition, access to offshore manufacturing is also making it easier for new companies to enter the markets in which we compete. If we fail to compete successfully in the future, our sales and profits may decline, we may lose +market share, our financial condition may deteriorate and the market price of our common stock is likely to fall. +We may be unable to +successfully execute our long-term growth strategy or maintain our current revenue levels. +Our ability to maintain our revenue levels +or to grow in the future depends on, among other things, the continued success of our efforts to maintain our brand image and bring compelling and revenue enhancing footwear offerings to market and our ability to expand within our current +distribution channels and increase sales of our products into new locations internationally. Successfully executing our long-term growth and profitability strategy will depend on many factors, including the strength of the Crocs brand, execution of +supply chain strategies, competitive conditions in new markets that we attempt to enter, our ability to attract and retain qualified distributors or agents or to develop direct sales channels, our ability to secure strategic retail store locations, +our ability to use and protect the Crocs brand and our other intellectual property in these new markets and territories and our ability to consolidate our network to leverage resources and simplify our fulfillment process. If we are unable to +successfully maintain our brand image, expand distribution channels, streamline our supply chain and sell our products in new markets abroad, our business may fail to grow, our brand may suffer and our results of operations may be adversely +impacted. +Expanding our footwear product line may be difficult and expensive. If we are unable to successfully continue such expansion, +our brand may be adversely affected and we may not be able to maintain or grow our current revenue and profit levels. +To successfully +expand our footwear product line, we must anticipate, understand and react to the rapidly changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful with consumers +or our brand may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decrease, our brand image may suffer, our operating performance may decline and +we may not be able to execute our growth plans. +In producing new footwear models, we may encounter difficulties that we did not anticipate +during the product development stage. Our development schedules for new products are difficult to predict and are subject to change in response to consumer preferences and competing products. If we are not able to efficiently manufacture new +products in quantities sufficient to support retail and wholesale distribution, we may not be able to recover our +9 +Table of Contents +investment in the development of new styles and product lines and we would continue to be subject to the risks inherent to having a limited product line. Even if we develop and manufacture new +footwear products that consumers find appealing, the ultimate success of a new style may depend on our pricing. We have a limited history of introducing new products in certain target markets; as such, we may set the prices of new styles too high +for the market to bear or we may not provide the appropriate level of marketing in order to educate the market and potential consumers about our new products. Achieving market acceptance will require us to exert substantial product development and +marketing efforts, which could result in a material increase in our selling, general and administrative expenses and there can be no assurance that we will have the resources necessary to undertake such efforts effectively. Failure to gain market +acceptance for new products could impede our ability to maintain or grow current revenue levels, reduce profits, adversely affect the image of our brands, erode our competitive position and result in long-term harm to our business. +Opening and operating additional retail stores are subject to numerous risks including the dependency on customer traffic in shopping malls; +declines in revenue of such retail stores could adversely affect our profitability. +In recent years, we have significantly expanded +and intend to continue the expansion of our retail sales channel. Opening retail stores globally involves substantial investment, including the construction of leasehold improvements, furniture and fixtures, equipment, information systems, inventory +and personnel. Operating global retail stores incurs fixed costs; if we have insufficient sales, we may be unable to reduce such fixed costs and avoid losses or negative cash flows. Due to the high fixed cost structure associated with the retail +segment, negative cash flows or the closure of a store could result in write downs of inventory, impairment of leasehold improvements, impairment losses on other long-lived assets, severance costs, significant lease termination costs or the loss of +working capital, which could adversely impact our financial position, results of operations or cash flows. Our ability to recover the investment in and expenditures of our retail operations can be adversely affected if sales at our retail stores are +lower than anticipated. +In addition, our ability to open new stores successfully depends on our ability to identify suitable store locations, +negotiate acceptable lease terms, hire, train and retain store personnel and satisfy the fashion preferences in new geographic areas. Many of our retail stores are located in shopping malls where we depend on obtaining prominent locations and the +overall success of the malls to generate customer traffic. We cannot control the success of individual malls and an increase in store closures by other retailers may lead to mall vacancies and reduced foot traffic. Reduced customer traffic could +reduce sales of existing retail stores or hinder our ability to open retail stores in new markets, which could negatively affect our operating results. +Our revolving credit facility contains financial covenants that require us to maintain certain financial metrics and ratios and restrictive covenants that limit our flexibility. A breach of those +covenants may cause us to be in default under the facility, and our lenders could foreclose on our assets. +The credit agreement for +our revolving credit facility requires us to maintain a certain leverage ratio at all times and a minimum fixed charge coverage ratio on a quarterly basis. A failure to maintain current revenue levels or an inability to control costs could +negatively impact our ability to meet these financial covenants and, if we breach such covenants or any of the restrictive covenants described below, the lenders could either refuse to lend funds to us or accelerate the repayment of any outstanding +borrowings under the revolving credit facility. We might not have sufficient assets to repay such indebtedness upon a default. If we are unable to repay the indebtedness, the lenders could initiate a bankruptcy proceeding against us or collection +proceedings with respect to our assets, all of which secure our indebtedness under the revolving credit facility. +The credit agreement also +contains certain restrictive covenants that limit and in some circumstances prohibit, our ability to, among other things incur additional debt, sell, lease or transfer our assets, pay dividends, make capital expenditures and investments, guarantee +debt or obligations, create liens, enter into transactions with our affiliates and enter into certain merger, consolidation or other reorganizations transactions. These restrictions could limit our ability to obtain future financing, make +acquisitions or needed capital expenditures, withstand the +10 +Table of Contents +current or future downturns in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a +competitive disadvantage relative to our competitors that have less debt and are not subject to such restrictions. +We manufacture a +portion of our products which causes us to incur greater fixed costs. Any difficulties or disruptions in our manufacturing operations could adversely affect our sales and results of operations. +We produce a portion of our footwear products at our internal manufacturing facilities in Mexico and Italy. Ownership of these facilities adds fixed +costs to our cost structure which are not as easily scalable as variable costs. In addition, the manufacture of our products from Croslite requires the use of a complex process and we may experience difficulty in producing footwear that meets our +high quality control standards. We will be required to absorb the costs of manufacturing and disposing of products that do not meet our quality standards. Any increases in our manufacturing costs could adversely impact our profit margins. +Furthermore, our manufacturing capabilities are subject to many of the same risks and challenges faced by our third party manufacturers (as noted in the risk factor below), including our ability to scale our production capabilities to meet the needs +of our customers. Our manufacturing may also be disrupted for reasons beyond our control, including work stoppages, fires, earthquakes, floods or other natural disasters. Any disruption to our manufacturing operations will hinder our ability to +deliver products to our customers in a timely manner and could have a material and adverse effect on our business and results of operations. +We depend heavily on third party manufacturers located outside the U.S. +Third party manufacturers located in China and Eastern Europe produce most of our footwear products. We depend on the ability of these manufacturers to finance the production of goods ordered, maintain +adequate manufacturing capacity and meet our quality standards. We compete with other companies for the production capacity of our third party manufacturers, and we do not exert direct control over the manufacturers’ operations. As such, we +have experienced at times, delays or inabilities to fulfill customer demand and orders, particularly in China. We cannot guarantee that any third party manufacturer will have sufficient production capacity, meet our production deadlines or meet our +quality standards. +In addition, we do not have long-term supply contracts with these third party manufacturers and any of them may +unilaterally terminate their relationship with us at any time or seek to increase the prices they charge us. As a result, we are not assured of an uninterrupted supply of products of an acceptable quality and price from our third party +manufacturers. Foreign manufacturing is subject to additional risks, including transportation delays and interruptions, work stoppages, political instability, expropriation, nationalization, foreign currency fluctuations, changing economic +conditions, changes in governmental policies and the imposition of tariffs, import and export controls and other non-tariff barriers. We may not be able to offset any interruption or decrease in supply of our products by increasing production in our +internal manufacturing facilities due to capacity constraints, and we may not be able to substitute suitable alternative third party manufacturers in a timely manner or at acceptable prices. Any disruption in the supply of products from our third +party manufacturers may harm our business and could result in a loss of sales and an increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or unexpected demand for our products may +require us to use faster, more expensive transportation methods, such as aircraft, which could adversely affect our profit margins. The cost of fuel is a significant component in transportation costs. Increases in the price of petroleum products can +adversely affect our profit margins. +In addition, because a large portion of our footwear products is manufactured in China, the possibility +of adverse changes in trade or political relations between the U.S. and China, political instability in China, increases in labor costs, or adverse weather conditions could significantly interfere with the production and shipment of our products, +which would have a material adverse affect on our operations and financial results. +11 +Table of Contents +Our third party manufacturing operations must comply with labor, trade and other laws; failure to do +so may adversely affect us. +We require our third party manufacturers to meet our quality control standards and footwear industry +standards for working conditions and other matters, including compliance with applicable labor, environmental and other laws. However, we do not control our third party manufacturers or their respective labor practices. A failure by any of our third +party manufacturers to adhere to quality standards or labor, environmental and other laws could cause us to incur additional costs for our products, generate negative publicity, damage our reputation and the value of our brand and discourage +customers from buying our products. We also require our third party manufacturers to meet certain product safety standards. A failure by any of our third party manufacturers to adhere to such product safety standards could lead to a product recall +which could result in critical media coverage and harm our business and reputation and could cause us to incur additional costs. +In addition, +if we or our third party manufacturers violate U.S. or foreign trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import or the loss of +our import privileges. Possible violations of U.S. or foreign laws or regulations could include inadequate record keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of +our imported products, fraudulent visas or labor violations. The effects of these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. We cannot predict +whether additional U.S. or foreign customs quotas, duties, taxes or other changes or restrictions will be imposed upon the importation of foreign produced products in the future or what effect such actions could have on our business, financial +condition or results of operations. +We conduct significant business activity outside the U.S. which exposes us to foreign currency and +other risks. +A significant portion of our revenues is from foreign sales. Our ability to maintain the current level of operations in +our existing international markets is subject to risks associated with international sales operations as well as the difficulties associated with promoting products in unfamiliar cultures. In addition to foreign manufacturing, we operate retail +stores and sell our products to retailers outside of the U.S. Foreign manufacturing and sales activities are subject to numerous risks, including tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas +and local content rules; delays associated with the manufacture, transportation and delivery of products; increased transportation costs due to distance, energy prices, or other factors; delays in the transportation and delivery of goods due to +increased security concerns; restrictions on the transfer of funds; restrictions, due to privacy laws, on the handling and transfer of consumer and other personal information; changes in governmental policies and regulations; political unrest, +changes in law, terrorism, or war, any of which can interrupt commerce; expropriation and nationalization; difficulties in managing foreign operations effectively and efficiently from the U.S.; and difficulties in understanding and complying with +local laws, regulations and customs in foreign jurisdictions. In addition, we are subject to customs laws and regulations with respect to our export and import activity which are complex and vary within legal jurisdictions in which we operate. We +cannot assure that there will be no control failure around customs enforcement despite the precautions we take. We are currently subject to an audit by the U.S. Customs Service for prior periods. Any failure to comply with customs laws and +regulations could be discovered during a U.S. or foreign government customs audit and could result in a substantial fines and penalties, which could have an adverse effect on our financial position and results of operations. +Foreign currency fluctuations could have a material adverse effect on our results of operations and financial condition. +As a global company, we have significant revenues, costs, assets, liabilities and intercompany balances denominated in currencies other than the U.S. +dollar. We pay the majority of expenses attributable to our foreign operations in the functional currency of the country in which such operations are conducted and pay the majority of our overseas third-party manufacturers in U.S. dollars. +12 +Table of Contents +Our ability to sell our products in foreign markets and the U.S. dollar value of the sales made in foreign +currencies can be significantly influenced by foreign currency fluctuations. A decrease in the value of foreign currencies relative to the U.S. dollar could result in lower revenues, product price pressures and increased losses from currency +exchange rates. Price increases caused by currency exchange rate fluctuations could make our products less competitive or have an adverse effect on our profitability as most of our purchases from third party suppliers are denominated in U.S. +dollars. Currency exchange rate fluctuations could also disrupt the business of the third party manufacturers that produce our products by making their purchases of raw materials more expensive and more difficult to finance. While we enter into +foreign currency exchange forward contracts as economic cash flow hedges to reduce our exposure to changes in exchange rates, the volatility of foreign currency exchange rates is dependent on many factors that cannot be forecasted with reliable +accuracy. +Our financial success may be limited to the strength of our relationships with our wholesale customers and to the success of +such wholesale customers. +Our financial success is significantly related to the willingness of our current and prospective wholesale +customers to carry our products. We do not have long term contracts with any of our wholesale customers. Sales to our wholesale customers are generally on an order-by-order basis and are subject to rights of cancellation and rescheduling by the +customer. If we cannot fill our customers’ orders in a timely manner, the sales of our products and our relationships with those customers may suffer. This could have a material adverse effect on our product sales and ability to grow our +product lines. +Changes in the global credit market could also affect our customers’ liquidity and capital resources and their ability to +meet payment obligations to us which could have a material adverse impact on our cash flows and capital resources. We continue to monitor our accounts receivable aging and record reserves against such receivables as we deem appropriate. +Additionally, many of our wholesale customers compete with each other. If they perceive that we are offering their competitors better pricing and support, they may reduce purchases of our products. Moreover, we compete directly with our wholesale +customers by selling our products directly to consumers over the internet and through our company-operated retail locations. If our wholesale customers believe that our direct sales to consumers divert sales from their stores, our relationships with +such customers may weaken and cause them to reduce purchases of our products. As we continue to grow our consumer direct channels (company-operated retail and internet) this issue could be exacerbated. +We depend on a limited number of suppliers for key production materials, and any disruption in the supply of such materials could interrupt product +manufacturing and increase product costs. +We depend on a limited number of sources for the primary materials used to make our +footwear. We source the elastomer resins that constitute the primary raw materials used in compounding Croslite, which we use to produce our footwear products, from multiple suppliers. If the suppliers we rely on for elastomer resins were to cease +production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production cycle, if at all. We are also subject to market issues related to supply and demand for our raw materials. We +may have to pay substantially higher prices in the future for the elastomer resins or any substitute materials we use, which would increase our production costs and could have a significantly adverse impact on our profit margins and results of +operations. If we are unable to obtain suitable elastomer resins or if we are unable to procure sufficient quantities of the Croslite material, we may not be able to meet our production requirements in a timely manner or may need to modify our +product characteristics resulting in less favorable market acceptance which could result in lost potential sales, delays in shipments to customers, strained relationships with customers and diminished brand loyalty. +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our +brand image and adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending +patents and trade dress and designs on nearly all of our products. We believe that having distinctive marks that are readily identifiable is +13 +Table of Contents +important to our brand, our success and our competitive position. The laws of some countries, for example, China, do not protect intellectual property rights to the same extent as do U.S. +laws. We periodically discover products that are counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party’s products on the basis of trademark +or design or utility patent infringement, particularly in some foreign countries, or if we are required to change our name or use a different logo, continued sales of such competing products by third parties could harm our brand and adversely impact +our business, financial condition, revenues and results of operations by resulting in the shift of consumer preference away from our products. If our brands are associated with inferior counterfeit reproductions, the integrity of our brands could be +adversely affected. Furthermore, our efforts to enforce our intellectual property rights are typically met with defenses and counterclaims attacking the validity and enforceability of our intellectual property rights. We may face significant +expenses and liability in connection with the protection of our intellectual property rights outside the U.S., and if we are unable to successfully protect our rights or resolve intellectual property conflicts with others, our business or financial +condition could be adversely affected. +We also rely on trade secrets, confidential information and other unpatented proprietary information +related to, among other things, the formulation of the Croslite material and product development, particularly where we do not believe patent protection is appropriate or obtainable. Using third party manufacturers and compounding facilities may +increase the risk of misappropriation of our trade secrets, confidential information and other unpatented proprietary information. The agreements we use in an effort to protect our intellectual property, confidential information and other unpatented +proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the agreement and we may not have adequate remedies for such +breach. As a result, our trade secrets, confidential information and other unpatented proprietary information may become known to others, including our competitors. Furthermore, our competitors or others may independently develop or discover such +trade secrets and information, which would render them less valuable to us. +If we do not accurately forecast consumer demand, we may +have excess inventory to liquidate or have greater difficulty filling our customers’ orders, either of which could adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid changes in consumer preferences, the effects of weather, general economic +conditions and other factors affecting demand and possibly impairing our brand image. These factors make it difficult to forecast consumer demand. If we overestimate demand for our products, we may be forced to liquidate excess inventories at +discounted prices resulting in lower gross margins. Conversely, if we underestimate consumer demand, we could have inventory shortages which can result in lower sales, delays in shipments to customers, strains on our relationships with customers and +diminished brand loyalty. A decline in demand for our products, or any failure on our part to satisfy increased demand for our products, could adversely affect our business and results of operations. +We have substantial cash requirements in the U.S.; however, a majority of our cash is generated and held outside of the U.S. The consequential +risks of holding cash abroad could adversely affect our financial condition and results of operations. +We have substantial cash +requirements in the U.S., but the majority of our cash is generated and held abroad. We generally consider unremitted earnings of subsidiaries operating outside of the U.S. to be indefinitely reinvested and it is not our current intent to change +this position. Cash held outside of the U.S. is primarily used for the ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., but under current law, +would be subject to U.S. federal and state income taxes, less applicable foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash +to another country. Certain countries, including China, may have monetary laws which may limit our ability to utilize cash resources in those +14 +Table of Contents +countries for operations in other countries. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and may adversely affect our +liquidity. Since repatriation of such cash is subject to limitations and may be subject to significant taxation, we cannot be certain that we will be able to repatriate such cash on favorable terms or in a timely manner. If we incur operating losses +on a continued basis and require cash that is held in international accounts for use in our U.S. operations, a failure to repatriate such cash in a timely and cost-effective manner could adversely affect our business, financial condition and results +of operations. +We have been named as a defendant in a securities class action lawsuit that may result in substantial costs and could +divert management’s attention. +Starting in November 2007, certain stockholders filed several purported shareholder class actions +in the U.S. District Court for the District of Colorado alleging violations of Sections 10(b) and 20(a) of the Exchange Act based on alleged statements made by us between July 27, 2007 and October 31, 2007. We and certain of our +current and former officers and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of Colorado. The first complaint was filed in November 2007; several other complaints were +filed shortly thereafter. These actions were consolidated and, in September 2008, the Court appointed a lead plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purports to state claims under +Section 10(b), 20(a), and 20A of the Exchange Act on behalf of a class of all persons who purchased our stock between April 2, 2007 and April 14, 2008 (the “Class Period”). The amended complaint alleges that, during the +Class Period, defendants made false and misleading public statements about us and our business and prospects and that, as a result, the market price of our stock was artificially inflated. The amended complaint also claims that certain current and +former officers and directors traded our stock on the basis of material non-public information. The amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified amount, interest and an award of attorneys’ fees +and costs of litigation. On February 28, 2011, the District Court granted motions to dismiss filed by the defendants and dismissed all claims. While a final judgment was thereafter entered, the plaintiffs have appealed and are challenging the +court’s February 28, 2011 order in the United States Court of Appeals for the Tenth Circuit. Due to the inherent uncertainties of litigation and because the litigation is at a preliminary stage, we cannot at this time accurately predict +the ultimate outcome of the matter or estimate the amount or range of potential loss, if any. It is possible that this action could be resolved adversely to us. Risks associated with legal liability are often difficult to assess or quantify and +their existence and magnitude can remain unknown for significant periods of time. While we maintain director and officer insurance, the amount of insurance coverage may not be sufficient to cover a claim and the continued availability of this +insurance cannot be assured. We may, in the future, be the target of additional proceedings and the present or future proceedings may result in substantial costs and divert management’s attention and resources that are needed to successfully +run our business. +We are subject to periodic litigation, which could result in unexpected expense of time and resources. +From time to time, we are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent +uncertainties of litigation, we cannot accurately predict the ultimate outcome of any such proceedings. An unfavorable outcome could have an adverse impact on our business, financial condition and results of operations. In addition, any significant +litigation in the future, regardless of its merits, could divert management’s attention from our operations and result in substantial legal fees. In the past, securities class action litigation has been brought against us. If our stock price is +volatile, we may become involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management’s attention and resources that are needed to successfully run our business. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of factors, including seasonal variations, which +could increase the volatility of the price of our common stock. +Sales of our products are subject to seasonal variations and are +sensitive to weather conditions. As a significant portion of our revenues are attributable to footwear styles that are more suitable for fair weather, we typically +15 +Table of Contents +experience our highest sales activity during the second and third quarters of the calendar year, when there is a revenue concentration in countries in the northern hemisphere. While we continue +to create new footwear styles that are more suitable for cold weather, the effects of favorable or unfavorable weather on sales can be significant enough to affect our quarterly results which could adversely affect our common stock price. Quarterly +results may also fluctuate as a result of other factors, including new style introductions, general economic conditions or changes in consumer preferences. Results for any one quarter are not necessarily indicative of results to be expected for any +other quarter or for any year and revenues for any particular period may fluctuate. This could lead to results outside of analyst and investor expectations, which could increase volatility of our stock price. +We may fail to meet analyst expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly and various securities analysts follow our financial results and frequently issue reports on us which include +information about our historical financial results as well as their estimates of our future performance. These estimates are based on their own opinions and are often different from management’s estimates or expectations of our business. If our +operating results are below the estimates or expectations of public market analysts and investors, our stock price could decline. +We +may fail to protect the integrity and security of customer and associate information. +We routinely possess sensitive customer and +associate information and, while we have taken reasonable and appropriate steps to protect that information, if our security procedures and controls were compromised, it could harm our business, reputation, results of operations and financial +condition and may increase the costs we incur to protect against such information security breaches, such as increased investment in technology, the costs of compliance with consumer protection laws and costs resulting from consumer fraud. +We depend on key personnel, the loss of whom would harm our business. +The loss of the services and expertise of any key employee could harm our business. Our future success depends on our ability to identify, attract and retain qualified personnel on a timely basis. In +addition, we must successfully integrate any newly hired management personnel within our organization in order to achieve our operating objectives. Changes in other key management positions may temporarily affect our financial performance and +results of operations as new management becomes familiar with our business. We have experienced significant management turnover in recent years. Turnover of senior management can adversely impact our stock price, our results of operations and our +client relationships and may make recruiting for future management positions more difficult. In some cases, we may be required to pay significant amounts of severance to terminated management employees. +Our current management information systems may not be sufficient for our business and planned system improvements may not be successfully +implemented on a timely basis or be sufficient for our business. +We are in the process of implementing numerous information systems +designed to support several areas of our business, including warehouse management, order management, retail point-of-sale and internet point-of-sale as well as various systems that provide interfaces between these systems. These systems are intended +to assist in streamlining our operational processes and eliminating certain manual processes. However, for certain business planning, finance and accounting functions, we still rely on manual processes that are difficult to control and are subject +to human error. We may experience difficulties in transitioning to our new or upgraded systems, including loss of data and decreases in productivity, as our personnel become familiar with these new systems. In addition, our management information +systems will require modification and refinement as our business needs change which could prolong the difficulties we experience with systems transitions and we may not always employ the most effective systems for our purposes. If we experience +difficulties in implementing new or upgraded information systems or experience significant system failures, or if we are unable to successfully modify our management information systems to respond to changes in our business needs, our ability to +properly run our business could be adversely affected. +16 +Table of Contents +Changes in tax laws and unanticipated tax liabilities and the results of tax audits or litigation +could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the United States and +numerous foreign jurisdictions. Our effective income tax rate in the future could be adversely affected by a number of factors, including: changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of +deferred tax assets and liabilities, changes in tax laws, the outcome of income tax audits in various jurisdictions around the world and any repatriation of non-US earnings for which we have not previously provided for U.S. taxes. We regularly +assess all of these matters to determine the adequacy of our tax provision, which is subject to significant discretion and we could face significant adverse impact if our assumptions are incorrect and/or face significant cost to defend our practices +from international and U.S. tax authorities. We are regularly subject to, and are currently undergoing, audits by tax authorities in the United States and foreign jurisdictions for prior tax years. Although we believe our tax estimates are +reasonable, the final outcome of tax audits and related litigation could be materially different than that reflected in our historical income tax provisions and accruals, and we could be subject to assessments of additional taxes and/or substantial +fines or penalties. The resolution of any audits or litigation could have an adverse effect on our financial position and results of operations. +Our financial results may be adversely affected if substantial investments in businesses and operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, acquisitions of new businesses and expansion of existing businesses, such as our retail +operations, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability. However, significant investments are subject to typical risks and uncertainties +inherent in acquiring or expanding a business. The failure of any significant investment to provide the returns or profitability we expect or the failure to integrate newly acquired businesses could have a material adverse effect on our financial +results and divert management attention from more profitable business operations. +Natural disasters could negatively impact our +operating results and financial condition. +Natural disasters such as earthquakes, hurricanes, tsunamis or other adverse weather and +climate conditions, whether occurring in the U.S. or abroad, and the consequences and effects thereof, including energy shortages and public health issues, could disrupt our operations or the operations of our vendors and other suppliers, or result +in economic instability that may negatively impact our operating results and financial condition. +Our restated certificate of +incorporation, amended and restated bylaws and Delaware law contain provisions that could discourage a third party from acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could delay, defer, or +prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of +control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change +of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to decline. +ITEM 1B. +Unresolved Staff Comments +None. +17 +Table of Contents +ITEM 2. +Properties +Our principal executive and +administrative offices are located at 7477 East Dry Creek Parkway, Niwot, Colorado. We lease, rather than own, all of our facilities. We enter into short-term and long-term leases for kiosks, office, retail, manufacturing and warehouse space +domestically and internationally. The terms of these leases include fixed monthly rents and/or contingent rents based on percentage of revenues, for our retail stores, and have expirations between 2012 and 2022. The general location, use and +approximate size of our principal properties are given below. +Location +Use +Approximate +Square Feet +Ontario, California +Warehouse +399,000 +Leon, Mexico +Manufacturing/offices +219,000 +Leon, Mexico +Warehouse +203,000 +Rotterdam, the Netherlands +Warehouse +183,000 +Niwot, Colorado +Corporate headquarters and regional offices +160,000 +Narita, Japan +Warehouse +156,000 +Tampere, Finland (1 ) +Warehouse/offices +61,000 +Padova, Italy +EXO’s Regional offices/manufacturing facility +44,000 +Melbourne, Australia (1 ) +Warehouse/offices +39,000 +Shenzen, China +Manufacturing/offices +31,000 +Den Haag, the Netherlands +Regional offices +27,000 +Gordon’s Bay, South Africa +Warehouse/offices +24,000 +Singapore +Regional offices +21,000 +Moscow, Russia +Warehouse/offices +21,000 +Tokyo, Japan +Regional offices +13,000 +(1 ) +The warehouse facilities are fully or partially subleased. +In addition to the properties listed above, we maintain small branch sales offices in the United States, Canada, South America, the United Emirates, India, Hong Kong, Taiwan and Korea. We also lease +retail space for 180 retail stores and 92 outlet stores and 158 kiosks and store in stores, globally. +ITEM 3. +Legal Proceedings +We and certain +current and former officers and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of Colorado. The first complaint was filed in November 2007 and several other +complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the district court appointed a lead plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended +complaint purports to state claims under Section 10(b), 20(a), and 20A of the Exchange Act on behalf of a class of all persons who purchased our common stock between April 2, 2007 and April 14, 2008 (the +“Class Period”). The amended complaint also added our independent auditor as a defendant. The amended complaint alleges that, during the Class Period, the defendants made false and misleading public statements about us and our +business and prospects and, as a result, the market price of our common stock was artificially inflated. The amended complaint also claims that certain current and former officers and directors traded in our common stock on the basis of material +non-public information. The amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified amount, including interest, and also added attorneys’ fees and costs of litigation. On February 28, 2011, the +District Court granted motions to dismiss filed by the defendants and dismissed all claims. A final judgment was thereafter entered. Plaintiffs have appealed and are challenging the District Court’s February 28, 2011 order in the United +States Court of Appeals for the Tenth Circuit. Due to the inherent uncertainties of litigation and because the litigation is at a preliminary stage, we cannot at this time accurately predict the ultimate outcome, or any potential liability, of the +matter. +18 +Table of Contents +On October 27, 2010, Spectrum Agencies (“Spectrum”) filed suit against our subsidiary, Crocs +Europe B.V. (“Crocs Europe”), in the High Court of Justice, Queen’s Bench Division, Royal Courts of Justice in London, United Kingdom (“UK”). Spectrum acted as an agent for Crocs products in the UK from 2005 until Crocs +Europe terminated the relationship on July 3, 2008 due to Spectrum’s breach of its duty to act in good faith towards Crocs Europe. Spectrum alleges that Crocs Europe unlawfully terminated the agency relationship and failed to pay certain +sales commissions. A trial on the liability, not quantum (compensation and damages), was held at the High Court in London from November 30, 2011 to December 5, 2011. On December 16, 2011, the High Court of Justice issued a judgment +that found that although Spectrum’s actions were a breach of its duty to act in good faith towards Crocs Europe the breach was not sufficiently severe to justify termination. We believe that the trial judge erred in his findings and permission +to appeal the judgment has been requested . Given that this phase of the proceedings only pertains to liability, there have been no findings in relation to the amount of compensation or damages other than with respect to legal fees. Under UK +law, the prevailing party is entitled to reimbursement of reasonable legal fees incurred in the liability proceedings. Spectrum has not quantified its claim for compensation and damages and the amount will be assessed later in the proceedings. Such +assessment may be stayed pending the outcome of an appeal on liability. If permission to appeal on liability is granted, a ruling on the appeal is expected to take between one and two years. If the appeal request is not granted, then a separate +trial on damages will commence, with a resolution expected in the fourth quarter of 2012 or beyond. +We are currently subject to an audit by +the U.S. Customs Service in respect of the period from 2006 to present. We anticipate that the U.S. Customs Service will present its audit report to us in the second half of 2012. At this time, we cannot accurately predict the ultimate outcome or +estimate potential loss, if any related to this matter. If an unfavorable outcome were to occur, it may result in substantial costs and a diversion of management’s attention and resources that are needed to successfully run our business. +We intend to vigorously defend these matters. Although we are subject to other litigation from time to time in the ordinary course of +business, including employment, intellectual property and product liability claims, we are not party to any other pending legal proceedings that we believe will have a material adverse impact on our business. +ITEM 4. +Mine Safety Disclosures +None. +PART II +ITEM 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock, +par value $0.001, is listed on the NASDAQ Global Select Market and trades under the stock symbol “CROX”. The following table shows the high and low sales prices of our common stock for the periods indicated. +Fiscal Year 2011 Three Months Ended +High +Low +March 31, 2011 +$ +19.61 +$ +15.28 +June 30, 2011 +26.04 +17.88 +September 30, 2011 +32.47 +23.12 +December 31, 2011 +$ +27.68 +$ +14.20 +Fiscal Year 2010 Three Months Ended +High +Low +March 31, 2010 +$ +9.00 +$ +5.81 +June 30, 2010 +12.28 +8.38 +September 30, 2010 +14.08 +9.88 +December 31, 2010 +$ +19.54 +$ +12.88 +19 +Table of Contents +Performance Graph +The following performance graph illustrates a five-year comparison of cumulative total return of our common stock, the NASDAQ Composite Index and the Dow Jones U.S. Footwear Index from December 31, +2006 through December 31, 2011. The graph assumes an investment of $100 on December 31, 2006 and assumes the reinvestment of all dividends and other distributions and reflects our stock prices post-stock split. +Comparison of Cumulative Total Return on Investment +12/31/2006 +12/31/2007 +12/31/2008 +12/31/2009 +12/31/2010 +12/31/2011 +Crocs, Inc. +$ +100.00 +$ +170.42 +$ +5.74 +$ +26.62 +$ +79.26 +$ +68.38 +Nasdaq Composite Index +100.00 +109.81 +65.29 +93.95 +109.84 +107.86 +Dow Jones US Footwear Index +$ +100.00 +$ +124.93 +$ +89.46 +$ +114.39 +$ +149.76 +$ +167.53 +The Dow Jones U.S. Footwear Index consists of Crocs, Inc., NIKE, Inc., Deckers Outdoor Corp. and Wolverine +World Wide, Inc. Because Crocs, Inc. is part of the Dow Jones U.S. Footwear Index, the price and returns of our stock have an effect on this index. The Dow Jones U.S. Footwear Index includes companies in the major line of business in which +we compete. This index does not encompass all of our competitors or all of our product categories and lines of business. +The stock +performance shown on the performance graph above is not necessarily indicative of future performance. We do not make nor endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 182 as +of January 31, 2012. Because many of the shares of our common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial owners represented by these stockholders of +record. +Dividends +We have +never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future earnings for use in the operation of our business and do not anticipate paying any cash dividends in the foreseeable future. +Our financing arrangements also contain restrictions on our ability to pay cash dividends. Any future determination to declare cash dividends will be made at the discretion of our board of directors, subject to compliance with covenants under any +then-existing financing agreements. +20 +Table of Contents +ITEM 6. +Selected Financial Data +The following +table presents selected historical financial data for each of our last five fiscal years. The information in this table should be read in conjunction with the consolidated financial statements and accompanying notes beginning on page F-1 and +with “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” included in Item 7 of this Form 10-K. +0000000000 +0000000000 +0000000000 +0000000000 +0000000000 +For the Year Ended December 31, +($ thousands, except per share data) +2011 +2010 +2009 +2008 +2007 +Consolidated Statements of Operations Data +Revenues +$ +1,000,903 +$ +789,695 +$ +645,767 +$ +721,589 +$ +847,350 +Cost of sales +464,493 +364,631 +337,720 +486,722 +349,701 +Restructuring charges +— +1,300 +7,086 +901 +— +Gross profit +536,410 +423,764 +300,961 +233,966 +497,649 +Selling, general and administrative expenses +402,769 +342,121 +311,592 +341,518 +268,978 +Foreign currency transaction (gains) losses, net +(5,426 +) +(2,912 +) +(665 +) +25,438 +(10,055 +) +Charitable contributions expense +2,034 +840 +7,510 +1,844 +959 +Restructuring charges +— +2,539 +7,623 +7,664 +— +Impairment charges +528 +141 +26,085 +45,784 +— +Income (loss) from operations +136,505 +81,035 +(51,184 +) +(188,282 +) +237,767 +Gain on charitable contributions +(714 +) +(223 +) +(3,163 +) +— +— +Interest expense +853 +657 +1,495 +1,793 +438 +Other (income) expense, net +(324 +) +(191 +) +(895 +) +(565 +) +(2,997 +) +Income (loss) before income taxes +136,690 +80,792 +(48,621 +) +(189,510 +) +240,326 +Income tax (benefit) expense +23,902 +13,066 +(6,543 +) +(4,434 +) +72,098 +Net income (loss) attributable to common stockholders +$ +112,788 +$ +67,726 +$ +(42,078 +) +$ +(185,076 +) +$ +168,228 +Income (loss) per common share: +Basic +$ +1.27 +$ +0.78 +$ +(0.49 +) +$ +(2.24 +) +$ +2.08 +Diluted +$ +1.24 +$ +0.76 +$ +(0.49 +) +$ +(2.24 +) +$ +2.00 +Weighted average common shares: +Basic +88,317,898 +85,482,055 +85,112,461 +82,767,540 +80,759,077 +Diluted +89,981,382 +87,595,618 +85,112,461 +82,767,540 +84,194,883 +December 31, +($ thousands) +2011 +2010 +2009 +2008 +2007 +Consolidated Balance Sheets Data +Cash and cash equivalents +$ +257,587 +$ +145,583 +$ +77,343 +$ +51,665 +$ +36,335 +Total assets +695,453 +549,481 +409,738 +455,999 +627,425 +Long term obligations +48,370 +35,613 +35,462 +35,303 +15,864 +Total stockholders’ equity +$ +491,780 +$ +376,106 +$ +287,620 +$ +287,163 +$ +444,113 +21 +Table of Contents +ITEM 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +Overview +We are a designer, +manufacturer, and distributor of footwear, apparel and accessories for men, women and children. We strive to be the global leader in molded footwear design and development. We offer a broad product range which provides new and exciting molded +footwear products featuring fun, comfort and functionality. Our primary products include footwear and accessories which utilize our proprietary closed cell-resin, called Croslite. The Croslite material is unique in that it enables us to produce an +innovative, lightweight, non-marking, and odor-resistant shoe. +Since the initial introduction and popularity of the Beach and Crocs Classic +designs, we have expanded our Croslite products to include a variety of new styles and products and have further extended our product reach through the acquisition of brand platforms such as Jibbitz, LLC (“Jibbitz”) and Ocean +Minded, Inc. (“Ocean Minded”). We continue to branch out into other types of footwear so as to bring a unique and original perspective to the consumer in styles that may be unexpected from Crocs. We believe this will help us to +continue to build a stable year-round business as we look to offer more winter-oriented styles. Our marketing efforts surround specific product launches and employ a fully integrated approach utilizing a variety of media outlets, including print and +online. Our marketing efforts drive business to both our wholesale partners and our company-operated retail and internet stores, ensuring that our presentation and story are first class and drive purchasing at the point of sale. +We currently sell our Crocs-branded products globally through domestic and international retailers and distributors. We also sell our products directly +to consumers through our webstores, company-operated retail stores, outlets and kiosks. The broad appeal of our footwear has allowed us to market our products to a wide range of distribution channels, including department stores and traditional +footwear retailers as well as a variety of specialty and independent retail channels. +Financial Highlights +During the year ended December 31, 2011, revenues increased $211.2 million, or 26.7%, compared to the same period in 2010, and exceeded $1.0 +billion for the first time in the history of our business. This revenue growth was driven by expansion in all three of our operating segments as we focused on improving average footwear selling prices with new product styles, the expansion of +existing and new wholesale accounts and the continued expansion of our direct-to-consumer sales channels. +Also during the year ended +December 31, 2011, diluted earnings per share improved to $1.24 compared to $0.76 during the same period in 2010 and operating margin increased to 13.6% from 10.3% which were both driven by improved leverage from selling, general and +administrative expenses while gross margin remained relatively flat. +These financial improvements resulted from stronger sales in each of our +geographic operating segments and more effective marketing and merchandising programs, ongoing investment in the growth of our retail and internet channels which have historically yielded higher margins. They also reflect strong global demand for +our diversified product line as we continue to transform Crocs brand awareness to an all-season footwear brand despite a difficult global economic selling environment and increased global competition from footwear manufacturers and retailers. As a +percentage of total revenues, sales generated from the clog silhouette sales continued to decrease with the expansion of our product line. For the year ended December 31, 2011, clog silhouette revenues made up 48.5% of total footwear revenues +(excluding 3.2% of revenues generated from clogs with licensed marks and B-grade or other discounted clog styles), down from 53.7% during the same period in 2010 (excluding 3.3% of revenues generated from clogs with licensed marks and B-grade or +other discounted clog styles). +22 +Table of Contents +Results of Operations +Comparison of the Years Ended December 31, 2011 and 2010 +Year Ended +December 31, +Change +($ thousands, except per share data) +2011 +2010 +$ +% +Revenues +$ +1,000,903 +$ +789,695 +$ +211,208 +26.7 +% +Cost of sales +464,493 +364,631 +99,862 +27.4 +Restructuring charges +— +1,300 +1,300 +100.0 +Gross profit +536,410 +423,764 +112,646 +26.6 +Selling, general and administrative expenses +402,769 +342,121 +60,648 +17.7 +Foreign currency transaction (gains) losses, net +(5,426 +) +(2,912 +) +(2,514 +) +(86.3 +) +Restructuring charges +— +2,539 +(2,539 +) +(100.0 +) +Asset impairment charges +528 +141 +387 +274.5 +Charitable contributions +2,034 +840 +1,194 +142.1 +Income (loss) from operations +136,505 +81,035 +55,470 +68.5 +Interest expense +853 +657 +196 +29.8 +Other, net +(1,038 +) +(414 +) +(624 +) +(150.7 +) +Income (loss) before income taxes +136,690 +80,792 +55,898 +69.2 +Income tax (benefit) expense +23,902 +13,066 +10,836 +82.9 +Net income (loss) +$ +112,788 +$ +67,726 +$ +45,062 +66.5 +% +Net income (loss) per basic share +$ +1.27 +$ +0.78 +$ +0.49 +62.8 +% +Net income (loss) per diluted share +$ +1.24 +$ +0.76 +$ +0.48 +63.2 +% +Gross margin +53.6% +53.7% +(7) bps +(0.1 +)% +Operating margin +13.6% +10.3% +338 bps +32.9 +% +Revenues . The following table sets forth revenues by channel, footwear average +selling price and unit sales for the years ended December 31, 2011 and 2010. +Year ended +December 31, +Change +($ millions, except footwear average selling price) +2011 +2010 +$ +% +Wholesale channel revenue +$ +598.4 +$ +481.8 +$ +116.6 +24.2% +Retail channel revenue +306.7 +232.9 +73.8 +31.7 +Internet channel revenue +$ +95.9 +$ +75.0 +$ +20.9 +27.9% +Footwear unit sales +47.7 +42.6 +5.1 +12.0% +Footwear average selling price +$ +20.04 +$ +17.69 +$ +2.35 +13.3% +During the year ended December 31, 2011, revenues increased $211.2 million, or 26.7%, compared to the same period in +2010, primarily due to an increase of 5.1 million, or 12.0%, in global footwear unit sales and an increase of $2.35, or 13.3%, in footwear average selling price. +Revenues by Channel. During the year ended December 31, 2011, revenues from our wholesale channel increased $116.6 million, or 24.2%, which was primarily driven by strong demand in all +three operating segments, particularly Asia. Revenues from our retail channel increased $73.8 million, or 31.7%, as we continued to grow our retail presence by opening new retail stores. We also continue to close certain kiosks as branded stores +allow us to better merchandise the full breadth and depth of our product line. Revenues from our internet channel increased $20.9 million, or 27.9%, primarily driven by increased internet sales in the Americas and Europe operating segments. +23 +Table of Contents +The table below illustrates the overall growth in the number of our company-operated retail locations as of +December 31, 2011 and 2010. +December 31, +2011 +2010 +Change +Type: +Kiosk/Store in Store +158 +164 +(6) +Retail Stores +180 +138 +42 +Outlet Stores +92 +76 +16 +Total +430 +378 +52 +Geography: +Americas +197 +197 +— +Asia +198 +159 +39 +Europe +35 +22 +13 +Total +430 +378 +52 +Impact on Revenues due to Foreign Exchange Rate Fluctuations. Average foreign currency exchange rates +during the year ended December 31, 2011 increased revenue by $39.0 million as compared to the same period in 2010. Sales in international markets in foreign currencies are expected to continue to represent a substantial portion of our +overall revenues. Accordingly, changes in foreign currency exchange rates could materially affect our overall revenues or the comparability of those revenues from period to period as a result of translating our financial statements into the U.S. +dollar. +Gross profit. During the year ended December 31, 2011, gross profit increased $112.6 million, or 26.6%, compared +to the same period in 2010, which was primarily attributable to the 12.0% increase in sales volume and 13.3%, in footwear average selling price as margin remained relatively flat year over year. +Impact on Gross Profit due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate +revenues and costs of sales from our functional currencies to our reporting currency, the U.S. dollar, during the year ended December 31, 2011 increased our gross profit by $22.2 million compared to the same period in 2010. We expect +that sales at subsidiary companies with functional currencies other than the U.S. dollar will continue to generate a substantial portion of our overall gross profit. Accordingly, changes in foreign currency exchange rates could materially affect our +overall gross profit or the comparability of our gross profit from period to period as a result of translating our financial statements into the U.S. dollar. +Selling, General and Administrative Expenses and Foreign Currency Transaction (Gains)/Losses . Selling, general and administrative expenses increased $60.6 million, or +17.7%, during the year ended December 31, 2011 compared to the same period in 2010 primarily due to (i) an increase of $29.3 million in salaries and related costs resulting from higher global headcount, (ii) an increase of $20.0 +million in rent and building related costs, both of which resulted from continued growth in the number of company-operated retail stores and (iii) an increase of $6.5 million in contract labor which was primarily attributable to higher internet +channel outsourced services, increased costs associated with contracted customer service and sales support, and other costs associated IT support and process improvement. As a percentage of revenues, selling, general and administrative expenses +decreased 7.1%, or 310 basis points, to 40.2% in 2011 from 43.3% in 2010. Foreign currency transaction gains increased $2.5 million, or 86.3%, primarily due to a correction related to an error in the classification of certain intercompany +receivables and payables balances that should have been deemed permanently invested in certain prior periods. See Note 16 – Unaudited Quarterly Consolidated Financial Information for further discussion. +24 +Table of Contents +Impact on Selling, General, and Administrative Expenses due to Foreign Exchange Rate +Fluctuations. Changes in average foreign currency exchange rates used to translate expenses from our functional currencies to our reporting currency during the year ended December 31, 2011 increased selling, general and administrative +expenses by approximately $10.3 million as compared to the same period in 2010. +Restructuring charges . +Restructuring charges decreased by $3.8 million during the year ended December 31, 2011 compared to the same period in 2010 as we had no restructurings during 2011. The 2010 restructuring charges consisted of $2.0 million in severance costs +related to the departure of a former executive and $1.8 million related to a change in estimate of our original accrual for lease termination costs for our office facility in Canada, which was closed in 2008. +Income tax (benefit) expense. During the year ended December 31, 2011, income tax expense increased $10.8 million compared to the same +period in 2010, which was primarily due to an increase in pre-tax income. In addition, the company recognized a one-time $3.6 million tax benefit recorded during the second quarter of 2011 as a result of a change in our international structure and a +$3.0 million tax benefit recognized in the third quarter of 2010 due to a change in an international tax treaty which reduced certain taxes for which accruals had previously been made. Our effective tax rate of 17.5% for the year ended +December 31, 2011 differs from the federal U.S. statutory rate primarily because of differences between income tax rates between US and foreign jurisdictions. +Comparison of the Years Ended December 31, 2010 and 2009 +Having experienced rapid +revenue growth and difficulty meeting demand for our footwear products since inception, our revenue growth moderated in the first half of 2008 and subsequently decreased through the year ended December 31, 2009. During this time, our total +revenues declined from $847.4 million in the year ended December 31, 2007 to $645.8 million during the year ended December 31, 2009. Accordingly, we implemented a turnaround strategy in 2008, which continued through 2009 and 2010 +and was aimed at aligning production and distribution capacities with revised demand projections, reducing costs and streamlining processes. As a result, we consolidated our global manufacturing facilities and distribution centers, reduced warehouse +and office space, cut global workforce by 33% and reduced other discretionary spending. During 2009, we sold excess discontinued and impaired product inventories, much of which had been written down in 2008 to a level that we had considered +realizable, at prices substantially higher than previously estimated. The consequential net effect of these sales was accretive to our gross profit in 2009. As a result of these and other actions taken as part of our turnaround strategy, we achieved +improved year-over-year gross margin in 2009 as well as improved operating margin and net loss, despite weakened economic conditions during 2009. The benefits of our turnaround strategy continued through the year ended December 31, 2010, during +which sales of discontinued and impaired product were at more normal levels. +Our turnaround strategy, as discussed above, had a considerable +impact on our operating results for the years ended December 31, 2010 and 2009. The following summarizes specific significant items related to the implementation of this strategy as well as other material events which should be considered in +evaluating the comparability of such results. +• +Revenues and gross profit for the year ended December 31, 2009 were impacted by the effect of the sale of excess discontinued and impaired product +inventories (much of which had been written down in 2008 to a level that we had considered realizable) at prices substantially higher than previously estimated. The net effect of these sales accretive to our gross profit during the year ended +December 31, 2009 was $49.8 million. Although we were able to sell $58.3 million of this impaired product at higher than anticipated price levels, such sales were deeply discounted and consequently drove down footwear average selling +price and revenues in 2009. During 2010 and 2008, sales of discontinued and impaired product were at more normal levels given seasonality and historical fluctuations in our business. +25 +Table of Contents +• +Cost of sales and selling, general and administrative expenses for the year ended December 31, 2009 were negatively impacted by $16.3 million +due to our stock option tender offer (the “2009 Tender Offer”). In April 2009, we offered to purchase stock options with exercise prices equal to or greater than $10.50 per share for cash from certain eligible employees in order to restore +the incentive value of our long-term performance award programs and in response to the fact that the exercise prices of a substantial number of outstanding stock options held by our employees far exceeded the market price of our common stock. As +part of the 2009 Tender Offer, we repurchased 2.3 million stock options from employees and non-employee directors and recorded a charge of $16.3 million related to previously unrecognized share- based compensation expense for these +tendered and cancelled options. Of this $16.3 million charge, $13.3 million was recorded to selling, general and administrative expenses and $3.0 million was recorded to cost of sales. +• +Selling, general and administrative expenses for the year ended December 31, 2009 were negatively impacted by $3.9 million due to an error in +our calculation of share-based compensation expense for prior periods. This error resulted in an accumulated $6.0 million understatement of share-based compensation expense, with a corresponding understatement of additional paid in capital, of +which $2.0 million was partially offset as a consequence of adjustments made pursuant to the 2009 Tender Offer. Consequently, we recorded an additional $3.9 million in share-based compensation during the fourth quarter of 2009 to correct +the balance of this error. We do not believe that these errors or related corrections are material to our previously issued historical consolidated financial statements for 2008 or our quarterly or annual results for 2009. +• +During 2009, the implementation of our turnaround strategy resulted in significantly higher restructuring costs and asset impairment charges as we +consolidated global distribution centers, warehouse and office space and assessed the useful life and carrying value recoverability of certain assets we no longer intended to utilize, including molds, tooling, equipment and other assets. These costs +decreased during 2010 as our turnaround strategy implementation came to an end. The portions of restructuring and impairment related to manufacturing assets are recognized in cost of sales on the consolidated statements of operations. The portions +related to non-product, non-manufacturing assets are reflected in restructuring charges and asset impairment charges as appropriate, on the consolidated statements of operations. +Year Ended +December 31, +Change +($ thousands, except per share data) +2010 +2009 +$ +% +Revenues +$ +789,695 +$ +645,767 +$ +143,928 +22.3 +% +Cost of sales +364,631 +337,720 +26,911 +8.0 +Restructuring charges +1,300 +7,086 +(5,786 +) +(81.7 +) +Gross profit +423,764 +300,961 +122,803 +40.8 +Selling, general and administrative expenses +342,121 +311,592 +30,529 +9.8 +Foreign currency transaction (gains) losses, net +(2,912 +) +(665 +) +(2,247 +) +(337.9 +) +Restructuring charges +2,539 +7,623 +(5,084 +) +(66.7 +) +Asset impairment charges +141 +26,085 +(25,944 +) +(99.5 +) +Charitable contribution expense +840 +7,510 +(6,670 +) +(88.8 +) +Income (loss) from operations +81,035 +(51,184 +) +132,219 +258.3 +Interest expense +657 +1,495 +(838 +) +(56.1 +) +Other, net +(414 +) +(4,058 +) +3,644 +89.8 +Income (loss) before income taxes +80,792 +(48,621 +) +129,413 +266.2 +Income tax (benefit) expense +13,066 +(6,543 +) +19,609 +299.7 +Net income (loss) +$ +67,726 +$ +(42,078 +) +$ +109,804 +261.0 +% +Net income (loss) per basic share +$ +0.78 +$ +(0.49 +) +$ +1.27 +259.2 +% +Net income (loss) per diluted share +$ +0.76 +$ +(0.49 +) +$ +1.25 +255.1 +% +Gross margin +53.7% +46.6 +% +710 bps +15.2 +% +Operating margin +10.3% +(7.9 +)% +1,820 bps +229.9 +% +26 +Table of Contents +Revenues . Revenues increased $143.9 million, or 22.3%, during the year ended +December 31, 2010 compared to the same period in 2009, due to a 15.8% increase in unit sales and a 6.6% increase in footwear average selling price per pair of shoes, as shown in the table below, both of which were driven by increased demand and +improvements in the global economy. During the year ended December 31, 2009, we sold $58.3 million in discontinued and impaired products as we disposed of excess and impaired inventory as previously mentioned. The following table sets +forth revenue by channel and by region as well as other revenue information for the years ended December 31, 2010 and 2009. +Year ended +December 31, +Change +($ millions, except footwear average selling price) +2010 +2009 +$ +% +Wholesale channel revenue +$ +481.8 +$ +404.5 +$ +77.3 +19.1 +% +Retail channel revenue +232.9 +180.9 +52.0 +28.7 +Internet channel revenue +$ +75.0 +$ +60.4 +$ +14.6 +24.2 +% +Footwear unit sales +42.6 +36.8 +5.8 +15.8 +% +Footwear average selling price +$ +17.69 +$ +16.60 +$ +1.09 +6.6 +% +Revenues by Channel. During the year ended December 31, 2010, revenues from our wholesale channel grew +by $77.3 million, or 19.1%, compared to the same period in 2009, particularly in the Americas and Asia, as demand for product continued to grow resulting from a stronger global economy, on-going efforts made to improve our wholesale customer +relationships and market acceptance of our new product line. Revenues from our company-operated retail locations increased $52.0 million, or 28.7%, during the year ended December 31, 2010 compared to the same period in 2009, which was +driven by the expanded availability of product to our retail customer due to the increase in retail locations where we can better merchandise the full breadth and depth of our product line and improved pricing year over year. Revenues from our +internet channel increased by $14.6 million, or 24.2%, primarily due to increased sales in our Europe segment, resulting from the addition of local language internet sites for France, Germany, Spain and Italy as well as stronger consumer +demand. These increases were partially offset by revenue declines from our internet channel in Asia where we saw a drop in demand due to prolonged cold weather and an increase in imitation products in the region, particularly in Japan. +The table below illustrates the overall growth in the number of our company-operated retail locations as of December 31, 2010 and 2009. +December 31, +2010 +2009 +Change +Type: +Kiosk/Store in Store +164 +170 +(6 +) +Retail Stores +138 +84 +54 +Outlet Stores +76 +63 +13 +Total +378 +317 +61 +Geography: +Americas +197 +182 +15 +Asia +159 +119 +40 +Europe +22 +16 +6 +Total +378 +317 +61 +Impact on Revenues due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange +rates during the year ended December 31, 2010 increased revenues by $22.2 million compared to the same period in 2009. +Gross +Profit. During the year ended December 31, 2010 gross profit increased $122.8 million, or 40.8%, compared to the same period in 2009. Gross margin increased 15.1% to 53.7% during the year ended +27 +Table of Contents +December 31, 2010 compared to the same period in 2009. These increases are primarily attributable to a 15.8% increase in sales volume, a 6.6% increase in footwear average selling price and +favorable shifts in product mix within the consumer direct channels toward higher margin products. The increase is also attributable to a decrease of $5.8 million in restructuring charges due to higher 2009 restructuring costs associated with +the closures and consolidation our distribution spaces in the Americas and Europe segments. Additionally, we continue to increase shipments made directly from the factories to our wholesale customers and our retail channel which lower distribution +costs. We realized improvements in gross profit during 2010 as factory direct shipment volume increased. Offsetting these increases was the accretive effect of impaired unit sales that took place during 2009 as previously discussed. The net effect +of these sales during the year ended December 31, 2009 was $49.8 million. During 2010, retail and internet sales continued to increase as a percentage of total revenue. This trend contributed to higher gross margins as we were able to +achieve a higher footwear average selling price in these channels while many of the fixed costs associated with operating our company-operated retail stores are included in selling, general and administrative expenses. Also during 2010, we sold a +wide range of products which required additional materials, such as canvas, cloth lining and suede, and additional processes, such as stitching, to manufacture, thereby increasing our direct costs and lowering our gross margins on those products. As +we continue to expand our portfolio and non-classic models become a larger portion of our business, we expect that our profit margins will be adversely affected. +Impact on Gross Profit due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates during the year ended December 31, 2010 increased our gross profit +by $13.0 million compared to the same period in 2009. +Selling, General and Administrative Expenses and Foreign Currency +Transaction (Gains)/Losses. Selling, general and administrative expenses increased $28.3 million, or 9.1%, in the year ended December 31, 2010 compared to the same period in 2009, primarily due to: +• +an increase of approximately $28.6 million in salaries, rent and other retail related costs largely driven by the expansion of our retail sales +channel; and +• +an increase of approximately $15.9 million in costs related to our 2010 marketing campaign; +• +which were partially offset by a decrease of $20.7 million in share-based compensation, $13.3 million of which was due to the acceleration of +share-based compensation expense from the 2009 Tender Offer; and +• +an increase of $2.2 million gains on transactions denominated in foreign currencies. +Impact on Selling, General, and Administrative Expenses due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency +exchange rates used to translate expenses from our functional currencies to our reporting currency, the U.S. dollar, during the year ended December 31, 2010 increased selling, general and administrative expenses by approximately +$5.0 million as compared to the same period in 2009. +Restructuring Charges. We recorded $3.8 million in restructuring +charges in the year ended December 31, 2010, of which $1.3 million was recorded to cost of sales. These restructuring charges consisted of $2.0 million in severance costs related to the departure of a former Chief Executive Officer, +and $1.8 million due to a change in estimate of our original accruals for lease termination costs for our Canadian office and our distribution facilities in North America and Europe. +During the year ended December 31, 2009, we recorded $14.7 million in restructuring charges, of which $7.1 million was included in costs of sales. These charges primarily consisted of: +• +$5.6 million in costs associated with the consolidation of our warehousing, distribution and office space worldwide; +• +$3.8 million related to the termination of our manufacturing agreement with a third party in Bosnia and our sponsorship agreement with the +Association of Volleyball Professionals; +28 +Table of Contents +• +$3.7 million in severance costs; and +• +$1.1 million related to the release from further obligations under the earn-out provisions of our acquisition of Bite, LLC. +Asset Impairment Charges. During the year ended December 31, 2010, we recorded $0.1 million in +impairment charges compared to $26.1 million in impairment charges recorded during the same period in 2009 due to the implementation of our turnaround strategy in 2009, as previously discussed. The 2009 charges primarily consisted of +$18.1 million related to the write-off of obsolete molds, tooling, manufacturing and distribution equipment, sales and marketing assets and other distribution and manufacturing assets, largely associated with the consolidation of warehouse and +distribution space; and $7.6 million related to the write-off of capitalized software, patents, trade names and other intangible assets that we no longer intended to utilize. Of the $26.1 million impairment charges recorded in 2009, $18.0 +million related to assets previously depreciated or amortized to cost of sales. +Interest Expense. Interest +expense decreased $0.8 million, or 56.1%, during the year ended December 31, 2010 compared to same period in 2009 primarily due to lower borrowing rates and lower borrowing balances under our current revolving credit facility. +Income Tax (Benefit) Expense. Income tax expense increased $19.6 million during the year ended December 31, 2010 compared to the +same period in 2009 which was primarily due to an increase of $129.4 million in income before taxes. Our 2010 effective tax rate of 16.2% differs from the federal U.S. statutory rate because of differences in the statutory rates of foreign +subsidiaries, certain items of revenue and/or expense for which there is a permanent difference in taxability treatment for financial reporting and tax purposes, and changes in the amount of valuation allowances resulting from changes in the +company’s judgments about whether certain deferred tax assets are more likely than not to be realized. For a reconciliation between the federal U.S. statutory rate and our effective tax rate, see Note 11—Income Taxes in the +accompanying notes to the consolidated financial statements. +Presentation of Reportable Segments +We have three reportable operating segments: Americas, Europe and Asia. Revenues of each of our reportable operating segments represent sales to external +customers. We also have an “Other businesses” category which aggregates insignificant operating segments that do not meet the reportable threshold and represent manufacturing operations located in Mexico and Italy. +Each of our reportable operating segments derives its revenues from the sale of footwear, apparel and accessories to external customers. Revenues of the +“Other businesses” category are primarily made up of intersegment sales which are eliminated when deriving total consolidated revenues. The remaining revenues for the “Other businesses” represent non-footwear product sales to +external customers. +Segment operating income (loss) is the primary measure used by our chief operating decision (“CODM”) maker to +evaluate segment operating performance and to decide how to allocate resources to segments. Segment performance evaluation is based primarily on segment results without allocating corporate expenses, or indirect general, administrative and other +expenses. Segment operating income (loss) is a non-GAAP performance measure and is defined as operating income before asset impairment charges and restructuring costs not included in cost of sales. We consider segment operating income (loss) as a +supplemental performance measure and useful information to investors because it reflects the operating performance of our business segments and excludes certain items that are not considered to be recurring in connection with the management of these +segments such as asset impairment and restructuring charges not included in cost of sales. However, segment operating income (loss) should not be viewed as an alternative measure of our financial performance since it excludes expenses which could +materially impact our results of operations. Further, our segment operating income (loss) may not be comparable to that of other companies, as they may use different methodologies for calculating segment operating income (loss). +29 +Table of Contents +The composition of our reportable segments is consistent with that used by our CODM to evaluate performance +and allocate resources. During the fourth quarter of 2010, we changed the internal segment reports used by our CODM to separately illustrate performance metrics of the “Other businesses.” Segment information for all periods presented has +been restated to reflect this change. Segment assets consist of cash and cash equivalents, accounts receivable and inventory as these assets make up the asset information used by the CODM. See Note 14—Operating Segments and Geographic +Information in the accompanying notes to the financial statements for further details. +Comparison of the Years Ended December 31, +2011 and 2010 +The following tables set forth information related to our reportable operating business segments for the years ended +December 31, 2011 and 2010. +Year Ended December 31, +($ thousands) +2011 +2010 +Revenues: +Americas +$ +447,985 +$ +377,080 +Asia +381,767 +284,814 +Europe +170,967 +127,713 +Total segment revenues +1,000,719 +789,607 +Other businesses +184 +88 +Total consolidated revenues +$ +1,000,903 +$ +789,695 +Operating income (loss): +Americas +$ +77,362 +$ +67,259 +Asia +122,724 +80,955 +Europe +40,685 +24,654 +Total segment operating income (loss) +240,771 +172,868 +Other businesses (1) +(2,814 +) +(281 +) +Intersegment eliminations +(2,196 +) +(218 +) +Unallocated corporate and other (2) +(98,728 +) +(88,654 +) +Restructuring charges +— +2,539 +Asset impairment charges +528 +141 +Total consolidated operating income (loss) +136,505 +81,035 +Interest expense +853 +657 +Gain on charitable contributions +(714 +) +(223 +) +Other (income) expense, net +(324 +) +(191 +) +Income (loss) before income taxes +$ +136,690 +$ +80,792 +(1) +During the year +ended December 31, 2011, operating losses of Other businesses increased $2.5 million primarily due to a $2.6 million negative impact of fluctuations in foreign currencies. +(2 ) +Includes a +corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, research and development, brand marketing, legal, depreciation on corporate and other assets not allocated to +operating segments and costs of the same nature of certain corporate holding companies. For the year ended December 31, 2011, Unallocated corporate and other expense increased $10.1 million compared to the same period in 2010, primarily due to +a $4.7 million increase in salaries and wages due to higher corporate headcount, a $2.9 million increase in outside services primarily costs associated with IT support and process improvement, a $1.8 million increase in depreciation and amortization +of unallocated corporate long-lived assets and a $1.2 million increase in marketing and travel costs. +Americas Operating +Segment . During the year ended December 31, 2011, revenues from the Americas segment increased $70.9 million, or 18.8%, compared to the same period in 2010 primarily due to a 9.3% increase in footwear units sold, a 7.8% increase in average +footwear selling price and a $2.7 million favorable impact from +30 +Table of Contents +foreign currency fluctuations. Significant sales growth for the segment included an increase of $29.6 million, or 16.8%, in wholesale channel revenue and an increase of $32.9 million, or 23.2%, +in retail channel revenue. Segment operating income increased by $10.1 million, or 15.0%, driven mainly by the revenue increase which was largely offset by a $15.9 million, or 11.9%, increase in selling, general and administrative expenses resulting +from the continued expansion of the retail channel, a slight decrease in segment gross margin of approximately 2.9%, or 150 basis points, and a $0.4 million unfavorable net impact from foreign currency fluctuations. +Asia Operating Segment . During the year ended December 31, 2011, revenues from the Asia segment increased $97.0 million, or 34.0%, compared +to the same period in 2010 primarily due to a 13.0% increase in average footwear selling price, a 10.6% increase in footwear units sold and a $27.4 million favorable impact from foreign currency fluctuations. Significant sales growth for the segment +included an increase of $59.3 million, or 29.7% in wholesale channel revenue and an increase of $34.3 million, or 44.4%, in retail channel revenue. Segment operating income increased $41.8 million, or 51.6%, primarily due to the increase in revenues +and a $15.6 million favorable net impact from foreign currency fluctuations which were partially offset by a $16.8 million, or 18.3% increase in selling, general and administrative expenses resulting from the continued expansion of the retail +channel as segment gross margin remained relatively flat. +Europe Operating Segment . During the year ended December 31, 2011, +revenues from the Europe segment increased $43.3 million, or 33.9%, compared to the same period in 2010 primarily due to a 23.2% increase in footwear units sold, a 4.8% increase in average footwear selling price and a $7.9 million favorable impact +from foreign currency fluctuations. Significant sales growth for the segment included an increase of $27.6 million, or 28.2%, in wholesale channel revenue and an increase of $9.3 million, or 56.2%, in internet channel revenue. In addition, segment +retail channel revenue grew $6.5 million, or 47.5%. Segment operating income increased $16.0 million, or 65.0%, primarily due to higher revenues, an increase in segment gross margin of approximately 4.7% or 200 basis points, and a $4.8 million +favorable net impact from foreign currency fluctuations which were partially offset by a $7.9 million, or 19.6%, increase in selling, general and administrative expenses resulting from the continued expansion of the retail channel. +31 +Table of Contents +Comparison of the Years Ended December 31, 2010 and 2009 +The following tables set forth information related to our reportable operating business segments for the years ended December 31, 2010 and 2009. +Year Ended December 31, +($ thousands) +2010 +2009 +Revenues: +Americas +$ +377,080 +$ +301,365 +Asia +284,814 +237,502 +Europe +127,713 +105,996 +Total segment revenues +789,607 +644,863 +Other businesses +88 +904 +Total consolidated revenues +$ +789,695 +$ +645,767 +Operating income (loss): +Americas +$ +67,259 +$ +21,598 +Asia +80,955 +57,836 +Europe +24,654 +11,087 +Total segment operating income (loss) +172,868 +90,521 +Other businesses (1) +(281 +) +76 +Intersegment eliminations +(218 +) +(2,313 +) +Unallocated corporate and other (2) +(88,654 +) +(105,760 +) +Restructuring charges +2,539 +7,623 +Asset impairment charges +141 +26,085 +Total consolidated operating income (loss) +81,035 +(51,184 +) +Interest expense +657 +1,495 +Gain on charitable contributions +(223 +) +(3,163 +) +Other (income) expense, net +(191 +) +(895 +) +Income (loss) before income taxes +$ +80,792 +$ +(48,621 +) +(1) +During the year ended December 31, 2010, operating income for the Other businesses remained relatively flat compared to the same period in 2009 as +the entities within this category are designed to operate on a break-even basis. +(2) +Includes a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand marketing, legal, depreciation on corporate and other assets not allocated to operating segments; and costs of the same nature related to certain corporate holding companies For the year ended December 31, 2010, +Unallocated corporate and other expense decreased $17.1 million, or 16.2%, compared to the same period in 2009, primarily due to a $22.4 million decrease in stock-based compensation (more fully discussed in Note 9 – Equity, in the accompanying +notes to the consolidated financial statements) and a $5.3 million decrease in expenses associated with charitable contributions which were partially offset by a $4.6 million increase in legal costs and a $4.2 million increase in bonus expense as +corporate bonuses were not distributed in 2009. +Americas Reportable Operating Segment. During the year ended +December 31, 2010, revenues from the Americas segment increased $75.7 million, or 25.1%, compared to the same period in 2009 primarily due to a 21.3% increase in footwear units sold driven by increased demand and a net increase of 15 +company-operated retail locations. Significant sales growth for the segment included an increase of $35.6 million, or 33.5%, in retail channel revenue and an increase of $34.7 million, or 23.2% in wholesale channel revenue. Changes in foreign +currency exchange rates during the year ended December 31, 2010 increased segment revenues by $6.2 million compared to the same period in 2009. +32 +Table of Contents +Segment operating income for the Americas increased $45.7 million, or 211.4%, primarily due an 18.6% +increase of segment gross margin as the increase in segment revenues outpaced the $13.4 million, or 8.0%, increase in cost of sales (excluding intersegment costs of sales) resulting from the use of more expensive materials and manufacturing +processes as well as the accretive effect of impaired unit sales which took place during 2009. The increase in gross margin was partially offset by a $20.7 million, or 18.5%, increase in selling, general and administrative expenses resulting from +the expansion of our retail sales channel and the 2010 fully-integrated marketing campaign. Changes in foreign currency exchange rates during the year ended December 31, 2010 increased segment operating income by $4.7 million compared +to the same period in 2009. +Asia Reportable Operating Segment. During the year ended December 31, 2010, revenues from the Asia +segment increased $47.3 million, or 19.9%, compared to the same period in 2009 primarily due to a 6.0% increase in footwear units sold and an increase of 6.4% in average footwear selling price which were driven by continued strong demand and a net +increase of 40 company-operated retail locations which was partially offset by the negative impact of a prolonged cold weather season in parts of the region and a rise in imitation products in Japan. Significant channel growth for the segment +included an increase of $33.3 million, or 20.0%, in wholesale channel revenue and an increase of $13.8 million, or 21.7% in retail channel revenue. Changes in foreign currency exchange rates during the year ended December 31, 2010 +increased segment revenues by $18.5 million compared to the same period in 2009. +The Asia segment operating income increased $23.1 +million, or 40.0%, primarily due to an increase of 7.8% in segment gross margin resulting from higher segment revenues and relatively flat costs of sales (excluding intersegment costs of sales). The increase in gross margin was partially offset by a +$6.3 million, or 7.9% increase in selling, general and administrative expenses resulting from the expansion of our retail sales channel and the 2010 fully-integrated marketing campaign. Changes in foreign currency exchange rates during the year +ended December 31, 2010 increased segment operating income by $0.6 million compared to the same period in 2009. +Europe +Reportable Operating Segment. During the year ended December 31, 2010, revenues from the Europe segment increased $21.7 million, or 20.5%, compared to the same period in 2009 primarily due to an increase of 127.7% in footwear units sold and +an increase of 5.7% in average footwear selling price which were driven by increased demand, the addition of local language internet sites for France, Germany, Spain and Italy and a net increase of 6 company-operated retail locations. Significant +sales growth for the segment included an increase of $9.5 million, or 10.8%, in wholesale channel revenue and an increase of $8.8 million, or 115.8% in internet channel revenue. Changes in foreign currency exchange rates during the year ended +December 31, 2010 decreased segment revenues by $4.3 million compared to the same period in 2009. +The Europe segment operating +income increased $13.6 million, or 122.4%, primarily due to a 7.3% increase of segment gross margin driven by higher segment revenues which were partially offset by an increase of $13.6 million, or 24.9%, increase in cost of sales (excluding +intersegment costs of sales) resulting from the use of more expensive materials and manufacturing processes as well as the accretive effect of impaired unit sales which took place during 2009. The increase in gross margin was partially offset by a +$6.2 million, or 17.3% increase in selling, general and administrative expenses resulting from the expansion of our retail sales channel and the 2010 fully-integrated marketing campaign. Changes in foreign currency exchange rates during the year +ended December 31, 2010 increased segment operating income by $2.7 million compared to the same period in 2009. +Liquidity +and Capital Resources +Cash and cash equivalents at December 31, 2011 increased 76.9% to $257.6 million compared to $145.6 million at +December 31, 2010. We anticipate that cash flows from operations will be sufficient to meet the ongoing needs of our business for the next twelve months. In order to provide additional liquidity in the future and to help support our strategic +goals, we also have a revolving credit facility with a syndicate of lenders, including PNC Bank, N.A. (“PNC”) (further discussed below), which currently provides us with up to $70.0 million in borrowings. Additional future financing may be +necessary and there can be no assurance that, if needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. +33 +Table of Contents +Revolving Credit Facility +On December 16, 2011, we entered into an Amended and Restated Credit Agreement (the “Credit Agreement”) with a syndicate of lenders, including PNC, which replaced our asset-backed line of +credit. The Credit Agreement provides for a revolving credit facility of $70.0 million (the “Credit Facility”), which can be increased to $100.0 million subject to certain conditions. The Credit Facility is available for working capital, +capital expenditures and other corporate purposes, including acquisitions and stock repurchases, and is currently set to mature in December 2016. Borrowings under the Credit Facility are secured by all of our assets including all receivables, +equipment, general intangibles, inventory, investment property, subsidiary stock and intellectual property. Borrowings under the Credit Agreement bear interest at a variable rate. For domestic rate loans, the interest rate is equal to the highest of +(i) the daily federal funds open rate as quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC’s prime rate and (iii) a daily LIBOR rate plus 1.0%, in each case there is an additional margin ranging from 0.75% to 1.50% based on +certain conditions. For LIBOR rate loans, the interest rate is equal to a LIBOR rate plus a margin ranging from 1.75% to 2.50% based on certain conditions. The Credit Agreement requires monthly interest payments with respect to domestic rate loans +and at the end of each interest period with respect to LIBOR rate loans and contains certain customary restrictive and financial covenants. We were in compliance with these restrictive financial covenants as of December 31, 2011. As of +December 31, 2011, we had $0.4 million of outstanding borrowings under the Credit Facility. As of December 31, 2010, we had an immaterial amount of outstanding borrowings under our previous Credit Facility. At December 31, 2011 and +2010, we had issued and outstanding letters of credit of $6.0 million and $1.0 million, respectively, which were reserved against the borrowing base. +Working Capital +As of December 31, 2011, accounts receivable increased +$20.5 million to $84.8 million when compared to December 31, 2010, primarily due to higher sales in the fourth quarter of 2011 compared to the fourth quarter of 2010. Inventories increased $8.5 million, or 7.0%, to $129.6 million as +of December 31, 2011 when compared to December 31, 2010, primarily due to the growth associated with the addition of 52 new retail locations and a 19.0% increase in order backlog. +Capital Assets +During the year ended December 31, 2011, capital expenditures +decreased slightly to $41.6 million compared to $45.1 million during the same period in 2010 as the pace of our retail presence expansion through new retail stores has leveled off and as we transition the purchase of new molds and other +tooling equipment related to new product manufacturing to our third party manufacturers with such costs realized as future product costs. +We +have entered into various operating leases that require cash payments on a specified schedule. Over the next five years we are committed to make payments of approximately $179.4 million related to our operating leases. We plan to continue to +enter into operating leases related to our retail stores. We also continue to evaluate cost reduction opportunities. Our evaluation of cost reduction opportunities will include an evaluation of contracts for sponsorships, operating lease contracts +and other contracts that require future minimum payments resulting in fixed operating costs. Any changes to these contracts may require early termination fees or other charges that could result in significant cash expenditures. +Repatriation of Cash +As we are +a global business, we have cash balances which are located in various countries and are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in +foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries have additional restrictions and covenants associated with them which adds increased strains on our liquidity and ability +to timely access and transfer cash balances between entities. +34 +Table of Contents +We generally consider unremitted earnings of subsidiaries operating outside of the U.S. to be indefinitely +reinvested and it is not our current intent to change this position with the exception of the expected repatriation of up to approximately $13.6 million in cash that was previously accrued for as a repatriation of 2010 foreign subsidiary +current-year earnings. Most of the cash balances held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal and state income taxes less applicable foreign tax credits. In some countries, +repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. Certain countries, including China, have monetary laws which may limit our ability to +utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries and could adversely affect our liquidity. As of +December 31, 2011, we held $235.7 million of our total $257.6 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the $235.7 million, +$39.3 million could potentially be restricted, as described above. If the remaining $196.4 million were to be immediately repatriated to the U.S., we would be required to pay approximately $40.7 million in taxes that were not previously provided for +in our consolidated statement of operations. +Contractual Obligations +In February 2011, we renewed and amended our supply agreement with Finproject S.r.l. which provides us the exclusive right to purchase certain raw materials used to manufacture our products. The +agreement also provides that we meet minimum purchase requirements to maintain exclusivity throughout the term of the agreement, which expires December 31, 2014. Historically, the minimum purchase requirements have not been onerous and we do +not expect them to become onerous in the future. Depending on the material purchased, pricing is either based on contracted price or is subject to quarterly reviews and fluctuates based on order volume, currency fluctuations and raw material prices. +Pursuant to the agreement, we guarantee the payment for certain third-party manufacturer purchases of these raw materials up to a maximum potential amount of €3.5 million (approximately $4.5 million as of December 31, 2011), +through a letter of credit that was issued to Finproject S.r.l. +The following table summarizes aggregate information about our contractual +cash obligations as of December 31, 2011, excluding the letter of credit issued to Finproject S.r.l. (mentioned above). +Payments due by period +($ thousands) +Total +Less than +1 year +1 - 3 +years +4 - 5 +years +More than +5 +years +Operating lease obligations +$ +245,496 +$ +56,903 +$ +74,537 +$ +47,979 +$ +66,077 +Inventory purchase obligations with third party manufacturers (1) +138,568 +138,568 +— +— +— +Estimated liability for uncertain tax positions +44,537 +— +35,264 +6,655 +2,618 +Minimum licensing royalties +7,530 +6,734 +796 +— +— +Other contracts +6,308 +2,190 +1,851 +1,503 +764 +Capital lease obligations +724 +699 +25 +— +— +Long-term debt obligations +422 +422 +— +— +— +Total +$ +443,585 +$ +205,516 +$ +112,473 +$ +56,137 +$ +69,459 +(1) +Includes $12.5 million in purchase commitments with certain third party manufacturers for yet-to-be-received finished product where title passes to us +upon receipt and a commitment to re-purchase $4.3 million of raw materials from a certain third party manufacturer. +Off-Balance Sheet Arrangements +We had no material off balance sheet arrangements at December 31, 2011. +35 +Table of Contents +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of +operations is based on the consolidated financial statements which have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). The preparation of these financial statements +requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We +evaluate our assumptions and estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making +judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The following discussion pertains to accounting +policies management believes are most critical to the portrayal of our financial condition and results of operations that require management’s most difficult, subjective or complex judgments. +Reserves for Uncollectible Accounts Receivable. We make ongoing estimates related to the collectability of our accounts +receivable and maintain a reserve for estimated losses resulting from the inability of our customers to make required payments. Our estimates are based on a variety of factors, including the length of time receivables are past due, economic trends +and conditions affecting our customer base, significant one-time events and historical write-off experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability to meet its financial +obligations. Because we cannot predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates and we may experience changes in the amount of reserves we recognize +for accounts receivable that we deem uncollectible. If the financial condition of some of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the event we determine that a smaller +or larger reserve is appropriate, we would record a credit or a charge to selling, general and administrative expenses in the period in which we made such a determination. +Sales Returns, Allowances and Discounts. We record reductions to revenue for estimated customer returns, allowances and discounts. Our estimated sales returns and allowances are +based on customer return history and actual outstanding returns yet to be received. Provisions for customer specific discounts based on contractual obligations with certain major customers are recorded as reductions to net sales. We may accept +returns from our wholesale and distributor customers on an exception basis at the sole discretion of management for the purpose of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, at the sole +discretion of management, we may provide markdown allowances to key wholesale and distributor customers to facilitate the “in-channel” markdown of products where we have experienced less than anticipated sell-through. We also record +reductions to revenue for estimated customer credits as a result of price mark-downs in certain markets. Fluctuations in our estimates for sales returns, allowances and discounts may be caused by many factors, including, but not limited to, +fluctuations in our sales revenue, changes in demand for our products. Our judgment in determining these estimates is impacted by various factors including customer acceptance of our new styles, customer inventory levels, shipping delays or errors, +known or suspected product defects, the seasonal nature of our products and macroeconomic factors affecting our customers. Because we cannot predict or control certain of these factors, the actual amounts of customer returns and allowances may +differ from our estimates. +Inventory Valuation. Inventories are valued at the lower of cost or market. Inventory +cost is determined using the moving average cost method. At least annually, we evaluate our inventory for possible impairment using standard categories to classify inventory based on the degree to which we believe that the products may need to be +discounted below cost to sell within a reasonable period. We base inventory fair value on several subjective and unobservable assumptions including estimated future demand and market conditions, as well as other observable factors such as current +sell-through of our products, recent changes in demand for our product as well +36 +Table of Contents +as shifting demand between the products we offer, global and regional economic conditions, historical experience selling through liquidation and “off-price” channels and the amount of +inventory on hand. If the estimated inventory fair value is less than its carrying value, the carrying value is adjusted to market value and the resulting impairment charge is recorded in cost of sales on the consolidated statements of operations. +The ultimate results achieved in selling excess and discontinued products in future periods may differ significantly from management’s fair value estimates. See Note 2—Inventories in the accompanying notes to the consolidated +financial statements for additional information regarding inventory and impaired product. +Impairment of Long-Lived +Assets. We test long-lived assets to be held and used for impairment when events or circumstances indicate the carrying value of a long-lived asset may not be fully recoverable. Events that may indicate the impairment of a +long-lived asset (or asset group, as defined below) include: (i) a significant decrease in its market price, (ii) a significant adverse change in the extent or manner in which it is being used or in its physical condition, (iii) a +significant adverse change in legal factors or business climate that could affect its value, including an adverse action or assessment by a regulator, (iv) an accumulation of costs significantly in excess of the amount originally expected for +its acquisition or construction, (v) its current period operating or cash flow losses combined with historical operating or cash flow losses or a forecast of its cash flows demonstrate continuing losses associated with its use, and (vi) a +current expectation that, more likely than not, it will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. If such facts indicate a potential impairment of a long-lived asset (or asset group), we +assess the recoverability by determining if its carrying value exceeds the sum of its projected undiscounted cash flows expected from its use and eventual disposition over its remaining economic life. If the asset is not supported on an undiscounted +cash flow basis, the amount of impairment is measured as the difference between its carrying value and its fair value. Assets held for sale are reported at the lower of the carrying amount or fair value less costs to sell. Fair value is determined +by independent third party appraisals, the net present value of expected cash flows, or other valuation techniques as appropriate. Assets to be abandoned or from which no further benefit is expected are written down to zero at the time that the +determination is made and the assets are removed entirely from service. +An asset group is the lowest level of assets and liabilities for +which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. We have determined that the lowest level of assets and liabilities for which identifiable cash flows are largely independent of the cash flows +of other assets and liabilities is at the retail store level for assets involved in our retail business. Our estimates of future cash flows over the remaining useful life of the asset group are based on management’s operating budgets and +forecasts. These budgets and forecasts take into consideration inputs from our regional management related to growth rates, pricing, new markets and other factors expected to affect the business, as well as management’s forecasts for inventory, +receivables, capital spending, and other cash needs. These considerations and expectations are inherently uncertain, and estimates included in our operating forecasts beyond a three to six month future period are extremely subjective. Accordingly, +actual cash flows may differ significantly from our estimated future cash flows. +Impairment charges are driven by, among other things, +changes in our strategic operational and financial decisions, global and regional economic conditions, demand for our product and other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our +long-lived assets and result in impairment charges in future periods. Significant impairment charges recognized during a reporting period could have an adverse affect on our reported financial results +Impairment of Intangible Assets. Intangible assets with indefinite lives are evaluated for impairment when events or changes in +circumstances indicate that the carrying value may not be fully recoverable and at least annually. Intangible assets that are determined to have definite lives, such as customer relationships, core technology, capitalized software, patents and +non-compete agreements are amortized over their useful lives and are evaluated for impairment only when events or circumstances indicate a carrying value may not be fully recoverable. Recoverability is based on the estimated future undiscounted cash +flows of an asset. If the asset is not supported on an undiscounted cash flow basis, the amount of impairment is measured as the difference +37 +Table of Contents +between its carrying value and its fair value. Determination of the fair value of indefinite lived intangible assets involves a number of management assumptions including the expected future +operating performance of our reporting units which may change in future periods due to technological changes, economic conditions, changes to our business operations, or the inability to meet business plans, among other things. The valuation is +sensitive to the actual results of any of these uncertain factors which could be negatively affected and may result in additional impairment charges should the actual results differ from management’s estimates. See Note 4—Intangible +Assets, in the accompanying notes to the consolidated financial statements for additional information regarding our intangible assets. +Share-based Compensation. We estimate the fair value of our stock option awards using a Black Scholes valuation model, the +inputs of which require various assumptions including the expected volatility of our stock price and the expected life of the option. The expected volatility assumptions are derived using our historical stock price volatility and the historical +volatilities of competitors whose shares are traded in the public markets. These assumptions reflect our best estimates, but they involve inherent uncertainties based on market conditions generally outside of our control. If factors change and we +use a different methodology for deriving the Black Scholes assumptions, our share- based compensation expense may differ materially in the future from that recorded in the current period. Additionally, we make certain estimates about the number of +awards which will be made under performance based incentive plans. As a result, if other assumptions or estimates had been used, share-based compensation expense could have been materially impacted. Furthermore, if we use different assumptions in +future periods, share-based compensation expense could be materially impacted in future periods. See Note 9—Equity in the accompanying notes to the consolidated financial statements for additional information regarding our share-based +compensation. +Income Taxes. We account for income taxes using the asset and liability method which requires the +recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and +future enacted tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax +positions. The impact of an uncertain tax position that is more likely than not of being sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of +an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained. Interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax +position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. +Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in +determining our annual tax expense and in evaluating our tax positions. Tax laws require items to be included in our tax returns at different times than when these items are reflected in the consolidated financial statements. As a result, the annual +tax rate reflected in our consolidated financial statements is different than that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some +differences reverse over time, such as depreciation expense. These timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and +tax basis of assets and liabilities. The tax rates used to determine deferred tax assets or liabilities are the enacted tax rates in effect for the year in which the differences are expected to reverse. Based on the evaluation of all available +information, we recognize future tax benefits, such as net operating loss carryforwards, to the extent that realizing these benefits is considered more likely than not. +We evaluate our ability to realize the tax benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the +reversal of existing temporary differences, taxable income in prior carry back years (if permitted) and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more +likely than not +38 +Table of Contents +that we will ultimately realize the tax benefit associated with a deferred tax asset. Undistributed earnings of a subsidiary are accounted for as a temporary difference, except that deferred tax +liabilities are not recorded for undistributed earnings of a foreign subsidiary that are deemed to be indefinitely reinvested in the foreign jurisdiction. We have operated under a specific plan for reinvestment of undistributed earnings of our +foreign subsidiaries which demonstrates that such earnings will be indefinitely reinvested in the applicable tax jurisdictions. Should we change our plans, we would be required to record a significant amount of deferred tax liabilities. We recognize +interest and penalties related to unrecognized tax benefits within the income tax expense line in the accompanying consolidated statement of operations. Accrued interest and penalties are included within the related tax liability line in the +consolidated balance sheets. See Note 11—Income Taxes in the accompanying notes to the consolidated financial statements for additional information regarding our income taxes. +Recent Accounting Pronouncements. See Note 1—Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements for recently +adopted accounting pronouncements. +ITEM 7A. +Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +Our exposure to market risk includes interest rate fluctuations in +connection with our revolving credit facility, see Note 8—Bank Borrowings and Capital Lease Obligations in the accompanying notes to the consolidated financial statements for additional information. Borrowings under the revolving credit +facility bear interest at a variable rate. For domestic rate loans, the interest rate is equal to the highest of (i) the daily federal funds open rate as quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC’s prime rate and +(iii) a daily LIBOR rate plus 1.0%, in each case there is an additional margin ranging from 0.75% to 1.50% based on certain conditions. For LIBOR rate loans, the interest rate is equal to a LIBOR rate plus a margin ranging from 1.75% to 2.50% +based on certain conditions. Borrowings under the revolving credit facility are therefore subject to risk based upon prevailing market interest rates. Interest rate risk may result from many factors, including governmental monetary and tax policies, +domestic and international economic and political considerations and other factors that are beyond our control. During the year ended December 31, 2011, the maximum amount borrowed under the Credit Facility was $16.2 million and the average +amount of borrowings outstanding was $5.9 million. As of December 31, 2011, the amount of total borrowings outstanding under the revolving credit facility was $0.4 million. If the prevailing market interest rates relative to these borrowings +increased by 10%, our interest expense during the year ended December 31, 2011 would have increased by $0.1 million. +Fluctuations +in the prevailing market interest rates, earned on our cash and cash equivalents and restricted cash balances during the year ended December 31, 2011, would have impacted the consolidated statements of operations by $0.1 million. +Foreign Currency Exchange Risk +As a +global company, we have significant revenues and costs denominated in currencies other than the U.S. dollar. We pay the majority of expenses attributable to our foreign operations in the functional currency of the country in which such operations +are conducted and pay the majority of our overseas third-party manufacturers in U.S. dollars. Our ability to sell our products in foreign markets and the U.S. dollar value of the sales made in foreign currencies can be significantly influenced by +foreign currency fluctuations. A decrease in the value of foreign currencies relative to the U.S. dollar could result in downward price pressure for our products and increase losses from currency exchange rates. A decrease of 1% in value of the U.S. +dollar relative to foreign currencies would have increased income before taxes during the year ended December 31, 2011 by approximately $2.5 million. The volatility of the applicable exchange rates is dependent on many factors that cannot be +forecasted with reliable accuracy. In the event our foreign sales and purchases increase and are denominated in currencies other than the U.S. dollar, our operating results may be affected by fluctuations in the +39 +Table of Contents +exchange rate of currencies we receive for such sales. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for a discussion of +the impact of foreign exchange rate variances experienced during the years ended December 31, 2011 and 2010. +We enter into foreign +currency exchange forward contracts as economic cash flow hedges to reduce our exposure to the effect of changes in exchange rates on our operating results. The following table summarizes the notional amounts of the outstanding foreign currency +exchange forward contracts at December 31, 2011 and 2010. The notional amounts of the derivative financial instruments shown below are denominated in their U.S. dollar equivalents and represent the amount of all contracts of the foreign +currency specified. These notional values do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the foreign currency exchange risks. +December 31, +($ thousands) +2011 +2010 +Foreign currency exchange forward contracts by currency: +Japanese Yen +$ +27,500 +$ +6,000 +Euro +10,055 +3,921 +Mexican Peso +6,500 +— +Pound Sterling +6,345 +2,385 +Total notional value, net +$ +50,400 +$ +12,306 +Latest maturity date +December 2012 +March 2011 +ITEM 8. +Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the “Index to Consolidated Financial Statements” on page 48. +ITEM 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. +Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design +and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of December 31, 2011 (the “Evaluation Date”). Based on this evaluation, our Chief Executive Officer +and Chief Financial Officer concluded that as of the Evaluation Date, our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be disclosed in our Securities +and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our Chief +Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. +Management’s Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2011, using the criteria set forth in the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway +Commission (COSO). Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2011. +40 +Table of Contents +Deloitte & Touche LLP, our independent registered public accounting firm, has issued a report +on our internal control over financial reporting, which is included herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially +affected, or is reasonable likely to materially affect, our internal control over financial reporting. +41 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, +2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal +control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Annual Report on Internal Control Over Financial Reporting”. Our +responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. +We conducted our +audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over +financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and +operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive +and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and +the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the +maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation +of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and +(3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override +of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to +the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal +Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We have also audited, +in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2011 of the Company and our report dated February 23, 2012 +expressed an unqualified opinion on those financial statements. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 23, 2012 +42 +Table of Contents +ITEM 9B. +Other Information +None. +PART III +ITEM 10. +Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2012 Annual Meeting of Stockholders to be filed with the SEC within 120 days after +December 31, 2011. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer, principal financial officer, principal accounting officer and controller. A copy of +our business code of conduct and ethics policy is available on our website: www.crocs.com. We are required to disclose any change to, or waiver from, our code of ethics for our senior financial officers. We intend to use our website as a method of +disseminating any change to, or waiver from, our business code of conduct and ethics policy as permitted by applicable SEC rules. +ITEM 11. +Executive Compensation +The information +required by this item is incorporated herein by reference to our definitive proxy statement for the 2012 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2011. +ITEM 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2012 Annual Meeting of Stockholders +to be filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2011, with the exception of those items listed below. +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table +below, we reserved 3.3 million shares of common stock for future issuance on exercise of outstanding options under equity compensation plans as of December 31, 2011. +Plan Category +Number of +Securities +to be Issued +on Exercise of +Outstanding Options +Weighted Average +Exercise Price +of +Outstanding +Options +Number of Securities +Remaining +Available +for Future +Issuance Under +Plans, +Excluding +Securities Available +in First Column +Equity compensation plans approved by stockholders (1) +3,331,031 +$ +11.91 +6,959,120 +Equity compensation plans not approved by stockholders +— +— +— +Total +3,331,031 +$ +11.91 +6,959,120 +(1) +On July 9, 2007, at the annual stockholders’ meeting, our stockholders approved the 2007 Equity Incentive Plan (the “2007 Plan”), +which previously had been approved by our board of directors and which became effective as of July 19, 2007. On June 28, 2011, our stockholders approved an amendment to the 2007 Plan to increase the number of shares of our common stock +available for issuance from 9.0 million shares to 15.3 million shares, subject to adjustment for future stock splits, +43 +Table of Contents +stock dividends and similar changes in our capitalization. On April 27, 2005, our board of directors adopted the 2005 Equity Incentive Plan (the “2005 Plan”). On January 10, +2006, our board of directors amended the 2005 Plan to increase the number of shares of our common stock available for issuance under the 2005 Plan from 11.7 million shares to 14.0 million shares. Following the adoption of the 2007 Plan, no +future grants were made under the 2005 Plan. +ITEM 13. +Certain Relationships and Related Transactions, and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2012 Annual Meeting of Stockholders to be filed with the SEC within 120 days after +December 31, 2011. +ITEM 14. +Principal Accountant Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2012 Annual Meeting of Stockholders +to be filed with the SEC within 120 days after December 31, 2011. +PART IV +ITEM 15. +Exhibits and Financial Statement Schedules +(1) +Financial Statements +The consolidated +financial statements filed as part of this report are listed on the “Index to Consolidated Financial Statements” on page 48. +(2) +Financial Statement Schedules +All +financial statement schedules have been omitted because they are not required, are not applicable or the information is included in the Financial Statements or Notes thereto. +44 +Table of Contents +(3) +Exhibit list +Exhibit +Number +Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Registration Statement on Form S-8, +filed on March 9, 2006 (File No. 333-132312)). +3.1 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report +on Form 8-K, filed on July 12, 2007). +3.2 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-8, filed on +March 9, 2006 (File No. 333-132312)). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-1/A, filed on +January 19, 2006 (File No. 333-127526)). +10.1* +Form of Indemnification Agreement between Crocs, Inc. and each of its directors and executive officers (incorporated herein by reference to Exhibit 10.1 to +Crocs, Inc.’s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.2* +Crocs, Inc. 2005 Equity Incentive Plan (the “2005 Plan”) (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.3* +Amendment No. 1 to the 2005 Plan (incorporated herein by reference to Exhibit 10.2.2 to Crocs, Inc.’s Registration Statement on Form S-1/A, filed on +January 19, 2006 (File No. 333-127526)). +10.4* +Form of Notice of Grant of Stock Option under the 2005 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.’s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.5* +Form of Notice of Grant of Stock Option for Non-Exempt Employees under the 2005 Plan (incorporated herein by reference to Exhibit 10.4 to Crocs, Inc.’s Registration +Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.6* +Form of Stock Purchase Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.5 to Crocs, Inc.’s Registration Statement on Form S-1, filed +on August 15, 2005 (File No. 333-127526)). +10.7* +Form of Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.6 to Crocs, Inc.’s Registration Statement on Form S-1, filed +on August 15, 2005 (File No. 333-127526)). +10.8* +Form of Restricted Stock Award Grant Notice under the 2005 Plan (incorporated herein by reference to Exhibit 10.7 to Crocs, Inc.’s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.9* +Form of Restricted Stock Award Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.8 to Crocs, Inc.’s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.10* +Form of Non Statutory Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.9 to Crocs, Inc.’s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.11* +Crocs, Inc. Amended and Restated 2007 Senior Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.15 to Crocs, Inc.’s Annual +Report on Form 10-K, filed on March 17, 2009). +45 +Table of Contents +Exhibit +Number +Description +10.12* +2008 Cash Incentive Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on Form 8-K, filed on July 12, +2007). +10.13* +Crocs, Inc. 2007 Equity Incentive Plan (As Amended and Restated) (the “2007 Plan”) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s +Current Report on Form 8-K, filed on July 1, 2011). +10.14* +Form of Incentive Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, +filed on November 14, 2007). +10.15* +Form of Non-Statutory Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on +Form 10-Q, filed on November 14, 2007). +10.16* +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.’s +Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.17* +Form of Restricted Stock Unit Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed +on July 1, 2011). +10.18* +Employment Agreement, dated February 9, 2009, between Crocs, Inc. and John McCarvel (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s +Current Report on Form 8-K, filed on February 13, 2009). +10.19* +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Crocs, Inc.’s Quarterly Report on +Form 10-Q, filed on August 5, 2010). +10.20 +Amended and Restated Credit Agreement, dated December 16, 2011, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein and +PNC Bank, National Association, as a lender and administrative agent for the lenders (incorporated herein by reference to Crocs, Inc.’s Current Report on Form 8-K, filed on December 19, 2011). +21† +Subsidiaries of the registrant. +23.1† +Consent of Deloitte & Touche LLP. +31.1† +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of +the Sarbanes-Oxley Act. +31.2† +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of +the Sarbanes- Oxley Act. +32† +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley +Act. +101.INS† +XBRL Instance Document** +101.SCH† +XBRL Taxonomy Extension Schema Document** +101.CAL† +XBRL Taxonomy Extension Calculation Linkbase Document** +101.LAB† +XBRL Taxonomy Extension Label Linkbase Document** +101.PRE† +XBRL Taxonomy Extension Presentation Linkbase Document** +* +Compensatory plan or arrangement +** +Pursuant to Rule 406T of Regulation S-T, the information in Exhibit 101 is deemed not filed or part of a registration statement or prospectus for purposes of +Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections. +† +Filed herewith. +46 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed +on its behalf by the undersigned, thereunto duly authorized, as of February 23, 2012. +CROCS, INC. +a +Delaware Corporation +By: +/s/ J OHN P. M C C ARVEL +Name: John P. McCarvel +Title: President and 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. +Signature +Title +Date +/ S / J OHN P. +M C C ARVEL +John P. McCarvel +President, Chief Executive Officer and Director (Principal Executive Officer) +February 23, 2012 +/ S / J EFFREY J. L ASHER +Jeffrey J. Lasher +Senior Vice President-Finance and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) +February 23, 2012 +/ S / W. S TEPHEN C ANNON +W. Stephen Cannon +Director +February 23, 2012 +/ S / R AYMOND D. C ROGHAN +Raymond D. Croghan +Director +February 23, 2012 +/ S / R ONALD L. F RASCH +Ronald L. Frasch +Director +February 23, 2012 +/ S / P ETER A. J ACOBI +Peter A. Jacobi +Director +February 23, 2012 +/ S / T HOMAS J. S MACH +Thomas J. Smach +Chairman of the Board +February 23, 2012 +/ S / D OREEN A. W RIGHT +Doreen A. Wright +Director +February 23, 2012 +47 +Table of Contents +INDEX TO CONSOLIDATED FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm +F-1 +Consolidated Statements of Operations for the Years Ended December 31, 2011, 2010 and +2009 +F-2 +Consolidated Balance Sheets as of December 31, 2011 and 2010 +F-3 +Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss) for the Years Ended December 31, +2011, 2010 and 2009 +F-4 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2011, 2010 and +2009 +F-5 +Notes to Consolidated Financial Statements +F-6 +48 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements +of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our +responsibility is to express an opinion on these financial statements based on our audits. +We conducted our audits in accordance with the +standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit +includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the +overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. +In our opinion, such +consolidated financial statements present fairly, in all material respects, the financial position of Crocs, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the +three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. +We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of +December 31, 2011, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 23, 2012 expressed an +unqualified opinion on the Company’s internal control over financial reporting. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 23, 2012 +F-1 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +Year Ended December 31, +($ thousands, except per share amounts) +2011 +2010 +2009 +Revenues +$ +1,000,903 +$ +789,695 +$ +645,767 +Cost of sales +464,493 +364,631 +337,720 +Restructuring charges +— +1,300 +7,086 +Gross profit +536,410 +423,764 +300,961 +Selling, general and administrative expenses +402,769 +342,121 +311,592 +Foreign currency transaction (gains) losses, net +(5,426 +) +(2,912 +) +(665 +) +Restructuring charges +— +2,539 +7,623 +Asset impairment charges +528 +141 +26,085 +Charitable contributions expense +2,034 +840 +7,510 +Income (loss) from operations +136,505 +81,035 +(51,184 +) +Interest expense +853 +657 +1,495 +Gain on charitable contributions +(714 +) +(223 +) +(3,163 +) +Other (income) expense, net +(324 +) +(191 +) +(895 +) +Income (loss) before income taxes +136,690 +80,792 +(48,621 +) +Income tax benefit (expense) +23,902 +13,066 +(6,543 +) +Net income (loss) +$ +112,788 +$ +67,726 +$ +(42,078 +) +Income (loss) per common share (Note 12): +Basic +$ +1.27 +$ +0.78 +$ +(0.49 +) +Diluted +$ +1.24 +$ +0.76 +$ +(0.49 +) +The accompanying notes are an integral part of these consolidated financial statements. +F-2 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +($ thousands, except number of shares) +2011 +2010 +ASSETS +Current assets: +Cash and cash equivalents +$ +257,587 +$ +145,583 +Accounts receivable, net of allowances of $15,508 and +$10,249, respectively +84,760 +64,260 +Inventories +129,627 +121,155 +Deferred tax assets, net +7,047 +15,888 +Income tax receivable +5,828 +9,062 +Other receivables +20,295 +11,637 +Prepaid expenses and other current assets +20,199 +13,429 +Total current assets +525,343 +381,014 +Property and equipment, net +67,684 +70,014 +Intangible assets, net +48,641 +45,461 +Deferred tax assets, net +30,375 +34,711 +Other assets +23,410 +18,281 +Total assets +$ +695,453 +$ +549,481 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +66,517 +$ +35,669 +Accrued expenses and other current liabilities +76,506 +59,488 +Deferred tax liabilities, net +2,889 +17,620 +Income taxes payable +8,273 +23,084 +Bank borrowings and current portion of capital lease obligations +1,118 +1,901 +Total current liabilities +155,303 +137,762 +Long term income tax payable +41,665 +29,861 +Other liabilities +6,705 +5,752 +Total liabilities +203,673 +173,375 +Commitments and contingencies (Note 13) +Stockholders’ equity: +Preferred shares, par value $0.001 per share, 5,000,000 shares authorized, none outstanding +— +— +Common shares, par value $0.001 per share, 250,000,000 shares authorized, 90,306,432 and 89,807,146 shares issued and +outstanding, respectively, at December 31, 2011 and 88,600,860 and 88,065,859 shares issued and outstanding, respectively, at December 31, 2010 +90 +88 +Treasury stock, at cost, 499,286 and 535,001 shares, respectively +(19,759 +) +(22,008 +) +Additional paid-in capital +293,959 +277,293 +Retained earnings +202,669 +89,881 +Accumulated other comprehensive income +14,821 +30,852 +Total stockholders’ equity +491,780 +376,106 +Total liabilities and stockholders’ equity +$ +695,453 +$ +549,481 +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS) +Common Stock +Treasury Stock +Additional +Paid +in +Capital +Deferred +Compensation +Retained +Earnings +Accumulated +Other +Comprehensive +Income +Total +Stock +Holders +Equity +Comprehensive +Income +(Loss) +($ thousands) +Shares +Amount +Shares +Amount +BALANCE—December 31, 2008 +83,019 +$ +84 +524 +$ +(25,022 +) +$ +232,037 +$ +(246 +) +$ +64,233 +$ +16,077 +$ +287,163 +Amortization of stock compensation (Note 9) +— +— +— +— +17,189 +208 +— +— +17,397 +Tender offer (Note 9) +— +— +— +— +16,197 +— +— +— +16,197 +Forfeitures +(116 +) +— +— +— +(199 +) +38 +— +— +(161 +) +Exercises of stock options and issuance of restricted stock awards (Note 9) +1,858 +1 +— +— +1,248 +— +— +— +1,249 +Adjustment for prior period RSA grants +939 +— +— +— +— +— +— +— +— +Repurchase of common stock for tax withholding +(41 +) +— +41 +(238 +) +— +— +— +— +(238 +) +Net loss +— +— +— +— +— +— +(42,078 +) +— +(42,078 +) +$ +(42,078 +) +Foreign currency translation +— +— +— +— +— +— +— +8,091 +8,091 +8,091 +Total comprehensive loss +$ +(33,987 +) +BALANCE—December 31, 2009 +85,659 +$ +85 +565 +$ +(25,260 +) +$ +266,472 +$ +— +$ +22,155 +$ +24,168 +$ +287,620 +Amortization of stock compensation (Note 9) +— +— +— +— +7,594 +— +— +— +7,594 +Forfeitures +(454 +) +— +— +— +(288 +) +— +— +— +(288 +) +Exercises of stock options and issuance of restricted stock awards (Note 9) +2,908 +3 +(77 +) +3,673 +3,515 +— +— +— +7,191 +Repurchase of common stock for tax withholding +(47 +) +— +47 +(421 +) +— +— +— +— +(421 +) +Net income +— +— +— +— +— +— +67,726 +— +67,726 +$ +67,726 +Foreign currency translation +— +— +— +— +— +— +— +9,048 +9,048 +9,048 +Reclassification of cumulative foreign exchange translation adjustments to net income (Note 1) +— +— +— +— +— +— +— +(2,364 +) +(2,364 +) +(2,364 +) +Total comprehensive income +$ +74,410 +BALANCE—December 31, 2010 +88,066 +$ +88 +535 +$ +(22,008 +) +$ +277,293 +$ +— +$ +89,881 +$ +30,852 +$ +376,106 +Amortization of stock compensation (Note 9) +— +— +— +— +8,928 +— +— +— +8,928 +Forfeitures +(149 +) +— +— +— +(435 +) +— +— +— +(435 +) +Exercises of stock options and issuance of restricted stock awards (Note 9) +1,912 +2 +(58 +) +2,739 +8,173 +— +— +10,914 +Repurchase of common stock for tax withholding +(22 +) +— +22 +(490 +) +— +— +— +— +(490 +) +Net income +— +— +— +— +— +— +112,788 +— +112,788 +112,788 +Foreign currency translation +— +— +— +— +— +— +— +(16,031 +) +(16,031 +) +(16,031 +) +Total comprehensive income +96,757 +BALANCE—December 31, 2011 +89,807 +$ +90 +499 +$ +(19,759 +) +$ +293,959 +— +$ +202,669 +$ +14,821 +$ +491,780 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +($ thousands) +2011 +2010 +2009 +Cash flows from operating activities: +Net income (loss) +$ +112,788 +$ +67,726 +$ +(42,078 +) +Adjustments to reconcile net income (loss) to net cash provided by operating activities: +Depreciation and amortization +37,263 +37,059 +36,671 +Unrealized (gain) loss on foreign exchange, net +(11,892 +) +1,334 +(11,267 +) +Deferred income taxes +(819 +) +(4,999 +) +5,399 +Asset impairment charges +528 +141 +26,027 +Inventory write-down charges +— +— +2,568 +Charitable contributions +2,034 +840 +7,424 +Non-cash restructuring charges +— +196 +2,196 +(Recovery of) provision for doubtful accounts, net +(383 +) +2,204 +1,316 +Share based compensation +8,550 +7,109 +15,237 +Share based compensation from 2009 Tender Offer +— +— +16,197 +Other non-cash items +(189 +) +942 +(3,924 +) +Changes in operating assets and liabilities: +Accounts receivable +(23,278 +) +(13,165 +) +(13,251 +) +Inventories +(13,328 +) +(27,908 +) +44,828 +Prepaid expenses and other assets +(17,598 +) +2,230 +(13,914 +) +Accounts payable +30,314 +12,689 +(17,387 +) +Accrued expenses and other liabilities +19,922 +20,344 +(19,304 +) +Accrued restructuring +(439 +) +(2,696 +) +1,208 +Income taxes receivable +(1,097 +) +228 +23,163 +Cash provided by (used in) operating activities +142,376 +104,274 +61,109 +Cash flows from investing activities: +Purchases of marketable securities +— +(5,654 +) +(1,502 +) +Sales of marketable securities +— +7,369 +— +Cash paid for purchases of property and equipment +(27,718 +) +(31,257 +) +(20,054 +) +Proceeds from disposal of property and equipment +319 +1,274 +2,476 +Cash paid for intangible assets +(13,922 +) +(13,848 +) +(6,973 +) +Restricted cash +(343 +) +38 +322 +Cash provided by (used in) investing activities +(41,664 +) +(42,078 +) +(25,731 +) +Cash flows from financing activities: +Proceeds from bank borrowings, net +316,595 +83,100 +293 +Repayment of bank borrowings and capital lease obligations +(317,704 +) +(84,625 +) +(23,078 +) +Deferred debt issuance costs +(398 +) +— +(458 +) +Issuances of common stock +10,914 +7,191 +1,290 +Repurchase of common stock for tax withholding +(490 +) +(421 +) +(238 +) +Cash provided by (used in) financing activities +8,917 +5,245 +(22,191 +) +Effect of exchange rate changes on cash +2,375 +799 +12,491 +Net increase (decrease) in cash and cash equivalents +112,004 +68,240 +25,678 +Cash and cash equivalents—beginning of year +145,583 +77,343 +51,665 +Cash and cash equivalents—end of year +$ +257,587 +$ +145,583 +$ +77,343 +Supplemental disclosure of cash flow information—cash paid during the year for: +Interest +$ +843 +$ +639 +$ +1,491 +Income taxes +$ +26,632 +$ +11,048 +$ +12,392 +Supplemental disclosure of non-cash, investing, and financing activities: +Assets acquired under capitalized leases +$ +— +$ +2,606 +$ +1,760 +Accrued purchases of property and equipment +$ +4,022 +$ +1,826 +$ +2,826 +Accrued purchases of intangibles +$ +223 +$ +3,786 +$ +2,411 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Organization —Crocs, Inc. and its subsidiaries (collectively the “Company,” “we,” +“our” or “us”) are engaged in the design, development, manufacturing, marketing and distribution of consumer products, primarily casual and athletic shoes and shoe charms, manufactured from specialty resins referred to as +Croslite. Our wholly owned subsidiaries include, among others, EXO Italia (“EXO”), which designs and develops EVA (Ethylene Vinyl Acetate) based finished products, primarily for the footwear industry; Jibbitz, LLC +(“Jibbitz”), a unique accessory brand with colorful snap-on charms specifically suited for our shoes; and Ocean Minded, Inc. (“Ocean Minded”), which designs, manufactures, markets and distributes high quality leather and EVA +based sandals primarily for the beach, adventure and action sports markets. +Basis of Consolidation and Variable Interest +Entities —The consolidated financial statements include the accounts of our wholly-owned and majority-owned subsidiaries as well as variable interest entities (“VIE”) for which we are the primary beneficiary after the +elimination of intercompany accounts and transactions. The primary beneficiary of a VIE is the entity that has (i) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and +(ii) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. +In 2007, we established a relationship with Shanghai Shengyiguan Trade, Ltd Co (“ST”) for the purpose of serving as a distributor of our +products in the People’s Republic of China. We have determined that ST is a VIE for which we are the primary beneficiary because of our variable interest in the equity of ST and because we currently control all business activities and absorb +all of the expected residual returns and expected losses of ST. All voting rights have been assigned to us and there is a transfer agreement under which all of the equity, assets, and liabilities of ST are to be transferred to us at our sole +discretion, subject to certain conditions. As of December 31, 2011 and 2010, the consolidated financial statements included $1.2 million and $7.3 million in total assets of ST, respectively, which primarily consisted of cash and cash +equivalents, inventory and receivables. These amounts were partially offset by $0.1 million and $0.2 million in total liabilities as of December 31, 2011 and 2010, respectively, which primarily consisted of accounts payable and +accrued expenses, excluding liabilities related to the support provided by us. ST’s cash assets are restricted to the extent that the monetary laws of the People’s Republic of China limit our ability to utilize ST’s cash. +In April 2011, we and an unrelated third party formed Crocs Gulf, LLC (“Crocs Gulf”) for the purpose of selling our products in the United Arab +Emirates. We have determined that Crocs Gulf is also a VIE for which we are the primary beneficiary due our variable interest in Crocs Gulf’s equity and because we currently control all of the VIE’s business activities and will absorb all +of its expected residual returns and expected losses. All voting and dividend rights have been assigned to us. As of December 31, 2011, the consolidated financial statements included $1.4 million in total assets of Crocs Gulf which +primarily consisted of cash and cash equivalents, inventory and property and equipment which were partially offset by an immaterial amount of total liabilities primarily consisting of accrued expenses, excluding intercompany payables. +Noncontrolling Interests —With the exception of Crocs India Private Limited (“Crocs India”) all of our subsidiaries are, in +substance, wholly owned. Effective January 1, 2010, we sold our interests in Crocs India. During the year ended December 31, 2009, the non-controlling interests in Crocs India were immaterial and were included in other (income) expenses on +the consolidated statements of income and in other liabilities on the consolidated balance sheets. +Change in Accounting +Principle —Effective January 1, 2010, we changed our inventory valuation method for all inventories from the first-in, first-out (“FIFO”) cost method to the moving average cost method, which approximates FIFO. We believe +the change to the moving average cost method is preferable because it results in +F-6 +Table of Contents +better alignment with the physical flow of inventory than the FIFO methodology. We calculate moving average cost using an inventory information system which incorporates automated controls. The +moving average method is used to value inventory by management when preparing budgets, reviewing actual and forecasted financial information and determining incentive management compensation. The moving average cost method results in substantially +the same results of operations in each reporting period. Financial statements for periods ended on or before December 31, 2009 have not been retroactively adjusted due to immateriality. The impact of the change for the year ended +December 31, 2010 was also immaterial. +Management Estimates —The preparation of financial statements in conformity +with generally accepted accounting principles in the United States of America (“GAAP”) requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial +statements and the reported amounts of revenue and expenses during the reporting period. Management believes that the estimates, judgments and assumptions made when accounting for items and matters such as, but not limited to, the allowance for +doubtful accounts, sales returns, impairment assessments and charges, recoverability of assets (including deferred tax assets), uncertain tax positions, share-based compensation expense, the assessment of lower of cost or market on inventory, useful +lives assigned to long-lived assets, depreciation and provisions for contingencies are reasonable based on information available at the time they are made. Management also makes estimates in the assessments of potential losses in relation to tax +matters and threatened or pending legal proceedings (see Note 15—Legal Proceedings). Actual results could materially differ from these estimates. For matters not related to income taxes, if a loss is considered probable and the amount can +be reasonably estimated, we recognize an expense for the estimated loss. If there is the potential to recover a portion of the estimated loss from a third party, we make a separate assessment of recoverability and reduce the estimated loss if +recovery is deemed probable. +Concentrations of Risk —We are exposed to concentrations of risks in the following categories. +Cash and cash equivalents - Our cash and cash equivalents are maintained in several different financial institutions +in amounts that typically exceed U.S. federally insured limits or in financial institutions in international jurisdictions where insurance is not provided and restrictions may exist. +As we are a global business, we have cash and cash equivalent balances which are located in various countries and are denominated in +various currencies. Most of the cash balances held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal and state income taxes less applicable foreign tax credits. In some countries, +repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. Certain countries, including China, have monetary laws which may limit our ability to +utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully utilize our cash and cash equivalent resources for needs in the U.S. or other countries and could adversely affect our +liquidity. As of December 31, 2011, we held $235.7 million of our total $257.6 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the +$235.7 million, $39.3 million could potentially be restricted, as described above. +Accounts receivable - We have not +experienced any significant losses in such accounts and believe we are not exposed to significant credit risk. We consider any concentration of credit risk related to accounts receivable to be mitigated by our credit policy, the insignificance of +outstanding balances owed by each individual customer at any point in time and the geographic dispersion of our customers. +Manufacturing sources - We rely on a limited source of internal and external manufacturers. Establishing a replacement source could +require significant additional time and expense. +Suppliers of certain raw materials - We source the elastomer resins +that constitute the primary raw materials used in compounding Croslite, which we use to produce our footwear products, from multiple suppliers. If the suppliers we rely on for elastomer resins were to cease production of these materials, we may not +be able +F-7 +Table of Contents +to obtain suitable substitute materials in time to avoid interruption of our production cycle, if at all. We may also have to pay materially higher prices in the future for the elastomer resins +or any substitute materials we use, which would increase our production costs and could have a materially adverse impact on our margins and results of operations. +Fair Value —Fair value is the price that would be received from the sale of an asset or settlement of a liability in an orderly transaction between market participants at the measurement +date. When determining the fair value measurements for assets and liabilities which are required to be recorded at fair value, we consider the principal or most advantageous market in which a hypothetical sale or transfer would take place and +consider assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of non-performance. +The fair value hierarchy is made up of three levels of inputs which may be used to measure fair value: Level 1—observable inputs such as quoted prices for identical instruments in active +markets; Level 2—observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model derived valuations in which all significant +inputs are observable in active markets; and Level 3—unobservable inputs for which there is little or no market data and which require us to develop our own assumptions. We categorize fair value measurements within the fair value hierarchy +based upon the lowest level of the most significant inputs used to determine such fair value measurement. +Derivative financial instruments +are required to be recorded at their fair value, on a recurring basis. The fair values of our derivative instruments are determined using a discounted cash flow valuation model. The significant inputs used in the model are readily available in +public markets or can be derived from observable market transactions, and therefore, have been classified as Level 2. These inputs include the applicable exchange rates and forward rates, and discount rates based on the prevailing LIBOR deposit +rates. +Our other financial instruments are not required to be carried at fair value on a recurring basis. The carrying value of these +financial instruments, including cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximates fair value due to their short maturities. Based on borrowing rates currently available to us, with similar terms, the +carrying values of capital lease obligations and the line of credit approximate their fair values. +Inventories and long-lived assets such as +property and equipment and intangible assets are also not required to be carried at fair value on a recurring basis. For a discussion of inventory estimated fair value see “Inventory Valuation” below. However, when determining impairment +losses, the fair values of property and equipment and intangibles must be determined. For such determination, we use either an income approach with inputs that are mainly unobservable, such as expected future cash flows, or a market approach using +observable inputs such as replacement cost or third party appraisals, as appropriate. Estimated future cash flows are based on management’s operating budgets and forecasts which take into consideration both observable and unobservable inputs +including growth rates, pricing, new markets and other factors expected to affect the business, as well as management’s forecasts for inventory, receivables, capital spending, and other cash needs. +Cash and Cash Equivalents —Cash and cash equivalents represent cash and short-term, highly liquid investments with maturities of three +months or less at the date of purchase. We consider receivables from credit card companies to be cash equivalents, if expected to be received within five days. +Accounts Receivable —Accounts receivable represent amounts due from customers. Accounts receivable are recorded at invoiced amounts, net of reserves and allowances, are not +collateralized and do not bear interest. We use our best estimate to determine the required allowance for doubtful accounts based on a variety of factors, including the length of time receivables are past due, economic trends and conditions +affecting our customer base, significant one-time events and historical non-collection experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability to meet its financial obligations. +F-8 +Table of Contents +Inventory Valuation —Inventories are valued at the lower of cost or market. Inventory cost +is determined using the moving average cost method. At least annually, we evaluate our inventory for possible impairment using standard categories to classify inventory based on the degree to which we believe that the products may need to be +discounted below cost to sell within a reasonable period. We base inventory fair value on several subjective assumptions including estimated future demand and market conditions, as well as other observable factors such as current sell-through of our +products, recent changes in demand for our products, global and regional economic conditions, historical experience selling through liquidation and price discounted channels and the amount of inventory on hand. If the estimated inventory fair value +is less than its carrying value, the carrying value is adjusted to market value and the resulting impairment charge is recorded in cost of sales on the consolidated statements of operations. During the years ended December 31, 2011 and 2010, no +inventory impairment charges were recorded. During the year ended December 31, 2009, we recorded $2.6 in inventory impairment charges. See Note 2—Inventories for further discussion related to inventory impairment charges. +Property and Equipment —Depreciation of property, equipment, furniture and fixtures is computed using the straight-line method based on +estimated useful lives ranging from two to five years. Leasehold improvements are amortized on the straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. Depreciation of manufacturing assets such as +molds and tooling is included in cost of sales on the consolidated statements of operations. Depreciation related to corporate, non-product and non-manufacturing assets is included in selling, general and administrative expenses on the consolidated +statements of operations. +Impairment of Long-Lived Assets —Long-lived assets to be held and used are evaluated for +impairment when events or circumstances indicate the carrying value of a long-lived asset may not be fully recoverable. Events that may indicate the impairment of a long-lived asset (or asset group, as defined below) include; (i) a significant +decrease in its market price, (ii) a significant adverse change in the extent or manner in which it is being used or in its physical condition, (iii) a significant adverse change in legal factors or business climate that could affect its +value, including an adverse action or assessment by a regulator, (iv) an accumulation of costs significantly in excess of the amount originally expected for its acquisition or construction, (v) its current period operating or cash flow +losses combined with historical operating or cash flow losses or a forecast of its cash flows demonstrate continuing losses associated with its use, and (vi) a current expectation that, more likely than not, it will be sold or otherwise +disposed of significantly before the end of its previously estimated useful life. If such facts indicate a potential impairment of a long-lived asset (or asset group), we assess the recoverability by determining if its carrying value exceeds the sum +of its projected undiscounted cash flows from its use and eventual disposition over its remaining economic life. If the asset is not supported on an undiscounted cash flow basis, the amount of impairment is measured as the difference between its +carrying value and its fair value. Assets held for sale are reported at the lower of the carrying amount or fair value less costs to sell. Assets to be abandoned or from which no further benefit is expected are written down to zero at the time that +the determination is made and the assets are removed entirely from service. +An asset group is the lowest level of assets and liabilities for +which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. We have determined that the lowest level of assets and liabilities for which identifiable cash flows are largely independent of the cash flows +of other assets and liabilities is at the retail store level for assets involved in our retail business. See Note 3 – Property and Equipment for a discussion of impairment losses recorded during the periods presented. +Intangible Assets —Intangible assets that are determined to have finite lives are amortized over their useful lives on a straight-line +basis. Customer relationships are amortized on a straight-line basis or an accelerated basis. Indefinite lived intangible assets, such as trade names, are not amortized and are evaluated for impairment at least annually and when circumstances imply +possible impairment. +F-9 +Table of Contents +Amortization of manufacturing intangible assets is included in cost of sales on the consolidated statements +of operations. Amortization related to corporate, non-product and non-manufacturing assets such as our global information systems is included in selling, general and administrative expenses on the consolidated statements of operations. The following +table sets forth our definite lived intangible assets and the periods over which they are amortized. +Intangible Asset Class +Weighted Average Amortization +Period +Patents +10 years +Customer relationships +Estimated customer life +Core technology +5 years +Non-competition agreement +Contractual term +Capitalized software +Shorter of 7 years or useful life +Capitalized Software —We capitalize certain internal and external software acquisition and development costs, +including the costs of employees and contractors devoting time to the software development projects and external direct costs for materials and services. Initial costs associated with internally-developed-and-used software are expensed until it is +determined that the project has reached the application development stage. Once in its development stage, subsequent additions, modifications or upgrades to an internal-use software project are capitalized to the extent that they add functionality. +Software maintenance and training costs are expensed in the period in which they are incurred. Capitalized software primarily consists of our enterprise resource system software, warehouse management software and point of sale software. At least +annually, we consider the potential impairment of capitalized software by assessing the substantive service potential of the software, changes, if any, in the extent or manner in which the software is used or is expected to be used, and the actual +cost of software development or modification compared to expected cost. See Note 4—Intangibles Assets for further discussion. +Impairment of Intangible Assets —Intangible assets with indefinite lives are evaluated for impairment when events or changes in +circumstances indicate that the carrying value may not be fully recoverable and at least annually. Intangible assets that are determined to have definite lives are amortized over their useful lives and are evaluated for impairment only when events +or circumstances indicate a carrying value may not be fully recoverable. Recoverability is based on the estimated future undiscounted cash flows of the asset. If the asset is not supported on an undiscounted cash flow basis, the amount of impairment +is measured as the difference between its carrying value and its fair value. +Earnings per Share —Basic and diluted earnings +(loss) per common share (“EPS”) is presented using the two-class method, which is an earnings allocation formula that determines earnings per share for common stock and any participating securities according to dividend rights and +participation rights in undistributed earnings. Under the two-class method, EPS is computed by dividing the sum of distributed and undistributed earnings (loss) attributable to common stockholders by the weighted average number of shares of common +stock outstanding during the period. A participating security is an unvested share-based payment award containing non-forfeitable rights to dividends and must be included in the computation of earnings per share pursuant to the two-class method. +Shares of the Company’s non-vested restricted stock awards are considered participating securities. Diluted EPS reflects the potential dilution from securities that could share in the earnings of the Company. Anti-dilutive securities are +excluded from diluted EPS. See Note 12—Earnings per Share for further discussion. +Recognition of +Revenues —Revenues are recognized when the customer takes title and assumes risk of loss, collection of related receivables is probable, persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Title +passes on shipment or on receipt by the customer depending on the country in which the sale occurs and the agreement terms with the customer. Allowances for estimated returns and discounts are recognized when the related revenue is earned. +F-10 +Table of Contents +Shipping and Handling Costs and Fees —Shipping and handling costs are expensed as incurred +and included in cost of sales. Shipping and handling fees billed to customers are included in revenues. +Share-based +Compensation —We have share-based compensation plans to which certain officers, employees and members of the Board of Directors are participants and may be granted stock options, restricted stock and stock performance awards. Awards +granted under these plans are fair valued and amortized, net of estimated forfeitures, over the vesting period using the straight-line method. The fair value of stock options is calculated by using the Black Scholes option pricing model that +requires estimates for expected volatility, expected dividends, the risk-free interest rate and the term of the option. If any of the assumptions used in the Black Scholes model or the anticipated number of shares to be awarded change significantly, +share-based compensation expense may differ materially in the future from that recorded in the current period. See additional information related to share-based compensation in Note 9—Equity. Share-based compensation expense associated +with our manufacturing and retail employees is included in cost of sales in the consolidated statements of operations. Share-based compensation expense associated with selling, marketing and administrative employees is included selling, general and +administrative expenses on the consolidated statements of operations. +Defined contribution plans —We have a 401(k) plan +known as the Crocs, Inc. 401(k) Plan (the “Plan”). The Plan is available to employees on our U.S. payroll and provides employees with tax deferred salary deductions and alternative investment options. The Plan does not provide employees +with the option to invest in our common stock. Employees may contribute up to 75.0% of their salary, subject to certain limitations. We match employees’ contributions to the Plan up to a maximum of 4.0% of eligible compensation. We expensed +$4.6 million, $3.3 million and $1.7 million in the years ended December 31, 2011, 2010 and 2009, respectively, for our employee match contributions to the Plan. +Advertising —Advertising costs are expensed as incurred and production costs are generally expensed when the advertising is run. Total advertising, marketing and promotional costs +reflected in selling, general, and administrative expenses on the consolidated statement of operations were $39.8 million, $44.1 million and $28.2 million for the years ended December 31, 2011, 2010 and 2009, respectively. As of +December 31, 2011 and 2010, we had $0.2 million and $2.2 million in prepaid advertising costs, respectively. +Research +and Development —Research and development costs are expensed as incurred. Research and development expenses amounted to $10.8 million, $7.8 million, and $7.7 million for the years ended December 31, 2011, 2010, and +2009, respectively, and are included in selling, general, and administrative expenses in the consolidated statement of operations. +Foreign Currency Translation and Foreign Currency Transactions —Our functional currency is the U.S. dollar. Assets and liabilities of +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 applicable period. Adjustments resulting +from translating foreign functional currency financial statements into U.S. dollars are included in the foreign currency translation adjustment, a component of accumulated other comprehensive income in stockholders’ equity. +Gains and losses generated by transactions denominated in foreign currencies are reflected in the consolidated statement of operations in the period in +which they occur and are primarily associated with payables and receivables arising from intercompany transactions. For the year ended December 31, 2011, we recognized $6.5 million of net realized losses on settled foreign currency +transactions. For the year ended December 31, 2010, we recognized $4.2 million of net realized gains on settled foreign currency transactions which included $2.4 million of net realized gains recognized on payments of intercompany +balances denominated in foreign currencies for which collection had not been planned or anticipated previously. For the year ended December 31, 2009, we recognized $10.6 million of net realized losses on settled foreign currency +transactions. For the year ended December 31, 2011, we recognized $11.9 million of net unrealized gains resulting from unsettled foreign currency transactions. For the year ended December 31, 2010, we recognized $1.3 million net +unrealized losses +F-11 +Table of Contents +resulting from unsettled foreign currency transactions. For the year ended December 31, 2009, we recognized $11.3 million of net unrealized gains resulting from unsettled foreign +currency translation transactions. +Derivative Foreign Currency Contracts —We are directly and indirectly affected by +fluctuations in foreign currency rates which may adversely impact our financial performance. To mitigate the potential impact of foreign currency exchange rate risk, we may employ derivative financial instruments including forward contracts and +option contracts. Forward contracts are agreements to buy or sell a quantity of a currency at a predetermined future date and at a predetermined rate. An option contract is an agreement that conveys the purchaser the right, but not the obligation, +to buy or sell a quantity of a currency at a predetermined rate during a period or at a time in the future. These derivative financial instruments are viewed as risk management tools and are not used for trading or speculative purposes. We recognize +derivative financial instruments as either assets or liabilities in the consolidated balance sheets and measure those instruments at fair value. Changes in the fair value of derivatives not designated or effective as hedges are recorded in other +expense (income), net in the consolidated statements of operations. We had no derivative instruments that qualified for hedge accounting during any of the periods presented. See Note 7—Fair Value Measurements and Financial Instruments for +further discussion. +Income Taxes —Income taxes are accounted for using the asset and liability method which requires the +recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. We provide for income taxes at the current and +future enacted tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax +positions. We recognize interest and penalties related to income tax matters in income tax expense in the consolidated statement of operations. See Note 11—Income Taxes for further discussion. +Taxes Assessed by Governmental Authorities —Taxes assessed by governmental authorities that are directly imposed on a revenue +transaction, including value added tax, are recorded on a net basis and are therefore excluded from sales. +Recent Accounting +Pronouncements— In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure +Requirements in GAAP and International Financial Reporting Standards (“IFRS”).” This pronouncement was issued to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are +similar between U.S. GAAP and IFRS. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for level 3 fair value measurements. This pronouncement is effective for reporting periods +beginning on or after December 15, 2011. We do not expect the adoption of ASU 2011-04 to have a significant impact to the consolidated financial position, results of operations or cash flows. +In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income.” ASU 2011-05 eliminates the option to report +other comprehensive income and its components in the statement of changes in stockholders’ equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income +either in a single continuous statement or in two separate but consecutive statements. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Because ASU 2011-05 +concerns presentation and disclosure only, its adoption will not have an impact on the consolidated financial position, results of operations or cash flows. +F-12 +Table of Contents +2. INVENTORIES +Inventories by major classification as of December 31, 2011 and 2010 were as follows: +December 31, +($ thousands) +2011 +2010 +Finished goods +$ +124,203 +$ +111,134 +Work-in-progress +291 +248 +Raw materials +5,133 +9,773 +Inventory +$ +129,627 +$ +121,155 +During the years ended December 31, 2011, 2010 and 2009, we donated certain inventory items to charitable +organizations consisting primarily of end of life units, some of which were partially or fully impaired. The contributions made were expensed at their fair value of $2.0 million, $0.8 million and $7.5 million, respectively. Also during the +years ended December 31, 2011, 2010 and 2009, we recognized a gain of $0.7 million, $0.2 million and $3.2 million, respectively, and a net reduction of inventory of $1.3 million, $0.6 million and $4.3 million, respectively, +as the fair value of the inventory contributed exceeded its carrying amount. +During the year ended December 31, 2009, sales of product +previously impaired resulted in $58.3 million of revenue for which the associated gross profit was $49.8 million. This impaired product was written down to levels considered realizable at the time impairment was assessed. However, we were +able to sell this product at prices substantially higher than what was previously estimated. +3. PROPERTY AND EQUIPMENT +Property and equipment as of December 31, 2011 and 2010 included the following: +December 31, +($ thousands) +2011 +2010 +Machinery and equipment +$ +68,005 +$ +70,962 +Leasehold improvements +65,338 +49,519 +Furniture, fixtures and other +16,196 +16,587 +Construction-in-progress +7,902 +7,902 +Property and equipment, gross (1) +157,441 +144,970 +Less: Accumulated depreciation and amortization (2) +(89,757 +) +(74,956 +) +Property and equipment, net +$ +67,684 +$ +70,014 +(1) +Includes $0.3 million and $0.4 million of certain equipment held under capital leases and classified as equipment as of December 31, 2011 and +2010, respectively. +(2) +Includes $0.3 million and $0.2 million of accumulated depreciation related to certain equipment held under capital leases, as of December 31 2011 +and 2010, respectively, which are depreciated using the straight-line method over the lease term. +During the years ended +December 31, 2011, 2010 and 2009, we recorded $27.5 million, $29.5 million, and $29.7 million, respectively, in depreciation expense of which $11.5 million, $14.7 million, and $15.6 million, respectively, was +recorded in cost of sales, with the remaining amounts recorded in selling, general and administrative expenses on the consolidated statements of operations. +During the years ended December 31, 2011 and 2010, we recorded $0.5 million and $0.1 million, respectively, in impairment charges which primarily related to obsolete molds which were +previously depreciated to costs of sales. During the year ended December 31, 2009, we recorded $18.5 million of impairment charges primarily related to (i) obsolete molds of footwear styles that we either no longer intended to +manufacture or styles that we +F-13 +Table of Contents +had more molds on hand than necessary to meet projected demand and (ii) equipment and fixtures of warehouse and distribution centers that were closed during the period. Management evaluated +the production capacity at company-operated facilities compared with demand projections and capacity requirements and made the decision to abandon certain tooling and equipment that represented excess capacity. Of the $18.5 million of impairment +charges recorded in 2009, $16.4 million related to assets previously depreciated to cost of sales. +4. INTANGIBLE ASSETS +Intangible Assets +The following table summarizes intangible assets as of December 31, 2011 and 2010. +December 31, 2011 +December 31, 2010 +($ thousands) +Gross +Carrying +Amount +Accumulated +Amortization +Net +Carrying +Amount +Gross +Carrying +Amount +Accumulated +Amortization +Net +Carrying +Amount +Capitalized software +$ +66,530 +(1) +$ +(22,156 +) (2) +$ +44,374 +$ +54,489 +(1 ) +$ +(13,674 +) (2 ) +$ +40,815 +Customer relationships +6,321 +(5,641 +) +680 +6,361 +(5,485 +) +876 +Patents, copyrights, and trademarks +6,109 +(2,994 +) +3,115 +5,703 +(1,933 +) +3,770 +Core technology +4,743 +(4,743 +) +— +4,843 +(4,843 +) +— +Other +997 +(636 +) +361 +636 +(636 +) +— +Total finite lived intangible assets +84,700 +(36,170 +) +48,530 +72,032 +(26,571 +) +45,461 +Indefinite lived intangible assets +111 +— +111 +— +— +— +Intangible assets +$ +84,811 +$ +(36,170 +) +$ +48,641 +$ +72,032 +$ +(26,571 +) +$ +45,461 +(1) +Includes $4.1 million of software held under a capital lease classified as capitalized software as of December 31, 2011 and 2010, +respectively. +(2) +Includes $0.7 million and $0.3 million of accumulated amortization of software held under a capital lease as of December 31, 2011 and +2010, respectively, which is amortized using the straight-line method over the useful life. +During the years ended +December 31, 2011, 2010 and 2009, amortization expense recorded for intangible assets with finite lives was $9.8 million, $7.6 million and $7.0 million, respectively, of which $2.9 million, $2.3 million and +$1.6 million was recorded in cost of sales, respectively. The remaining amounts were recorded in selling, general and administrative expenses. Estimated future annual amortization of intangible assets is as follows (in thousands): +Fiscal years ending December 31, +Amortization +2012 +$ +12,116 +2013 +11,037 +2014 +8,890 +2015 +6,412 +2016 +4,958 +Thereafter +5,117 +Total +$ +48,530 +No impairment charges related to intangible assets were recorded during the years ended December 31, 2011 and 2010. +During the year ended December 31, 2009, we recorded $7.6 million in impairment charges related to the write-off of certain intangible assets associated with the discontinued Tagger brand and certain capitalized software no longer intended +for use. Of the $7.6 million impairment charges recorded in 2009, $1.6 million related to assets previously amortized to cost of sales. +F-14 +Table of Contents +5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES +Accrued expenses and other current liabilities as of December 31, 2011 and 2010 include the following: +December 31, +($ thousands) +2011 +2010 +Accrued compensation and benefits +$ +28,680 +$ +25,666 +Fulfillment, freight and duties +7,151 +5,396 +Professional services +8,429 +4,704 +Sales/use and VAT tax payable +9,642 +6,061 +Other (1) +22,604 +17,661 +Total accrued expenses and other current liabilities +$ +76,506 +$ +59,488 +(1) +Includes entrusted +loan payable balances of $9.1 million and $2.9 million as of December 31, 2011 and 2010, respectively, for which a corresponding $9.1 million and $2.9 million are recorded in Prepaid expenses and other current assets, respectively, as +entrusted loan receivables related to our subsidiaries in China. +Asset Retirement Obligations +We record a liability equal to the fair value of the estimated future cost to retire an asset, if the liability’s fair value can be reasonably +estimated. Our asset retirement obligation (“ARO”) liabilities are primarily associated with the disposal of property and equipment which we are contractually obligated to remove at the end of certain retail and office leases in order to +restore the facilities back original condition as specified in the related lease agreements. We estimate the fair value of these liabilities based on current store closing costs and discount the costs back as if they were to be performed at the +inception of the lease. At the inception of such leases, we record the ARO as a liability and also record a related asset in an amount equal to the estimated fair value of the obligation. The capitalized asset is then depreciated on a straight-line +basis over the useful life of the asset. Upon retirement of the ARO liability, any difference between the actual retirement costs incurred and the previously recorded estimated ARO liability is recognized as a gain or loss in the consolidated +statements of operations. Our ARO liability as of December 31, 2011 and 2010 was $1.9 million and $1.6 million, respectively. +6. RESTRUCTURING ACTIVITIES +In response to declining revenues during the years ended December 31, 2009 and 2008, we implemented a turnaround strategy aimed +at aligning production and distribution capacities with revised demand projections, reducing costs and streamlining processes. As a result, we consolidated our global manufacturing facilities and distribution centers, reduced warehouse and office +space and cut global workforce. Specifically, during the year ended December 31, 2008, we closed our Canadian and Brazilian manufacturing facilities and consolidated our Canadian distribution activities into existing North American operations. +During the year ended December 31, 2009, we pursued further restructuring efforts and made certain organizational changes in order to better align costs with revenues which included the closure of various warehouses and office buildings as well +as the settlement and termination of contracts prior to term. As of December 31, 2010, the cumulative amounts related to one-time employee termination benefits, operating lease exit costs and other associated costs were $10.6 million, +$9.1 million and $7.4 million, respectively. During the year ended December 31 2011, no additional costs in connection with these activities were incurred. +During the year ended December 31, 2010, we recorded restructuring charges of $3.8 million, of which $1.3 million is reflected in cost of sales. These charges are primarily related to a +change in the estimate in lease termination costs associated with the closure of distribution facilities in North America and Europe, and $2.0 million of severance pay and additional share-based compensation related to the departure of a former +officer. See Note 9—Equity for additional information on the separation agreement. See Note 14—Operating Segments and Geographic Information for restructuring charges incurred by segment. +F-15 +Table of Contents +Restructuring charges are included in the following line items: cost of sales and restructuring charges on +the consolidated statements of operations. The following table summarizes the changes in the restructuring accruals during the year ended December 31, 2011 and 2010. +($ thousands) +December 31, +2009 +Additions +Cash +Payments +Foreign +Currency +Translation +and Other +December 31, +2010 +Additions +Cash +Payments +Foreign +Currency +Translation +and Other +December 31, +2011 +Termination benefits +$ +516 +$ +2,009 +$ +(2,460 +) +$ +(65 +) +$ +— +$ +— +$ +— +$ +— +$ +— +Operating lease exit costs +2,233 +1,634 +(3,565 +) +137 +439 +— +(439 +) +— +— +Other restructuring costs (1) +387 +— +(391 +) +4 +— +— +— +— +— +$ +3,136 +$ +3,643 +$ +(6,416 +) +$ +76 +$ +439 +$ +— +$ +(439 +) +$ +— +$ +— +(1) +Includes costs associated with the settlement and termination of contracts prior to term. +7. FAIR VALUE MEASUREMENTS AND FINANCIAL INSTRUMENTS +Recurring Fair Value Measurements +The following table summarizes the financial instruments required to be measured at fair value on a recurring basis as of December 31, 2011 and 2010. Other financial instruments including debt are +not required to be carried at fair value on a recurring basis. The carrying value of these financial instruments, including cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximate fair value due to their short +maturities. Based on borrowing rates currently available to us, with similar terms, the carrying values of capital lease obligations and the line of credit approximate their fair values. +Fair Value as of December 31, 2011 +Fair Value as of December 31, 2010 +Balance Sheet Classification +($ thousands) +Level 1 +Level 2 +Level 3 +Level 1 +Level 2 +Level 3 +Cash equivalents +$ +10,286 +$ +— +$ +— +$ +— +$ +— +$ +— +Cash and cash +equivalents +Derivative assets: +Foreign currency forward contracts +- +596 +— +— +5 +— +Prepaid expenses and +other current assets +Derivative liabilities: +Foreign currency forward contracts +$ +- +$ +1,035 +$ +— +$ +— +$ +134 +$ +— +Accrued expenses and +other current liabilities +Non-Recurring Fair Value Measurements +The majority of our non-financial instruments, which include inventories, property and equipment and intangible assets, are not required to be carried at fair value on a recurring basis. However, if +certain triggering events occur such that a non-financial instrument is required to be evaluated for impairment and the carrying value is not recoverable, the carrying value would be adjusted to the lower of its cost or fair value and an impairment +charge would be recorded. See Note 1—Summary of Significant Accounting Policies for an explanation of our fair value determinations. See Note 3 – Property and Equipment and Note 4 – Intangible Assets for discussions on impairment +charges recorded during the periods presented. +Derivative Financial Instruments +We enter into foreign currency exchange forward contracts as economic cash flow hedges to reduce our exposure to the effect of changes in exchange rates +on our operating results. The following table summarizes the notional +F-16 +Table of Contents +amounts of the outstanding foreign currency exchange forward contracts at December 31, 2011 and 2010. The notional amounts of the derivative financial instruments shown below are denominated +in their U.S. dollar equivalents and represent the amount of all contracts of the foreign currency specified. These notional values do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our +exposure to the foreign currency exchange risks. +December 31, +($ thousands) +2011 +2010 +Foreign currency exchange forward contracts by currency: +Japanese Yen +$ +27,500 +$ +6,000 +Euro +10,055 +3,921 +Mexican Peso +6,500 +— +Pound Sterling +6,345 +2,385 +Total notional value, net +$ +50,400 +$ +12,306 +Latest maturity date +December 2012 +March 2011 +During all periods presented, we did not designate any derivatives as hedges. Therefore, all changes in the fair value of +derivative financial instruments are reflected in the results of operations. The following tables present the amounts affecting the consolidated statements of operations for the years ended December 31, 2011 and 2010. We did not employ the use +of derivative instruments during the year ended December 31, 2009. +Year ended December 31 +($ thousands) +2011 +2010 +Location of (Gain) Loss Recognized +In Income on +Derivatives +Derivatives not designated as hedging instruments: +Foreign currency exchange forwards +$ +540 +$ +587 +Other (income) expense, net +8. BANK BORROWINGS AND CAPITAL LEASE OBLIGATIONS +Bank borrowings and capital lease obligations as of December 31, 2011 and 2010 consist of the following: +December 31, +($ thousands) +2011 +2010 +Revolving credit facility +$ +422 +$ +3 +Capital lease obligations (for certain capitalized software) bearing interest rates ranging from 8.7% to 12.4% and +maturities through 2013 +640 +2,488 +Capital lease obligations (for certain equipment) bearing interest at 8.8% and maturities through 2014 +81 +155 +Total notes payable and capital lease obligations +$ +1,143 +$ +2,646 +Minimum future annual rental commitments under capital leases for each of the five succeeding years as of +December 31, 2011, are as follows (in thousands): +Fiscal years ending December 31, +2012 +$ +696 +2013 +20 +2014 +5 +2015 +— +2016 +— +Thereafter +— +Total minimum lease payments +$ +721 +F-17 +Table of Contents +Revolving Credit Facility +On December 16, 2011, we entered into an Amended and Restated Credit Agreement (the “Credit Agreement”) with a syndicate of lenders, including PNC Bank, National Association +(“PNC”), which replaced our asset-backed line of credit. The Credit Agreement provides for a revolving credit facility of $70.0 million (the “Credit Facility”), which can be increased to $100.0 million subject to certain +conditions. The Credit Facility is available for working capital, capital expenditures and other corporate purposes, including acquisitions and stock repurchases, and is currently set to mature in December 2016. Borrowings under the Credit Facility +are secured by all of our assets including all receivables, equipment, general intangibles, inventory, investment property, subsidiary stock and intellectual property. Borrowings under the Credit Agreement bear interest at a variable rate. For +domestic rate loans, the interest rate is equal to the highest of (i) the daily federal funds open rate as quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC’s prime rate and (iii) a daily LIBOR rate plus 1.0%, in each case +there is an additional margin ranging from 0.75% to 1.50% based on certain conditions. For LIBOR rate loans, the interest rate is equal to a LIBOR rate plus a margin ranging from 1.75% to 2.50% based on certain conditions. The Credit Agreement +requires monthly interest payments with respect to domestic rate loans and at the end of each interest period with respect LIBOR rate loans and contains certain customary restrictive and financial covenants. We were in compliance with these +restrictive financial covenants as of December 31, 2011. +As of December 31, 2011 and 2010, we had issued and outstanding letters of +credit of $6.0 million and $1.0 million, respectively, which were reserved against the borrowing base under the Credit Agreement. During the year ended December 31, 2011, we capitalized $0.4 million in fees and third party costs +which were incurred in connection with the Credit Agreement, as deferred financing costs. During the year ended December 31, 2010, no deferred financing costs were recorded. +9. EQUITY +Equity Incentive Plans +On August 15, 2005, we adopted the 2005 Equity Incentive Plan (the “2005 Plan”), which permitted the issuance of up to 14.0 million common shares in connection with the grant of +non-qualified stock options, incentive stock options, and restricted stock to eligible employees, consultants and members of our Board of Directors. As of December 31, 2011 and 2010, 1.0 million and 2.0 million stock options, +respectively, were outstanding under the 2005 Plan. No shares are available for future issuance under the 2005 Plan. +On June 28, 2011, +we amended the 2007 Equity Incentive Plan (the “2007 Plan”) which increased the allowable number of shares of our common stock to be issued by 6.3 million shares to 15.3 million (subject to adjustment for future stock splits, +stock dividends and similar changes in our capitalization) in connection with the grant of non-qualified stock options, incentive stock options, restricted stock, restricted stock units, stock appreciation rights, performance units, common stock or +any other share-based award to eligible employees, consultants and members of our Board of Directors. As of December 31, 2011 and 2010, 3.6 million and 4.1 million stock options, restricted stock awards and restricted stock units were +outstanding under the 2007 Plan, respectively. As of December 31, 2011, 7.0 million shares were available for future issuance under the 2007 Plan. +Stock options under both the 2005 Plan and the 2007 Plan generally vest ratably over four years with the first year vesting on a “cliff” basis followed by monthly vesting for the remaining three +years. Restricted stock awards generally vest annually on a straight-line basis over three or four years depending on the terms of the award agreement. +2009 Tender Offer +Due to declines in the market price of our common stock, the exercise +prices of a substantial number of outstanding stock options held by our employees far exceeded the market price of our common stock as of April 2, 2009. This decline in our common stock price substantially eliminated the incentive and retention +value +F-18 +Table of Contents +of the options previously granted to our employees. Consequently, on April 2, 2009, we offered to purchase stock options with exercise prices equal to or greater than $10.50 per share for +cash from certain eligible employees (the “2009 Tender Offer”) in order to restore the incentive value of our long-term performance award programs. Individuals eligible to participate in the 2009 Tender Offer were those employees, +including officers and non-employee directors, who continued employment through the date of the offer’s expiration, April 30, 2009. Participation in the 2009 Tender Offer was voluntary. In connection with the 2009 Tender Offer, we made an +aggregate cash payment of $0.1 million to repurchase the 2.3 million options tendered and recorded a charge of $16.3 million related to previously unrecognized share-based compensation expense for the tendered options. Of this +$16.3 million charge, $13.3 million was recorded to selling, general and administrative expenses and $3.0 million was recorded to cost of sales. As a result of the 2009 Tender Offer, the pool of awards available for future grant under +the 2007 Plan increased by 0.8 million shares. Tendered stock options that were originally granted from the 2005 Plan are not available for future grant. +Stock Option Activity +The following table summarizes stock option transactions for +the years ended December 31, 2011 and 2010. +Shares +Weighted +Average +Exercise +Price +Weighted +Average +Remaining +Contractual +Life +(Years) +Aggregate +Intrinsic +Value +($ thousands) +Outstanding at December 31, 2008 +9,898,462 +$ +14.62 +7.65 +$ +293 +Granted +2,412,000 +3.64 +Exercised +(575,817 +) +2.17 +Forfeited or expired +(3,979,391 +) +23.29 +Outstanding at December 31, 2009 +7,755,254 +7.67 +7.48 +$ +15,290 +Granted +342,250 +12.68 +Exercised +(2,133,806 +) +3.37 +Forfeited or expired +(956,361 +) +11.56 +Outstanding at December 31, 2010 +5,007,337 +9.10 +6.36 +47,009 +Granted +468,000 +19.81 +Exercised +(1,738,741 +) +6.28 +Forfeited or expired +(405,565 +) +10.46 +Outstanding at December 31, 2011 +3,331,031 +$ +11.91 +6.35 +$ +18,468 +Exercisable at December 31, 2011 +1,974,095 +$ +12.70 +5.23 +$ +10,584 +Vested and expected to vest at December 31, 2011 +3,081,527 +$ +11.60 +6.16 +$ +17,857 +During the years ended December 31, 2011, 2010 and 2009, options issued were valued using the Black Scholes option +pricing model using the following assumptions. +Year Ended December 31, +2011 +2010 +2009 +Expected volatility +50 - 60% +60% +50 - 60% +Dividend yield +— +— +— +Risk-free interest rate +0.87% - 2.31% +1.64% - 2.27% +1.44% - 2.75% +Expected life (in years) +4.35 - 4.89 +5.66 - 6.49 +4.59 - 6.86 +The weighted average fair value of options granted during the years ended December 31, 2011, 2010 and 2009 was +approximately $9.19, $7.10 and $2.01, respectively. The aggregate intrinsic value of options exercised during the years ended December 31, 2011, 2010 and 2009 was $27.3 million, $21.0 million and $1.0 million, +F-19 +Table of Contents +respectively. During the year ended December 31, 2011, we received $10.9 million in cash with no income tax benefit due to our domestic tax loss position (see Note 11—Income +Taxes). The total grant date fair value of stock options vested during the years ended December 31, 2011, 2010 and 2009 was $2.7 million, $5.4 million and $13.0 million, respectively. +As of December 31, 2011, we had $6.4 million of total unrecognized share-based compensation expense related to unvested options which is +expected to be amortized over the remaining weighted average period of 2.15 years. +Restricted Stock Shares and Units +From time to time, we grant restricted stock shares and restricted stock units to our employees. Unvested restricted stock shares +have the same rights as those of common shares including voting rights and non-forfeitable dividend rights. However, ownership of unvested restricted stock shares cannot be transferred until they are vested. An unvested restricted stock unit +(“RSU”) is a contractual right to receive a share of common stock only upon its vesting. RSUs have dividend equivalent rights which accrue over the term of the award and are paid if and when the RSUs vest. +From time to time, we may issue grants of restricted stock awards and units to certain employees as part of a performance incentive plan program. During +2011, the Board of Directors approved 0.4 million of restricted stock units to certain executives. Half of the 2011 grants vest ratably on each of the first three anniversaries of the grant date; 25% will vest upon achievement of certain +performance metrics; and the remaining 25% will vest one year from such date. If actual performance metrics exceed the targeted performance metrics by a predetermined amount, the executives are eligible to receive up to 200% of the performance based +share portion of their award. During 2010, the Board of Directors approved grants of 0.7 million restricted stock awards and units to certain employees. Half of such grants vest ratably on each of the first four anniversaries of the grant date. +The remaining half vest on a cliff basis on the fourth anniversary of the grant date, provided that certain corporate performance metrics are achieved. We have determined that the achievement of the performance benchmarks associated with the +performance based restricted stock units granted in 2011 is probable and recorded $0.5 million in share-based payment expense related to such units. +The following table summarizes restricted stock award and unit activity during the years ended December 31, 2011, 2010 and 2009. +Restricted Stock Awards +Restricted Stock Units +Shares +Weighted +Average +Grant Date +Fair Value +Units +Weighted +Average +Grant Date +Fair Value +Nonvested at December 31, 2008 +939,000 +$ +3.87 +— +$ +— +Granted +1,282,110 +2.43 +— +— +Vested +(783,202 +) +2.88 +— +— +Forfeited +(115,668 +) +4.08 +— +— +Nonvested at December 31, 2009 +1,322,240 +3.04 +— +— +Granted +637,557 +12.10 +116,400 +12.99 +Vested +(688,049 +) +3.93 +— +— +Forfeited +(318,325 +) +2.77 +— +— +Nonvested at December 31, 2010 +953,423 +8.54 +116,400 +12.99 +Granted +118,520 +19.10 +651,791 +24.89 +Vested +(352,150 +) +6.19 +(21,150 +) +17.25 +Forfeited +(148,618 +) +9.67 +(35,061 +) +15.41 +Nonvested at December 31, 2011 +571,175 +$ +11.87 +711,980 +$ +23.43 +F-20 +Table of Contents +The total grant date fair value of restricted stock awards vested during the years ended December 31, +2011, 2010 and 2009 was $2.2 million, $2.7 million and $2.3 million, respectively. At December 31, 2011, we had $4.1 million of total unrecognized share-based compensation expense related to non-vested restricted stock +awards. The non-vested restricted stock awards are expected to be amortized over the remaining weighted average period of 2.14 years. +The total grant date fair value of restricted stock units vested during the year ended December 31, 2011 was $0.4 million. At December 31, +2011, we had $11.0 million of total unrecognized share-based compensation expense related to non-vested restricted stock units. The non-vested restricted stock awards are expected to be amortized over the remaining weighted average period of +2.4 years. +Share-based Compensation +During the year ended December 31, 2011, we recorded $8.6 million of pre-tax share-based compensation expense of which $1.3 million was recorded in Cost of sales. No associated tax benefits were +recognized in the year ended December 31, 2011, due to our domestic tax loss position and valuation allowance (see Note 11—Income Taxes). +During the year ended December 31, 2010, we recorded $7.3 million of pre-tax share-based compensation expense of which $1.3 million was recorded in Cost of sales and $0.2 million of +accelerated vesting charges related to the separation agreement of a former officer was recorded as restructuring charges in the consolidated statements of operations. +During the year ended December 31, 2009, we recorded $33.6 million of pre-tax share-based compensation expense of which $5.0 million was recorded in Cost of sales and which included the +following non-routine items. +• +We incurred $16.3 million in charges related to the 2009 Tender Offer. +• +We recorded a $3.9 million adjustment related to an error in the calculation of share-based compensation expense which was identified after our +third party equity accounting software provider notified us that it made a change to how its software program calculates share-based compensation expense. Specifically, the prior version of this software calculated share-based compensation expense +by incorrectly continuing to apply a weighted average forfeiture rate to the vested portion of a stock option award until the final vesting date of such award rather than reflecting actual forfeitures as vested, resulting in an understatement of +share-based compensation expense in certain periods prior to the award’s final vesting. Because our stock option awards generally vest on a monthly basis after the first anniversary date of the award, our share-based compensation expense was +understated in certain periods. This error changed the timing of share-based compensation expense recognition, but did not change the total share-based compensation expense. As share-based compensation expense is a non-cash item, this error did not +impact net cash provided by operations in any period. This error resulted in an understatement of approximately $4.5 million in share-based compensation expense, with a corresponding understatement of additional paid in capital, as of +December 31, 2008 which was corrected in 2009. We do not believe that either the understatement of share-based compensation expense in 2008 or the effect of the related correction in 2009 were material to the consolidated financial statements. +• +We recorded $2.0 million of accelerated vesting charges and $0.2 million of accelerated amortization of deferred compensation related to the +separation agreements with certain former executives which were included in restructuring charges in the consolidated statements of operations. +Separation Agreements +On March 31, 2010, we entered into a separation +agreement with a former officer pursuant to which the vesting of 0.1 million stock options and 0.1 million shares of restricted stock were accelerated as of March 31, 2010. +F-21 +Table of Contents +During the year ended December 31, 2010, we recorded $0.2 million amount to restructuring charges related to these vesting accelerations. Also in connection with this separation +agreement, 0.2 million stock options and 0.2 million shares of restricted stock were forfeited. +During the year ended +December 31, 2009, we entered into two separation agreements with certain former officers. Pursuant to these agreements, the vesting of 0.3 million stock options and 0.1 million restricted stock awards were accelerated during the year +ended December 31, 2009 of which 0.1 million stock options vested during 2010. We recorded a restructuring charge of $2.0 million related to such vesting accelerations as well as $0.2 million in accelerated amortization of +deferred compensation in 2009. Also in connection with these separation agreements, 0.2 million stock options were forfeited. +10. ALLOWANCES +The changes in the allowance for doubtful accounts and reserve for sales returns and allowances for the years ended December 31, +2011, 2010 and 2009, are as follows: +($ thousands) +Balance at +Beginning of +Year +Charged to +costs and +expenses +Reversals +and +Write-offs +Balance at +End of +Year +Year ended December 31, 2009: +Allowance for doubtful accounts +$ +5,262 +$ +1,262 +$ +(2,551 +) +$ +3,973 +Reserve for sales returns and allowances +18,836 +8,368 +(21,338 +) +5,866 +Year ended December 31, 2010: +Allowance for doubtful accounts +3,973 +2,204 +(1,535 +) +4,642 +Reserve for sales returns and allowances +5,866 +4,971 +(5,230 +) +5,607 +Year ended December 31, 2011: +Allowance for doubtful accounts +4,642 +(383 +) +(579 +) +3,680 +Reserve for sales returns and allowances +$ +5,607 +$ +9,965 +$ +(3,744 +) +$ +11,828 +11. INCOME TAXES +The following table sets forth income (loss) before taxes and the expense (benefit) for income taxes for the years ended +December 31, 2011, 2010 and 2009. +December 31, +($ thousands) +2011 +2010 +2009 +Income (loss) before taxes: +U.S. +$ +(12,057 +) +$ +(14,835 +) +$ +(63,961 +) +Foreign +148,747 +95,627 +15,340 +Total income (loss) before taxes +$ +136,690 +$ +80,792 +$ +(48,621 +) +Income tax expense (benefit): +Current income taxes +U.S. federal +$ +4,798 +$ +47 +$ +(5,452 +) +U.S. state +165 +95 +— +Foreign +19,758 +17,923 +(6,490 +) +Total current income taxes +24,721 +18,065 +(11,942 +) +Deferred income taxes: +U.S. federal +(2,338 +) +— +(1,330 +) +U.S. state +— +— +— +Foreign +1,519 +(4,999 +) +6,729 +Total deferred income taxes +(819 +) +(4,999 +) +5,399 +Total income tax expense (benefit) +$ +23,902 +$ +13,066 +$ +(6,543 +) +F-22 +Table of Contents +The following table sets forth income (loss) reconciliations of the statutory federal income tax rate to our +actual rates based on income or loss before income taxes as of December 31, 2011, 2010 and 2009. +December 31, +($ thousands) +2011 +2010 +2009 +Consolidated income before taxes +35.0 +% +35.0 +% +35.0 +% +State income taxes net of federal benefit +0.3 +(0.3 +) +9.0 +Foreign tax rate differential +(30.3 +) +(22.2 +) +(12.0 +) +Permanent items +3.2 +12.5 +(3.8 +) +Permanent portion of equity compensation +0.4 +1.6 +(13.6 +) +Charitable donations of inventory +— +(0.1 +) +11.1 +Change in valuation allowance +3.6 +(34.2 +) +(36.5 +) +Unremitted foreign earnings of subsidiary +— +21.7 +— +Uncertain tax positions +8.7 +1.4 +(0.1 +) +Benefit of international restructuring +— +— +28.7 +Other +(3.4 +) +0.8 +(4.4 +) +17.5 +% +16.2 +% +13.4 +% +The following table sets forth deferred income tax assets and liabilities as of December 31, 2011 and 2010. +December 31, +($ thousands) +2011 +2010 +Current deferred tax assets: +Accrued expenses +$ +12,575 +$ +19,908 +Inventory +— +454 +Intangible assets +— +238 +Property and equipment +— +368 +Other +2,383 +1,718 +Valuation allowance +(6,054 +) +(6,918 +) +Total current deferred tax assets +$ +8,904 +$ +15,768 +Current deferred tax liabilities: +Unremitted earnings of foreign subsidiary +$ +(4,746 +) +$ +(17,500 +) +Total current deferred tax liabilities. +$ +(4,746 +) +$ +(17,500 +) +Non-current deferred tax assets: +Stock compensation expense +$ +7,630 +$ +7,409 +Long-term accrued expenses +— +2,711 +Net operating loss and charitable contribution carryovers +26,219 +39,185 +Intangible assets +— +993 +Property and equipment +8,641 +— +Future uncertain tax position offset +13,638 +13,577 +Unrealized (gain) loss on foreign currency +5,644 +— +Foreign tax credit +3,177 +626 +Other +190 +101 +Valuation allowance +(33,889 +) +(28,192 +) +Total non-current deferred tax assets +$ +31,250 +$ +36,410 +Non-current deferred tax liabilities: +Intangible assets +$ +(1,009 +) +$ +(196 +) +Property and equipment +— +(2,350 +) +Total non-current deferred tax liabilities +$ +(1,009 +) +$ +(2,546 +) +F-23 +Table of Contents +We do not provide for deferred taxes on the excess of the financial reporting basis over the tax basis in +our investments in foreign subsidiaries that are essentially permanent in duration. In general, it is our practice and intention to reinvest the earnings of our foreign subsidiaries in those operations. Generally, the earnings of our foreign +subsidiaries become subject to U.S. taxation upon the remittance of dividends and under certain other circumstances. Exceptions may be made on a year-by-year basis to repatriate current year earnings of certain foreign subsidiaries based on cash +needs in the U.S. As of December 31, 2011, we have provided for deferred U.S. income tax of $4.7 million on $13.6 million of foreign subsidiary earnings. No withholding tax is due with respect to the repatriation of these earnings to +the U.S. and none has been provided for. +At December 31, 2011 and 2010, U.S. income and foreign withholding taxes have not been provided +for on approximately $371.0 million and $279.2 million, respectively, of unremitted earnings of subsidiaries operating outside of the U.S. These earnings are estimated to represent the excess of the financial reporting over the tax basis +in our investments in those subsidiaries. These earnings, which are considered to be indefinitely reinvested, would become subject to U.S. income tax if they were remitted to the U.S. The amount of unrecognized deferred U.S. income tax liability on +the unremitted earnings has not been determined because the hypothetical calculation is not practicable. +We have deferred tax assets related +to certain deductible temporary differences in various tax jurisdictions for which we have recorded a valuation allowance of $39.9 million against these deferred tax assets because we do not believe that it is more likely than not that we will +be able to realize these deferred tax assets. The significant components of the deferred tax assets for which a valuation allowance has been applied consist of net operating losses in certain tax jurisdictions for which management believes there is +not sufficient positive evidence that such net operating losses will be realized against future income and book expenses not deductible for tax purposes in the current year such as inventory impairment reserves, equity compensation and unrealized +foreign exchange loss that would increase such net operating losses in the same jurisdictions. These temporary differences are amounts which arose in jurisdictions where (i) current losses exist, (ii) such losses are in excess of any loss +carryback potential, (iii) no tax planning strategies exist with which to overcome such losses and (iv) no profits are projected for the following year. For these reasons it is determined that it is more likely than not that these deferred +tax assets will not be realized and a valuation allowance has been provided with respect to these deferred tax assets. +At December 31, +2011, we had U.S. federal net operating loss carryforwards of $7.2 million, state net operating loss carryforwards of $121.6 million, charitable contribution carryforwards of $24.0 million and foreign tax credits $2.4 million which will expire +at various dates between 2015 and 2035. We do not believe that it is more likely than not that the benefit from certain state net operating losses and charitable contribution carryforwards will be realized. Consequently, we have a valuation +allowance of $13.9 million on the deferred tax assets relating to these state net operating loss carryforwards and charitable contribution carryforwards. +At December 31, 2011, we have a foreign deferred tax asset of $10.3 million reflecting the benefit of $45.6 million in foreign net operating loss carryforwards. Such deferred tax assets +expire at various dates between 2015 and 2030. We do not believe it is more likely than not that the benefit from certain foreign net operating loss carryforwards will be realized. Consequently, we have provided a valuation allowance of +$5.1 million on the deferred tax assets relating to these foreign net operating loss carryforwards. +We had approximately +$34.4 million in net deferred tax assets at December 31, 2011. Approximately $14.1 million of the net deferred tax assets were located in foreign jurisdictions for which a sufficient history and expected future profits indicated that +it is more likely than not that such deferred tax assets will be realized. Pre-tax profit of approximately $71.2 million is required to realize the net deferred tax assets. +At December 31, 2011, approximately $18.5 million of net deferred tax assets consists of deferred tax assets related to estimated liabilities for uncertain tax positions that would be realized +if such liabilities are actually incurred. The deferred tax assets represent primarily the reduction in withholding tax expense that would occur upon a disallowance of intercompany royalty expense by various taxing authorities. Approximately +$44.8 million of taxable income would have to be recognized to realize these deferred tax assets. +F-24 +Table of Contents +As a result of certain accounting realization requirements, the table of deferred tax assets and liabilities +shown above does not include certain deferred tax assets at December 31, 2011 that arose directly from tax deductions related to equity compensation in excess of compensation recognized for financial reporting. Equity will be increased by +$16.4 million if and when such deferred tax assets are ultimately realized. We use ASC 740 ordering for purposes of determining when excess tax benefits have been realized. +The following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits during the years ended December 31, 2011, 2010 and 2009. +($ thousands) +2011 +2010 +2009 +Unrecognized tax benefit—January 1 +$ +33,042 +$ +29,163 +$ +28,210 +Gross increases—tax positions in prior period +8,332 +943 +1,440 +Gross decreases—tax positions in prior period +— +(4,868 +) +Gross increases—tax positions in current period +4,689 +3,086 +4,381 +Settlements +(427 +) +— +— +Lapse of statute of limitations +(1,099 +) +(150 +) +— +Unrecognized tax benefit—December 31 +$ +44,537 +$ +33,042 +$ +29,163 +Unrecognized tax benefits of $44.5 million, $33.0 million and $29.2 million at December 31, 2011, +2010 and 2009, respectively, if recognized, would reduce our annual effective tax rate. +Interest and penalties related to income tax +liabilities are included in income tax expense in the consolidated statement of operations. During 2011, 2010 and 2009, we recorded approximately $1.0 million, $0.1 million and $0.8 million, respectively, of penalties and interest +which resulted in a cumulative accrued balance of penalties and interest of $3.9 million, $2.9 million and $2.8 million at December 31, 2011, 2010 and 2009, respectively. +Unrecognized tax benefits consist primarily of tax positions related to intercompany transfer pricing in multiple international jurisdictions. The gross increase for tax positions in current and prior +periods in 2011 of $13.0 million primarily includes specific transfer pricing exposures in various jurisdictions. We believe that it is not reasonably possible that any unrecognized tax benefits will be released in the next twelve months. +The following table sets forth the remaining tax years subject to examination for the major jurisdictions where we conduct business as of +December 31, 2011. +United States +2005 to 2011 +Netherlands +2006 to 2011 +Canada +2007 to 2011 +Japan +2007 to 2011 +Singapore +2008 to 2011 +State income tax returns are generally subject to examination for a period of three to five years after filing of the +respective return. The state impact of any federal changes remains subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. +F-25 +Table of Contents +12. EARNINGS PER SHARE +The following table illustrates the basic and diluted EPS computations for the years ended December 31, 2011, 2010 and 2009. +Year Ended December 31, +($ thousands, except share and per share data) +2011 +2010 +2009 +Numerator +Net income (loss) attributable to common stockholders +$ +112,788 +$ +67,726 +$ +(42,078 +) +Less: income allocated to participating securities +(1,014 +) +(863 +) +— +Net income (loss) attributable to common stockholders - basic +$ +111,774 +$ +66,863 +$ +(42,078 +) +Denominator +Weighted average common shares outstanding - basic +88,317,898 +85,482,055 +85,112,461 +Plus: dilutive effect of stock options and unvested units +1,663,484 +2,113,563 +— +Weighted average common shares outstanding - diluted +89,981,382 +87,595,618 +85,112,461 +Net income (loss) attributable to common stockholders +Basic +$ +1.27 +$ +0.78 +$ +(0.49 +) +Diluted +$ +1.24 +$ +0.76 +$ +(0.49 +) +For the years ended December 31, 2011 and 2010, 1.1 million and 1.3 million options and restricted stock +units, respectively, were not included in diluted income (loss) per share as their effect would have been anti-dilutive. Due to the net loss for the year ended December 31, 2009, the dilutive effect of 4.0 million participating securities +and stock options were not included in the computation of EPS as their effect would have been anti-dilutive. +13. COMMITMENTS AND CONTINGENCIES +We rent space for certain of our offices, warehouses, vehicles and equipment under lease agreements that expire at various dates +through 2022. Certain leases contain rent escalation clauses (step rents) that require additional rental amounts in the later years of the term. Rent expense for leases with step rents or rent holidays is recognized on a straight-line basis over the +minimum lease term. Deferred rent is included in the consolidated balance sheets in Accrued expenses and other current liabilities. Total rent expense was $81.7 million, $67.3 million and $59.6 million for the years ended +December 31, 2011, 2010 and 2009, respectively. Included in such amounts are contingent rents of $13.6 million, $9.8 million and $7.1 million in 2011, 2010 and 2009, respectively. +Minimum future annual rental commitments under non-cancelable operating leases for each of the five succeeding years as of December 31, 2011, are as +follows (in thousands): +Fiscal years ending December 31, +2012 +$ +56,903 +2013 +42,768 +2014 +31,769 +2015 +25,915 +2016 +22,064 +Thereafter +66,077 +Total minimum lease payments (1) +$ +245,496 +(1) +Minimum payments have not been reduced by minimum sublease rentals of $1.3 million due in the future under non-cancelable subleases. They also do not +include contingent rentals which may be paid under certain retail leases on a basis of percentage of sales in excess of stipulated amounts. +F-26 +Table of Contents +As of December 31, 2011, we had purchase commitments with certain third party manufacturers for +$138.2 million, of which $12.5 million was for yet-to-be-received finished product where title passes to us upon receipt and a commitment to re-purchase $4.3 million of raw materials from a certain third party manufacturer. As of +December 31, 2010, we had purchase commitments with certain third party manufacturers for $84.1 million of which $7.9 million was for yet-to-be-received finished product where title passes to us upon receipt. +In February 2011, we renewed and amended our supply agreement with Finproject S.r.l. which provides us the exclusive right to purchase certain +raw materials used to manufacture our products. The agreement also provides that we meet minimum purchase requirements to maintain exclusivity throughout the term of the agreement, which expires December 31, 2014. Historically, the minimum +purchase requirements have not been onerous and we do not expect them to become onerous in the future. Depending on the material purchased, pricing is either based on contracted price or is subject to quarterly reviews and fluctuates based on order +volume, currency fluctuations and raw material prices. Pursuant to the agreement, we guarantee the payment for certain third party manufacturer purchases of these raw materials up to a maximum potential amount of €3.5 million +(approximately $4.5 million as of December 31, 2011), through a letter of credit that was issued to Finproject S.r.l. +14. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +We have three reportable operating segments: Americas, Europe and Asia. We also have an “Other businesses” category which +aggregates insignificant operating segments that do not meet the reportable threshold and represent manufacturing operations located in Mexico and Italy. The composition of our reportable operating segments is consistent with that used by our chief +operating decision maker (“CODM”) to evaluate performance and allocate resources. +Each of our reportable operating segments derives +its revenues from the sale of footwear, apparel and accessories to external customers. Revenues of the “Other businesses” category are primarily made up of intersegment sales which are eliminated when deriving total consolidated revenues. +The remaining revenues for the “Other businesses” represent non-footwear product sales to external customers. +Segment operating +income (loss) is the primary measure used by our CODM to evaluate segment operating performance and to decide how to allocate resources to segments. Segment performance evaluation is based primarily on segment results without allocating corporate +expenses, or indirect general, administrative and other expenses. Segment profits or losses of our reportable operating segments include adjustments to eliminate intersegment profit or losses on intersegment sales. Segment operating income (loss) is +defined as operating income before asset impairment charges and restructuring costs not included in cost of sales. We consider segment operating income (loss) as a supplemental performance measure and useful information to investors because it +reflects the operating performance of our business segments and excludes certain items that are not considered to be recurring in connection with the management of these segments such as asset impairment and restructuring charges not included in +cost of sales. However, segment operating income (loss) should not be viewed as an alternative measure of our financial performance since it excludes expenses which could materially impact our results of operations. Further, our segment operating +income (loss) may not be comparable to that of other companies, as they may use different methodologies for calculating segment operating income (loss). Segment assets consist of cash and cash equivalents, accounts receivable and inventory as these +assets make up the asset information used by the CODM. +F-27 +Table of Contents +The following tables set forth information related to our reportable operating business segments as of and +for the years ended December 31, 2011, 2010 and 2009. +Year Ended December 31, +($ thousands) +2011 +2010 +2009 +Revenues: +Americas +$ +447,985 +$ +377,080 +$ +301,365 +Asia +381,767 +284,814 +237,502 +Europe +170,967 +127,713 +105,996 +Total segment revenues +1,000,719 +789,607 +644,863 +Other businesses +184 +88 +904 +Total consolidated revenues +$ +1,000,903 +$ +789,695 +$ +645,767 +Operating income (loss): +Americas +$ +77,362 +$ +67,259 +$ +21,598 +Asia +122,724 +80,955 +57,836 +Europe +40,685 +24,654 +11,087 +Total segment operating income (loss) +240,771 +172,868 +90,521 +Reconciliation of total segment operating income (loss) to income (loss) before income taxes: +Other businesses +(2,814 +) +(281 +) +76 +Intersegment eliminations +(2,196 +) +(218 +) +(2,313 +) +Unallocated corporate and other (1) +(98,728 +) +(88,654 +) +(105,760 +) +Restructuring charges +— +2,539 +7,623 +Asset impairment charges (2) +528 +141 +26,085 +Total consolidated operating income (loss) (3) +136,505 +81,035 +(51,184 +) +Interest expense +853 +657 +1,495 +Gain on charitable contributions +(714 +) +(223 +) +(3,163 +) +Other (income) expense, net +(324 +) +(191 +) +(895 +) +Income (loss) before income taxes +$ +136,690 +$ +80,792 +$ +(48,621 +) +Depreciation and amortization: +Americas +$ +9,112 +$ +8,852 +$ +9,977 +Asia +6,343 +7,035 +6,659 +Europe +2,657 +2,048 +2,746 +Total segment depreciation and amortization +18,112 +17,935 +19,382 +Other businesses +1,384 +1,324 +1,201 +Unallocated corporate and other (1) +17,767 +17,800 +16,088 +Total consolidated depreciation and amortization +$ +37,263 +$ +37,059 +$ +36,671 +(1) +Includes a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand marketing, legal, depreciation and amortization of corporate and other assets not allocated to operating segments and costs of the same nature related to certain corporate holding companies. +(2) +Impairment charges incurred during the year ended December 31, 2009 by segment were recorded as follows: $2.0 million in the Europe segment +and $4.8 million in the Americas segment. See Note 2—Property and Equipment for further details of impairment charges related to property and equipment. +F-28 +Table of Contents +(3) +Includes total restructuring charges incurred by segment as follows: $1.0 million in the Americas segment, $0.6 million in the Europe segment +and $0.2 million in the Asia segment, during the year ended December 31, 2010; and $6.3 million in the Americas segment, $3.4 million in the Europe segment and $0.4 million in the Asia segment during the year ended +December 31, 2009. See Note 6—Restructuring Activities for further details. +December 31, +($ thousands) +2011 +2010 +Assets: +Americas +$ +107,330 +$ +94,760 +(1) +Asia +241,354 +164,855 +Europe +83,909 +46,712 +Total segment assets +432,593 +306,327 +Other businesses +17,598 +16,533 +(1) +Unallocated corporate and other (2) +21,783 +8,138 +Deferred tax assets, net +7,047 +15,888 +Income tax receivable +5,828 +9,062 +Other receivables +20,295 +11,637 +Prepaid expenses and other current assets +20,199 +13,429 +Total current assets +525,343 +381,014 +Property and equipment, net +67,684 +70,014 +Intangible assets, net +48,641 +45,461 +Deferred tax assets, net +30,375 +34,711 +Other assets +23,410 +18,281 +Total consolidated assets +$ +695,453 +$ +549,481 +(1) +Certain inventory assets disclosed in the Other businesses as of December 31, 2010 have been reclassified to the Americas segment to conform with +current period reporting and classification. +(2) +Corporate assets primarily consist of cash and equivalents. +There were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2011, 2010 and 2009. The following table sets forth geographical information regarding +our revenues during the years ended December 31, 2011, 2010 and 2009. +Year Ended December 31, +($ thousands) +2011 +2010 +2009 +Product: +Footwear +$ +956,816 +$ +753,951 +$ +611,138 +Other +44,087 +35,744 +34,629 +Total revenues +$ +1,000,903 +$ +789,695 +$ +645,767 +Location: +United States +$ +355,560 +$ +299,026 +$ +251,487 +International +645,343 +490,669 +394,280 +Total revenues +$ +1,000,903 +$ +789,695 +$ +645,767 +Foreign country revenues in excess of 10% of total revenues: +Japan +$ +154,925 +$ +111,764 +$ +99,193 +F-29 +Table of Contents +The following table sets forth geographical information regarding our property and equipment assets as of +December 31, 2011 and 2010. +December 31, +($ thousands) +2011 +2010 +Location: +United States +$ +39,063 +$ +37,261 +International +28,621 +32,753 +Total long-lived assets +$ +67,684 +$ +70,014 +Foreign countries where more than 10% of long-lived assets reside: ( 1) +China +$ +— +$ +8,075 +Mexico +$ +— +$ +5,943 +( 1) +Not more than 10% of our long-lived assets resided in any individual foreign country in 2011. +15. LEGAL PROCEEDINGS +We and certain current and former officers and directors have been named as defendants in complaints filed by investors in the United +States District Court for the District of Colorado. The first complaint was filed in November 2007 and several other complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the district court +appointed a lead plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purports to state claims under Section 10(b), 20(a), and 20A of the Exchange Act on behalf of a class of all +persons who purchased our common stock between April 2, 2007 and April 14, 2008 (the “Class Period”). The amended complaint also added our independent auditor as a defendant. The amended complaint alleges that, during the +Class Period, the defendants made false and misleading public statements about us and our business and prospects and, as a result, the market price of our common stock was artificially inflated. The amended complaint also claims that certain +current and former officers and directors traded in our common stock on the basis of material non-public information. The amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified amount, including interest and +also added attorneys’ fees and costs of litigation. On February 28, 2011, the District Court granted motions to dismiss filed by the defendants and dismissed all claims. A final judgment was thereafter entered. Plaintiffs have appealed and +are challenging the District Court’s February 28, 2011 order in the United States Court of Appeals for the Tenth Circuit. Due to the inherent uncertainties of litigation and because the litigation is at a preliminary stage, we cannot at +this time accurately predict the ultimate outcome, or any potential liability, of the matter. +On October 27, 2010, Spectrum Agencies +(“Spectrum”) filed suit against our subsidiary, Crocs Europe B.V. (“Crocs Europe”), in the High Court of Justice, Queen’s Bench Division, Royal Courts of Justice in London, United Kingdom (“UK”). Spectrum acted as +an agent for Crocs products in the UK from 2005 until Crocs Europe terminated the relationship on July 3, 2008 due to Spectrum’s breach of its duty to act in good faith towards Crocs Europe. Spectrum alleges that Crocs Europe unlawfully +terminated the agency relationship and failed to pay certain sales commissions. A trial on the liability, not quantum (compensation and damages), was held at the High Court in London from November 30, 2011 to December 5, 2011. On +December 16, 2011, the High Court of Justice issued a judgment that found that although Spectrum’s actions were a breach of its duty to act in good faith towards Crocs Europe the breach was not sufficiently severe to justify termination. +We believe that the trial judge erred in his findings and permission to appeal the judgment has been requested. Given that this phase of the proceedings only pertains to liability, there have been no findings in relation to the amount of +compensation or damages other than with respect to legal fees. Under UK law, the prevailing party is entitled to reimbursement of reasonable legal fees incurred in the liability proceedings. Spectrum has not quantified its claim for compensation and +damages and the amount will be assessed later in the proceedings. Such assessment may be stayed pending +F-30 +Table of Contents +the outcome of an appeal on liability. If permission to appeal on liability is granted, a ruling on the appeal is expected to take between one and two years. If the appeal request is not granted, +then a separate trial on damages will commence, with a resolution expected in the fourth quarter of 2012 or beyond. +With respect to our +outstanding litigation matters, we have accrued an aggregate of $0.5 million in Accrued expenses and other current liabilities on the consolidated balance sheets as of December 31, 2011. While we intend to vigorously defend these matters, based +on our current knowledge, it is reasonably possible that adverse outcomes could result in aggregate losses beyond accrued amounts. However, the outcome of such legal matters is inherently unpredictable and subject to significant uncertainties. Due +to the nature of these legal proceedings we are currently unable to reasonably estimate a range of potential outcomes. If unfavorable final outcomes were to occur beyond these amounts, it may have a material adverse effect on our financial +statements. +We are currently subject to an audit by the U.S. Customs Service in respect of the period from 2006 to present. We anticipate that +the U.S. Customs Service will present its audit report to us in the second half of 2012. At this time, we cannot accurately predict the ultimate outcome or estimate potential loss, if any related to this matter. If an unfavorable outcome were to +occur, it may result in substantial costs and a diversion of management’s attention and resources that are needed to successfully run our business. +Although we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product liability claims, we are not party to any other +pending legal proceedings that we believe will have a material adverse impact on our business. +16. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +($ thousands, except per share data) +Quarter +Ended +March 31 +Quarter +Ended +June 30 +Quarter +Ended +September 30 +Quarter +Ended +December 31 +Year Ended December 31, 2011 +Revenues +$ +226,708 +$ +295,585 +$ +274,897 +$ +203,713 +Gross profit +119,206 +170,218 +147,175 +99,811 +Asset impairment charges +32 +— +495 +1 +Income from operations +28,248 +64,774 +37,068 +6,415 +Net income +$ +21,504 +$ +55,506 +$ +30,207 +$ +5,571 +(1) +Basic income per common share +$ +0.24 +$ +0.62 +$ +0.34 +$ +0.06 +Diluted income per common share +$ +0.24 +$ +0.61 +$ +0.33 +$ +0.06 +Year Ended December 31, 2010 +Revenues +$ +166,852 +$ +228,046 +$ +215,605 +$ +179,192 +Cost of Sales—Restructuring Charges +10 +1,251 +91 +(53 +) +Gross profit +86,704 +131,919 +118,808 +86,333 +Restructuring charges +2,539 +— +— +— +Asset impairment charges +141 +— +— +— +Income from operations +9,395 +38,726 +27,446 +5,468 +Net income +$ +5,717 +$ +32,284 +$ +24,996 +$ +4,729 +Basic income per common share +$ +0.07 +$ +0.38 +$ +0.29 +$ +0.05 +Diluted income per common share +$ +0.07 +$ +0.37 +$ +0.28 +$ +0.05 +(1) +During the fourth quarter of 2011, we identified an error in the classification of certain intercompany receivables and payables balances that should +have been deemed permanently invested in certain prior periods. Accordingly, certain foreign currency transaction gains or losses were recorded on the consolidated statements of operations in prior periods that otherwise would have been recorded as +a currency translation gain or loss in Other comprehensive income. The error resulted in a $1.6 million understatement and $0.1 million overstatement of Foreign currency transaction (gains) losses, net for the years ended December 31, 2010 and +2009, respectively, and a corresponding $1.6 million understatement and $0.1 million. +F-31 +Table of Contents +overstatement of our currency translation adjustment recorded in Other comprehensive income as of December 31, 2010 and 2009, respectively. In addition, foreign currency transaction gains +(losses), net in the first, second and third quarters of 2011 were understated by approximately $0.2 million, $0.4 million and $0.1 million, respectively; none of which was material to the related period. +We recorded an adjustment to correct the error in the fourth quarter of 2011 which increased Foreign currency transaction (gains) losses, net, by approximately $2.1 +million. We do not believe that either the $1.6 million understatement or the $0.1 million overstatement of pre-tax income in 2010 and 2009, respectively, are material to the consolidated financial statements as previously reported or that the +effect of correcting the error in 2011 is material to the consolidated financial statements for the year ended December 31, 2011 +F-32 \ No newline at end of file diff --git a/raw/filings/0001334036/2011/0001193125-12-075455/filing_metadata.csv b/raw/filings/0001334036/2011/0001193125-12-075455/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..2f8bef36857403adb4448eca95a1900a16923116 --- /dev/null +++ b/raw/filings/0001334036/2011/0001193125-12-075455/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2012-02-23,2011-12-31,2012-02-23T21:46:11.000Z,0001193125-12-075455,d280890d10k.htm,FORM 10-K,5248269,1,0,https://www.sec.gov/Archives/edgar/data/1334036/000119312512075455/d280890d10k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000119312512075455/,2011,2011,1 diff --git a/raw/filings/0001334036/2011/0001193125-12-075455/item1.txt b/raw/filings/0001334036/2011/0001193125-12-075455/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..f4758ec3b71969fa45a0ea6e9ae3525461e944c7 --- /dev/null +++ b/raw/filings/0001334036/2011/0001193125-12-075455/item1.txt @@ -0,0 +1,207 @@ +ITEM 1. +BUSINESS +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the “Company,” “we,” “our” or “us”) is a +designer, manufacturer and distributor of footwear and accessories for men, women and children. We strive to be the global leader in the sale of molded footwear featuring fun, comfort and functionality. Our primary products utilize our proprietary +closed cell-resin, called Croslite. The use of this unique material allows us to produce innovative, lightweight, non-marking and odor-resistant footwear. We currently sell our products in more than 90 countries through domestic and international +retailers and distributors and directly to end-user consumers through our company-operated retail stores, outlets, kiosks and webstores. +We +were organized in 1999 as a limited liability company. In 2002, we launched the marketing and distribution of our original clog style footwear in the United States. The unique characteristics of Croslite enabled us to offer consumers a shoe unlike +any other footwear model then available. In January 2005, we converted to a Colorado corporation and subsequently re-incorporated as a Delaware corporation in June 2005. In February 2006, we completed our initial public offering and trading of our +common stock on NASDAQ commenced. +Since the initial introduction and popularity of the Beach and Crocs Classic designs, we have expanded our +Croslite products to include a variety of new styles and products and have further extended our product reach through the acquisition of brand platforms such as Jibbitz, LLC (“Jibbitz”) and Ocean Minded, Inc. (“Ocean +Minded”). We continue to branch out into other types of footwear so as to bring a unique and original perspective to the consumer in styles that may be unexpected from Crocs. We believe this will help us to continue to build a stable year-round +business as we look to offer more styles oriented for cold weather. Our marketing efforts surround specific product launches and employ a fully integrated approach utilizing a variety of media outlets, including print and online. Our marketing +efforts drive business to both our wholesale partners and our company-operated retail and internet stores, ensuring that our presentation and story are first class and drive purchasing at the point of sale. +Products +While the majority of our +products consist of footwear, we also offer accessories and apparel which generated approximately 3.7% of our total revenues during the year ended December 31, 2011. Our footwear products are divided into four product offerings: Core-Comfort, +Active, Casual and Style. The Core product offering primarily includes molded products that are derivatives of the original Crocs Classic designs and is targeted toward a wide range of consumers. The Active product offering is comprised of footwear +intended for healthy living and includes sport inspired products and footwear suited for activities such as boating, walking, hiking and even recovery after workouts. The Casual product offering includes sporty and relaxed styles appealing to a +broad range of customers. The Style product offering includes stylish products which are intended to broaden the wearing occasion for Crocs lovers. +Crocs has an active licensing program that includes licensing various marks from companies such as Disney, Marvel and Viacom, among others, for Crocs branded footwear and Jibbitz branded shoe charms. In +2011, Crocs began to license certain of its own marks to third parties in connection with a strategy to extend the Crocs brand into new product types. +Footwear +Our footwear product offering has grown significantly since we first +introduced the Crocs single style clog in six colors, in 2002. We currently offer a wide product line of footwear, some of which include boots, sandals, sneakers, mules and flats which are made of materials like leather and textile fabrics as well +as Croslite. In addition to the Crocs brand, some of our market specific product lines include the following. +• +Crocs Work is a product offering targeted at the healthcare, service/hospitality and airline markets that include both molded and leather footwear +styles that feature Crocs Lock™ tread for slip- +1 +Table of Contents +resistance that exceeds industry standards. The Crocs Work products have an established distribution channels with uniform supply companies and large Group Purchasing Organizations, thus +providing us market access to specific industry consumers and large hospitality chains. In 2010, the Bistro style received the 2010 Gold Medal Seal from Chef’s of America. Also in 2011 the Bistro, Specialist and Specialist Vent styles +received the “Seal of Acceptance” by the American Podiatric Medical Association (“APMA”), while several other work styles are currently in the same approval process. +• +Crocs Rx is a medical needs product offering targeted at the general foot care and diabetic needs markets with a distribution to 1,358 podiatry offices +and medical shoe stores. Relief, Ultimate Cloud and Custom Cloud Rx styles have also received the “Seal of Acceptance” by the APMA. +• +Ocean Minded is a product offering featuring high quality leather and EVA (Ethylene Vinyl Acetate) footwear, sandals and printed apparel primarily for +the beach, action and adventure markets. +A key differentiating feature of our footwear products is the Croslite material, +which is uniquely suited for comfort and functionality. Croslite is carefully formulated to be of a density that creates extremely lightweight, comfortable and non-marking footwear which conforms to the shape of the foot and increase comfort. +Croslite is a closed cell resin material which is water resistant, virtually odor free and allows many of our footwear styles to be cleaned simply with water. As we have expanded our product offering, we have incorporated traditional materials such +as textile fabric and leather into many new styles. However, we continue to utilize the Croslite material for the foot bed, sole and other key structural components for many of these styles. +Footwear sales made up 95.6%, 95.5% and 94.6% of total revenues for the years ended December 31, 2011, 2010 and 2009, respectively. During the years ended December 31, 2011, 2010 and 2009, +approximately 73.1%, 75.5% and 77.5% of unit sales consisted of products geared towards adults, respectively, compared to 26.9%, 24.5% and 22.5% of unit sales of products geared towards children, respectively. +Accessories +In addition to our +footwear brands, we own the Jibbitz brand, a unique accessory product-line with colorful snap-on charms specifically suited for Crocs shoes. We acquired Jibbitz, LLC (“Jibbitz”) in December 2006 and have expanded the product-line to +include a wide variety of charms in varying shapes and sizes, with designs such as flowers, sports gear, seasonal and holiday designs, animals, symbols, letters and rhinestones. Crocs licensing agreements also extend to Jibbitz, which allows Jibbitz +to create designs bearing logos and emblems of Disney, Nickelodeon and the Crocs collegiate line, among others. Jibbitz designs allow Crocs consumers to personalize their footwear to creatively express their individuality. As of December 31, +2011, more than 3,000 unique Jibbitz charm designs were sold to consumers for personalizing their Crocs footwear. Sales from Jibbitz designs made up 3.7%, 3.5% and 3.9% of total revenues for the years ended December 31, 2011, 2010 and 2009, +respectively. +Sales and Marketing +While the broad appeal of our footwear has allowed us to market our products in a wide range of distribution channels, including department stores, traditional footwear retailers and a variety of +specialty and independent retail channels, our marketing approach has become significantly target defined. Our marketing efforts center on specific product launches and employ a fully integrated approach utilizing a variety of media outlets, +including print and the internet. We have three primary sales channels: wholesale, retail and internet. Our marketing efforts drive business to both our wholesale partners and our company-operated retail and internet stores, ensuring that our +presentation and story are first class and drive purchasing at the point of sale. +2 +Table of Contents +Wholesale Channel +During the years ended December 31, 2011, 2010 and 2009, approximately 59.8%, 61.0% and 62.6% of net revenues, respectively, were derived from sales through the wholesale channel which consists of +sales to distributors and third party retailers. Wholesale customers include national and regional retail chains, department stores, sporting goods stores independent footwear retailers and family footwear retailers, such as Dick’s Sporting +Goods, Famous Footwear, Academy, DSW, Nordstrom, Murasaki Sports and Centauro, as well as on-line retailers such as Zappos and Amazon. No single customer accounted for 10% or more of revenues for the years ended December 31, 2011, 2010 or 2009. +We use third party distributors in select markets where we believe such arrangements are preferable to direct sales. These third party +distributors purchase products pursuant to a price list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical distribution agreements have terms of one to four years, are +generally terminable on 30 days prior notice and have minimum sales requirements. At our discretion, we may accept returns from wholesale customers for defective products, quality issues and shipment errors on an exception basis or, for certain +wholesale customers, extend pricing discounts in lieu of defective product returns. Also at our discretion, we may accept returns from our wholesale customers, on an exception basis, for the purpose of stock re-balancing to ensure that our products +are merchandised in the proper assortments. Additionally, we may provide markdown allowances to key wholesale customers to facilitate in-channel product markdowns where sell-through is less than anticipated. +Consumer Direct Channels +Consumer direct sales channels include retail and internet channels and serve as an important and effective means to enhance our product and brand +awareness as they provide direct access to our consumers and an opportunity to showcase our entire line of footwear and accessory offerings. Consequently, we view the consumer direct channels to be complementary to our wholesale channel. +Retail Channel +During the years ended +December 31, 2011, 2010 and 2009, approximately 30.6%, 29.5% and 28.0%, respectively, of our net revenues were derived from sales through our retail channel, which consists of kiosks/store in stores, company-operated retail and outlet stores. +Retail Stores As of December 31, 2011, 2010 and 2009, we operated 180, 138 and 84 global retail stores, +respectively. Our retail stores allow us to effectively market the full breadth and depth of our new and existing products and interact with customers in order to enhance brand awareness. +Outlet Stores As of December 31, 2011, 2010 and 2009, we operated 92, 76 and 63 global outlet stores, respectively. +Outlet stores help us move older products in an orderly fashion. We also sell full priced products in our outlet stores. +Kiosks/Store in Stores As of December 31, 2011, 2010 and 2009, we operated 158, 164 and 170 global retail kiosks and store in +stores, respectively, located in malls and other high foot traffic areas. +Of our total 430 global stores as of December 31, 2011, 180 +were located in the U.S., 51 were located in Korea, 41 were located in Taiwan, 32 were located in China, 24 were located in Japan, 21 were located in Hong Kong, 13 were located in Canada, 13 were located in Russia and the remaining were located +throughout Asia, Europe, Australia, the Middle East, South America and South Africa. +Internet Channel +As of December 31, 2011, 2010 and 2009, we offered our products through 42, 37 and 23 company-operated internet webstores, respectively, worldwide. +During the years ended December 31, 2011, 2010 and 2009, +3 +Table of Contents +approximately 9.6%, 9.5% and 9.4%, respectively, of our net revenues were derived from sales through our internet channel. Our internet presence enables us to have increased access to our +customers and provides us with an opportunity to educate them about our products and brand. We continue to expand our web-based marketing efforts to increase consumer awareness of our full product range. +Business Segments and Geographic Information +We have three reportable operating segments: Americas, Europe and Asia. Revenues of each of our reportable operating segments represent sales to external customers. We also have an “Other +businesses” category which aggregates insignificant operating segments that do not meet the reportable threshold and represent manufacturing operations located in Mexico and Italy. Revenues of the “Other businesses” category are +primarily made up of intersegment sales which are eliminated when deriving total consolidated revenues. The remaining revenues for the “Other businesses” represent non-footwear product sales to external customers. Financial information +relating to our operating segments as well as foreign country revenues and long-lived assets is provided in Note 14—Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements. +Americas +The +Americas segment consists of revenues and expenses related to product sales in the North and South America geographic regions. Regional wholesale channel customers consist of a broad range of sporting goods and department stores as well as specialty +retailers. The regional retail channel sells directly to the consumer through 197 company-operated store locations as well as through webstores. During the years ended December 31, 2011, 2010 and 2009, revenues from the Americas segment +constituted approximately 44.8%, 47.8% and 46.7% of our consolidated revenues, respectively. +Asia +The Asia segment consists of revenues and expenses related to product sales throughout Asia, Australia, New Zealand, the Middle East and South Africa. +The Asia wholesale channel consists of sales to a broad range of retailers, similar to the wholesale channel we have established in the Americas. We also sell products directly to the consumer through 198 company-operated stores as well as through +our webstores. During the years ended December 31, 2011, 2010 and 2009, revenues from the Asia segment constituted 38.1%, 36.1% and 36.8% of our consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related to product +sales throughout Europe and Russia. Europe segment wholesale channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas. We also sell our products directly to the consumer through 35 +company-operated stores including kiosks and retail stores as well as through our webstores. During the years ended December 31, 2011, 2010 and 2009, revenues from the Europe segment constituted 17.1%, 16.2% and 16.4% of our consolidated +revenues, respectively. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network so as to further streamline our supply chain, increase our speed to market and lower operating costs. During the year ended +December 31, 2011, we stored our raw material and finished goods inventories in company-operated warehouse and distribution facilities located in the United States, Mexico, the Netherlands, Japan, Finland, Australia, South Africa, Russia and +Italy. We also utilize distribution centers which are operated by third parties located in China, Japan, Hong Kong, Australia, Korea, Singapore, India, Taiwan, Russia, Mexico, Brazil, Puerto Rico and Italy. Throughout 2011, we continued to engage in +efforts to consolidate our global warehouse and distribution facilities to maintain a lean cost structure. As of December 31, 2011, 2010 and 2009, our company-operated warehouse and +4 +Table of Contents +distribution facilities provided us with 1.0 million square feet, 1.3 million square feet and 1.5 million square feet, respectively, and our third party operated distribution +facilities provided us with 0.5 million square feet, 0.3 million square feet and 0.2 million square feet, respectively. We also ship a portion of our products directly to our customers from our internal and third party manufacturers. +We are actively pursuing initiatives aimed at shipping more of our product directly to our customers in an effort to lower future cost of sales. +Raw Materials +Croslite material, our proprietary closed-cell resin, is the primary raw +material used in the majority of our footwear and some of our accessories. Croslite material is soft and durable and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and development +in order to refine our materials to enhance these properties and to target the development of new properties for specific applications. +Croslite material is produced by compounding elastomer resins that we or one of our third party processors purchase from major chemical manufacturers +together with certain other production inputs such as color dyes. At this time, we have identified multiple suppliers that produce the particular elastomer resins used in the Croslite material. We may, however, in the future identify and utilize +materials produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use to produce the Croslite material are readily available for +purchase from multiple suppliers. +Since our inception, we have substantially increased the number of footwear products that we offer. Many of +our new products are constructed using leather, textile fabrics or other non-Croslite materials. We, or our third party manufacturers, obtain these materials from a number of third party sources and we believe these materials are broadly available. +We also outsource the compounding of Croslite material and continue to purchase a portion of our compounded raw materials from a third party in Europe. +Design and Development +We have expanded into new footwear categories by designing new +footwear styles using both internal designers and external recognized footwear design experts. As part of this strategy, we acquired EXO Italia (“EXO”) in 2006, which expanded our internal design capabilities. EXO is based in Padova, Italy +and is an Italian producer of EVA (Ethylene Vinyl Acetate) based finished products, primarily for the footwear industry. By introducing outside sources to the design process, we are able to capture a variety of different design perspectives on a +cost-efficient basis and anticipate trends more quickly. +We continue to dedicate significant resources to product design and development as +we develop footwear styles based on opportunities we identify in the marketplace. Our design and development process is highly collaborative, as members of the design team frequently meet with sales and marketing staff, production and supply +managers and certain of our retail customers to further refine our products to meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs +while maintaining product quality. We spent $10.8 million, $7.8 million and $7.7 million in research, design and development activities for the years ended December 31, 2011, 2010 and 2009, respectively. +Manufacturing and Sourcing +Our +strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have company-operated production facilities in Mexico and Italy. We also contract with third party manufacturers to produce certain of our footwear +styles or provide support to our internal production processes. We believe that our internal manufacturing capabilities enable us to rapidly make changes to production, providing us with the +5 +Table of Contents +flexibility to quickly respond to orders for high demand models and colors throughout the year, while outsourcing allows us to capitalize on the efficiencies and cost benefits of using contracted +manufacturing services. We believe this strategy will continue to minimize our production costs, increase overall operating efficiencies and shorten production and development times. +In the years ended December 31, 2011, 2010 and 2009, we manufactured approximately 20.6%, 21.0% and 26.4%, respectively, of our footwear products internally. We sourced the remaining footwear +production from multiple third party manufacturers primarily in China, Vietnam, Eastern Europe and South America. During the years ended December 31, 2011, 2010 and 2009, our largest third party manufacturer in China produced approximately +33.1%, 38.8% and 35.7%, respectively, of our footwear unit volume. We do not have written supply agreements with our primary third party manufacturers in China. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, +trade secret, trade dress and patent protection to establish, protect and enforce our intellectual property rights in our product designs, brand, materials and research and development efforts, although no such methods can afford complete +protection. We own or license the material trademarks used in connection with the marketing, distribution and sale of all of our products, both domestically and internationally, where our products are currently either sold or manufactured. Our major +trademarks include the Crocs logo and design and the Crocs word mark, both of which are registered or pending registration in the U.S., the European Union, Japan, Taiwan, China and Canada among other places. We also have registrations or pending +registrations for trademark rights or have pending trademark applications for the marks Jibbitz, Jibbitz Logo, YOU by Crocs, YOU by Crocs Logo, Ocean Minded, Tail Logo, Bite, Bite Logo, Crocband, Crocs Tone and Crocs Littles, as well as for our +proprietary material Croslite and the Croslite logo, globally. +In the U.S., our patents are generally in effect for up to 20 years from +the date of the filing of the patent application. Our trademarks registered within and outside of the U.S. are generally valid as long as they are in use and their registrations are properly maintained and have not been found to become generic. We +believe our trademarks are crucial to the successful marketing and sale of our products. We intend to continue to strategically register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in +the future. We will also continue to aggressively police our patent, trademarks and copyrights and pursue those who infringe upon them, both domestically and internationally, as we deem necessary. +We consider the formulation of the material referred to by our trademark Croslite and used to produce our shoes to be a valuable trade secret. Croslite +material is manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source these components but protect the formula by using +exclusive supply agreements for key components, confidentiality agreements with our third party processors and by requiring our employees to execute confidentiality agreements concerning the protection of our confidential information. Other than our +third party processors and a third party licensee, we are not aware of any third party that has independently developed the formula or that otherwise has the right to use the formula. We believe the comfort and utility of our products depend on the +properties achieved from the compounding of Croslite material and constitute a key competitive advantage for us, and we intend to continue to vigorously protect this trade secret. +We also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, distributors and retailers to police against infringing products by +encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives are also educated on our patents, pending patents, trademarks and trade dress to assist in preventing potentially infringing +products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal +protection for our intellectual property in certain jurisdictions. +6 +Table of Contents +Seasonality +Due to the seasonal nature of our footwear which is more heavily focused on styles suitable for warm weather, revenues generated during our first and fourth quarters are typically less than revenues +generated during our second and third quarters, when the northern hemisphere is experiencing warmer weather. We continue to expand our product line to include more winter oriented styles to mitigate some of the seasonality of our revenues. Our +quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including the timing of new model introductions or general economic or consumer conditions. Accordingly, results of operations and cash flows +for any one quarter are not necessarily indicative of results to be expected for any other quarter or year. +Backlog +We receive a significant portion of orders as preseason orders, generally four to five months prior to shipment date. We provide customers with price +incentives to participate in such preseason programs to enable us to better plan our production schedule, inventory and shipping needs. Unfulfilled customer orders as of any date are referred to as backlog and represent orders scheduled to be +shipped at a future date. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing schedule and the timing of product shipments. Further, the mix of future and immediate delivery orders can vary +significantly period over period. Due to these factors and since the unfulfilled orders can be canceled at any time prior to shipment by our customers, backlog may not be a reliable measure of future sales and comparisons of backlog from period to +period may be misleading. In addition, our historical cancellation experience may not be indicative of future cancellation rates. Backlog as of December 31, 2011 and 2010 was $307.4 million and $258.4 million, respectively. +Competition +The global +casual, athletic and fashion footwear markets are highly competitive. Although we believe that we do not compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale business +compete with companies such as, but not limited to, Deckers Outdoor Corp., Skechers USA Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations also compete with footwear retailers such as +Genesco, Inc., Macy’s, Dillard’s, Dick’s Sporting Goods Inc., The Finish Line, Inc and Footlocker, Inc. +The principal +elements of competition in these markets include brand awareness, product functionality, design, quality, pricing, customer service, marketing and distribution. We believe that our unique footwear designs, the Croslite material, our prices, expanded +product-line and our distribution network continue to position us well in the marketplace. However, some companies in the casual footwear and apparel industry have greater financial resources, more comprehensive product lines, broader market +presence, longer standing relationships with wholesalers, longer operating histories, greater distribution capabilities, stronger brand recognition and greater marketing resources than we have. Furthermore, we face competition from new players who +have been attracted to the market with imitation products similar to ours as the result of the unique design and success of our footwear products. +Employees +As of December 31, 2011, we had approximately 4,157 full-time, part-time +and seasonal employees, none of which were represented by a union. +Available Information +Our internet address is www.crocs.com on which we post the following filings, free of charge, as soon as reasonably practicable after they are +electronically filed with or furnished to the Securities and Exchange +7 +Table of Contents +Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to +Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”). Copies of any of these documents will be provided in print to any stockholder who submits a request in writing to Integrated Corporate +Relations, 761 Main Avenue, Norwalk, CT 06851. \ No newline at end of file diff --git a/raw/filings/0001334036/2011/0001193125-12-075455/item13.txt b/raw/filings/0001334036/2011/0001193125-12-075455/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..fa285fe05b7c9d530daf2e3f09b8e7fb42dfd3e4 --- /dev/null +++ b/raw/filings/0001334036/2011/0001193125-12-075455/item13.txt @@ -0,0 +1,4 @@ +ITEM 13. +Certain Relationships and Related Transactions, and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2012 Annual Meeting of Stockholders to be filed with the SEC within 120 days after +December 31, 2011. \ No newline at end of file diff --git a/raw/filings/0001334036/2011/0001193125-12-075455/item9a.txt b/raw/filings/0001334036/2011/0001193125-12-075455/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..a6e676192c999e821b044ddcc252ed03ddceab63 --- /dev/null +++ b/raw/filings/0001334036/2011/0001193125-12-075455/item9a.txt @@ -0,0 +1,52 @@ +ITEM 9A. +Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design +and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of December 31, 2011 (the “Evaluation Date”). Based on this evaluation, our Chief Executive Officer +and Chief Financial Officer concluded that as of the Evaluation Date, our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be disclosed in our Securities +and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our Chief +Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. +Management’s Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2011, using the criteria set forth in the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway +Commission (COSO). Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2011. +40 +Table of Contents +Deloitte & Touche LLP, our independent registered public accounting firm, has issued a report +on our internal control over financial reporting, which is included herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially +affected, or is reasonable likely to materially affect, our internal control over financial reporting. +41 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, +2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal +control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Annual Report on Internal Control Over Financial Reporting”. Our +responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. +We conducted our +audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over +financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and +operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive +and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and +the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the +maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation +of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and +(3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override +of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to +the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal +Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. +We have also audited, +in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2011 of the Company and our report dated February 23, 2012 +expressed an unqualified opinion on those financial statements. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 23, 2012 +42 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2011/0001193125-12-075455/rp_note.txt b/raw/filings/0001334036/2011/0001193125-12-075455/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2011/0001193125-12-075455/rpt_disclosure.txt b/raw/filings/0001334036/2011/0001193125-12-075455/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..9703a900fc4995e26ae349e7ed6f9582de181f65 --- /dev/null +++ b/raw/filings/0001334036/2011/0001193125-12-075455/rpt_disclosure.txt @@ -0,0 +1,18 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +We had no +transactions with related persons during 2011 which are required to be disclosed by the rules of the SEC. +Policy on Transactions with +Related Persons +Our Code of Business Conduct and Ethics requires that any transaction involving us in which one of our directors, +nominees for director, executive officers, or greater than five percent stockholders, or one of the aforementioned’s immediate family members (each, a “related person”), have a material interest be approved or ratified by the Audit +Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course of business transactions in which directors have +an interest as part of the Board’s annual director independence review, and our Code of Business Conduct and Ethics permits the full Board to waive any conflicts of interest between us and any director or officer. In determining whether to +approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. +Director and Officer Indemnification +We have entered into agreements to indemnify certain directors and executive officers in addition to the indemnification provided for in our certificate +of incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys’ fees), judgments, fines and settlement amounts incurred by any +such person in any action or proceeding, including any action by us or in our right, arising out of such person’s services as a director or executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person +provided services at our request. We believe that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. +15 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2012/0001193125-13-072829/filing.txt b/raw/filings/0001334036/2012/0001193125-13-072829/filing.txt new file mode 100644 index 0000000000000000000000000000000000000000..84cbd3df322ee3cd6dafb0e96b7c133d078cc3ed --- /dev/null +++ b/raw/filings/0001334036/2012/0001193125-13-072829/filing.txt @@ -0,0 +1,5988 @@ +10-K +1 +d445683d10k.htm +FORM 10-K +Form 10-K +Table of Contents +UNITED STATES +SECURITIES AND EXCHANGE COMMISSION +Washington, D.C. 20549 +FORM 10-K +x +ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the fiscal year ended December 31, 2012 +or +¨ +TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 +For the transition period +from to +Commission File No. 0-51754 +CROCS, INC. +(Exact name of registrant as specified in its charter) +Delaware +20-2164234 +(State or other jurisdiction of +incorporation or organization) +(I.R.S. Employer +Identification No.) +7477 East Dry Creek Parkway +Niwot, Colorado 80503 +(303) 848-7000 +(Address, including zip code and telephone number, +including area code, of registrant’s principal executive offices) +Securities registered pursuant to Section 12(b) of +the Act: +Title of each class: +Name of each exchange on which +registered: +Common Stock, par value $0.001 per share +The NASDAQ Global Select Market +Securities registered pursuant to Section 12(g) of the Act: None +Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities +Act. Yes x No ¨ +Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x +Indicate by check mark +whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file +such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ +Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File +required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such +files). Yes x No ¨ +Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and +will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to the Form 10-K. x +Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, +a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): +Large accelerated filer x +Accelerated filer ¨ +Non-accelerated filer ¨ +Smaller reporting company ¨ +(do not check if a +smaller reporting company) +Indicate by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x +The aggregate market value of +the voting common stock held by non-affiliates of the registrant as of June 30, 2012 was $1.4 billion. For the purpose of the foregoing calculation only, all directors and executive officers of the registrant and owners of more than 10% of +the registrant’s common stock are assumed to be affiliates of the registrant. This determination of affiliate status is not necessarily conclusive for any other purpose. +The number of shares of the registrant’s common stock outstanding as of January 31, 2013 was 88,134,790. +DOCUMENTS INCORPORATED BY REFERENCE +Part III incorporates certain information by +reference from the registrant’s proxy statement for the 2013 annual meeting of stockholders to be filed no later than 120 days after the end of the registrant’s fiscal year ended December 31, 2012. +Table of Contents +Crocs, Inc. +Table of Contents to the Annual Report on Form 10-K +For the Year Ended December 31, 2012 +PART I +Item 1. +Business +1 +Item 1A. +Risk Factors +8 +Item 1B. +Unresolved Staff Comments +18 +Item 2. +Properties +19 +Item 3. +Legal Proceedings +19 +Item 4. +Mine Safety Disclosures +21 +PART II +Item 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +21 +Item 6. +Selected Financial Data +24 +Item 7. +Management’s Discussion and Analysis of Financial Condition and Results of +Operations +25 +Item 7A. +Quantitative and Qualitative Disclosures About Market Risk +44 +Item 8. +Financial Statements and Supplementary Data +45 +Item 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +45 +Item 9A. +Controls and Procedures +45 +Item 9B. +Other Information +48 +PART III +Item 10. +Directors, Executive Officers and Corporate Governance +48 +Item 11. +Executive Compensation +48 +Item 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder +Matters +48 +Item 13. +Certain Relationships and Related Transactions, and Director Independence +49 +Item 14. +Principal Accountant Fees and Services +49 +PART IV +Item 15. +Exhibits and Financial Statement Schedules +49 +Signatures +53 +Table of Contents +PART I +ITEM 1. +Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the “Company,” “we,” “our” or “us”) is a +designer, manufacturer and distributor of footwear and accessories for men, women and children. We strive to be the global leader in the sale of molded footwear featuring fun, comfort, color and functionality. Our primary products utilize our +proprietary closed cell-resin, called Croslite. The use of this unique material allows us to produce innovative, lightweight, non-marking and odor-resistant footwear. We currently sell our products in more than 90 countries through domestic and +international retailers and distributors and directly to end-user consumers through our company-operated retail stores, outlets, kiosks and webstores. In 2002, we launched the marketing and distribution of our original clog style footwear in the +United States. The unique characteristics of Croslite enabled us to offer consumers a shoe unlike any other footwear model then available. +Since the initial introduction and popularity of the Beach and Crocs Classic designs, we have expanded our Croslite products to include a variety of new +styles and products and have further extended our product reach through the acquisition of brand platforms such as Jibbitz, LLC (“Jibbitz”) and Ocean Minded, Inc. (“Ocean Minded”). We continue to branch out into other types +of footwear so as to bring a unique and original perspective to the consumer in styles that may be unexpected from Crocs. We believe this will help us to continue to build a stable year-round business as we look to offer more styles oriented for +cold weather. Our marketing efforts surround specific product launches and employ a fully integrated approach utilizing a variety of media outlets, including print and online. Our marketing efforts drive business to both our wholesale partners and +our company-operated retail and internet stores, ensuring that our presentation and story are first class and drive purchasing at the point of sale. +We were organized in 1999 as a limited liability company. In January 2005, we converted to a Colorado corporation and subsequently re-incorporated as a Delaware corporation in June 2005. In February 2006, +we completed our initial public offering and trading of our common stock on NASDAQ commenced. +Products +While the majority of our products consist of footwear, we also offer accessories and apparel which generated approximately 3.5% and 0.1%, respectively, +of our total revenues during the year ended December 31, 2012. Our footwear products are divided into four product offerings: Core-Comfort, Active, Casual and Style. The Core-Comfort product offering primarily includes molded and unisex +products targeted toward a wide range of consumers established through core Crocs attributes which include comfort, easy on-and-off capability, and color. The Active product offering is comprised of footwear intended for healthy living and includes +sport inspired products and footwear suited for activities such as boating, walking, hiking and even recovery after workouts. The Casual product offering includes sporty and relaxed styles appealing to a broad range of customers. The Style product +offering includes stylish products which are intended to broaden the wearing occasion for Crocs lovers. +We have an active licensing program +that includes licensing various marks from companies such as Disney, Marvel and Viacom, among others, for Crocs branded footwear and Jibbitz branded shoe charms. We also license certain of our own marks to third parties in connection with a strategy +to extend the Crocs brand into new product types. +Footwear +Our footwear product offering has grown significantly since we first introduced the Crocs single style clog in six colors, in 2002. We currently offer a wide product line of footwear, some of which +include boots, sandals, sneakers, mules and flats which are made of materials like leather and textile fabrics as well as Croslite. +1 +Table of Contents +A key differentiating feature of our footwear products is the Croslite material, which is uniquely suited +for comfort and functionality. Croslite is carefully formulated to be of a density that creates extremely lightweight, comfortable and non-marking footwear which conforms to the shape of the foot and increases comfort. Croslite is a closed cell +resin material which is water resistant, virtually odor free and allows many of our footwear styles to be cleaned simply with water. As we have expanded our product offering, we have incorporated traditional materials such as textile fabric and +leather into many new styles. However, we continue to utilize the Croslite material for the foot bed, sole and other key structural components for many of these styles. +As a global leader in casual footwear, we recognize the responsibility we have to our employees and the global communities we serve. We strive to maintain a spirit of “giving back” as a part of +the Crocs culture and worldwide reputation. With the help of our donation partners, we are able to provide a basic necessity—shoes—to millions of individuals that may not otherwise have a pair. As of December 31, 2012, we have donated +over 3 million pairs of shoes to individuals in need both domestically and internationally in more than 40 countries including Democratic Republic of The Congo, Haiti, Iraq, and Malawi. These donations and other social responsibility +initiatives, form the Crocs Cares program. Crocs is dedicated to providing robust programs, donations, and community work opportunities designed to make a difference in the lives of our employees as well as both local and global communities. +Footwear sales made up 95.8%, 95.6% and 95.5% of total revenues for the years ended December 31, 2012, 2011 and 2010, respectively. +During the years ended December 31, 2012, 2011 and 2010, approximately 75.3%, 73.1% and 75.5% of unit sales consisted of products geared towards adults, respectively, compared to 24.7%, 26.9% and 24.5% of unit sales of products geared towards +children, respectively. +Accessories +In addition to our footwear brands, we own the Jibbitz brand, a unique accessory product-line with colorful snap-on charms specifically suited for Crocs shoes. We acquired Jibbitz in December 2006 and +have expanded the product-line to include a wide variety of charms in varying shapes and sizes, with designs such as flowers, sports gear, seasonal and holiday designs, animals, symbols, letters and rhinestones. Crocs licensing agreements also +extend to Jibbitz, which allows Jibbitz to create designs bearing logos and emblems of Disney, Nickelodeon and the Crocs collegiate line, among others. Jibbitz designs allow Crocs consumers to personalize their footwear to creatively express their +individuality. As of December 31, 2012, more than 3,000 unique Jibbitz charm designs were sold to consumers for personalizing their Crocs footwear. Sales from Jibbitz designs made up 3.5%, 3.7% and 3.5% of total revenues for the years ended +December 31, 2012, 2011 and 2010, respectively. +Sales and Marketing +The broad appeal of our footwear has allowed us to market our products in a wide range of distribution channels, including department stores, traditional footwear retailers and a variety of specialty and +independent retail channels. Each season, we focus on presenting a compelling “brand story and experience” for our new product collections and our broader casual lifestyle assortment. Our marketing efforts center on multi-level story +telling across diverse wearing occasions and product silhouettes. +As we are a global brand, our model is based on global relevance while +still allowing for regional flexibility in execution and message. At the regional or market level, campaigns are initiated using a mix of digital, social, and traditional media outlets that align with local marketplaces and target consumer dynamics. +This strategy allows for relevant cross-channel input coordinated through our global brand objectives to drive an aligned global marketing and brand strategy. +We utilize an in-house creative team to execute our marketing efforts. Local marketing teams focus on localizing campaigns by establishing and executing marketing programs to effectively engage target +customers in a +2 +Table of Contents +meaningful manner. We utilize a proprietary Brand Performance System to help prioritize demand generation initiatives and optimize local marketing activities. The Brand Performance System +integrates multiple research and consumer database platforms across key markets to provide guidance on highest yielding customer growth opportunities and market performance analysis. +We have three primary sales channels: wholesale, retail and internet (discussed at a more detailed level below). Our marketing efforts are aimed toward driving business to both our wholesale partners and +our company-operated retail and internet stores. Our marketing efforts in the wholesale and retail channels are focused on visual product merchandising with alignment on key stories, activation materials and creative materials. Retail stores provide +a unique opportunity to engage with customers in a three-dimensional manner. Strong emphasis is placed on making the store experience a meaningful and memorable showcase of our larger assortment of casual lifestyle footwear and key new product +launches. Our marketing, merchandising, and visual merchandising departments work closely together to ensure the store environment and merchandise are aligned to support key seasonal product stories while promoting the larger product lines and +iconic product collections. +We have an in-house digital marketing team that oversees digital marketing programs and platforms that include +paid-and-organic search, display, re-targeting, email and affiliate marketing to drive new customers to the brand and retain existing customers. Under our universal seasonal brand campaign, the team helps to adapt key brand story content and +produces additional web-specific content for our internet channel. +Wholesale Channel +During the years ended December 31, 2012, 2011 and 2010, approximately 57.5%, 59.8% and 60.8% of net revenues, respectively, were derived from sales +through the wholesale channel which consists of sales to distributors and third party retailers. Wholesale customers include national and regional retail chains, department stores, sporting goods stores, independent footwear retailers and family +footwear retailers, such as Dick’s Sporting Goods, Famous Footwear, Academy, Kohl’s, Nordstrom, Xebio and Murasaki Sports, as well as on-line retailers such as Zappos and Amazon. No single customer accounted for 10% or more of our revenues +for the years ended December 31, 2012, 2011 and 2010. +We use third party distributors in select markets where we believe such +arrangements are preferable to direct sales. These third party distributors purchase products pursuant to a price list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical +distribution agreements have terms of one to four years, are generally terminable on 30 days prior notice and have minimum sales requirements. Many of our agreements allow us to accept returns from wholesale customers at our discretion for +defective products, quality issues and shipment errors on an exception basis or, for certain wholesale customers, extend pricing discounts in lieu of defective product returns. We also may accept returns from our wholesale customers, on an exception +basis, for the purpose of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, we may provide markdown allowances to key wholesale customers to facilitate in-channel product markdowns where +sell-through is less than anticipated. +Consumer Direct Channels +Consumer direct sales channels include retail and internet channels and serve as an important and effective means to enhance our product and brand awareness as they provide direct access to our consumers +and an opportunity to showcase our entire line of footwear and accessory offerings. Consequently, we view the consumer direct channels to be complementary to our wholesale channel. +3 +Table of Contents +Retail Channel +During the years ended December 31, 2012, 2011 and 2010, approximately 33.4%, 30.6% and 29.7%, respectively, of our net revenues were derived from sales through our retail channel, which consists of +kiosks/store in stores, company-operated retail and outlet stores. +Retail Stores As of December 31, 2012, +2011 and 2010, we operated 287, 180 and 136 global retail stores, respectively. Our retail stores allow us to effectively market the full breadth and depth of our new and existing products and interact with customers in order to enhance brand +awareness. +Outlet Stores As of December 31, 2012, 2011 and 2010, we operated 129, 92 and 78 global outlet +stores, respectively. Outlet stores help us move older products in an orderly fashion. We also sell full priced products in our outlet stores. +Kiosks/Store in Stores As of December 31, 2012, 2011 and 2010, we operated 121, 158 and 153 global retail kiosks and store in stores, respectively, located in malls and other high foot traffic +areas. +Of our 537 global stores, 199 stores operated in our Americas segment, including 170 located in the U.S. and 12 located in Canada; 241 +stores operated in our Asia segment, including 63 located in Korea, 43 located in Taiwan, 40 located in Japan, 39 located in China and 17 located in Hong Kong; and 97 stores operated in our Europe segment, including 29 located in Russia, 18 located +in Germany, and 16 located in Great Britain. The remaining stores were located throughout Asia, Europe, Australia, the Middle East, South America and South Africa. +Internet Channel +As of December 31, 2012, 2011 and 2010, we offered our products +through 43, 42 and 37 company-operated internet webstores, respectively, worldwide. During the years ended December 31, 2012, 2011 and 2010, approximately 9.1%, 9.6% and 9.5%, respectively, of our net revenues were derived from sales through +our internet channel. Our internet presence enables us to have increased access to our customers and provides us with an opportunity to educate them about our products and brand. We continue to expand our web-based marketing efforts to increase +consumer awareness of our full product range and have begun expanding the implementation of locally executed internet web stores at the regional level. +Business Segments and Geographic Information +We have three reportable operating segments: +Americas, Europe and Asia. Revenues of each of our reportable operating segments represent sales to external customers. We also have an “Other businesses” category which aggregates insignificant operating segments that do not meet the +reportable threshold and represent manufacturing operations located in Mexico and Italy. Revenues of the “Other businesses” category are primarily made up of intersegment sales which are eliminated when deriving total consolidated +revenues. The remaining revenues for the “Other businesses” represent non-footwear product sales to external customers. Financial information relating to our operating segments as well as foreign country revenues and long-lived assets is +provided in Note 14—Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements. +Americas +The Americas segment +consists of revenues and expenses related primarily to product sales in the North and South America geographic regions. Regional wholesale channel customers consist of a broad range of sporting goods and department stores as well as specialty +retailers. The regional retail channel sells directly to the consumer through 199 company-operated store locations as well as through webstores. During the years ended December 31, 2012, 2011 and 2010, revenues from the Americas segment +constituted approximately 44.1%, 44.8% and 47.5% of our consolidated revenues, respectively. +4 +Table of Contents +Asia +The Asia segment consists of revenues and expenses related primarily to product sales throughout Asia, Australia, New Zealand, the Middle East and South Africa. The Asia wholesale channel consists of +sales to a broad range of retailers similar to the wholesale channel we have established in the Americas. We also sell products directly to the consumer through 241 company-operated stores as well as through our webstores. During the years ended +December 31, 2012, 2011 and 2010, revenues from the Asia segment constituted 40.7%, 38.1% and 36.1% of our consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related primarily to +product sales throughout Europe and Russia. Europe segment wholesale channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas. We also sell our products directly to the consumer +through 97 company-operated stores including kiosks and retail stores as well as through our webstores. During the years ended December 31, 2012, 2011 and 2010, revenues from the Europe segment constituted 15.1%, 17.1% and 16.2% of our +consolidated revenues, respectively. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network so as to further streamline our supply chain, increase our speed to market and lower operating costs. During the year ended +December 31, 2012, we stored our raw material and finished goods inventories in company-operated warehouse and distribution facilities located in the United States, Mexico, the Netherlands, Japan, Finland, South Africa, Russia and Italy. We +also utilize distribution centers which are operated by third parties located in the United States, China, Japan, Hong Kong, Australia, Korea, Singapore, India, Taiwan, the United Arab Emirates, Russia, Brazil, Argentina, Chile, Puerto Rico and +Italy. Throughout 2012, we continued to engage in efforts to consolidate our global warehouse and distribution facilities to maintain a lean cost structure. As of December 31, 2012, 2011 and 2010, our company-operated warehouse and distribution +facilities provided us with approximately 1.0 million square feet, 1.0 million square feet and 1.3 million square feet, respectively, and our third party operated distribution facilities provided us with approximately 0.3 million +square feet, 0.5 million square feet and 0.3 million square feet, respectively. We also ship a portion of our products directly to our customers from our internal and third party manufacturers. We are actively pursuing initiatives aimed at +shipping more of our product directly to our customers in an effort to lower future cost of sales. +Raw Materials +“Croslite”, our branded proprietary closed-cell resin, is the primary raw material used in the majority of our footwear and some of our +accessories. Croslite is soft and durable and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and development in order to refine our materials to enhance these properties and to +target the development of new properties for specific applications. +Croslite material is produced by compounding elastomer resins that we or +one of our third party processors purchase from major chemical manufacturers together with certain other production inputs such as color dyes. At this time, we have identified multiple suppliers that produce the elastomer resins used in the Croslite +material. We may, however, in the future identify and utilize materials produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use +to produce the Croslite products are readily available for purchase from multiple suppliers. +Since our inception, we have substantially +increased the number of footwear products that we offer. Many of our new products are constructed using leather, textile fabrics or other non-Croslite materials. We, or our third party manufacturers, obtain these materials from a number of third +party sources and we believe these materials are +5 +Table of Contents +broadly available. We also outsource the compounding of the Croslite material and continue to purchase a portion of our compounded raw materials from a third party in Europe. +Design and Development +We continue to +dedicate significant resources to product design and development as we develop footwear styles based on opportunities we identify in the marketplace. Our design and development process is highly collaborative, as members of the regional design +teams, including our EXO Italia (“EXO”) location, which specializes in EVA (Ethylene Vinyl Acetate) based finish products for the footwear industry, frequently meet with sales and marketing staff, production and supply managers and certain +of our retail customers to further refine our products to meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs while maintaining product +quality. We spent $12.0 million, $10.8 million and $7.8 million in research, design and development activities for the years ended December 31, 2012, 2011 and 2010, respectively. +Manufacturing and Sourcing +Our +strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have company-operated production facilities in Mexico and Italy. We also contract with third party manufacturers to produce certain of our footwear +styles or provide support to our internal production processes. We believe that our internal manufacturing capabilities enable us to rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high demand +models and colors throughout the year, while outsourcing allows us to capitalize on the efficiencies and cost benefits of using contracted manufacturing services. We believe this strategy will continue to minimize our production costs, increase +overall operating efficiencies and shorten production and development times. +In the years ended December 31, 2012, 2011 and 2010, we +manufactured approximately 21.1%, 20.6% and 21.0%, respectively, of our footwear products internally. We sourced the remaining footwear production from multiple third party manufacturers primarily in China, Vietnam, Eastern Europe and South America. +During the years ended December 31, 2012, 2011 and 2010, our largest third party manufacturer in China produced approximately 31.7%, 33.1% and 38.8%, respectively, of our footwear unit volume. We do not have written supply agreements with our +primary third party manufacturers in China. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress and patent protection to establish, protect and enforce our intellectual +property rights in our product designs, brand, materials and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution and +sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or +pending registration in the U.S., the European Union, Japan, Taiwan, China and Canada among other places. We also have registrations or pending trademark applications for the marks Jibbitz, Jibbitz Logo, YOU by Crocs, YOU by Crocs Logo, Ocean +Minded, Tail Logo, Bite, Bite Logo, Crocband, Crocs Tone and Crocs Littles, “ Croslite” and the Croslite logo, as well as other marks in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks registered within and outside of the U.S. are generally valid +as long as they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks are crucial to the successful marketing and sale of our products. We intend to continue to strategically +register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the future. We will also continue to aggressively police our patent, trademarks and copyrights and pursue those who infringe upon +them, both domestically and internationally, as we deem necessary. +6 +Table of Contents +We consider the formulations of the materials covered by our trademark Croslite and used to produce our +shoes to be a valuable trade secret. Croslite material is manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source +these components but protect the formula by using exclusive supply agreements for key components, confidentiality agreements with our third party processors and by requiring our employees to execute confidentiality agreements concerning the +protection of our confidential information. Other than our third party processors and a third party licensee, we are not aware of any third party that has independently developed the formula or that otherwise has the right to use the formula. We +believe the comfort and utility of our products depend on the properties achieved from the compounding of Croslite material and constitute a key competitive advantage for us, and we intend to continue to vigorously protect this trade secret. +We also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, +distributors and retailers, as well as outside investigators and attorneys, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and +distributors are also educated on our patents, pending patents, trademarks and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property +rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain jurisdictions. +Seasonality +Due to the seasonal nature +of our footwear which is more heavily focused on styles suitable for warm weather, revenues generated during our first and fourth quarters are typically less than revenues generated during our second and third quarters, when the northern hemisphere +is experiencing warmer weather. We continue to expand our product line to include more winter oriented styles to mitigate some of the seasonality of our revenues. Our quarterly results of operations may also fluctuate significantly as a result of a +variety of other factors, including the timing of new model introductions or general economic or consumer conditions. Accordingly, results of operations and cash flows for any one quarter are not necessarily indicative of results to be expected for +any other quarter or year. +Backlog +We receive a significant portion of orders as preseason orders, generally four to six months prior to shipment date. We provide customers with price incentives to participate in such preseason programs to +enable us to better plan our production schedule, inventory and shipping needs. Unfulfilled customer orders as of any date are referred to as backlog and represent orders scheduled to be shipped at a future date. Backlog as of a particular date is +affected by a number of factors, including seasonality, manufacturing schedule and the timing of product shipments. Further, the mix of future and immediate delivery orders can vary significantly period over period. Due to these factors and since +the unfulfilled orders can be canceled at any time prior to shipment by our customers, backlog may not be a reliable measure of future sales and comparisons of backlog from period to period may be misleading. In addition, our historical cancellation +experience may not be indicative of future cancellation rates. Backlog as of December 31, 2012 and 2011 was $354.3 million and $307.4 million, respectively. +Competition +The global casual, athletic and fashion footwear markets are highly +competitive. Although we believe that we do not compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale business compete with companies such as, but not limited to, Deckers +Outdoor Corp., Skechers USA Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations also compete with footwear retailers such as Genesco, Inc., Macy’s, Dillard’s, Dick’s +Sporting Goods Inc., The Finish Line, Inc and Footlocker, Inc. +7 +Table of Contents +The principal elements of competition in these markets include brand awareness, product functionality, +design, quality, pricing, customer service, marketing and distribution. We believe that our unique footwear designs, the Croslite material, our prices, expanded product-line and our distribution network continue to position us well in the +marketplace. However, some companies in the casual footwear and apparel industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, +greater distribution capabilities, stronger brand recognition and greater marketing resources than we have. Furthermore, we face competition from new players who have been attracted to the market with imitation products similar to ours as the result +of the unique design and success of our footwear products. +Employees +As of December 31, 2012, we had approximately 4,900 full-time, part-time and seasonal employees, none of which were represented by a union. +Available Information +Our internet address is www.crocs.com on which we post the +following filings, free of charge, as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our +current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Copies of any of these documents will +be provided in print to any stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. +ITEM 1A. +Risk Factors +Special Note Regarding +Forward Looking Statements +Statements in this Form 10-K and in documents incorporated by reference herein (or otherwise made by us +or on our behalf) contain “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications from time to time that contain such +statements. Forward looking statements include statements as to industry trends, our future expectations and other matters that do not relate strictly to historical facts and are based on certain assumptions of our management. These statements are +often identified by the use of words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “strive,” “will,” and variations of such +words or similar expressions. Further, these statements are based on the beliefs and assumptions of management based on information currently available. Such forward looking statements are subject to risks, uncertainties and other factors that could +cause actual results to differ materially from future results expressed or implied by such forward looking statements. Important factors that could cause actual results to differ materially from the forward looking statements include, without +limitation, the risk factors mentioned below. Moreover, such forward looking statements speak only as of the date of this report. We undertake no obligation to update any forward looking statements to reflect events or circumstances after the date +of such statements. +The risks included herein are not exhaustive. Other sections of this Form 10-K may include additional factors which +could adversely affect our business and financial performance. Since we operate in a very competitive and rapidly changing environment, new risk factors emerge from time to time and it is not possible for management to predict all such risk factors, +nor can it assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward looking statements. Given these +risks and uncertainties, investors should not place undue reliance on forward looking statements as a prediction of actual results. +8 +Table of Contents +Current global economic conditions may adversely affect consumer spending and the financial health of +our customers and others with whom we do business which may adversely affect our financial condition, results of operations and cash resources. +Uncertainty about the current and future global economic conditions may cause consumers and retailers to defer purchases or cancel purchase orders for our products in response to tighter credit, decreased +cash availability and weakened consumer confidence. For example, sales and operating performance in our Europe segment in 2012 were adversely affected by the macroeconomic conditions surrounding the European sovereign debt crisis and may continue to +be affected if such conditions do not improve. Our financial success is sensitive to changes in general economic conditions, both globally and nationally. Recessionary economic cycles, higher interest borrowing rates, higher fuel and other energy +costs, inflation, increases in commodity prices, higher levels of unemployment, higher consumer debt levels, higher tax rates and other changes in tax laws or other economic factors that may affect consumer spending could adversely affect the demand +for our products. As a result, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new retail stores, maintain or increase our international operations on a profitable basis, or +maintain or improve our earnings from operations as a percentage of net sales. Our financial success is also significantly related to the success of our wholesale customers who are directly impacted by fluctuations in the broader economy including +the global economic downturns which reduce foot traffic in shopping malls and lessen consumer demand for our products. +In addition, any +decrease in available credit caused by a weakened global economy may result in financial difficulties for our wholesale and retail customers, product suppliers and other service providers, as well as the financial institutions that are +counterparties to our credit facility and derivative transactions. If credit pressures or other financial difficulties result in insolvency for these parties, it could adversely impact our estimated reserves, our ability to obtain future financing +and our financial results. In particular, if our customers experience diminished liquidity, we may experience a reduction in product orders, an increase in customer order cancellations and/or the need to extend customer payment terms which could +lead to higher accounts receivable balances, reduced cash flows, greater expense associated with collection efforts and increased bad debt expense. +We face significant competition. +The footwear industry is highly competitive. +Continued growth in the market for casual footwear has encouraged the entry of new competitors into the marketplace and has increased competition from established companies. Our competitors include most major athletic and footwear companies, branded +apparel companies and retailers with their own private label footwear products. A number of our competitors have significantly greater financial resources than us, more comprehensive product lines, a broader market presence, longer standing +relationships with wholesalers, a longer operating history, greater distribution capabilities, stronger brand recognition and spend substantially more than we do on product marketing. Our competitors’ greater capabilities in these areas may +enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and production and more quickly develop new products. Additionally, some of our competitors are offering products that are +substantially similar, in design and materials, to Crocs branded footwear. In addition, access to offshore manufacturing is also making it easier for new companies to enter the markets in which we compete. If we fail to compete successfully in the +future, our sales and profits may decline, we may lose market share, our financial condition may deteriorate and the market price of our common stock is likely to fall. +We may be unable to successfully execute our long-term growth strategy or maintain our current revenue levels. +Our ability to maintain our revenue levels or to grow in the future depends on, among other things, the continued success of our efforts to maintain our brand image and bring compelling and revenue +enhancing footwear offerings to market and our ability to expand within our current distribution channels and increase sales of our +9 +Table of Contents +products into new locations internationally. Successfully executing our long-term growth and profitability strategy will depend on many factors, including the strength of the Crocs brand, +execution of supply chain strategies, competitive conditions in new markets that we attempt to enter, our ability to attract and retain qualified distributors or agents or to continue to develop direct sales channels, our ability to secure strategic +retail store locations, our ability to use and protect the Crocs brand and our other intellectual property in these new markets and territories and our ability to consolidate our network to leverage resources and simplify our fulfillment process. If +we are unable to successfully maintain our brand image, expand distribution channels, streamline our supply chain and sell our products in new markets abroad, our business may fail to grow, our brand may suffer and our results of operations may be +adversely impacted. +Expanding our footwear product line may be difficult and expensive. If we are unable to successfully continue such +expansion, our brand may be adversely affected and we may not be able to maintain or grow our current revenue and profit levels. +To +successfully expand our footwear product line, we must anticipate, understand and react to the rapidly changing tastes of consumers and provide appealing merchandise in a timely manner. New footwear models that we introduce may not be successful +with consumers or our brand may fall out of favor with consumers. If we are unable to anticipate, identify, or react appropriately to changes in consumer preferences, our revenues may decrease, our brand image may suffer, our operating performance +may decline and we may not be able to execute our growth plans. +In producing new footwear models, we may encounter difficulties that we did +not anticipate during the product development stage. Our development schedules for new products are difficult to predict and are subject to change in response to consumer preferences and competing products. If we are not able to efficiently +manufacture new products in quantities sufficient to support retail and wholesale distribution, we may not be able to recover our investment in the development of new styles and product lines and we would continue to be subject to the risks inherent +to having a limited product line. Even if we develop and manufacture new footwear products that consumers find appealing, the ultimate success of a new style may depend on our pricing. We have a limited history of introducing new products in certain +target markets; as such, we may set the prices of new styles too high for the market to bear or we may not provide the appropriate level of marketing in order to educate the market and potential consumers about our new products. Achieving market +acceptance will require us to exert substantial product development and marketing efforts, which could result in a material increase in our selling, general and administrative expenses and there can be no assurance that we will have the resources +necessary to undertake such efforts effectively or that such efforts will be successful. Failure to gain market acceptance for new products could impede our ability to maintain or grow current revenue levels, reduce profits, adversely affect the +image of our brands, erode our competitive position and result in long-term harm to our business. +Opening and operating additional +retail stores are subject to numerous risks including the dependency on customer traffic in shopping malls; declines in revenue of such retail stores could adversely affect our profitability. +In recent years, we have significantly expanded and intend to continue the expansion of our retail sales channel. Opening retail stores globally involves +substantial investment, including the construction of leasehold improvements, furniture and fixtures, equipment, information systems, inventory and personnel. Operating global retail stores incurs fixed costs; if we have insufficient sales, we may +be unable to reduce such fixed costs and avoid losses or negative cash flows. Due to the high fixed cost structure associated with the retail segment, negative cash flows or the closure of a store could result in write downs of inventory, impairment +of leasehold improvements, impairment losses on other long-lived assets, severance costs, significant lease termination costs or the loss of working capital, which could adversely impact our financial position, results of operations or cash flows. +Our ability to recover the investment in and expenditures of our retail operations can be adversely affected if sales at our retail stores are lower than anticipated. +10 +Table of Contents +In addition, our ability to open new stores successfully depends on our ability to identify suitable store +locations, negotiate acceptable lease terms, hire, train and retain store personnel and satisfy the fashion preferences in new geographic areas. Many of our retail stores are located in shopping malls where we depend on obtaining prominent locations +and the overall success of the malls to generate customer traffic. We cannot control the success of individual malls and an increase in store closures by other retailers may lead to mall vacancies and reduced foot traffic. Reduced customer traffic +could reduce sales of existing retail stores or hinder our ability to open retail stores in new markets, which could negatively affect our operating results. +We have incurred substantial financial commitments and fixed costs related to our retail stores that we will not be able to recover if our stores are not successful. +The success of an individual store location is dependent on the success of the shopping mall or outlet center where the store is located, and may be +influenced by changing customer demographic and consumer spending patterns. These factors cannot be predicted with accuracy. Because we enter into long-term financial commitments when leasing retail store locations and incur substantial fixed costs +for each store’s design, leasehold improvements, fixtures and management information systems, it would be costly for us to close a store that does not prove successful. +The testing of our retail stores’ long-lived assets for impairment requires us to make significant estimates about our future performance and cash flows that are inherently uncertain. These estimates +can be affected by numerous factors, including changes in economic conditions, our results of operations, and competitive conditions in the industry. Due to the high fixed cost structure associated with our retail operations, negative cash flows or +the closure of a store could result in write downs of inventory, impairment of leasehold improvements, impairment losses on other long-lived assets, severance costs, significant lease termination costs or the loss of working capital, which could +adversely impact our financial position, results of operations or cash flows. For example, during 2012, we recorded impairments relating to retail stores of $1.4 million, and these impairment charges may increase as we expand our retail operations. +Our revolving credit facility contains financial covenants that require us to maintain certain financial metrics and ratios and +restrictive covenants that limit our flexibility. A breach of those covenants may cause us to be in default under the facility, and our lenders could foreclose on our assets. +The credit agreement for our revolving credit facility requires us to maintain a certain leverage ratio at all times, a certain level of unrestricted cash at all times, and a minimum fixed charge coverage +ratio on a quarterly basis. A failure to maintain current revenue levels or an inability to control costs could negatively impact our ability to meet these financial covenants and, if we breach such covenants or any of the restrictive covenants +described below, the lenders could either refuse to lend funds to us or accelerate the repayment of any outstanding borrowings under the revolving credit facility. We might not have sufficient assets to repay such indebtedness upon a default. If we +are unable to repay the indebtedness, the lenders could initiate a bankruptcy proceeding against us or collection proceedings with respect to our assets, all of which secure our indebtedness under the revolving credit facility. +The credit agreement also contains certain restrictive covenants that limit and in some circumstances prohibit, our ability to, among other things incur +additional debt, sell, lease or transfer our assets, pay dividends, make capital expenditures and investments, guarantee debt or obligations, create liens, enter into transactions with our affiliates and enter into certain merger, consolidation or +other reorganizations transactions. These restrictions could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand the current or future downturns in our business or the economy in general, conduct +operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors that have less debt and are not subject to such restrictions. +11 +Table of Contents +We manufacture a portion of our products which causes us to incur greater fixed costs. Any +difficulties or disruptions in our manufacturing operations could adversely affect our sales and results of operations. +We produce a +portion of our footwear products at our internal manufacturing facilities in Mexico and Italy. Ownership of these facilities adds fixed costs to our cost structure which are not as easily scalable as variable costs. In addition, the manufacture of +our products from the Croslite material requires the use of a complex process and we may experience difficulty in producing footwear that meets our high quality control standards. We will be required to absorb the costs of manufacturing and +disposing of products that do not meet our quality standards. Any increases in our manufacturing costs could adversely impact our profit margins. Furthermore, our manufacturing capabilities are subject to many of the same risks and challenges faced +by our third party manufacturers (as noted in the risk factor below), including our ability to scale our production capabilities to meet the needs of our customers. Our manufacturing may also be disrupted for reasons beyond our control, including +work stoppages, fires, earthquakes, floods or other natural disasters. Any disruption to our manufacturing operations will hinder our ability to deliver products to our customers in a timely manner and could have a material and adverse effect on our +business and results of operations. +We depend heavily on third party manufacturers located outside the U.S. +Third party manufacturers located in China and Vietnam produce most of our footwear products. We depend on the ability of these manufacturers to finance +the production of goods ordered, maintain adequate manufacturing capacity and meet our quality standards. We compete with other companies for the production capacity of our third party manufacturers, and we do not exert direct control over the +manufacturers’ operations. As such, we have experienced at times, delays or inabilities to fulfill customer demand and orders, particularly in China. We cannot guarantee that any third party manufacturer will have sufficient production +capacity, meet our production deadlines or meet our quality standards. +In addition, we do not have long-term supply contracts with these +third party manufacturers and any of them may unilaterally terminate their relationship with us at any time or seek to increase the prices they charge us. As a result, we are not assured of an uninterrupted supply of products of an acceptable +quality and price from our third party manufacturers. Foreign manufacturing is subject to additional risks, including transportation delays and interruptions, work stoppages, political instability, expropriation, nationalization, foreign currency +fluctuations, changing economic conditions, changes in governmental policies and the imposition of tariffs, import and export controls and other non-tariff barriers. We may not be able to offset any interruption or decrease in supply of our products +by increasing production in our internal manufacturing facilities due to capacity constraints, and we may not be able to substitute suitable alternative third party manufacturers in a timely manner or at acceptable prices. Any disruption in the +supply of products from our third party manufacturers may harm our business and could result in a loss of sales and an increase in production costs, which would adversely affect our results of operations. In addition, manufacturing delays or +unexpected demand for our products may require us to use faster, more expensive transportation methods, such as aircraft, which could adversely affect our profit margins. The cost of fuel is a significant component in transportation costs. Increases +in the price of petroleum products can adversely affect our profit margins. +In addition, because a large portion of our footwear products is +manufactured in China and Vietnam, the possibility of adverse changes in trade or political relations between the U.S. and these countries, political instability in China, increases in labor costs, or adverse weather conditions could significantly +interfere with the production and shipment of our products, which would have a material adverse affect on our operations and financial results. +Our third party manufacturing operations must comply with labor, trade and other laws; failure to do so may adversely affect us. +We require our third party manufacturers to meet our quality control standards and footwear industry standards for working conditions +and other matters, including compliance with applicable labor, environmental and other +12 +Table of Contents +laws. However, we do not control our third party manufacturers or their respective labor practices. A failure by any of our third party manufacturers to adhere to quality standards or labor, +environmental and other laws could cause us to incur additional costs for our products, generate negative publicity, damage our reputation and the value of our brand and discourage customers from buying our products. We also require our third party +manufacturers to meet certain product safety standards. A failure by any of our third party manufacturers to adhere to such product safety standards could lead to a product recall which could result in critical media coverage and harm our business +and reputation and could cause us to incur additional costs. +In addition, if we or our third party manufacturers violate U.S. or foreign +trade laws or regulations, we may be subject to extra duties, significant monetary penalties, the seizure and the forfeiture of the products we are attempting to import or the loss of our import privileges. Possible violations of U.S. or foreign +laws or regulations could include inadequate record keeping of our imported products, misstatements or errors as to the origin, quota category, classification, marketing or valuation of our imported products, fraudulent visas or labor violations. +The effects of these factors could render our conduct of business in a particular country undesirable or impractical and have a negative impact on our operating results. We cannot predict whether additional U.S. or foreign customs quotas, duties, +taxes or other changes or restrictions will be imposed upon the importation of foreign produced products in the future or what effect such actions could have on our business, financial condition or results of operations. +We conduct significant business activity outside the U.S. which exposes us to risks of international commerce. +A significant portion of our revenues is from foreign sales. Our ability to maintain the current level of operations in our existing international +markets is subject to risks associated with international sales operations as well as the difficulties associated with promoting products in unfamiliar cultures. In addition to foreign manufacturing, we operate retail stores and sell our products to +retailers outside of the U.S. Foreign manufacturing and sales activities are subject to numerous risks, including tariffs, anti-dumping fines, import and export controls, and other non-tariff barriers such as quotas and local content rules; delays +associated with the manufacture, transportation and delivery of products; increased transportation costs due to distance, energy prices, or other factors; delays in the transportation and delivery of goods due to increased security concerns; +restrictions on the transfer of funds; restrictions, due to privacy laws, on the handling and transfer of consumer and other personal information; changes in governmental policies and regulations; political unrest, changes in law, terrorism, or war, +any of which can interrupt commerce; U.S. and foreign anti-corruption laws; expropriation and nationalization; difficulties in managing foreign operations effectively and efficiently from the U.S.; and difficulties in understanding and complying +with local laws, regulations and customs in foreign jurisdictions. In addition, we are subject to customs laws and regulations with respect to our export and import activity which are complex and vary within legal jurisdictions in which we operate. +We cannot assure that there will be no control failure around customs enforcement despite the precautions we take. We are currently subject to audits by various Customs Authorities including the U.S. and Mexico. Any failure to comply with customs +laws and regulations could be discovered during a U.S. or foreign government customs audit and could result in substantial fines and penalties, which could have an adverse effect on our financial position and results of operations. +Foreign currency fluctuations could have a material adverse effect on our results of operations and financial condition. +As a global company, we have significant revenues, costs, assets, liabilities and intercompany balances denominated in currencies other than the U.S. +dollar. We pay the majority of expenses attributable to our foreign operations in the functional currency of the country in which such operations are conducted and pay the majority of our overseas third-party manufacturers in U.S. dollars. +Our ability to sell our products in foreign markets and the U.S. dollar value of the sales made in foreign currencies can be significantly +influenced by foreign currency fluctuations. A decrease in the value of foreign currencies relative to the U.S. dollar could result in lower revenues, product price pressures and increased losses +13 +Table of Contents +from currency exchange rates. Price increases caused by currency exchange rate fluctuations could make our products less competitive or have an adverse effect on our profitability as most of our +purchases from third party suppliers are denominated in U.S. dollars. Currency exchange rate fluctuations could also disrupt the business of the third party manufacturers that produce our products by making their purchases of raw materials more +expensive and more difficult to finance. While we enter into foreign currency exchange forward contracts as economic cash flow hedges to reduce our exposure to changes in exchange rates, the volatility of foreign currency exchange rates is dependent +on many factors that cannot be forecasted with reliable accuracy. +Our financial success may be limited to the strength of our +relationships with our wholesale customers and to the success of such wholesale customers. +Our financial success is related to the +willingness of our current and prospective wholesale customers to carry our products. We do not have long term contracts with any of our wholesale customers. Sales to our wholesale customers are generally on an order-by-order basis and are subject +to rights of cancellation and rescheduling by the customer. If we cannot fill our customers’ orders in a timely manner, the sales of our products and our relationships with those customers may suffer. This could have a material adverse effect +on our product sales and ability to grow our product lines. +Changes in the global credit market could also affect our customers’ +liquidity and capital resources and their ability to meet payment obligations to us which could have a material adverse impact on our cash flows and capital resources. We continue to monitor our accounts receivable aging and record reserves against +such receivables as we deem appropriate. Additionally, many of our wholesale customers compete with each other. If they perceive that we are offering their competitors better pricing and support, they may reduce purchases of our products. Moreover, +we compete directly with our wholesale customers by selling our products directly to consumers over the internet and through our company-operated retail locations. If our wholesale customers believe that our direct sales to consumers divert sales +from their stores, our relationships with such customers may weaken and cause them to reduce purchases of our products. As we continue to grow our consumer direct channels (company-operated retail and internet) this issue could be exacerbated. +We depend on a limited number of suppliers for key production materials, and any disruption in the supply of such materials could +interrupt product manufacturing and increase product costs. +We depend on a limited number of sources for the primary materials used +to make our footwear. We source the elastomer resins that constitute the primary raw materials used in compounding our Croslite products, which we use to produce our various footwear products, from multiple suppliers. If the suppliers we rely on for +elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production cycle. We are also subject to market issues related to supply and demand for our +raw materials. We may have to pay substantially higher prices in the future for the elastomer resins or any substitute materials we use, which would increase our production costs and could have a significantly adverse impact on our profit margins +and results of operations. If we are unable to obtain suitable elastomer resins or if we are unable to procure sufficient quantities of the Croslite material, we may not be able to meet our production requirements in a timely manner or may need to +modify our product characteristics resulting in less favorable market acceptance which could result in lost potential sales, delays in shipments to customers, strained relationships with customers and diminished brand loyalty. +Failure to adequately protect our trademarks and other intellectual property rights and counterfeiting of our brands could divert sales, damage our +brand image and adversely affect our business. +We utilize trademarks, trade names, copyrights, trade secrets, issued and pending +patents and trade dress and designs on nearly all of our products. We believe that having distinctive marks that are readily identifiable is important to our brand, our success and our competitive position. The laws of some countries, for +example, China, do not protect intellectual property rights to the same extent as do U.S. laws. We frequently +14 +Table of Contents +discover products that are counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. If we are unsuccessful in challenging another party’s +products on the basis of trademark or design or utility patent infringement, particularly in some foreign countries, or if we are required to change our name or use a different logo, continued sales of such competing products by third parties could +harm our brand and adversely impact our business, financial condition, revenues and results of operations by resulting in the shift of consumer preference away from our products. If our brands are associated with inferior counterfeit reproductions, +the integrity and reputation of our brands could be adversely affected. Furthermore, our efforts to enforce our intellectual property rights are typically met with defenses and counterclaims attacking the validity and enforceability of our +intellectual property rights. We may face significant expenses and liability in connection with the protection of our intellectual property, and if we are unable to successfully protect our rights or resolve intellectual property conflicts with +others, our business or financial condition could be adversely affected. +We also rely on trade secrets, confidential information and other +unpatented proprietary rights and information related to, among other things, the Croslite material and product development, particularly where we do not believe patent protection is appropriate or obtainable. Using third party manufacturers and +compounding facilities may increase the risk of misappropriation of our trade secrets, confidential information and other unpatented proprietary information. The agreements we use in an effort to protect our intellectual property, confidential +information and other unpatented proprietary information may be ineffective or insufficient to prevent unauthorized use or disclosure of such trade secrets and information. A party to one of these agreements may breach the agreement and we may not +have adequate remedies for such breach. As a result, our trade secrets, confidential information and other unpatented proprietary rights and information may become known to others, including our competitors. Furthermore, our competitors or others +may independently develop or discover such trade secrets and information, which would render them less valuable to us. +If we do not +accurately forecast consumer demand, we may have excess inventory to liquidate or have greater difficulty filling our customers’ orders, either of which could adversely affect our business. +The footwear industry is subject to cyclical variations, consolidation, contraction and closings, as well as fashion trends, rapid changes in consumer +preferences, the effects of weather, general economic conditions and other factors affecting demand and possibly impairing our brand image. In addition, sales to our wholesale customers are generally subject to rights of cancellation and +rescheduling by the customer. These factors make it difficult to forecast consumer demand. If we overestimate demand for our products, we may be forced to liquidate excess inventories at discounted prices resulting in lower gross margins. +Conversely, if we underestimate consumer demand, we could have inventory shortages which can result in lower sales, delays in shipments to customers, strains on our relationships with customers and diminished brand loyalty. A decline in demand for +our products, or any failure on our part to satisfy increased demand for our products, could adversely affect our business and results of operations. +We have substantial cash requirements in the U.S.; however, a majority of our cash is generated and held outside of the U.S. The consequential risks of holding cash abroad could adversely affect our +financial condition and results of operations. +We have substantial cash requirements in the U.S., but the majority of our cash is +generated and held abroad. We generally consider unremitted earnings of subsidiaries operating outside of the U.S. to be indefinitely reinvested and it is not our current intent to change this position. Cash held outside of the U.S. is primarily +used for the ongoing operations of the business in the locations in which the cash is held. Most of the cash held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal and state income taxes, +less applicable foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. Certain countries, including China, +may have monetary laws which may limit our ability to utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or other countries +and may adversely affect our liquidity. Since repatriation of such cash is subject to limitations and may be subject to significant taxation, we cannot be certain that we will be able to repatriate such cash on favorable terms or in a timely manner. +If we incur operating losses on a continued +15 +Table of Contents +basis and require cash that is held in international accounts for use in our U.S. operations, a failure to repatriate such cash in a timely and cost-effective manner could adversely affect our +business, financial condition and results of operations. +We have been named as a defendant in a securities class action lawsuit that +may result in substantial costs and could divert management’s attention. +Starting in November 2007, certain stockholders filed +several purported shareholder class actions in the U.S. District Court for the District of Colorado alleging violations of Sections 10(b) and 20(a) of the Exchange Act based on alleged statements made by us between July 27, 2007 and +October 31, 2007. We and certain of our current and former officers and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of Colorado. The first complaint was filed in +November 2007; several other complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the Court appointed a lead plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The +amended complaint purports to state claims under Section 10(b), 20(a), and 20A of the Exchange Act on behalf of a class of all persons who purchased our stock between April 2, 2007 and April 14, 2008 (the “Class Period”). +The amended complaint alleges that, during the Class Period, defendants made false and misleading public statements about us and our business and prospects and that, as a result, the market price of our stock was artificially inflated. The amended +complaint also claims that certain current and former officers and directors traded our stock on the basis of material non-public information. The amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified amount, +interest and an award of attorneys’ fees and costs of litigation. On February 28, 2011, the District Court granted motions to dismiss filed by the defendants and dismissed all claims. A final judgment was thereafter entered. Plaintiffs +subsequently appealed to the United States Court of Appeals for the Tenth Circuit. We and those current and former officers and directors named as defendants have entered into a Stipulation of Settlement with the plaintiffs that would, if approved +by the United States District Court for the District of Colorado, resolve all claims asserted against us by the plaintiffs on behalf of the putative class, and plaintiffs’ appeal would be dismissed. Our independent auditor is not a party to the +Stipulation of Settlement. The Stipulation of Settlement is subject to customary conditions, including preliminary court approval, and final court approval following notice to stockholders. If the settlement becomes final, all amounts required by +the settlement will be paid by our insurers. There can be no assurance that the settlement will be finally approved by the District Court, or that approval by the District Court will, if challenged, be upheld by the Tenth Circuit. +We are subject to periodic litigation, which could result in unexpected expense of time and resources. +From time to time, we are called upon to defend ourselves against lawsuits relating to our business. Due to the inherent uncertainties of litigation, we +cannot accurately predict the ultimate outcome of any such proceedings. An unfavorable outcome could have an adverse impact on our business, financial condition and results of operations. In addition, any significant litigation in the future, +regardless of its merits, could divert management’s attention from our operations and result in substantial legal fees. In the past, securities class action litigation has been brought against us. If our stock price is volatile, we may become +involved in this type of litigation in the future. Any litigation could result in substantial costs and a diversion of management’s attention and resources that are needed to successfully run our business. +Our quarterly revenues and operating results are subject to fluctuation as a result of a variety of factors, including seasonal variations, which +could increase the volatility of the price of our common stock. +Sales of our products are subject to seasonal variations and are +sensitive to weather conditions. As a significant portion of our revenues are attributable to footwear styles that are more suitable for fair weather, we typically experience our highest sales activity during the second and third quarters of the +calendar year, when there is a revenue concentration in countries in the northern hemisphere. While we continue to create new footwear styles that are more suitable for cold weather, the effects of favorable or unfavorable weather on sales can be +significant enough to affect our quarterly results which could adversely affect our common stock price. Quarterly results may also fluctuate as a result of other factors, including new style introductions, general economic conditions or +16 +Table of Contents +changes in consumer preferences. Results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year and revenues for any particular period +may fluctuate. This could lead to results outside of analyst and investor expectations, which could increase volatility of our stock price. +We may fail to meet analyst expectations, which could cause the price of our stock to decline. +Our common stock is traded publicly and various securities analysts follow our financial results and frequently issue reports on us which include +information about our historical financial results as well as their estimates of our future performance. These estimates are based on their own opinions and are often different from management’s estimates or expectations of our business. If our +operating results are below the estimates or expectations of public market analysts and investors, our stock price could decline. +We +may fail to protect the integrity and security of customer and associate information. +We routinely possess sensitive customer and +associate information and, while we believe we have taken reasonable and appropriate steps to protect that information, if our security procedures and controls were compromised, it could harm our business, reputation, results of operations and +financial condition and may increase the costs we incur to protect against such information security breaches, such as increased investment in technology, the costs of compliance with consumer protection laws and costs resulting from consumer fraud. +We depend on key personnel, the loss of whom would harm our business. +The loss of the services and expertise of any key employee could harm our business. Our future success depends on our ability to identify, attract and retain qualified personnel on a timely basis. In +addition, we must successfully integrate any newly hired management personnel within our organization in order to achieve our operating objectives. Changes in other key management positions may temporarily affect our financial performance and +results of operations as new management becomes familiar with our business. We have experienced management turnover in recent years. Turnover of senior management can adversely impact our stock price, our results of operations and our client +relationships and may make recruiting for future management positions more difficult. In some cases, we may be required to pay significant amounts of severance to terminated management employees. +Our current management information systems may not be sufficient for our business and planned system improvements may not be successfully +implemented on a timely basis or be sufficient for our business. +We are in the process of implementing numerous information systems +designed to support several areas of our business, including warehouse management, order management, retail point-of-sale and internet point-of-sale as well as various systems that provide interfaces between these systems. These systems are intended +to assist in streamlining our operational processes and eliminating certain manual processes. However, for certain business planning, finance and accounting functions, we still rely on manual processes that are difficult to control and are subject +to human error. We may experience difficulties in transitioning to our new or upgraded systems, including loss of data and decreases in productivity, as our personnel become familiar with these new systems. In addition, our management information +systems will require modification and refinement as our business needs change which could prolong the difficulties we experience with systems transitions and we may not always employ the most effective systems for our purposes. If we experience +difficulties in implementing new or upgraded information systems or experience significant system failures, or if we are unable to successfully modify our management information systems to respond to changes in our business needs, our ability to +properly run our business could be adversely affected. +Changes in tax laws and unanticipated tax liabilities and the results of tax +audits or litigation could adversely affect our effective income tax rate and profitability. +We are subject to income taxes in the +United States and numerous foreign jurisdictions. Our effective income tax rate in the future could be adversely affected by a number of factors, including: changes in the mix of earnings in +17 +Table of Contents +countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, changes in tax laws, the outcome of income tax audits in various jurisdictions +around the world and any repatriation of non-US earnings for which we have not previously provided for U.S. taxes. We regularly assess all of these matters to determine the adequacy of our tax provision, which is subject to significant discretion +and we could face significant adverse impact if our assumptions are incorrect and/or face significant cost to defend our practices from international and U.S. tax authorities. We are regularly subject to, and are currently undergoing, audits by tax +authorities in the United States and foreign jurisdictions for prior tax years. For example, we are currently subject to a tax audit in Mexico on the value of imported raw material and have been notified of a $22.0 million penalty. See Part I +Item 3 “Legal Proceedings” for additional details regarding the Mexican tax audit. In addition, in Brazil we have been assessed $1.1 million in additional sales taxes, excluding penalties and interest, relating to our usage of tax +credits for the period May 2009 through April 2010. Although we believe our tax estimates are reasonable and we intend to defend our positions through litigation if necessary, the final outcome of tax audits and related litigation is inherently +uncertain and could be materially different than that reflected in our historical income tax provisions and accruals. Moreover, we could be subject to assessments of substantial additional taxes and/or fines or penalties relating to ongoing or +future audits. The adverse resolution of any audits or litigation could have an adverse effect on our financial position and results of operations. +Our financial results may be adversely affected if substantial investments in businesses and operations fail to produce expected returns. +From time to time, we may invest in business infrastructure, acquisitions of new businesses and expansion of existing businesses, such as our retail +operations, which require substantial cash investment and management attention. We believe cost effective investments are essential to business growth and profitability. However, significant investments are subject to typical risks and uncertainties +inherent in acquiring or expanding a business. The failure of any significant investment to provide the returns or profitability we expect or the failure to integrate newly acquired businesses could have a material adverse effect on our financial +results and divert management attention from more profitable business operations. +Natural disasters could negatively impact our +operating results and financial condition. +Natural disasters such as earthquakes, hurricanes, tsunamis or other adverse weather and +climate conditions, whether occurring in the U.S. or abroad, and the consequences and effects thereof, including energy shortages and public health issues, could disrupt our operations or the operations of our vendors and other suppliers, or result +in economic instability that may negatively impact our operating results and financial condition. +Our restated certificate of +incorporation, amended and restated bylaws and Delaware law contain provisions that could discourage a third party from acquiring us and consequently decrease the market value of an investment in our stock. +Our restated certificate of incorporation, amended and restated bylaws, and Delaware corporate law each contain provisions that could delay, defer, or +prevent a change in control of us or changes in our management. These provisions could discourage proxy contests and make it more difficult for our stockholders to elect directors and take other corporate actions, which may prevent a change of +control or changes in our management that a stockholder might consider favorable. In addition, Section 203 of the Delaware General Corporation Law may discourage, delay, or prevent a change in control of us. Any delay or prevention of a change +of control or change in management that stockholders might otherwise consider to be favorable could cause the market price of our common stock to decline. +ITEM 1B. Unresolved Staff Comments +None. +18 +Table of Contents +ITEM 2. +Properties +Our principal executive and +administrative offices are located at 7477 East Dry Creek Parkway, Niwot, Colorado. We lease, rather than own, all of our facilities. We enter into short-term and long-term leases for kiosks, office, retail, manufacturing and warehouse space +domestically and internationally. The terms of these leases include fixed monthly rents and/or contingent rents based on percentage of revenues, for our retail stores, and have expirations between 2013 and 2023. The general location, use and +approximate size of our principal properties are given below. +Location +Operating Segment(s) +that Use this Property +Use +Approximate +Square Feet +Ontario, California +Americas +Warehouse +399,000 +Leon, Mexico +Americas, Asia, Other businesses +Manufacturing/offices +219,000 +Leon, Mexico +Americas, Asia, Other businesses +Warehouse +173,000 +Rotterdam, the Netherlands +Europe +Warehouse +174,000 +Niwot, Colorado +Americas +Corporate headquarters and regional offices +160,000 +Narita, Japan +Asia +Warehouse +156,000 +Tampere, Finland (1) +Europe +Warehouse/offices +61,000 +Padova, Italy +Americas, Asia, Europe, Other businesses +EXO’s regional offices/manufacturing/warehouse +45,000 +Hoopddorf, the Netherlands +Europe +Regional offices +31,000 +Shenzen, China +Americas, Asia, Europe, Other businesses +Manufacturing/offices +28,000 +Moscow, Russia +Europe +Warehouse/offices +27,000 +Gordon’s Bay, South Africa +Asia +Warehouse/offices +24,000 +Singapore +Asia +Regional offices +23,000 +Shanghai, China +Asia +Regional offices +17,000 +Tokyo, Japan +Asia +Regional offices +13,000 +(1) +The warehouse facilities in this location are fully or partially subleased. +In addition to the properties listed above, we maintain small branch sales offices in the United States, Canada, South America, Taiwan, Hong Kong, Australia, Korea, China, the United Emirates, India and +Europe. We also lease retail space for 287 retail stores, 129 outlet stores and 121 kiosks and store in stores, globally as of December 31, 2012. +Of our 537 global stores, 199 stores operated in our Americas segment, including 170 located in the U.S. and 12 located in Canada; 241 stores operated in our Asia segment, including 63 located in Korea, +43 located in Taiwan, 40 located in Japan, 39 located in China and 17 located in Hong Kong; and 97 stores operated in our Europe segment, including 29 located in Russia, 18 located in Germany, and 16 located in Great Britain. The remaining stores +were located throughout Asia, Europe, Australia, the Middle East, South America and South Africa. +ITEM 3. +Legal Proceedings +We and certain +current and former officers and directors have been named as defendants in complaints filed by investors in the United States District Court for the District of Colorado. The first complaint was filed in November 2007 and several other complaints +were filed shortly thereafter. These actions were consolidated and, in September 2008, the district court appointed a lead plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purports to state +claims under Section 10(b), 20(a), and +19 +Table of Contents +20A of the Exchange Act on behalf of a class of all persons who purchased our common stock between April 2, 2007 and April 14, 2008 (the “Class Period”). The amended complaint +also added our independent auditor as a defendant. The amended complaint alleges that, during the Class Period, the defendants made false and misleading public statements about us and our business and prospects and, as a result, the market price of +our common stock was artificially inflated. The amended complaint also claims that certain current and former officers and directors traded in our common stock on the basis of material non-public information. The amended complaint seeks compensatory +damages on behalf of the alleged class in an unspecified amount, including interest, and also added attorneys’ fees and costs of litigation. On February 28, 2011, the District Court granted motions to dismiss filed by the defendants and +dismissed all claims. A final judgment was thereafter entered. Plaintiffs subsequently appealed to the United States Court of Appeals for the Tenth Circuit. We and those current and former officers and directors named as defendants have entered into +a Stipulation of Settlement with the plaintiffs that would, if approved by the United States District Court for the District of Colorado, resolve all claims asserted against us by the plaintiffs on behalf of the putative class, and plaintiffs’ +appeal would be dismissed. Our independent auditor is not a party to the Stipulation of Settlement. The Stipulation of Settlement is subject to customary conditions, including preliminary court approval, and final court approval following notice to +stockholders. If the settlement becomes final, all amounts required by the settlement will be paid by our insurers. There can be no assurance that the settlement will be finally approved by the District Court, or that approval by the District Court +will, if challenged, be upheld by the Tenth Circuit. +On October 27, 2010, Spectrum Agencies (“Spectrum”) filed suit against +our subsidiary, Crocs Europe B.V. (“Crocs Europe”), in the High Court of Justice, Queen’s Bench Division, Royal Courts of Justice in London, United Kingdom (“UK”). Spectrum acted as an agent for Crocs products in the UK from +2005 until Crocs Europe terminated the relationship on July 3, 2008 due to Spectrum’s breach of its duty to act in good faith towards Crocs Europe. Spectrum alleges that Crocs Europe unlawfully terminated the agency relationship and failed +to pay certain sales commissions. A trial on the liability, not quantum (compensation and damages), was held at the High Court in London from November 30, 2011 to December 5, 2011. On December 16, 2011, the High Court of Justice +issued a judgment that found that although Spectrum’s actions were a breach of its duty to act in good faith towards Crocs Europe the breach was not sufficiently severe to justify termination. We believe that the trial judge erred in his +findings and subsequently appealed the judgment. On October 30, 2012, the Court of Appeal handed down its judgment confirming the trial judge’s findings. We submitted a request to the Supreme Court seeking permission to appeal and +anticipate that a decision by the Supreme Court on permission to appeal will be rendered in the first quarter of 2013. Given that this phase of the proceedings only pertains to liability, there have been no findings in relation to the amount of +compensation or damages other than with respect to legal fees. Under English law, the prevailing party is entitled to reimbursement of reasonable legal fees incurred in the liability proceedings. Spectrum has not quantified its claim for +compensation and damages and the amount will be assessed later in the proceedings. Proceedings on quantum may be stayed until a decision on permission to appeal has been handed down or in the event that permission is granted, until a final decision +on the merits. +We are currently subject to an audit by U.S. Customs & Border Protection (“CBP”) in respect of the period +from 2006 to 2010. CBP issued a draft audit report to which we subsequently filed comments and objections. We believe that a final report (and notice of a formal claim) will not be issued until sometime in mid-2013. CBP has provided us +with preliminary projections and a draft audit report that reflect unpaid duties totaling approximately $14.3 million during the period under review. We have responded that these projections are erroneous and provided arguments that demonstrate the +amount due in connection with this matter is considerably less than the preliminary projection. CBP is currently reviewing this response. It is not possible at this time to predict whether our arguments will be successful in eliminating or +reducing the amount in dispute. Likewise, it is not possible to predict whether CBP may seek to assert a claim for penalties in addition to any loss of revenue claim. +We are currently subject to an audit by Mexico’s Federal Tax Authority (“SAT”) for the period from January 2006 to July 2011. There are two phases to the audit, the first for capital +equipment and finished goods and the second for raw materials. The first phase is complete and no major discrepancies were noted by the SAT. On January 9, 2013, Crocs received a notice for the second phase in which the SAT proposed a tax +assessment (taxes +20 +Table of Contents +and penalties) of roughly 280 million pesos (approximately $22.0 million) based on the value of all of Crocs’ imported raw materials during the audit period. We believe that the +proposed penalty amount is unfounded and without merit. We have retained local counsel to handle the matter and who will argue that the amount due in connection with the matter, if any, is substantially less than that proposed by the SAT. We expect +it to take between two and three years for resolution of this matter in the Mexican courts. It is not possible at this time to predict the outcome of this matter or reasonably estimate any potential loss. +Although we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property and product +liability claims, we are not party to any other pending legal proceedings that we believe will have a material adverse impact on our business. +ITEM 4. Mine Safety Disclosures +None. +PART II +ITEM 5. +Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities +Market Information +Our common stock, +par value $0.001, is listed on the NASDAQ Global Select Market and trades under the stock symbol “CROX”. The following table shows the high and low sales prices of our common stock for the periods indicated. +Fiscal Year 2012 Three Months Ended +High +Low +March 31, 2012 +$ +22.40 +$ +15.06 +June 30, 2012 +22.59 +15.24 +September 30, 2012 +18.60 +13.80 +December 31, 2012 +$ +16.79 +$ +12.00 +Fiscal Year 2011 Three Months Ended +High +Low +March 31, 2011 +$ +19.61 +$ +15.28 +June 30, 2011 +26.04 +17.88 +September 30, 2011 +32.47 +23.12 +December 31, 2011 +$ +27.68 +$ +14.20 +21 +Table of Contents +Performance Graph +The following performance graph illustrates a five-year comparison of cumulative total return of our common stock, the NASDAQ Composite Index and the Dow Jones U.S. Footwear Index from December 31, +2007 through December 31, 2012. The graph assumes an investment of $100 on December 31, 2007 and assumes the reinvestment of all dividends and other distributions and reflects our stock prices post-stock split. +Comparison of Cumulative Total Return on Investment +12/31/2007 +12/31/2008 +12/31/2009 +12/31/2010 +12/31/2011 +12/31/2012 +Crocs, Inc. +$ +100.00 +$ +3.37 +$ +15.62 +$ +46.51 +$ +40.12 +$ +39.09 +Nasdaq Composite Index +100.00 +59.46 +85.55 +100.02 +98.22 +113.85 +Dow Jones US Footwear Index +$ +100.00 +$ +71.61 +$ +91.56 +$ +119.87 +$ +134.10 +$ +140.52 +The Dow Jones U.S. Footwear Index includes companies in the major line of business in which we compete. This index does +not encompass all of our competitors or all of our product categories and lines of business. The Dow Jones U.S. Footwear Index consists of Crocs, Inc., NIKE, Inc., Deckers Outdoor Corp. and Wolverine World Wide, Inc. As +Crocs, Inc. is part of the Dow Jones U.S. Footwear Index, the price and returns of our stock have an effect on this index. +The stock +performance shown on the performance graph above is not necessarily indicative of future performance. We do not make nor endorse any predictions as to future stock performance. +Holders +The approximate number of stockholders of record of our common stock was 168 as +of January 31, 2013. Because many of the shares of our common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial owners represented by these stockholders of +record. +Dividends +We have +never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future earnings for use in the operation of our business and do not anticipate paying any cash +22 +Table of Contents +dividends in the foreseeable future. Our financing arrangements also contain restrictions on our ability to pay cash dividends. Any future determination to declare cash dividends will be made at +the discretion of our board of directors, subject to compliance with covenants under any then-existing financing agreements. +ISSUER PURCHASE OF EQUITY SECURITIES +Period +Total Number +of Shares +(or Units) +Purchased +Average +Price Paid +per Share +(or Unit) +Total Number of +Shares (or Units) +Purchased as Part +of +Publicly Announced +Plans or Programs +Maximum Number (or +Approximate Dollar Value) of +Shares (or +Units) that May Yet +Be Purchased Under the Plans +Programs (1) +October 1, 2012—October 31, 2012 +— +$ +— +— +5,476,000 +November 1, 2012—November 30, 2012 +625,900 +12.24 +625,900 +4,850,100 +December 1, 2012—December 31, 2012 +1,257,640 +13.78 +1,257,640 +3,592,460 +Total +1,883,540 +$ +13.27 +1,883,540 +3,592,460 +(1) +On November 1, 2007 and April 14, 2008, our Board of Directors approved an authorization to repurchase up to 1.0 million shares and 5.0 million +shares, respectively, of our common stock. As of December 31, 2012, approximately 3.6 million shares remained available for repurchase under our share repurchase authorization. Share repurchases may be made in the open market or in +privately negotiated transactions. The repurchase authorization does not have an expiration date and does not oblige us to acquire any particular amount of our common stock. The repurchase authorization maybe be modified, suspended or discontinued +at any time. +23 +Table of Contents +ITEM 6. Selected Financial Data +The following table presents selected historical financial data for each of our last five fiscal years. The information in this table should be read in +conjunction with the consolidated financial statements and accompanying notes beginning on page F-1 and with “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” included in Item 7 of this +Form 10-K. +For the Year Ended December 31, +($ thousands, except share data) +2012 +2011 +2010 +2009 +2008 +Consolidated Statements of Operations Data +Revenues +$ +1,123,301 +$ +1,000,903 +$ +789,695 +$ +645,767 +$ +721,589 +Cost of sales +515,324 +464,493 +364,631 +337,720 +486,722 +Restructuring charges +— +— +1,300 +7,086 +901 +Gross profit +607,977 +536,410 +423,764 +300,961 +233,966 +Selling, general and administrative expenses +460,393 +404,803 +342,961 +319,102 +343,362 +Restructuring charges +— +— +2,539 +7,623 +7,664 +Asset impairments +1,410 +528 +141 +26,085 +45,784 +Income (loss) from operations +146,174 +131,079 +78,123 +(51,849 +) +(162,844 +) +Foreign currency transaction (gains) losses, net +2,500 +(4,886 +) +(2,325 +) +(665 +) +25,438 +Other income, net +(2,711 +) +(1,578 +) +(1,001 +) +(4,058 +) +(565 +) +Interest expense +837 +853 +657 +1,495 +1,793 +Income (loss) before income taxes +145,548 +136,690 +80,792 +(48,621 +) +(189,510 +) +Income tax (benefit) expense +14,205 +23,902 +13,066 +(6,543 +) +(4,434 +) +Net income (loss) attributable to common stockholders +$ +131,343 +$ +112,788 +$ +67,726 +$ +(42,078 +) +$ +(185,076 +) +Income (loss) per common share: +Basic +$ +1.46 +$ +1.27 +$ +0.78 +$ +(0.49 +) +$ +(2.24 +) +Diluted +$ +1.44 +$ +1.24 +$ +0.76 +$ +(0.49 +) +$ +(2.24 +) +Weighted average common shares: +Basic +89,571,105 +88,317,898 +85,482,055 +85,112,461 +82,767,540 +Diluted +90,588,416 +89,981,382 +87,595,618 +85,112,461 +82,767,540 +December 31, +($ thousands) +2012 +2011 +2010 +2009 +2008 +Consolidated Balance Sheets Data +Cash and cash equivalents +$ +294,348 +$ +257,587 +$ +145,583 +$ +77,343 +$ +51,665 +Total assets +829,638 +695,453 +549,481 +409,738 +455,999 +Long term obligations +54,300 +48,370 +35,613 +35,462 +35,303 +Total stockholders’ equity +$ +617,400 +$ +491,780 +$ +376,106 +$ +287,620 +$ +287,163 +24 +Table of Contents +ITEM 7. +Management’s Discussion and Analysis of Financial Condition and Results of Operations +Business Overview +We are a designer, +manufacturer, distributor, worldwide marketer and brand manager of innovative casual lifestyle footwear, apparel and accessories for men, women and children. We strive to be the global leader in molded footwear design and development. We design, +manufacture and sell a broad product offering that provides new and exciting molded footwear products that feature comfort, fun, color and functionality. Our products include footwear and accessories that utilize our proprietary closed cell-resin, +called Croslite. Our Croslite material is unique in that it enables us to produce an innovative, lightweight, non-marking, and odor-resistant shoe. +Since the initial introduction and popularity of our Beach and Crocs Classic designs, we have expanded our Croslite products to include a variety of new styles and products and have extended our product +reach through the acquisition of brand platforms such as Jibbitz and Ocean Minded. We intend to continue to expand the breadth of our footwear product lines, bringing a unique and original perspective to the consumer in styles that may be unexpected +from Crocs. We believe this will help us to continue to build a stable year-round business as we move towards becoming a four-season brand. +We currently sell our Crocs-branded products globally through domestic and international retailers and distributors. We also sell our products directly +to consumers through our company-operated retail stores, outlets, kiosks and webstores,. The broad appeal of our footwear has allowed us to market our products to a wide range of distribution channels, including department stores and traditional +footwear retailers as well as a variety of specialty and independent retail channels. +As a global company, we have significant revenues and +costs denominated in currencies other than the U. S. dollar. Sales in international markets in foreign currencies are expected to continue to represent a substantial portion of our revenues. Likewise, we expect our subsidiaries with functional +currencies other than the U.S. dollar will continue to represent a substantial portion of our overall gross margin and related expenses. Accordingly, changes in foreign currency exchange rates could materially affect revenues and costs or the +comparability of revenues and costs from period to period as a result of translating our financial statements into our reporting currency. +2012 Financial Highlights +Our business +continues to experience positive results primarily from higher sales volumes and higher average shoe prices. Results for 2012 reflect increases in both consolidated revenues and earnings driven by balanced international growth, operational +efficiency, and customer focus. +The following are the more significant developments in our businesses during the year ended December 31, +2012: +• +Revenues increased $122.4 million, or 12.2%, from 2011 to $1,123.3 million in 2012. Revenue growth was driven by increased sales volume and focused +improvements on average footwear selling prices with new product styles as we continue to transform Crocs brand awareness into an all-season footwear brand. +• +Gross profit increased $71.6 million, or 13.3%, from 2011 to $608.0 million in 2012. Gross margin percentage increased slightly compared to last year +driven by higher average selling prices and higher footwear unit sales, which are results of the continued growth and expansion of our retail and internet channels as the growth in combined sales from these channels began to outpace our wholesale +channel. These drivers were offset by higher costs primarily from the expansion of our +25 +Table of Contents +product offerings in 2012 utilizing traditional materials, such as textile fabric and leather, and increased offerings of discounted products and promotional items through our wholesale and +direct-to-consumer channels. +• +Selling, general, and administrative expenses increased $55.6 million, or 13.7%, from 2011 to $460.4 million in 2012, which consists of $229.8 million +in indirect expenses and $230.6 million in direct expenses. Selling, general, and administrative expenses continue to increase as we continue to increase our retail store locations and continue to make strategic purchases to improve the operational +efficiency of the Company. +• +Net income increased $18.6 million, or 16.5%, from 2011 to $131.3 million in 2012 driving our basic and diluted earnings per share from $1.27 to $1.46 +and $1.24 to $1.44, respectively, due to higher operating results and to a lesser extent a lower effective tax rate. +• +In October 2012, we began the implementation of a customized and fully integrated operations, accounting, and finance enterprise resource planning +(“ERP”) system which is expected to launch in the first half of 2014. The introduction of the new ERP to our current environment will allow for seamless, high-quality, and compliant data across the Company. As of December 31, 2012, +total costs related to the ERP implementation were $9.9 million, of which $9.0 million was capitalized and $0.9 million was expensed. We have financed $6.6 million of our total costs related to the ERP under a Master Installment Payment Agreement +with PNC Bank National Association (“PNC”). Our total anticipated expenses to complete the ERP implementation are $25.0 million. +• +In December 2012, we renegotiated our Credit Agreement to increase our credit line to $100 million, extending the agreement until December 2017, +reducing our interest rate by 50 basis points for both domestic and LIBOR rate loans, as well as allowing for up to $50 million per quarter, or $150 million per year, to be used towards share repurchases. +• +In the fourth quarter of 2012, approximately 1.9 million shares were repurchased at an average price of $13.27 for a total of value of $25.0 +million, excluding related commission charges. +2013 Outlook +In 2013, we expect another year of increased revenue and earnings as indicated by increased year-over-year global preseason orders from our wholesale +customers for spring and summer and an estimated expansion of retail locations across the globe by 70 to 95 net stores. We expect to have increased revenues driven by continued higher volumes as a result of improving selling conditions, higher +average selling prices, and positive market acceptance on new products contributing to the continued expansion of our reputation as a four season brand. We anticipate margins to continually increase in 2013 as we expand our retail and internet +channels. These channels give us the ability to focus on visual merchandising of new products. +During 2013, we plan to make significant +investments in the operational and technological efficiency of the Company as well as consumer marketing. These investments include a new ERP system, as discussed above, which we currently expect to reduce our 2013 earnings per share by +$0.08—$0.10 per diluted share and represents a transformational change intended to improve our operational efficiency as we adapt as a global company, retail store metrics including increased size of stores and visual merchandising with a focus +on high traffic, outlet locations, and the launching of new web designs in certain regions complimented by suggestive selling tactics and mobile point of sale systems to better assist customers. We intend to focus on organic growth including the +launch of new innovative products, attracting new consumers, retail excellence and wholesale channel expansion with key partners. +26 +Table of Contents +Results of Operations +Comparison of the Years Ended December 31, 2012 and 2011 +Year Ended +December 31, +Change +($ thousands, except per share data and average footwear selling +price) +2012 +2011 +$ +% +Revenues +$ +1,123,301 +$ +1,000,903 +$ +122,398 +12.2 +% +Cost of sales +515,324 +464,493 +50,831 +10.9 +Gross profit +607,977 +536,410 +71,567 +13.3 +Selling, general and administrative expenses +460,393 +404,803 +55,590 +13.7 +Asset impairments +1,410 +528 +882 +167.0 +Income from operations +146,174 +131,079 +15,095 +11.5 +Foreign currency transaction (gains) losses, net +2,500 +(4,886 +) +7,386 +(151.2 +) +Other income, net +(2,711 +) +(1,578 +) +(1,133 +) +71.8 +Interest expense +837 +853 +(16 +) +(1.9 +) +Income before income taxes +145,548 +136,690 +8,858 +6.5 +Income tax expense +14,205 +23,902 +(9,697 +) +(40.6 +) +Net income +$ +131,343 +$ +112,788 +$ +18,555 +16.5 +% +Net income per common share: +Basic +$ +1.46 +$ +1.27 +$ +0.19 +15.0 +% +Diluted +$ +1.44 +$ +1.24 +$ +0.20 +16.1 +% +Gross margin +54.1% +53.6% +50 bps +0.9 +% +Operating margin +13.0% +13.1% +(10) bps +(0.8 +)% +Footwear unit sales +49,947 +47,736 +2,211 +4.6 +% +Average footwear selling price +$ +21.55 +$ +20.04 +$ +1.51 +7.5 +% +Revenues. The following table sets forth revenues by channel for the years ended +December 31, 2012 and 2011. During the year ended December 31, 2012, revenues increased $122.4 million, or 12.2%, compared to the same period in 2011, primarily due to an increase of 2.2 million, or 4.6%, in global footwear unit sales +and an increase of $1.51, or 7.5%, in footwear average selling price. For the year ended December 31, 2012, revenues from our wholesale channel increased $47.5 million, or 7.9%, which was primarily driven by increased wholesale sales in +Americas and Asia. Revenues from our retail channel increased $68.2 million, or 22.2%, primarily driven by strong demand in all three reportable segments as well as continued growth of our retail presence by opening 107 retail stores net during +2012. We also continue to close certain kiosks as branded stores allow us to better merchandise the full breadth and depth of our product line. Revenues from our internet channel increased $6.7 million, or 7.0%, compared to 2011 primarily +driven by increased brand awareness in the Americas and Asia operating segments and focus on improving our regional webstore presence. +27 +Table of Contents +The following table summarizes our total revenue by channel for the years ended December 31, 2012 and +2011. +Year Ended +December 31, +Change +Constant +Currency +Change (1) +($ thousands) +2012 +2011 +$ +% +$ +% +Channel revenues: +Wholesale: +Americas +$ +235,988 +$ +214,062 +$ +21,926 +10.2 +% +$ +25,920 +12.1 +% +Asia +298,350 +259,104 +39,246 +15.1 +38,984 +15.0 +Europe +110,947 +124,995 +(14,048 +) +(11.2 +) +(5,168 +) +(4.1 +) +Other businesses +574 +191 +383 +200.5 +406 +212.4 +Total Wholesale +645,859 +598,352 +47,507 +7.9 +60,142 +10.1 +Consumer-direct: +Retail: +Americas +196,711 +174,840 +21,871 +12.5 +22,691 +13.0 +Asia +143,062 +111,650 +31,412 +28.1 +32,543 +29.1 +Europe +35,052 +20,167 +14,885 +73.8 +16,093 +79.8 +Total Retail +374,825 +306,657 +68,168 +22.2 +71,327 +23.3 +Internet: +Americas +63,153 +59,175 +3,978 +6.7 +4,069 +6.9 +Asia +15,999 +11,012 +4,987 +45.3 +5,049 +45.8 +Europe +23,465 +25,707 +(2,242 +) +(8.7 +) +(163 +) +(0.6 +) +Total Internet +102,617 +95,894 +6,723 +7.0 +8,955 +9.3 +Total revenues: +$ +1,123,301 +$ +1,000,903 +$ +122,398 +12.2 +% +$ +140,424 +14.0 +% +(1) +Reflects year over year change as if the current period results were in “constant currency,” which is a non-GAAP financial measure. See +“Non-GAAP Financial Measures” below for more information. +The table below illustrates the overall growth in the +number of our company-operated retail locations as of December 31, 2012 and 2011. +December 31, +2012 +Opened +Closed +December 31, +2011 +Type: +Kiosk/Store in Store +121 +39 +(76 +) +158 +Retail Stores +287 +120 +(13 +) +180 +Outlet Stores +129 +42 +(5 +) +92 +Total +537 +201 +(94 +) +430 +Geography: +Americas +199 +44 +(42 +) +197 +Asia +241 +94 +(51 +) +198 +Europe +97 +63 +(1 +) +35 +Total +537 +201 +(94 +) +430 +Gross profit. During the year ended December 31, 2012, gross profit increased $71.6 million, or 13.3%, +compared to the same period in 2011, which was primarily attributable to the 4.6% increase in sales volume and a 7.5% increase in footwear average selling price. Higher prices and sales volume are the result of the continued growth and expansion of +our retail and internet channels as the growth in combined sales from these channels began to outpace our wholesale channel. These drivers were offset by higher costs primarily from the expansion of our product offerings in 2012 which utilize +traditional materials, such as textile fabric and leather, and increased offerings of discounted products and promotional items through our wholesale and direct-to-consumer channels. +28 +Table of Contents +Impact on Gross Profit due to Foreign Exchange Rate Fluctuations. Changes in average foreign +currency exchange rates used to translate revenues and costs of sales from our functional currencies to our reporting currency during the year ended December 31, 2012 decreased our gross profit by $7.8 million compared to the same period +in 2011. +Selling, General and Administrative Expenses . Selling, general and administrative expenses increased +$55.6 million, or 13.7%, during the year ended December 31, 2012 compared to the same period in 2011 primarily due to: +(i) +an increase of $23.7 million in rent and building related costs, both of which resulted from continued growth in the number of company operated retail stores; +(ii) +an increase of $14.4 million in salaries and related costs, including variable compensation, resulting from higher global headcount including those needed for new +retail store openings and increased stock compensation; +(iii) +an increase of $9.7 million in other expenses primarily from increases in depreciation and amortization expenses related to additional retail store locations, and +capitalized software as well as bad debt and sales tax expense increases; +(iv) +an increase of $9.8 million in professional service expenses resulting from increased use of outside accounting and finance services, consulting for our new ERP +implementation which began in October 2012, certain legal contingency accruals, increased outside IT costs related to the implementation of new networking devices in our corporate headquarters, and increased costs associated with contracted customer +service, sales support, and performance improvement; and +(v) +the remaining difference is primarily a result of $2.1 million of net decreases in selling, general, and administrative expenses including travel, as we continue to be +conscious of operating expenses throughout the company. +As a percentage of revenues, selling, general and administrative +expenses increased 1.5%, or 60 basis points, to 41.0% in 2012 from 40.4% in 2011. +Impact on Selling, General, and Administrative +Expenses due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate expenses from our functional currencies to our reporting currency during the year ended December 31, 2012, +decreased selling, general and administrative expenses by approximately $4.8 million as compared to the same period in 2011. +Asset +Impairments. Asset impairments increased $0.9 million, or 167%, during the year ended December 31, 2012 primarily due to the impairment of $1.4 million of long-lived assets related to retail stores in the United States and Canada. +During 2012, we recorded impairments related to four retail locations as our projected discounted future cash flows of these locations is currently not sufficient to cover our fixed asset investments for these stores. +Foreign Currency Transaction (Gains)/Losses . The line item entitled “Foreign currency transaction (gains)/losses, net” is +comprised of foreign currency gains and losses from the re-measurement and settlement of monetary assets and liabilities denominated in non-functional currencies and the impact of certain foreign currency derivative instruments. In 2012, we +recognized a loss of $2.5 million related to foreign currency transactions, compared to a $4.9 million gain in 2011, primarily due to a $4.3 million loss in the first quarter of 2012 as a result of large currency fluctuations and an increase in +international business. We implemented a foreign currency hedging strategy in the second quarter of 2012. As a result of this strategy, we have been able to reduce the impacts of foreign currency fluctuations on our financial statements. +29 +Table of Contents +Income tax (benefit) expense . During the year ended December 31, 2012, income tax +expense decreased $9.7 million resulting in a 7.7% decrease in effective tax rate compared to the same period in 2011, which was primarily due to a reversal of certain tax provisions and the release of certain valuation allowances associated +with deferred tax assets. Our effective tax rate of 9.8% for the year ended December 31, 2012 differs from the federal U.S. statutory rate primarily because of the above releases as well as differences between income tax rates between U.S. and +foreign jurisdictions. +Comparison of the Years Ended December 31, 2011 and 2010 +Year Ended December 31, +Change +($ thousands, except per share data and average footwear selling price) +2011 +2010 +$ +% +Revenues +$ +1,000,903 +$ +789,695 +$ +211,208 +26.7 +% +Cost of sales +464,493 +364,631 +99,862 +27.4 +Restructuring charges +— +1,300 +(1,300 +) +(100.0 +) +Gross profit +536,410 +423,764 +112,646 +26.6 +Selling, general and administrative expenses +404,803 +342,961 +61,842 +18.0 +Restructuring charges +— +2,539 +(2,539 +) +(100.0 +) +Asset impairments +528 +141 +387 +274.5 +Income from operations +131,079 +78,123 +52,956 +67.8 +Foreign currency transaction gains, net +(4,886 +) +(2,325 +) +(2,561 +) +110.2 +Other income, net +(1,578 +) +(1,001 +) +(577 +) +57.6 +Interest expense +853 +657 +196 +29.8 +Income before income taxes +136,690 +80,792 +55,898 +69.2 +Income tax expense +23,902 +13,066 +10,836 +82.9 +Net income +$ +112,788 +$ +67,726 +$ +45,062 +66.5 +% +Net income per common share: +Basic +$ +1.27 +$ +0.78 +$ +0.49 +62.8 +% +Diluted +$ +1.24 +$ +0.76 +$ +0.48 +63.2 +% +Gross margin +53.6 +% +53.7 +% +(10) bps +(0.2 +)% +Operating margin +13.1 +% +9.9 +% +320 bps +32.3 +% +Footwear unit sales +47,736 +42,618 +5,118 +12.0 +% +Average footwear selling price +$ +20.04 +$ +17.69 +$ +2.35 +13.3 +% +Revenues. During the year ended December 31, 2011, revenues from our wholesale channel increased +$118.3 million, or 24.6%, which was primarily driven by strong demand in all three operating segments, particularly Asia. Revenues from our retail channel increased $72.0 million, or 30.7%, as we continued to grow our retail presence by opening +new retail stores. We also closed certain kiosks as branded stores allow us to better merchandise the full breadth and depth of our product line. Revenues from our internet channel increased $20.9 million, or 27.9%, primarily driven by increased +internet sales in the Americas and Europe operating segments. +30 +Table of Contents +The following table summarizes our total revenue by channel for the years ended December 31, 2011 and +2010. +Year Ended +December, 31 +Change +Constant +Currency +Change (1) +($ thousands) +2011 +2010 +$ +% +$ +% +Channel revenues: +Wholesale: +Americas +$ +214,062 +$ +182,149 +$ +31,913 +17.5 +% +$ +29,914 +16.4 +% +Asia +259,104 +200,013 +59,091 +29.5 +40,317 +20.2 +Europe +124,995 +95,806 +29,189 +30.5 +23,629 +24.7 +Other businesses +191 +2,119 +(1,928 +) +(91.0 +) +(1,927 +) +(90.9 +) +Total Wholesale +598,352 +480,087 +118,265 +24.6 +91,934 +19.1 +Consumer-direct: +Retail: +Americas +174,840 +141,892 +32,948 +23.2 +32,369 +22.8 +Asia +111,650 +77,319 +34,331 +44.4 +27,561 +35.6 +Europe +20,167 +15,426 +4,741 +30.7 +3,799 +24.6 +Total Retail +306,657 +234,637 +72,020 +30.7 +63,729 +27.2 +Internet: +Americas +59,175 +50,832 +8,343 +16.4 +8,246 +16.2 +Asia +11,012 +7,685 +3,327 +43.3 +2,382 +31.0 +Europe +25,707 +16,454 +9,253 +56.2 +7,890 +48.0 +Total Internet +95,894 +74,971 +20,923 +27.9 +18,518 +24.7 +Total revenues: +$ +1,000,903 +$ +789,695 +$ +211,208 +26.7 +% +$ +174,181 +22.1 +% +(1) +Reflects year over year change as if the current period results were in “constant currency,” which is a non-GAAP financial measure. See +“Non-GAAP Financial Measures” below for more information. +The table below illustrates the overall growth in the +number of our company-operated retail locations as of December 31, 2011 and 2010. +December 31, +2011 +Opened +Closed +December 31, +2010 +Type: +Kiosk/Store in Store +158 +30 +(25 +) +153 +Retail Stores +180 +57 +(13 +) +136 +Outlet Stores +92 +14 +— +78 +Total +430 +101 +(38 +) +367 +Geography: +Americas +197 +27 +(22 +) +192 +Asia +198 +63 +(16 +) +151 +Europe +35 +11 +— +24 +Total +430 +101 +(38 +) +367 +Gross Profit. During the year ended December 31, 2011, gross profit increased $112.6 million, or +26.6%, compared to the same period in 2010, which was primarily attributable to the 12.0% increase in sales volume and 13.3% in footwear average selling price as margin remained relatively flat year over year. +Impact on Gross Profit due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate +revenues and costs of sales from our functional currencies to our reporting currency, the U.S. dollar, during the year ended December 31, 2011 increased our gross profit by $22.2 million compared to the same period in 2010. +31 +Table of Contents +Selling, General and Administrative Expenses . Selling, general and administrative +expenses increased $61.8 million, or 18.0%, during the year ended December 31, 2011 compared to the same period in 2010 primarily due to (i) an increase of $29.3 million in salaries and related costs resulting from higher global +headcount, (ii) an increase of $20.0 million in rent and building related costs, both of which resulted from continued growth in the number of company-operated retail stores and (iii) an increase of $6.5 million in contract labor which was +primarily attributable to higher internet channel outsourced services, increased costs associated with contracted customer service and sales support, and other costs associated with IT support and process improvement. As a percentage of revenues, +selling, general and administrative expenses decreased 6.9%, or 300 basis points, to 40.4% in 2011 from 43.4% in 2010. +Impact on +Selling, General, and Administrative Expenses due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate expenses from our functional currencies to our reporting currency during the year +ended December 31, 2011 increased selling, general and administrative expenses by approximately $14.8 million as compared to the same period in 2010. +Restructuring charges . Restructuring charges decreased by $3.8 million during the year ended December 31, 2011 compared to the same period in 2010 as we had no restructurings +during 2011. The 2010 restructuring charges consisted of $2.0 million in severance costs related to the departure of a former executive and $1.8 million related to a change in estimate of our original accrual for lease termination costs for our +office facility in Canada, which was closed in 2008. +Foreign Currency Transaction (Gains)/Losses . Foreign currency +transaction gains increased $2.6 million, or 110.2%, during the year ended December 31, 2011 compared to the same period in 2010, primarily due to a correction related to an error in the classification of certain intercompany receivables and +payables balances that should have been deemed permanently invested in certain prior periods. +Income tax (benefit) expense. +During the year ended December 31, 2011, income tax expense increased $10.8 million compared to the same period in 2010, which was primarily due to an increase in pre-tax income. In addition, the company recognized a one-time $3.6 million +tax benefit recorded during the second quarter of 2011 as a result of a change in our international structure and a $3.0 million tax benefit recognized in the third quarter of 2010 due to a change in an international tax treaty which reduced certain +taxes for which accruals had previously been made. Our effective tax rate of 17.5% for the year ended December 31, 2011 differs from the federal U.S. statutory rate primarily because of differences between income tax rates between US and +foreign jurisdictions. +Presentation of Reportable Segments +We have three reportable operating segments: Americas, Europe and Asia. Revenues of each of our reportable operating segments represent sales to external customers. We also have an “Other +businesses” category which aggregates insignificant operating segments that do not meet the reportable threshold and represent manufacturing operations located in Mexico and Italy. The composition of our reportable operating segments is +consistent with that used by our chief operating decision maker (“CODM”) to evaluate performance and allocate resources. Each of our reportable operating segments derives its revenues from the sale of footwear, apparel and accessories to +external customers. Revenues for the “Other businesses” represent non-footwear product sales to external customers. Segment assets consist of cash and cash equivalents, accounts receivable and inventory. +Segment operating income is the primary measure used by our CODM to evaluate segment operating performance and to decide how to allocate resources to +segments. Segment performance evaluation is based primarily on segment results without allocating corporate expenses, or indirect general, administrative and other expenses. Segment profits or losses of our reportable operating segments include +adjustments to eliminate intersegment profit or losses on intersegment sales. +32 +Table of Contents +During the first quarter of 2012, we changed the internal reports used by our CODM to align the definition +of our segment operating income with “Income from operations.” Previously, segment operating income excluded asset impairment charges and restructuring costs not included in cost of sales. Segment operating income also reflects the +reclassification of “Foreign currency transaction (gains) losses, net” from “Income from operations” on the consolidated statements of income. See Note 1—Organization & Summary of Significant Accounting Policies for +further discussion. Segment information for all periods presented has been reclassified to reflect these changes. +Comparison of the Years +Ended December 31, 2012 and 2011 +The following tables set forth information related to our reportable operating business segments +for the years ended December 31, 2012 and 2011. +Year Ended December 31, +Change +Constant Currency +Change (4) +($ thousands) +2012 +2011 +$ +% +$ +% +Revenues: +Americas +$ +495,852 +$ +448,077 +$ +47,775 +10.7 +% +$ +52,680 +11.8 +% +Asia +457,411 +381,766 +75,645 +19.8 +76,576 +20.1 +Europe +169,464 +170,869 +(1,405 +) +(0.8 +) +10,762 +6.3 +Total segment revenues +1,122,727 +1,000,712 +122,015 +12.2 +140,018 +14.0 +Other businesses +574 +191 +383 +200.5 +406 +212.4 +Total consolidated revenues +$ +1,123,301 +$ +1,000,903 +$ +122,398 +12.2 +% +$ +140,424 +14.0 +% +Operating income: +Americas +$ +85,538 +$ +70,532 +$ +15,006 +21.3 +% +$ +14,962 +21.2 +% +Asia +140,828 +123,918 +16,910 +13.6 +16,701 +13.5 +Europe +21,678 +37,106 +(15,428 +) +(41.6 +) +(12,137 +) +(32.7 +) +Total segment operating income +248,044 +231,556 +16,488 +7.1 +19,526 +8.4 +Other businesses (1) +(10,805 +) +(14,128 +) +3,323 +(23.5 +) +3,235 +(22.9 +) +Intersegment eliminations +60 +66 +(6 +) +(9.1 +) +(16 +) +(23.6 +) +Unallocated corporate and other (2) +(91,125 +) +(86,415 +) +(4,710 +) +5.5 +(4,785 +) +5.5 +Total consolidated operating income (3) +$ +146,174 +$ +131,079 +$ +15,095 +11.5 +% +$ +17,960 +13.7 +% +(1) +During the year ended December 31, 2012, operating losses of Other businesses decreased $3.3 million primarily due to a $2.5 million increase in +gross margin and a $0.8 million decrease in selling, general and administrative expenses. +(2) +Includes a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand marketing, legal, depreciation on corporate and other assets not allocated to operating segments and costs of the same nature of certain corporate holding companies. For the year ended December 31, 2012, +Unallocated corporate and other expenses increased $4.7 million compared to the same period in 2011, primarily due to a $3.3 million increase in cost of sales and a $2.0 million increase in selling, general, and administrative costs due to higher +corporate headcount partially offset by a decrease of $0.5 million in asset impairments and a decrease of $0.1 million in charitable contributions. +(3) +Please refer to our Results of Operations to reconcile total consolidated operating income to net income as segment information does not have an effect +on values below total consolidated operating income. +(4) +Reflects year over year change as if the current period results were in “constant currency,” which is a non-GAAP financial measure. See +“Non-GAAP Financial Measures” below for more information. +Americas Operating Segment. During the year +ended December 31, 2012, revenues from the Americas segment increased $47.8 million, or 10.7%, compared to the same period in 2011 primarily due to a 4.3% increase in +33 +Table of Contents +footwear units sold and a 5.8% increase in average footwear selling price partially offset by a $4.9 million unfavorable impact from foreign currency fluctuations. Revenue growth for the region +was realized primarily in the wholesale channel which increased $21.9 million, or 10.2%, and in the retail channel which increased $21.9 million, or 12.5%. We continue to focus on disciplined expansion of our retail channel by opening 22 full +price stores net and 15 outlet stores net in 2012, offset by the closing of 35 underperforming kiosk locations net. Segment operating income increased by $15.0 million, or 21.3%, driven mainly by the revenue increase and a slight increase in segment +gross margin of approximately 2.2%, or 110 basis points, which was largely offset by a $12.5 million, or 8.3%, increase in selling, general and administrative expenses resulting from the continued expansion of the retail channel. Foreign currency +fluctuations had a net negative impact of $1.8 million on gross margin and an immaterial impact on operating income for the Americas region. +Asia Operating Segment . During the year ended December 31, 2012, revenues from the Asia segment increased $75.6 million, or 19.8%, compared +to the same period in 2011 primarily due to a 14.5% increase in footwear units sold and a 5.1% increase in average footwear selling price partially offset by a $0.9 million unfavorable impact from foreign currency fluctuations. Revenue growth for +the region was realized in all three channels as we retain strong support from our wholesale channel customers, continue to focus on disciplined expansion of our retail channel and continue to implement new, consumer-friendly webstores in various +countries in our internet channel. Wholesale channel revenue increased $39.2 million, or 15.1%, retail channel revenue increased $31.4 million, or 28.1%, and internet channel revenue increased $5.0 million, or 45.3%. In 2012, we opened 43 total +stores net in the Asia region including 41 full price stores net and 8 outlet stores net partially offset by the closing of 6 underperforming kiosk locations net. Segment operating income increased $16.9 million, or 13.6%, primarily due to the +increase in revenues and a $0.2 million favorable net impact from foreign currency fluctuations which were partially offset by a $27.7 million, or 24.3%, increase in selling, general and administrative expenses resulting from the continued expansion +of the retail channel and a slight decrease in segment gross margin of approximately 1.0%, or 60 basis points. Foreign currency fluctuations had a net negative impact of $0.5 million on the Asia gross margin. +Europe Operating Segment. During the year ended December 31, 2012, revenues from the Europe segment decreased $1.4 million, or 0.8%, compared +to the same period in 2011 primarily due to an 11.3% decrease in footwear units sold and a $12.2 million unfavorable impact from foreign currency fluctuations partially offset by a 13.4% increase in average footwear selling price. A decrease of +$14.0 million, or 11.2%, in wholesale channel revenue and a decrease of $2.2 million, or 8.7%, in internet channel revenue drove the decline in total segment revenues which was primarily due to the decrease in footwear units sold and unfavorable +impact of foreign currency fluctuations as a result of challenging macroeconomic conditions in Europe. The wholesale and internet channel revenue decreases were partially offset by a revenue increase of $14.9 million, or 73.8%, in the retail channel +as we opened 62 stores net in 2012 including 44 full price stores net, 14 outlet stores net and 4 kiosk locations net. Segment operating income decreased by $15.4 million, or 41.6%, driven mainly by decreased revenues, an increase of $14.3 million, +or 28.4%, in selling, general, and administrative expenses resulting from the continued expansion of the retail channel, a $3.3 million unfavorable net impact from foreign currency fluctuations, and a slight decrease in segment gross margin of +approximately 0.4%, or 20 basis points. Foreign currency fluctuations had a net negative impact of $6.1 million on the Europe gross margin. +34 +Table of Contents +Comparison of the Years Ended December 31, 2011 and 2010 +The following tables set forth information related to our reportable operating business segments for the years ended December 31, 2011 and 2010. +Year Ended December 31, +Change +Constant Currency +Change (4) +($ thousands) +2011 +2010 +$ +% +$ +% +Revenues: +Americas +$ +448,077 +$ +374,873 +$ +73,204 +19.5 +% +$ +70,529 +18.8 +% +Asia +381,766 +285,017 +96,749 +33.9 +70,260 +24.7 +Europe +170,869 +127,686 +43,183 +33.8 +35,319 +27.7 +Total segment revenues +1,000,712 +787,576 +213,136 +27.1 +176,108 +22.4 +Other businesses +191 +2,119 +(1,928 +) +(91.0 +) +(1,927 +) +(90.9 +) +Total consolidated revenues +$ +1,000,903 +$ +789,695 +$ +211,208 +26.7 +$ +174,181 +22.1 +% +Operating income: +Americas +$ +70,532 +$ +64,099 +$ +6,433 +10.0 +$ +6,138 +9.6 +% +Asia +123,918 +89,248 +34,670 +38.8 +24,707 +27.7 +Europe +37,106 +22,258 +14,848 +66.7 +12,739 +57.2 +Total segment operating income +231,556 +175,605 +55,951 +31.9 +43,584 +24.8 +Other businesses (1) +(14,128 +) +(23,321 +) +9,193 +(39.4 +) +9,598 +(41.2 +) +Intersegment eliminations +66 +1,360 +(1,294 +) +(95.1 +) +(1,294 +) +(95.2 +) +Unallocated corporate and other (2) +(86,415 +) +(75,522 +) +(10,893 +) +14.4 +(10,721 +) +14.2 +Total consolidated operating income (3) +$ +131,079 +$ +78,122 +$ +52,957 +67.8 +% +$ +41,167 +52.7 +% +(1) +During the year ended December 31, 2011, operating losses of Other businesses decreased $9.2 million primarily due to a $7.6 million increase in +gross profit related to higher revenues and a $1.5 million decrease in selling, general, and administrative expenses primarily related to lower salaries and wages associated with lower supply chain headcount. +(2) +Includes a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand marketing, legal, depreciation on corporate and other assets not allocated to operating segments and costs of the same nature of certain corporate holding companies. For the year ended December 31, 2011, +Unallocated corporate and other expense increased $10.9 million compared to the same period in 2010, primarily due to a $4.7 million increase in salaries and wages due to higher corporate headcount, a $2.9 million increase in outside services +primarily costs associated with IT support and process improvement, a $1.8 million increase in depreciation and amortization of unallocated corporate long-lived assets and a $1.2 million increase in marketing and travel costs. +(3) +Please refer to our Results of Operations to reconcile total consolidated operating income to net income as segment information does not have an effect +on values below total consolidated operating income. +(4) +Reflects year over year change as if the current period results were in “constant currency,” which is a non-GAAP financial measure. See +“Non-GAAP Financial Measures” below for more information. +Americas Operating Segment . During the year +ended December 31, 2011, revenues from the Americas segment increased $73.2 million, or 19.5%, compared to the same period in 2010 primarily due to a 9.3% increase in footwear units sold, a 7.8% increase in average footwear selling price and a +$2.7 million favorable impact from foreign currency fluctuations. Significant sales growth for the segment included an increase of $31.9 million, or 17.5%, in wholesale channel revenue and an increase of $32.9 million, or 23.2%, in retail channel +revenue. Segment operating income increased by $6.4 million, or 10.0%, driven mainly by the revenue increase and a $0.3 million favorable net impact from foreign currency fluctuations which was largely offset by a $16.9 million, +35 +Table of Contents +or 12.6%, increase in selling, general and administrative expenses resulting from the continued expansion of the retail channel and a decrease in segment gross margin of approximately 6.8%, or +360 basis points. +Asia Operating Segment . During the year ended December 31, 2011, revenues from the Asia segment increased $96.8 +million, or 33.9%, compared to the same period in 2010 primarily due to a 13.0% increase in average footwear selling price, a 10.6% increase in footwear units sold and a $26.5 million favorable impact from foreign currency fluctuations. Significant +sales growth for the segment included an increase of $59.1 million, or 29.5% in wholesale channel revenue, an increase of $34.3 million, or 44.4%, in retail channel revenue, and an increase of $3.3 million, or 43.3%, in internet channel revenue. +Segment operating income increased $34.7 million, or 38.8%, primarily due to the increase in revenues and a $10.0 million favorable net impact from foreign currency fluctuations which were partially offset by a $24.3 million, or 27.0% increase in +selling, general and administrative expenses resulting from the continued expansion of the retail channel as segment gross margin remained relatively flat. +Europe Operating Segment . During the year ended December 31, 2011, revenues from the Europe segment increased $43.2 million, or 33.8%, compared to the same period in 2010 primarily due to a +23.2% increase in footwear units sold, a 4.8% increase in average footwear selling price and a $7.9 million favorable impact from foreign currency fluctuations. Significant sales growth for the segment included an increase of $29.2 million, or +30.5%, in wholesale channel revenue, an increase of $4.7 million, or 30.7%, in retail channel revenue and an increase of $9.3 million, or 56.2%, in internet channel revenue. Segment operating income increased $14.8 million, or 66.7%, primarily +due to higher revenues, an increase in segment gross margin of approximately 3.7% or 180 basis points and a $2.1 million favorable net impact from foreign currency fluctuations which were partially offset by a $9.8 million, or 24.1%, increase in +selling, general and administrative expenses resulting from the continued expansion of the retail channel. +Non-GAAP Financial Measures +In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America +(“U.S. GAAP”), we present current period results below in ‘adjusted net income’, which is a non-GAAP financial measure. Adjusted net income excludes the impact of new enterprise resource planning system (“ERP”) +implementation expenses, non-recurring tax benefits, accelerated depreciation and amortization of our current ERP system and certain legal and other contingency accruals. +We also present certain information related to our current period results of operations in this Item 7 through “constant currency”, which is a non-GAAP financial measure and should be +viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been restated using prior year average foreign exchange rates for the +comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rate fluctuations. +Management uses adjusted net income and constant currency figures to assist in comparing business trends from period to period on a consistent basis without regard to the impact of non-recurring items and +foreign exchange rate fluctuations and in communications with the board of directors, stockholders, analysts and investors concerning our financial performance. We believe that these non-GAAP measures are used by, and are useful to, investors and +other users of our financial statements in evaluating operating performance by providing better comparability between reporting periods because they provide an additional tool to evaluate our performance without regard to foreign currency +fluctuations and non-recurring items that may not be indicative of overall business trends and provide a better baseline for analyzing trends in our operations. We do not suggest that investors should consider these non-GAAP measures in isolation +from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. +36 +Table of Contents +The following table is a reconciliation of our net income, the most directly comparable U.S. GAAP measure, +to non-GAAP net income: +Year Ended December, 31 +Reconciliation of GAAP Net Income to Non-GAAP Adjusted +Net Income: +2012 +2011 +2010 +GAAP net income +$ +131,343 +$ +112,788 +$ +67,726 +New ERP implementation (1) +870 +— +— +Contingency accruals (2) +5,904 +— +— +Depreciation and Amortization (3) +903 +— +— +Non-GAAP adjusted net income before income taxes +$ +139,020 +$ +112,788 +$ +67,726 +Income tax benefit (4) +(11,368 +) +(3,634 +) +(3,080 +) +Non-GAAP adjusted net income +$ +127,652 +$ +109,154 +$ +64,646 +Non-GAAP adjusted net income per diluted share +$ +1.40 +$ +1.20 +$ +0.73 +(1) +This proforma adjustment in the GAAP to Non-GAAP reconciliations above represents expenses related to the implementation of a new ERP system. +(2) +This proforma adjustment in the GAAP to Non-GAAP reconciliations above represents contingency accruals of which $2.2 million was recorded in selling, +general and administrative expenses and $3.7 million was recorded in cost of sales. +(3) +This proforma adjustment in this GAAP to Non-GAAP reconciliation represents the add-back of accelerated depreciation and amortization on tangible and +intangible items related to our current ERP system and supporting platforms that will no longer be utilized once the implementation of a new ERP is complete. +(4) +The proforma adjustments in this GAAP to Non-GAAP reconciliation represent the add-back of certain one-time income tax benefits. The year-ended +December 31, 2012 includes a one-time tax benefit of $11.4 million related to the reversal of reserves related to specific uncertain tax positions and the release of certain valuation allowances associated with deferred tax assets. The +year-ended December 31, 2011 includes a one-time tax benefit of $3.6 million related to a change in the international tax structure. The year-ended December 31, 2010 includes a one-time tax benefit of $3.0 million related to a change in an +international tax treaty. +Liquidity and Capital Resources +Cash and cash equivalents at December 31, 2012 increased 14.2% to $294.3 million compared to $257.6 million at December 31, 2011. We anticipate that cash flows from operations will be sufficient +to meet the ongoing needs of our business for the next twelve months. In order to provide additional liquidity in the future and to help support our strategic goals, we also have a revolving credit facility with a syndicate of lenders, including PNC +Bank, N.A. (“PNC”) (further discussed below), which currently provides us with up to $100.0 million in borrowing capacity and matures in December 2017. Additional future financing may be necessary and there can be no assurance that, if +needed, we will be able to secure additional debt or equity financing on terms acceptable to us or at all. +We continue to evaluate options to +maximize the returns on our cash and maintain an appropriate capital structure, including, among other alternatives, repurchases of our common stock. Subject to certain restrictions on repurchases under our revolving credit facility, we have +authorization to repurchase up to 5.5 million shares of our common stock under previous board authorizations. During the fourth quarter of 2012, the Company repurchased approximately 1.9 million shares for an aggregate price of +approximately $25.0 million, excluding related commission charges. The number, price and timing of repurchases, if any, will be at our sole discretion and future repurchases will be evaluated depending on market conditions, liquidity needs and other +factors. +37 +Table of Contents +Revolving Credit Facility +On December 10, 2012, Crocs, Inc. (the “Company”) and its subsidiaries, Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC and Bite, Inc. (collectively with the +Company, the “Borrowers”) entered into the First Amendment to Amended and Restated Credit Agreement (the “First Amendment”) with the lenders named therein and PNC Bank, National Association (“PNC”), as a lender and +administrative agent for the lenders, pursuant to which certain terms of the Amended and Restated Credit Agreement (the “Credit Agreement”), dated December 16, 2011, were amended. The First Amendment, among other things, +(i) extends the maturity date from December 16, 2016 to December 16, 2017, (ii) increases the total commitments under the revolving credit facility from $70 million to $100 million, with the ability to increase commitments to up +to $125 million subject to certain conditions, (iii) decreases the revolving interest rate by 50 basis points for both domestic and LIBOR rate loans, (iv) increases the ability of the Company to make stock repurchases from up to $25 +million per year to up to $150 million per year, subject to certain conditions, (v) increases the limit for permitted acquisitions from up to $40 million per year to up to $100 million per year, subject to certain conditions, (vi) adds a +covenant to maintain unrestricted cash of at least $100 million at all times, subject to limitations, and (vii) amends certain restrictive covenants to be more favorable to the Borrowers. +The Credit Agreement is available for working capital, capital expenditures, permitted acquisitions, reimbursement of drawings under letters of credit, +and permitted dividends, distributions, purchases, redemptions and retirements of equity interests. Borrowings under the Credit Agreement are secured by all of our assets including all receivables, equipment, general intangibles, inventory, +investment property, subsidiary stock and intellectual property. Borrowings under the Credit Agreement bear interest at a variable rate. For domestic rate loans, the interest rate is equal to the highest of (i) the daily federal funds open rate +as quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC’s prime rate and (iii) a daily LIBOR rate plus 1.0%, in each case there is an additional margin ranging from 0.25% to 1.00% based on certain conditions. For LIBOR rate loans, +the interest rate is equal to a LIBOR rate plus a margin ranging from 1.25% to 2.00% based on certain conditions. The Credit Agreement requires monthly interest payments with respect to domestic rate loans and at the end of each interest period with +respect to LIBOR rate loans and contains certain customary restrictive and financial covenants. We were in compliance with these restrictive financial covenants as of December 31, 2012. As of December 31, 2012 and 2011, we had no +outstanding borrowings and $0.4 million of outstanding borrowings, respectively, under the Credit Agreement. At December 31, 2012 and 2011, we had issued and outstanding letters of credit of $6.4 million and $6.0 million, +respectively, which were reserved against the borrowing base. During the years ended December 31, 2012 and 2011, we capitalized $0.5 million and $0.4 million, respectively, in fees and third party costs which were incurred in connection +with the Credit Agreement, as deferred financing costs. +Long-term Debt Agreement +On December 10, 2012, we entered into a Master Installment Payment Agreement (“Master IPA”) with PNC Bank National Association +(“PNC”) in which PNC will finance our purchase of software and services, which may include but are not limited to third party costs to design, install and implement software systems, and associated hardware described in the schedules +defined within the Master IPA. This agreement was entered into to finance the recent implementation of a new ERP system which began in October 2012 and is estimated to continue through early 2014. The terms of the agreement consist of variable +interest rates and payment terms based on amounts borrowed and timing of activity throughout the implementation of the ERP. As of December 31, 2012, we had $6.6 million of long-term debt outstanding under the agreement payable over the next +four years bearing interest at a rate of 2.63% per annum. Interest rates and payment terms are subject to changes as further financing occurs under the Master IPA. +Acquisitions +On July 16, 2012, our subsidiaries Crocs Europe B.V., Crocs +Stores B.V. and Crocs Belgium N.V. (collectively referred to as “Crocs Europe”), acquired certain net assets and activities from Crocs Benelux B.V. (“Benelux”) +38 +Table of Contents +pursuant to a sale and purchase agreement dated July 9, 2012. Prior to the acquisition, Benelux was a distributor of the Company. The Company acquired Benelux’ retail +business and wholesale business, including inventory, fixed assets, customer relationships, 10 retail stores and their associated leases. Total consideration paid was cash of € 3.6 million (approximately $4.6 million). This +acquisition will allow us to take direct control in expanding our business in the Europe region. +Working Capital +As of December 31, 2012, accounts receivable increased $7.5 million to $92.3 million when compared to December 31, 2011, primarily due to +higher sales in the fourth quarter of 2012 compared to the fourth quarter of 2011. Inventories increased $35.2 million, or 27.1%, to $164.8 million as of December 31, 2012 when compared to December 31, 2011, primarily due to wholesale +order growth and higher cost new product introductions, particularly in the Americas and Asia segments, in addition to the global increase in company-operated retail stores. +Capital Assets +During the year ended December 31, 2012, net capital +expenditures, inclusive of intangible assets, acquired with cash increased to $59.5 million compared to $41.6 million during the same period in 2011 primarily due to the capitalization of our ERP implementation costs and leasehold +improvements related to our retail store expansion. +We have entered into various operating leases that require cash payments on a specified +schedule. Over the next five years we are committed to make payments of approximately $278.5 million related to our operating leases. We plan to continue to enter into operating leases related to our retail stores. We also continue to evaluate +cost reduction opportunities. Our evaluation of cost reduction opportunities will include an evaluation of contracts for sponsorships, operating lease contracts and other contracts that require future minimum payments resulting in fixed operating +costs. Any changes to these contracts may require early termination fees or other charges that could result in significant cash expenditures. +Repatriation of Cash +As we are +a global business, we have cash balances which are located in various countries and are denominated in various currencies. Fluctuations in foreign currency exchange rates impact our results of operations and cash positions. Future fluctuations in +foreign currencies may have a material impact on our cash flows and capital resources. Cash balances held in foreign countries have additional restrictions and covenants associated with them which adds increased strains on our liquidity and ability +to timely access and transfer cash balances between entities. +We generally consider unremitted earnings of subsidiaries operating outside of +the U.S. to be indefinitely reinvested and it is not our current intent to change this position with the exception of the expected repatriation of up to approximately $13.6 million in cash that was previously accrued for as a repatriation of 2010 +foreign subsidiary earnings and approximately $25.0 million of 2012 foreign subsidiary earnings. Most of the cash balances held outside of the U.S. could be repatriated to the U.S., but under current law, would be subject to U.S. federal and state +income taxes less applicable foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the cash to another country. Certain countries, +including China, have monetary laws which may limit our ability to utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully utilize our cash resources for needs in the U.S. or +other countries and could adversely affect our liquidity. As of December 31, 2012, we held $272.0 million of our total $294.3 million in cash in international locations. This cash is primarily used for the ongoing operations of the business in +the locations in which the cash is held. Of the $272.0 million, $38.2 million could potentially be restricted, as described above. If the remaining $233.8 million were to be immediately repatriated to the U.S., we would be required to pay +approximately $50.8 million in taxes that were not previously provided for in our consolidated statement of operations. +39 +Table of Contents +Contractual Obligations +In February 2011, we renewed and amended our supply agreement with Finproject S.r.l. which provides us the exclusive right to purchase certain raw materials used to manufacture our products. The +agreement also provides that we meet minimum purchase requirements to maintain exclusivity throughout the term of the agreement, which expires December 31, 2014. Historically, the minimum purchase requirements have not been onerous and we do +not expect them to become onerous in the future. Depending on the material purchased, pricing is either based on contracted price or is subject to quarterly reviews and fluctuates based on order volume, currency fluctuations and raw material prices. +Pursuant to the agreement, we guarantee the payment for certain third-party manufacturer purchases of these raw materials up to a maximum potential amount of €3.5 million (approximately $4.6 million as of December 31, 2012), +through a letter of credit that was issued to Finproject S.r.l. +The following table summarizes aggregate information about our significant +contractual cash obligations as of December 31, 2012. +Payments due by period +($ thousands) +Total +Less than +1 year +1 - 3 +years +4 - 5 +years +More than +5 years +Operating lease obligations +$ +410,904 +$ +80,020 +$ +117,535 +$ +80,959 +$ +132,390 +Inventory purchase obligations with third party manufacturers (1) +152,779 +152,779 +— +— +— +Estimated liability for uncertain tax positions +31,900 +216 +11,766 +10,333 +9,585 +Other contracts (2) +42,257 +13,356 +14,992 +12,418 +1,491 +Debt obligations (3)(4) +6,910 +2,159 +3,455 +1,296 +— +Minimum licensing royalties +3,247 +709 +1,316 +815 +407 +Capital lease obligations (4) +57 +27 +21 +9 +— +Total +$ +648,054 +$ +249,266 +$ +149,085 +$ +105,830 +$ +143,873 +(1) +Includes $5.9 million in purchase commitments with certain third party manufacturers for yet-to-be-received finished product where title passes to us +upon receipt. +(2) +The Other contracts line item consists of various agreements with third-party providers primarily for IT renovation and maintenance in our Niwot, CO +facility and global accounting services. +(3) +In December 2012, we entered into an agreement with PNC Bank to finance the purchase of software and services related to a new ERP system installation, +which began in October 2012 and is estimated to continue through early 2014. +(4) +Amounts include anticipated interest payments. +Off-Balance Sheet Arrangements +We had no material off balance sheet arrangements +as of December 31, 2012. +Critical Accounting Policies and Estimates +General +Our discussion and analysis of financial condition and results of +operations is based on the consolidated financial statements which have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”). The preparation of these financial statements +requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We +evaluate our assumptions and estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis +40 +Table of Contents +for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different +assumptions or conditions. The following discussion pertains to accounting policies management believes are most critical to the portrayal of our financial condition and results of operations that require management’s most difficult, subjective +or complex judgments. +Reserves for Uncollectible Accounts Receivable. We make ongoing estimates related to the +collectability of our accounts receivable and maintain a reserve for estimated losses resulting from the inability of our customers to make required payments. Our estimates are based on a variety of factors, including the length of time receivables +are past due, economic trends and conditions affecting our customer base, significant one-time events and historical write-off experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s +inability to meet its financial obligations. Because we cannot predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates and we may experience changes in the +amount of reserves we recognize for accounts receivable that we deem uncollectible. If the financial condition of some of our customers were to deteriorate, resulting in their inability to make payments, a larger reserve might be required. In the +event we determine that a smaller or larger reserve is appropriate, we would record a credit or a charge to selling, general and administrative expenses in the period in which we made such a determination. +Sales Returns, Allowances and Discounts. We record reductions to revenue for estimated customer returns, allowances and +discounts. Our estimated sales returns and allowances are based on customer return history and actual outstanding returns yet to be received. Provisions for customer specific discounts based on contractual obligations with certain major customers +are recorded as reductions to net sales. We may accept returns from our wholesale and distributor customers on an exception basis at the sole discretion of management for the purpose of stock re-balancing to ensure that our products are merchandised +in the proper assortments. Additionally, at the sole discretion of management, we may provide markdown allowances to key wholesale and distributor customers to facilitate the “in-channel” markdown of products where we have experienced less +than anticipated sell-through. We also record reductions to revenue for estimated customer credits as a result of price mark-downs in certain markets. Fluctuations in our estimates for sales returns, allowances and discounts may be caused by many +factors, including, but not limited to, fluctuations in our sales revenue and changes in demand for our products. Our judgment in determining these estimates is impacted by various factors including customer acceptance of our new styles, customer +inventory levels, shipping delays or errors, known or suspected product defects, the seasonal nature of our products and macroeconomic factors affecting our customers. Because we cannot predict or control certain of these factors, the actual amounts +of customer returns and allowances may differ from our estimates. +Inventory Valuation. Inventories are valued at the +lower of cost or market. Inventory cost is determined using the moving average cost method. At least annually, we evaluate our inventory for possible impairment using standard categories to classify inventory based on the degree to which we believe +that the products may need to be discounted below cost to sell within a reasonable period. We base inventory fair value on several subjective and unobservable assumptions including estimated future demand and market conditions and other observable +factors such as current sell-through of our products, recent changes in demand for our product, shifting demand between the products we offer, global and regional economic conditions, historical experience selling through liquidation and +“off-price” channels and the amount of inventory on hand. If the estimated inventory fair value is less than its carrying value, the carrying value is adjusted to market value and the resulting impairment charge is recorded in cost of +sales on the consolidated statements of operations. The ultimate results achieved in selling excess and discontinued products in future periods may differ significantly from management’s fair value estimates. See Note 2—Inventories in +the accompanying notes to the consolidated financial statements for additional information regarding inventory. +Impairment of +Long-Lived Assets. We test long-lived assets to be held and used for impairment when events or circumstances indicate the carrying value of a long-lived asset may not be fully recoverable. Events that may indicate the impairment +of a long-lived asset (or asset group, as defined below) include: (i) a significant decrease +41 +Table of Contents +in its market price, (ii) a significant adverse change in the extent or manner in which it is being used or in its physical condition, (iii) a significant adverse change in legal +factors or business climate that could affect its value, including an adverse action or assessment by a regulator, (iv) an accumulation of costs significantly in excess of the amount originally expected for its acquisition or construction, +(v) its current period operating or cash flow losses combined with historical operating or cash flow losses or a forecast of its cash flows demonstrate continuing losses associated with its use, and (vi) a current expectation that, more +likely than not, it will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. If such facts indicate a potential impairment of a long-lived asset (or asset group), we assess the recoverability by +determining if its carrying value exceeds the sum of its projected undiscounted cash flows expected from its use and eventual disposition over its remaining economic life. If the asset is not supported on an undiscounted cash flow basis, the amount +of impairment is measured as the difference between its carrying value and its fair value. Assets held for sale are reported at the lower of the carrying amount or fair value less costs to sell. Fair value is determined by independent third party +appraisals, the net present value of expected cash flows, or other valuation techniques as appropriate. Assets to be abandoned or from which no further benefit is expected are written down to zero at the time that the determination is made and the +assets are removed entirely from service. +An asset group is the lowest level of assets and liabilities for which identifiable cash flows are +largely independent of the cash flows of other assets and liabilities. For assets involved in our retail business, our asset group is at the retail store level. Our estimates of future cash flows over the remaining useful life of the asset group are +based on management’s operating budgets and forecasts. These budgets and forecasts take into consideration inputs from our regional management related to growth rates, pricing, new markets and other factors expected to affect the business, as +well as management’s forecasts for inventory, receivables, capital spending, and other cash needs. These considerations and expectations are inherently uncertain, and estimates included in our operating forecasts beyond a three to six month +future period are extremely subjective. Accordingly, actual cash flows may differ significantly from our estimated future cash flows. +Impairment charges are driven by, among other things, changes in our strategic operational and financial decisions, global and regional economic +conditions, demand for our product and other corporate initiatives which may eliminate or significantly decrease the realization of future benefits from our long-lived assets and result in impairment charges in future periods. Significant impairment +charges recognized during a reporting period could have an adverse effect on our reported financial results. +Impairment of +Goodwill & Intangible Assets. Intangible assets with indefinite lives (i.e. goodwill) are evaluated for impairment when events or changes in circumstances indicate that the carrying value may not be fully recoverable and, +at least, annually. Intangible assets that are determined to have definite lives, such as customer relationships, core technology, capitalized software, patents and non-compete agreements are amortized over their useful lives and are evaluated for +impairment only when events or circumstances indicate a carrying value may not be fully recoverable. Recoverability is based on the estimated future undiscounted cash flows of an asset. If the asset is not supported on an undiscounted cash flow +basis, the amount of impairment is measured as the difference between its carrying value and its fair value. Determination of the fair value of indefinite lived intangible assets involves a number of management assumptions including the expected +future operating performance of our reporting units which may change in future periods due to technological changes, economic conditions, changes to our business operations, or the inability to meet business plans, among other things. The valuation +is sensitive to the actual results of any of these uncertain factors which could be negatively affected and may result in additional impairment charges should the actual results differ from management’s estimates. See +Note 4—Goodwill & Intangible Assets, in the accompanying notes to the consolidated financial statements for additional information regarding our intangible assets. +Share-based Compensation. We estimate the fair value of our stock option awards using a Black Scholes valuation model, the inputs of which require various assumptions including +the expected volatility of our stock price and the expected life of the option. The expected volatility assumptions are derived using our historical stock price volatility and the historical volatilities of competitors whose shares are traded in the +public markets. +42 +Table of Contents +These assumptions reflect our best estimates, however; they involve inherent uncertainties based on market conditions generally outside of our control. If factors change and we use a different +methodology for deriving the Black Scholes assumptions, our share- based compensation expense may differ materially in the future from that recorded in the current period. Additionally, we make certain estimates about the number of awards which will +be made under performance based incentive plans. As a result, if other assumptions or estimates had been used, share-based compensation expense could have been materially impacted. Furthermore, if we use different assumptions in future periods, +share-based compensation expense could be materially impacted in future periods. See Note 9—Equity in the accompanying notes to the consolidated financial statements for additional information regarding our share-based compensation. +Income Taxes. We account for income taxes using the asset and liability method which requires the recognition of +deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities. We provide for income taxes at the current and future enacted tax +rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The impact of +an uncertain tax position that is more likely than not of being sustained upon examination by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax +position will be recognized if the position has less than a 50% likelihood of being sustained. Interest expense is recognized on the full amount of deferred benefits for uncertain tax positions. While the validity of any tax position is a matter of +tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. +Our annual +tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax expense and in evaluating our tax +positions. Tax laws require items to be included in our tax returns at different times than when these items are reflected in the consolidated financial statements. As a result, the annual tax rate reflected in our consolidated financial statements +is different than that reported in our tax return (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These +timing differences create deferred tax assets and liabilities. Deferred tax assets and liabilities are determined based on temporary differences between the financial reporting and tax basis of assets and liabilities. The tax rates used to determine +deferred tax assets or liabilities are the enacted tax rates in effect for the year in which the differences are expected to reverse. Based on the evaluation of all available information, we recognize future tax benefits, such as net operating loss +carryforwards, to the extent that realizing these benefits is considered more likely than not. +We evaluate our ability to realize the tax +benefits associated with deferred tax assets by analyzing our forecasted taxable income using both historical and projected future operating results, the reversal of existing temporary differences, taxable income in prior carry back years (if +permitted) and the availability of tax planning strategies. A valuation allowance is required to be established unless management determines that it is more likely than not that we will ultimately realize the tax benefit associated with a deferred +tax asset. Undistributed earnings of a subsidiary are accounted for as a temporary difference, except that deferred tax liabilities are not recorded for undistributed earnings of a foreign subsidiary that are deemed to be indefinitely reinvested in +the foreign jurisdiction. We have operated under a specific plan for reinvestment of undistributed earnings of our foreign subsidiaries which demonstrates that such earnings will be indefinitely reinvested in the applicable tax jurisdictions. Should +we change our plans, we would be required to record a significant amount of deferred tax liabilities. We recognize interest and penalties related to unrecognized tax benefits within the “Income tax expense” line in the accompanying +consolidated statement of operations. Accrued interest and penalties are included within the related tax liability line in the consolidated balance sheets. See Note 11—Income Taxes in the accompanying notes to the consolidated financial +statements for additional information regarding our income taxes. +Recent Accounting Pronouncements. See +Note 1—Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements for recently adopted and issued accounting pronouncements. +43 +Table of Contents +ITEM 7A. +Quantitative and Qualitative Disclosures About Market Risk +Interest Rate Risk +Our exposure to market risk includes interest rate fluctuations in +connection with our revolving credit facility. Borrowings under the revolving credit facility bear interest at a variable rate. For domestic rate loans, the interest rate is equal to the highest of (i) the daily federal funds open rate as +quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC’s prime rate and (iii) a daily LIBOR rate plus 1.0%, in each case there is an additional margin ranging from 0.25% to 1.00% based on certain conditions. For LIBOR rate loans, the +interest rate is equal to a LIBOR rate plus a margin ranging from 1.25% to 2.00% based on certain conditions. Borrowings under the revolving credit facility are therefore subject to risk based upon prevailing market interest rates. Interest rates +fluctuate as a result of many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control. During the year ended December 31, 2012, +the maximum amount borrowed under the Credit Facility was $31.0 million and the average amount of borrowings outstanding was $6.1 million. As of December 31, 2012, there were no borrowings outstanding under the revolving credit facility. If the +prevailing market interest rates relative to these borrowings increased by 10%, our interest expense during the year ended December 31, 2012 would have increased by $0.1 million. +Fluctuations in the prevailing market interest rates, earned on our cash and cash equivalents and restricted cash balances during the year ended +December 31, 2012, would have impacted the consolidated statements of operations by $0.2 million. +Foreign Currency Exchange Risk +As a global company, we have significant revenues and costs denominated in currencies other than the U.S. dollar. We pay the majority of +expenses attributable to our foreign operations in the functional currency of the country in which such operations are conducted and pay the majority of our overseas third-party manufacturers in U.S. dollars. Our ability to sell our products in +foreign markets and the U.S. dollar value of the sales made in foreign currencies can be significantly influenced by foreign currency fluctuations. Fluctuations in the value of foreign currencies relative to the U.S. dollar could result in downward +price pressure for our products and increase losses from currency exchange rates. A decrease of 1% in value of the U.S. dollar relative to foreign currencies would have decreased income before taxes during the year ended December 31, 2012 by +approximately $2.4 million. The volatility of the applicable exchange rates is dependent on many factors that cannot be forecasted with reliable accuracy. In the event our foreign sales and purchases increase and are denominated in currencies other +than the U.S. dollar, our operating results may be affected by fluctuations in the exchange rate of currencies we receive for such sales. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of +Operations,” for a discussion of the impact of foreign exchange rate variances experienced during the years ended December 31, 2012 and 2011. +We transact business in various foreign countries and are therefore exposed to foreign currency exchange rate risk inherent in revenues, costs, and monetary assets and liabilities denominated in +non-functional currencies. We have entered into foreign currency exchange forward contracts and currency swap derivative instruments to selectively protect against volatility in the value of non-functional currency denominated monetary assets and +liabilities, and of future cash flows caused by changes in foreign currency exchange rates. +44 +Table of Contents +The following table summarizes the notional amounts of the outstanding foreign currency exchange contracts +at December 31, 2012 and 2011. The notional amounts of the derivative financial instruments shown below are denominated in their U.S. dollar equivalents and represent the amount of all contracts of the foreign currency specified. These notional +values do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the foreign currency exchange risks. +December 31, +($ thousands) +2012 +2011 +Foreign currency exchange forward contracts by currency: +Japanese Yen +$ +112,500 +$ +27,500 +Euro +5,159 +10,055 +Australian Dollar +4,178 +— +Mexican Peso +11,400 +6,500 +Pound Sterling +8,742 +6,345 +New Zealand Dollar +1,137 +— +Total notional value, net +$ +143,116 +$ +50,400 +Latest maturity date +December 2015 +December 2012 +ITEM 8. +Financial Statements and Supplementary Data +The consolidated financial statements and supplementary data are as set forth in the “Index to Consolidated Financial Statements” on page 46. +ITEM 9. +Changes in and Disagreements with Accountants on Accounting and Financial Disclosure +None. +ITEM 9A. +Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design +and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of December 31, 2012 (the “Evaluation Date”). Based on this evaluation, our Chief Executive Officer +and Chief Financial Officer concluded that as of the Evaluation Date, our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be disclosed in our Securities +and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our Chief +Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. +Management’s Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2012, using the criteria set forth in the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway +Commission (COSO). Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2012. +45 +Table of Contents +Deloitte & Touche LLP, our independent registered public accounting firm, has issued a report +on our internal control over financial reporting, which is included herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially +affected, or is reasonably likely to materially affect, our internal control over financial reporting. +46 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the Company) as of December 31, 2012, based on criteria +established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial +reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Annual Report on Internal Control Over Financial Reporting”. Our responsibility is to +express an opinion on the Company’s internal control over financial reporting based on our audit. +We conducted our audit in accordance +with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was +maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of +internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive +and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and +the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the +maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of +financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide +reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override +of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to +the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal Control +— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission . +We have also audited, +in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2012 of the Company and our report dated February 25, 2013 +expressed an unqualified opinion on those financial statements. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 25, 2013 +47 +Table of Contents +ITEM 9B. +Other Information +On December 10, +2012, we entered into the Master Installment Payment Agreement (“Master IPA”) with PNC Bank to finance our purchase of software and services, which may include but are not limited to third party costs to design, install and implement +software systems, and associated hardware described in the schedules defined within the Master IPA. The Master IPA was entered into to finance the implementation of a new ERP system, which began in October 2012 and is expected to continue through +early 2014. The Master IPA has a borrowing capacity of $25.0 million and provides for variable interest rates and variable payment terms based on amounts borrowed and timing of activity throughout the implementation of the ERP system. As of +December 31, 2012, we had borrowings of $6.6 million outstanding under the Master IPA, payable over the next four years bearing interest at a rate of 2.63% per annum. +PART III +ITEM 10. +Directors, Executive Officers and Corporate Governance +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2013 Annual Meeting of Stockholders to be filed with the SEC within 120 days after +December 31, 2012. +Code of Ethics +We have a written code of ethics in place that applies to all our employees, including our principal executive officer, principal financial officer, principal accounting officer and controller. A copy of +our business code of conduct and ethics policy is available on our website: www.crocs.com. We are required to disclose any change to, or waiver from, our code of ethics for our senior financial officers. We intend to use our website as a method of +disseminating any change to, or waiver from, our business code of conduct and ethics policy as permitted by applicable SEC rules. +ITEM 11. +Executive Compensation +The information +required by this item is incorporated herein by reference to our definitive proxy statement for the 2013 Annual Meeting of Stockholders to be filed with the SEC within 120 days after December 31, 2012. +ITEM 12. +Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2013 Annual Meeting of Stockholders +to be filed with the SEC within 120 days after December 31, 2012, with the exception of those items listed below. +48 +Table of Contents +Securities Authorized for Issuance under Equity Compensation Plans +As shown in the table below, we reserved 2.6 million shares of common stock for future issuance on exercise of outstanding options under equity +compensation plans as of December 31, 2012. +Plan Category +Number of +Securities +to be +Issued +on Exercise of +Outstanding Options +Weighted Average +Exercise Price of +Outstanding +Options +Number of Securities +Remaining Available +for Future +Issuance Under +Plans, Excluding +Securities Available +in First Column +Equity compensation plans approved by stockholders (1) +2,621,686 +$ +13.03 +5,711,637 +Equity compensation plans not approved by stockholders +— +— +— +Total +2,621,686 +$ +13.03 +5,711,637 +(1) +On July 9, 2007, at the annual stockholders’ meeting, our stockholders approved the 2007 Equity Incentive Plan (the “2007 Plan”), +which previously had been approved by our board of directors and which became effective as of July 19, 2007. On June 28, 2011, our stockholders approved an amendment to the 2007 Plan to increase the number of shares of our common stock +available for issuance from 9.0 million shares to 15.3 million shares, subject to adjustment for future stock splits, stock dividends and similar changes in our capitalization. On April 27, 2005, our board of directors adopted the +2005 Equity Incentive Plan (the “2005 Plan”). On January 10, 2006, our board of directors amended the 2005 Plan to increase the number of shares of our common stock available for issuance under the 2005 Plan from 11.7 million +shares to 14.0 million shares. Following the adoption of the 2007 Plan, no future grants were made under the 2005 Plan. +ITEM 13. +Certain Relationships and Related Transactions, and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2013 Annual Meeting of Stockholders to be filed with the SEC within 120 days after +December 31, 2012. +ITEM 14. +Principal Accountant Fees and Services +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2013 Annual Meeting of Stockholders +to be filed with the SEC within 120 days after December 31, 2012. +PART IV +ITEM 15. +Exhibits and Financial Statement Schedules +(1) +Financial Statements +The financial +statements filed as part of this report are listed on the index to financial statements on page 46. +(2) +Financial Statement Schedules +All +financial statement schedules have been omitted because they are not required, are not applicable or the information is included in the Financial Statements or Notes thereto. +49 +Table of Contents +(3) +Exhibit list +Exhibit +Number +Description +3.1 +Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 4.1 to Crocs, Inc.’s Registration Statement on Form S-8, +filed on March 9, 2006 (File No. 333-132312)). +3.1 +Certificate of Amendment to Restated Certificate of Incorporation of Crocs, Inc. (incorporated herein by reference to Exhibit 3.1 to Crocs, Inc.’s Current Report +on Form 8-K, filed on July 12, 2007). +3.2 +Amended and Restated Bylaws of Crocs, Inc. (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-8, filed on +March 9, 2006 (File No. 333-132312)). +4.1 +Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.2 to Crocs, Inc.’s Registration Statement on Form S-1/A, filed on +January 19, 2006 (File No. 333-127526)). +10.1* +Form of Indemnification Agreement between Crocs, Inc. and each of its directors and executive officers (incorporated herein by reference to Exhibit 10.1 to +Crocs, Inc.’s Registration Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.2* +Crocs, Inc. 2005 Equity Incentive Plan (the “2005 Plan”) (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.3* +Amendment No. 1 to the 2005 Plan (incorporated herein by reference to Exhibit 10.2.2 to Crocs, Inc.’s Registration Statement on Form S-1/A, filed on +January 19, 2006 (File No. 333-127526)). +10.4* +Form of Notice of Grant of Stock Option under the 2005 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.’s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.5* +Form of Notice of Grant of Stock Option for Non-Exempt Employees under the 2005 Plan (incorporated herein by reference to Exhibit 10.4 to Crocs, Inc.’s Registration +Statement on Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.6* +Form of Stock Purchase Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.5 to Crocs, Inc.’s Registration Statement on Form S-1, filed +on August 15, 2005 (File No. 333-127526)). +10.7* +Form of Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.6 to Crocs, Inc.’s Registration Statement on Form S-1, filed +on August 15, 2005 (File No. 333-127526)). +10.8* +Form of Restricted Stock Award Grant Notice under the 2005 Plan (incorporated herein by reference to Exhibit 10.7 to Crocs, Inc.’s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.9* +Form of Restricted Stock Award Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.8 to Crocs, Inc.’s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.10* +Form of Non Statutory Stock Option Agreement under the 2005 Plan (incorporated herein by reference to Exhibit 10.9 to Crocs, Inc.’s Registration Statement on +Form S-1, filed on August 15, 2005 (File No. 333-127526)). +10.11* +Crocs, Inc. 2011 Board of Directors Compensation Plan. +50 +Table of Contents +Exhibit +Number +Description +10.12* +Crocs, Inc. Amended and Restated 2007 Senior Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.15 to Crocs, Inc.’s Annual +Report on Form 10-K, filed on March 17, 2009). +10.14* +2008 Cash Incentive Plan (As Amended and Restated Effective June 4, 2012) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Current Report on +Form 8-K, filed on June 7, 2012). +10.15* +Crocs, Inc. 2007 Equity Incentive Plan (As Amended and Restated) (the “2007 Plan”) (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s +Current Report on Form 8-K, filed on July 1, 2011). +10.16* +Form of Incentive Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s Quarterly Report on Form 10-Q, +filed on November 14, 2007). +10.17* +Form of Non-Statutory Stock Option Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Quarterly Report on +Form 10-Q, filed on November 14, 2007). +10.18* +Form of Non-Statutory Stock Option Agreement for Non-Employee Directors under the 2007 Plan (incorporated herein by reference to Exhibit 10.3 to Crocs, Inc.’s +Quarterly Report on Form 10-Q, filed on November 14, 2007). +10.19* +Form of Restricted Stock Unit Agreement under the 2007 Plan (incorporated herein by reference to Exhibit 10.2 to Crocs, Inc.’s Current Report on Form 8-K, filed +on July 1, 2011). +10.20* +Employment Agreement, dated February 9, 2009, between Crocs, Inc. and John McCarvel (incorporated herein by reference to Exhibit 10.1 to Crocs, Inc.’s +Current Report on Form 8-K, filed on February 13, 2009). +10.21* +Employment Agreement, dated May 18, 2009, between Crocs, Inc. and Daniel P. Hart (incorporated herein by reference to Crocs, Inc.’s Quarterly Report on +Form 10-Q, filed on August 5, 2010). +10.22 +Amended and Restated Credit Agreement, dated December 16, 2011, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the lenders named therein +and PNC Bank, National Association, as a lender and administrative agent for the lenders (the “Amended and Restated Credit Agreement”) (incorporated herein by reference to Crocs, Inc.’s Current Report on Form 8-K, filed on +December 19, 2011). +10.23 +First Amendment to the Amended and Restated Credit Agreement, dated December 10, 2012, among Crocs, Inc., Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC, Bite, Inc., the +lenders named therein and PNC Bank, National Association, as a lender and administrative agent (incorporated herein by reference to Crocs, Inc.’s Current Report on Form 8-K, filed on December 11, 2012). +10.24† +Master Installment Payment Agreement, dated December 10, 2012, among Crocs, Inc. the lender named therein and PNC Bank National Association, as a lender and administrative +agent. +21† +Subsidiaries of the registrant. +23.1† +Consent of Deloitte & Touche LLP. +31.1† +Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of +the Sarbanes-Oxley Act. +31.2† +Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of +the Sarbanes- Oxley Act. +32† +Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley +Act. +51 +Table of Contents +Exhibit +Number +Description +101.INS† +XBRL Instance Document** +101.SCH† +XBRL Taxonomy Extension Schema Document** +101.CAL† +XBRL Taxonomy Extension Calculation Linkbase Document** +101.DEF† +XBRL Taxonomy Extension Definition Linkbase Document** +101.LAB† +XBRL Taxonomy Extension Label Linkbase Document** +101.PRE† +XBRL Taxonomy Extension Presentation Linkbase Document** +* +Compensatory plan or arrangement +** +Pursuant to Rule 406T of Regulation S-T, the information in Exhibit 101 is deemed not filed or part of a registration statement or prospectus for purposes of +Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections. +† +Filed herewith. +52 +Table of Contents +SIGNATURES +Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed +on its behalf by the undersigned, thereunto duly authorized, as of February 25, 2013. +CROCS, INC. +a +Delaware Corporation +By: +/s/ J OHN P. M C C ARVEL +Name: John P. McCarvel +Title: President and 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. +Signature +Title +Date +/ S / J OHN P. +M C C ARVEL +John P. McCarvel +President, Chief Executive Officer and Director (Principal Executive Officer) +February 25, 2013 +/ S / J EFFREY J. L ASHER +Jeffrey J. Lasher +Senior Vice President-Finance and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) +February 25, 2013 +/ S / W. S TEPHEN C ANNON +W. Stephen Cannon +Director +February 25, 2013 +/ S / R AYMOND D. C ROGHAN +Raymond D. Croghan +Director +February 25, 2013 +/ S / R ONALD L. F RASCH +Ronald L. Frasch +Director +February 25, 2013 +/ S / P ETER A. J ACOBI +Peter A. Jacobi +Director +February 25, 2013 +/ S / T HOMAS J. S MACH +Thomas J. Smach +Chairman of the Board +February 25, 2013 +/ S / D OREEN A. W RIGHT +Doreen A. Wright +Director +February 25, 2013 +/ S / J EFFREY H. M ARGOLIS +Jeffrey H. Margolis +Director +February 25, 2013 +53 +Table of Contents +INDEX TO FINANCIAL STATEMENTS +Financial Statements: +Report of Independent Registered Public Accounting Firm +F-1 +Consolidated Statements of Operations for the Years Ended December 31, 2012, 2011 and +2010 +F-2 +Consolidated Statements of Comprehensive Income as of December 31, 2012, 2011 and +2010 +F-3 +Consolidated Balance Sheets as of December 31, 2012 and 2011 +F-4 +Consolidated Statements of Stockholders’ Equity for the Years Ended December +31, 2012, 2011 and 2010 +F-5 +Consolidated Statements of Cash Flows for the Years Ended December 31, 2012, 2011 and +2010 +F-6 +Notes to Consolidated Financial Statements +F-7 +54 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We have audited the accompanying consolidated balance sheets of Crocs, Inc. and subsidiaries (the “Company”) as of December 31, 2012 and 2011 and the related consolidated statements of +operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is +to express an opinion on the financial statements based on our audits. +We conducted our audits in accordance with the standards of the Public +Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a +test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial +statement presentation. We believe that our audits provide a reasonable basis for our opinion. +In our opinion, such consolidated financial +statements present fairly, in all material respects, the financial position of Crocs, Inc. and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended +December 31, 2012, in conformity with accounting principles generally accepted in the United States of America +We have also audited, in +accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal Control — +Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2013 expressed an unqualified opinion on the Company’s internal control over financial reporting. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 25, 2013 +F-1 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF OPERATIONS +Year Ended December 31, +($ thousands, except per share data) +2012 +2011 +2010 +Revenues +$ +1,123,301 +$ +1,000,903 +$ +789,695 +Cost of sales +515,324 +464,493 +364,631 +Restructuring charges +— +— +1,300 +Gross profit +607,977 +536,410 +423,764 +Selling, general and administrative expenses +460,393 +404,803 +342,961 +Restructuring charges +— +— +2,539 +Asset impairments +1,410 +528 +141 +Income from operations +146,174 +131,079 +78,123 +Foreign currency transaction (gains) losses, net +2,500 +(4,886 +) +(2,325 +) +Other income, net +(2,711 +) +(1,578 +) +(1,001 +) +Interest expense +837 +853 +657 +Income before income taxes +145,548 +136,690 +80,792 +Income tax expense +14,205 +23,902 +13,066 +Net income +$ +131,343 +$ +112,788 +$ +67,726 +Net income per common share (Note 12): +Basic +$ +1.46 +$ +1.27 +$ +0.78 +Diluted +$ +1.44 +$ +1.24 +$ +0.76 +The accompanying notes are an integral part of these consolidated financial statements. +F-2 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME +December 31, +($ thousands) +2012 +2011 +2010 +Net income +$ +131,343 +$ +112,788 +$ +67,726 +Other comprehensive income (loss): +Foreign currency translation +5,525 +(16,031 +) +9,048 +Reclassification of cumulative foreign exchange translation adjustments to net income +(658 +) +— +(2,364 +) +Total comprehensive income +$ +136,210 +$ +96,757 +$ +74,410 +The accompanying notes are an integral part of these consolidated financial statements. +F-3 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED BALANCE SHEETS +December 31, +($ thousands, except number of shares) +2012 +2011 +ASSETS +Current assets: +Cash and cash equivalents +$ +294,348 +$ +257,587 +Accounts receivable, net of allowances of $13,315 and $15,508, respectively +92,278 +84,760 +Inventories +164,804 +129,627 +Deferred tax assets, net +6,284 +7,047 +Income tax receivable +5,613 +5,828 +Other receivables +24,821 +20,295 +Prepaid expenses and other current assets +24,967 +20,199 +Total current assets +613,115 +525,343 +Property and equipment, net +82,241 +67,684 +Intangible assets, net +59,931 +48,641 +Deferred tax assets, net +34,112 +30,375 +Other assets +40,239 +23,410 +Total assets +$ +829,638 +$ +695,453 +LIABILITIES AND STOCKHOLDERS’ EQUITY +Current liabilities: +Accounts payable +$ +63,976 +$ +66,517 +Accrued expenses and other current liabilities +81,371 +76,506 +Deferred tax liabilities, net +2,405 +2,889 +Income taxes payable +8,147 +8,273 +Current portion of long-term borrowings and capital lease obligations +2,039 +1,118 +Total current liabilities +157,938 +155,303 +Long term income tax payable +36,343 +41,665 +Long-term borrowings and capital lease obligations +4,596 +— +Other liabilities +13,361 +6,705 +Total liabilities +212,238 +203,673 +Commitments and contingencies (Note 13) +Stockholders’ equity: +Preferred shares, par value $0.001 per share, 5,000,000 shares authorized, none outstanding +— +— +Common shares, par value $0.001 per share, 250,000,000 shares authorized, 91,047,297 and 88,662,845 shares issued and +outstanding, respectively, at December 31, 2012 and 90,306,432 and 89,807,146 shares issued and outstanding, respectively, at December 31, 2011 +91 +90 +Treasury stock, at cost, 2,384,452 and 499,286 shares, respectively +(44,214 +) +(19,759 +) +Additional paid-in capital +307,823 +293,959 +Retained earnings +334,012 +202,669 +Accumulated other comprehensive income +19,688 +14,821 +Total stockholders’ equity +617,400 +491,780 +Total liabilities and stockholders’ equity +$ +829,638 +$ +695,453 +The accompanying notes are an integral part of these consolidated financial statements. +F-4 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY +Common Stock +Treasury Stock +Additional +Paid +in +Capital +Retained +Earnings +Accumulated +Other +Comprehensive +Income +Total +Stock +Holders’ +Equity +($ thousands) +Shares +Amount +Shares +Amount +BALANCE—January 1, 2010 +85,659 +$ +85 +565 +$ +(25,260 +) +$ +266,472 +$ +22,155 +$ +24,168 +$ +287,620 +Amortization of stock compensation +— +— +— +— +7,594 +— +— +7,594 +Forfeitures +(454 +) +— +— +— +(288 +) +— +— +(288 +) +Exercises of stock options and issuance of restricted stock awards +2,908 +3 +(77 +) +3,673 +3,515 +— +— +7,191 +Repurchase of common stock for tax withholding +(47 +) +— +47 +(421 +) +— +— +— +(421 +) +Net income +— +— +— +— +— +67,726 +— +67,726 +Foreign currency translation +— +— +— +— +— +— +9,048 +9,048 +Reclassification of cumulative foreign exchange translation adjustments to net income +— +— +— +— +— +— +(2,364 +) +(2,364 +) +BALANCE—December 31, 2010 +88,066 +$ +88 +535 +$ +(22,008 +) +$ +277,293 +$ +89,881 +$ +30,852 +$ +376,106 +Amortization of stock compensation +— +— +— +— +8,928 +— +— +8,928 +Forfeitures +(149 +) +— +— +— +(435 +) +— +— +(435 +) +Exercises of stock options and issuance of restricted stock awards +1,912 +2 +(58 +) +2,739 +8,173 +— +— +10,914 +Repurchase of common stock for tax withholding +(22 +) +— +22 +(490 +) +— +— +— +(490 +) +Net income +— +— +— +— +— +112,788 +— +112,788 +Foreign currency translation +— +— +— +— +— +— +(16,031 +) +(16,031 +) +BALANCE—December 31, 2011 +89,807 +$ +90 +499 +$ +(19,759 +) +$ +293,959 +$ +202,669 +$ +14,821 +$ +491,780 +Amortization of stock compensation +— +— +— +— +11,764 +— +— +11,764 +Forfeitures +(43 +) +— +— +— +(493 +) +— +— +(493 +) +Exercises of stock options and issuance of restricted stock awards +783 +1 +(29 +) +1,112 +2,593 +— +— +3,706 +Repurchase of common stock for tax withholding +— +— +30 +(493 +) +— +— +— +(493 +) +Purchase of treasury stock +(1,884 +) +— +1,884 +(25,074 +) +— +— +— +(25,074 +) +Net income +— +— +— +— +— +131,343 +— +131,343 +Foreign currency translation +— +— +— +— +— +— +5,525 +5,525 +Reclassification of cumulative foreign exchange translation adjustments to net income +— +— +— +— +— +— +(658 +) +(658 +) +BALANCE—December 31, 2012 +88,663 +$ +91 +2,384 +$ +(44,214 +) +$ +307,823 +$ +334,012 +$ +19,688 +$ +617,400 +The accompanying notes are an integral part of these consolidated financial statements. +F-5 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +CONSOLIDATED STATEMENTS OF CASH FLOWS +Year Ended December 31, +($ thousands) +2012 +2011 +2010 +Cash flows from operating activities: +Net income +$ +131,343 +$ +112,788 +$ +67,726 +Adjustments to reconcile net income to net cash provided by operating activities: +Depreciation and amortization +36,694 +37,263 +37,059 +Unrealized (gain) loss on foreign exchange, net +13,928 +(11,892 +) +1,334 +Deferred income taxes +(2,981 +) +(819 +) +(4,999 +) +Charitable contributions +1,743 +2,034 +840 +Non-cash restructuring charges +— +— +196 +Provision for (recovery of) doubtful accounts, net +2,166 +(383 +) +2,204 +Share-based compensation +11,321 +8,550 +7,109 +Other non-cash items +1,392 +339 +1,083 +Changes in operating assets and liabilities: +Accounts receivable +(9,475 +) +(23,278 +) +(13,165 +) +Inventories +(35,493 +) +(13,328 +) +(27,908 +) +Prepaid expenses and other assets +(25,490 +) +(17,598 +) +2,230 +Accounts payable +99 +30,314 +12,689 +Accrued expenses and other liabilities +8,016 +19,922 +20,344 +Accrued restructuring +— +(439 +) +(2,696 +) +Income taxes +(4,907 +) +(1,097 +) +228 +Cash provided by operating activities +128,356 +142,376 +104,274 +Cash flows from investing activities: +Purchases of marketable securities +— +— +(5,654 +) +Sales of marketable securities +— +— +7,369 +Cash paid for purchases of property and equipment +(39,762 +) +(27,718 +) +(31,257 +) +Proceeds from disposal of property and equipment +2,216 +319 +1,274 +Cash paid for intangible assets +(21,074 +) +(13,922 +) +(13,848 +) +Business acquisitions, net of cash +(5,169 +) +— +— +Restricted cash +(2,154 +) +(343 +) +38 +Cash (used in) investing activities +(65,943 +) +(41,664 +) +(42,078 +) +Cash flows from financing activities: +Proceeds from bank borrowings +96,086 +316,595 +83,100 +Repayment of bank borrowings and capital lease obligations +(90,625 +) +(317,704 +) +(84,625 +) +Deferred debt issuance costs +(225 +) +(398 +) +— +Issuances of common stock +3,706 +10,914 +7,191 +Purchase of treasury stock +(25,074 +) +— +— +Repurchase of common stock for tax withholding +(493 +) +(490 +) +(421 +) +Cash provided by (used in) financing activities +(16,625 +) +8,917 +5,245 +Effect of exchange rate changes on cash +(9,027 +) +2,375 +799 +Net increase in cash and cash equivalents +36,761 +112,004 +68,240 +Cash and cash equivalents—beginning of year +257,587 +145,583 +77,343 +Cash and cash equivalents—end of year +$ +294,348 +$ +257,587 +$ +145,583 +Supplemental disclosure of cash flow information—cash paid during the year for: +Interest +$ +619 +$ +843 +$ +639 +Income taxes +$ +29,385 +$ +26,632 +$ +11,048 +Supplemental disclosure of non-cash, investing, and financing activities: +Assets acquired under capitalized leases +$ +34 +$ +— +$ +2,606 +Accrued purchases of property and equipment +$ +2,368 +$ +4,022 +$ +1,826 +Accrued purchases of intangibles +$ +768 +$ +223 +$ +3,786 +The accompanying notes are an integral part of these consolidated financial statements. +F-6 +Table of Contents +CROCS, INC. AND SUBSIDIARIES +NOTES TO CONSOLIDATED FINANCIAL STATEMENTS +1. ORGANIZATION & SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES +Organization —Crocs, Inc. and its subsidiaries (collectively the “Company,” “we,” +“our” or “us”) are engaged in the design, development, manufacturing, marketing and distribution of consumer products, primarily casual and athletic shoes and shoe charms, manufactured from specialty resins referred to as +Croslite. Our wholly owned subsidiaries include, among others, EXO Italia (“EXO”), which designs and develops EVA (Ethylene Vinyl Acetate) based finished products, primarily for the footwear industry; Jibbitz, LLC +(“Jibbitz”), a unique accessory brand with colorful snap-on charms specifically suited for our shoes; and Ocean Minded, Inc. (“Ocean Minded”), which designs, manufactures, markets and distributes high quality leather and EVA +based sandals primarily for the beach, adventure and action sports markets. +Basis of Consolidation and Variable Interest +Entities —The consolidated financial statements include the accounts of our wholly-owned and majority-owned subsidiaries as well as variable interest entities (“VIE”) for which we are the primary beneficiary after the +elimination of intercompany accounts and transactions. The primary beneficiary of a VIE is the entity that has (i) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and +(ii) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. +In 2007, we established a relationship with Shanghai Shengyiguan Trade, Ltd Co (“ST”) for the purpose of serving as a distributor of our +products in the People’s Republic of China. We had previously determined that ST was a VIE for which we were the primary beneficiary and consequently it was consolidated as if a wholly-owned subsidiary. On March 15, 2012, the Company exercised +an Equity Option Agreement that we had in place with ST and became the sole owner of ST. +In April 2011, we and an unrelated third party +formed Crocs Gulf, LLC (“Crocs Gulf”) for the purpose of selling our products in the United Arab Emirates. We have determined that Crocs Gulf is also a VIE for which we are the primary beneficiary due our variable interest in Crocs +Gulf’s equity and because we currently control all of the VIE’s business activities and will absorb all of its expected residual returns and expected losses. All voting and dividend rights have been assigned to us. As of December 31, +2012 and 2011, the consolidated financial statements included $2.5 million and $1.4 million in total assets of Crocs Gulf, respectively, which primarily consisted of cash and cash equivalents, inventory and property and equipment. The total +assets as of December 31, 2012 were partially offset by $0.2 million in total liabilities, which primarily consisted of accounts payable and accrued expenses, excluding liabilities related to the support provided by us. The total assets as of +December 31, 2011 were partially offset by an immaterial amount of total liabilities primarily consisting of accrued expenses, excluding intercompany payables. +Noncontrolling Interests —As of December 31, 2012, all of our subsidiaries were, in substance, wholly owned. +Concentrations of Risk —We are exposed to concentrations of risks in the following categories. +Cash and cash equivalents —Our cash and cash equivalents are maintained in several different financial institutions in amounts that typically exceed U.S. federally insured limits or in +financial institutions in international jurisdictions where insurance is not provided and restrictions may exist. +As we are a +global business, we have cash and cash equivalent balances which are located in various countries and are denominated in various currencies. Most of the cash balances held outside of the U.S. could be repatriated to the U.S., but under current law, +would be subject to U.S. federal and state income +F-7 +Table of Contents +taxes less applicable foreign tax credits. In some countries, repatriation of certain foreign balances is restricted by local laws and could have adverse tax consequences if we were to move the +cash to another country. Certain countries, including China, have monetary laws which may limit our ability to utilize cash resources in those countries for operations in other countries. These limitations may affect our ability to fully utilize our +cash and cash equivalent resources for needs in the U.S. or other countries and could adversely affect our liquidity. As of December 31, 2012, we held $272.0 million of our total $294.3 million in cash in international locations. This cash is +primarily used for the ongoing operations of the business in the locations in which the cash is held. Of the $272.0 million held in international locations, $38.2 million could potentially be restricted, as described above. +Accounts receivable —We have not experienced any significant losses in such accounts and believe we are not exposed to +significant credit risk. We consider any concentration of credit risk related to accounts receivable to be mitigated by our credit policy, the insignificance of outstanding balances owed by each individual customer at any point in time and the +geographic dispersion of our customers. +Manufacturing sources —We rely on a limited source of internal and +external manufacturers. Establishing a replacement source could require significant additional time and expense. +Suppliers +of certain raw materials —We source the elastomer resins that constitute the primary raw materials used in compounding Croslite, which we use to produce our footwear products, from multiple suppliers. If the suppliers we rely on for +elastomer resins were to cease production of these materials, we may not be able to obtain suitable substitute materials in time to avoid interruption of our production cycle, if at all. We may also have to pay materially higher prices in the future +for the elastomer resins or any substitute materials we use, which would increase our production costs and could have a materially adverse impact on our margins and results of operations. +Reclassifications —Certain prior period amounts presented in the consolidated financial statements have been reclassified to conform to current period presentation as follows. We +reclassified ‘Foreign currency transaction (gains) losses, net’ line item from ‘Income from operations’ to ‘Income before income taxes’ in the Consolidated Statements of Operations. We also reclassified (gains) losses +on our derivative contracts from ‘Other (income) expense’ to the ‘Foreign currency transactions (gains) losses, net’ line item. As a result of these reclassifications, ‘Income from operations’ decreased $5.4 million and +$2.9 million, respectively, for the years ended December 31, 2011 and 2010. +Summary of Significant Accounting Policies +Management Estimates —The preparation of financial statements in conformity with generally accepted accounting +principles in the United States of America (“GAAP”) requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported +amounts of revenue and expenses during the reporting period. Management believes that the estimates, judgments and assumptions made when accounting for items and matters such as, but not limited to, the allowance for doubtful accounts, sales +returns, impairment assessments and charges, recoverability of assets (including deferred tax assets), uncertain tax positions, share-based compensation expense, the assessment of lower of cost or market on inventory, useful lives assigned to +long-lived assets, depreciation and provisions for contingencies are reasonable based on information available at the time they are made. Management also makes estimates in the assessments of potential losses in relation to tax and customs matters +and threatened or pending legal proceedings (see Note 15—Legal Proceedings). Actual results could materially differ from these estimates. For matters not related to income taxes, if a loss is considered probable and the amount can be +reasonably estimated, we recognize an expense for the estimated loss. If there is the potential to recover a portion of the estimated loss from a third party, we make a separate assessment of recoverability and reduce the estimated loss if recovery +is deemed probable. +F-8 +Table of Contents +Fair Value —Fair value is the price that would be received from the sale of an asset or +transfer of a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities which are required to be recorded at fair value, we consider the principal +or most advantageous market in which a hypothetical sale or transfer would take place and consider assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of +non-performance. +The fair value hierarchy is made up of three levels of inputs which may be used to measure fair value: +Level 1—observable inputs such as quoted prices for identical instruments in active markets; +Level 2—observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments +in markets that are not active and model derived valuations in which all significant inputs are observable in active markets; and +Level 3—unobservable inputs for which there is little or no market data and which require us to develop our own assumptions. We categorize fair +value measurements within the fair value hierarchy based upon the lowest level of the most significant inputs used to determine such fair value measurement. +Cash equivalents primarily include time deposits and certificates of deposit with original maturities of three months or less. Time deposits and certificates of deposit included in cash equivalents are +valued at amortized cost, which approximates fair value. These investments have been classified as a Level 1 measurement. +Derivative +financial instruments are required to be recorded at their fair value, on a recurring basis. The fair values of our derivative instruments are determined using a discounted cash flow valuation model. The significant inputs used in the model are +readily available in public markets or can be derived from observable market transactions, and therefore, have been classified as Level 2. These inputs include the applicable exchange rates and forward rates, and discount rates based on the +prevailing LIBOR deposit rates. +Our other financial instruments are not required to be carried at fair value on a recurring basis. The +carrying value of these financial instruments, including cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximates fair value due to their short maturities. Based on borrowing rates currently available to us, with +similar terms, the carrying values of capital lease obligations and the line of credit approximate their fair values. +Inventories and +long-lived assets such as property and equipment and intangible assets are also not required to be carried at fair value on a recurring basis. For a discussion of inventory estimated fair value see “Inventory Valuation” below. However, +when determining impairment losses, the fair values of property and equipment and intangibles must be determined. For such determination, we generally use either an income approach with inputs that are mainly unobservable, such as expected future +cash flows, or a market approach using observable inputs such as replacement cost or third party appraisals, as appropriate. Estimated future cash flows are based on management’s operating budgets and forecasts which take into consideration +both observable and unobservable inputs including growth rates, pricing, new markets and other factors expected to affect the business, as well as management’s forecasts for inventory, receivables, capital spending, and other cash needs. See +Note 6—Fair Value Measurements for further discussion related to fair value measurements. +Cash and Cash +Equivalents —Cash and cash equivalents represent cash and short-term, highly liquid investments with maturities of three months or less at the date of purchase. We consider receivables from credit card companies to be cash equivalents, +if expected to be received within five days. +Accounts Receivable —Accounts receivable represent amounts due from customers. +Accounts receivable are recorded at invoiced amounts, net of reserves and allowances, are not collateralized and do not bear interest. We +F-9 +Table of Contents +use our best estimate to determine the required allowance for doubtful accounts based on a variety of factors, including the length of time receivables are past due, economic trends and +conditions affecting our customer base, significant one-time events and historical non-collection experience. Specific provisions are recorded for individual receivables when we become aware of a customer’s inability to meet its financial +obligations. +Inventory Valuation —Inventories are valued at the lower of cost or market. Inventory cost is determined using +the moving average cost method. At least annually, we evaluate our inventory for possible impairment using standard categories to classify inventory based on the degree to which we believe that the products may need to be discounted below cost to +sell within a reasonable period. We base inventory fair value on several subjective assumptions including estimated future demand and market conditions, as well as other observable factors such as current sell-through of our products, recent changes +in demand for our products, global and regional economic conditions, historical experience selling through liquidation and price discounted channels and the amount of inventory on hand. If the estimated inventory fair value is less than its carrying +value, the carrying value is adjusted to market value and the resulting impairment charge is recorded in cost of sales on the consolidated statements of operations. See Note 2—Inventories for further discussion related to inventories. +Property and Equipment —Depreciation of property, equipment, furniture and fixtures is computed using the straight-line +method based on estimated useful lives ranging from two to five years. Leasehold improvements are amortized on the straight-line basis over their estimated economic useful lives or the lease term, whichever is shorter. Depreciation of manufacturing +assets such as molds and tooling is included in cost of sales on the consolidated statements of operations. Depreciation related to corporate, non-product and non-manufacturing assets is included in selling, general and administrative expenses on +the consolidated statements of operations. +Impairment of Long-Lived Assets —Long-lived assets to be held and used are +evaluated for impairment when events or circumstances indicate the carrying value of a long-lived asset may not be fully recoverable. Events that may indicate the impairment of a long-lived asset (or asset group, as defined below) include; +(i) a significant decrease in its market price, (ii) a significant adverse change in the extent or manner in which it is being used or in its physical condition, (iii) a significant adverse change in legal factors or business climate +that could affect its value, including an adverse action or assessment by a regulator, (iv) an accumulation of costs significantly in excess of the amount originally expected for its acquisition or construction, (v) its current period +operating or cash flow losses combined with historical operating or cash flow losses or a forecast of its cash flows demonstrate continuing losses associated with its use, and (vi) a current expectation that, more likely than not, it will be +sold or otherwise disposed of significantly before the end of its previously estimated useful life. If such facts indicate a potential impairment of a long-lived asset (or asset group), we assess the recoverability by determining if its carrying +value exceeds the sum of its projected undiscounted cash flows from its use and eventual disposition over its remaining economic life. If the asset is not supported on an undiscounted cash flow basis, the amount of impairment is measured as the +difference between its carrying value and its fair value. Assets held for sale are reported at the lower of the carrying amount or fair value less costs to sell. Assets to be abandoned or from which no further benefit is expected are written down to +zero at the time that the determination is made and the assets are removed entirely from service. +An asset group is the lowest level of +assets and liabilities for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. For assets involved in our retail business our asset group is at the retail store level. See Note 3—Property and +Equipment for a discussion of impairment losses recorded during the periods presented. +Intangible Assets —Intangible assets +that are determined to have finite lives are amortized over their useful lives on a straight-line basis. Customer relationships are amortized on a straight-line basis or an accelerated basis. Indefinite lived intangible assets, such as trade names, +are not amortized and are evaluated for impairment at least annually and when circumstances imply possible impairment. +Amortization of +manufacturing intangible assets is included in cost of sales on the consolidated statements of operations. Amortization related to corporate, non-product and non-manufacturing assets such as our global +F-10 +Table of Contents +information systems is included in selling, general and administrative expenses on the consolidated statements of operations. The following table sets forth our definite lived intangible assets +and the periods over which they are amortized. +Intangible Asset Class +Weighted Average Amortization +Period +Patents +10 years +Customer relationships +Estimated customer life +Core technology +5 years +Non-competition agreement +Contractual term +Capitalized software +Shorter of 7 years or useful life +Capitalized Software —We capitalize certain internal and external software acquisition and +development costs, including the costs of employees and contractors devoting time to the software development projects and external direct costs for materials and services. Initial costs associated with internally-developed-and-used software are +expensed until it is determined that the project has reached the application development stage. Once in its development stage, subsequent additions, modifications or upgrades to an internal-use software project are capitalized to the extent that +they add functionality. Software maintenance and training costs are expensed in the period in which they are incurred. Capitalized software primarily consists of our enterprise resource system software, warehouse management software and point of +sale software. At least annually, we consider the potential impairment of capitalized software by assessing the substantive service potential of the software, changes, if any, in the extent or manner in which the software is used or is expected to +be used, and the actual cost of software development or modification compared to expected cost. See Note 4—Goodwill and Intangible Assets for further discussion. +Impairment of Intangible Assets —Intangible assets with indefinite lives are evaluated for impairment when events or changes in circumstances indicate that the carrying value may not be fully +recoverable and at least annually. Intangible assets that are determined to have definite lives are amortized over their useful lives and are evaluated for impairment only when events or circumstances indicate a carrying value may not be fully +recoverable. Recoverability is based on the estimated future undiscounted cash flows of the asset. If the asset is not supported on an undiscounted cash flow basis, the amount of impairment is measured as the difference between its carrying value +and its fair value. +Goodwill —Goodwill represents the excess purchase price paid over the fair value of assets acquired and +liabilities assumed in acquisitions. Goodwill is considered an indefinite lived asset and therefore is not amortized. The Company assesses goodwill for impairment annually on the last day of the fourth quarter, or more frequently if events and +circumstances indicate impairment may have occurred. If the carrying value of goodwill exceeds its implied fair value, the Company records an impairment loss equal to the difference. See Note 4—Goodwill and Intangible Assets for discussion +of goodwill balances. There was no impairment of goodwill for the year ended December 31, 2012. We did not have any goodwill for the year ended December 31, 2011. +Earnings per Share —Basic and diluted earnings (loss) per common share (“EPS”) is presented using the two-class method, which is an earnings allocation formula that determines +earnings per share for common stock and any participating securities according to dividend rights and participation rights in undistributed earnings. Under the two-class method, EPS is computed by dividing the sum of distributed and undistributed +earnings (loss) attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. A participating security is an unvested share-based payment award containing non-forfeitable rights to +dividends and must be included in the computation of earnings per share pursuant to the two-class method. Shares of the Company’s non-vested restricted stock awards are considered participating securities. Diluted EPS reflects the potential +dilution from securities that could share in the earnings of the Company. Anti-dilutive securities are excluded from diluted EPS. See Note 12—Earnings per Share for further discussion. +F-11 +Table of Contents +Recognition of Revenues —Revenues are recognized when the customer takes title and assumes +risk of loss, collection of related receivables is probable, persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer depending on the country in which the +sale occurs and the agreement terms with the customer. Allowances for estimated returns and discounts are recognized when the related revenue is earned. +Shipping and Handling Costs and Fees —Shipping and handling costs are expensed as incurred and included in cost of sales. Shipping and handling fees billed to customers are included in +revenues. +Share-based Compensation —We have share-based compensation plans in which certain officers, employees and members +of the Board of Directors are participants and may be granted stock options, restricted stock and stock performance awards. Awards granted under these plans are fair valued and amortized, net of estimated forfeitures, over the vesting period using +the straight-line method. The fair value of stock options is calculated by using the Black Scholes option pricing model that requires estimates for expected volatility, expected dividends, the risk-free interest rate and the term of the option. If +any of the assumptions used in the Black Scholes model or the anticipated number of shares to be awarded change significantly, share-based compensation expense may differ materially in the future from that recorded in the current period. See +additional information related to share-based compensation in Note 9—Equity. Share-based compensation expense associated with our manufacturing and retail employees is included in cost of sales in the consolidated statements of operations. +Share-based compensation expense associated with selling, marketing and administrative employees is included selling, general and administrative expenses on the consolidated statements of operations. +Defined contribution plans —We have a 401(k) plan known as the Crocs, Inc. 401(k) Plan (the “Plan”). The Plan is available to +employees on our U.S. payroll and provides employees with tax deferred salary deductions and alternative investment options. The Plan does not provide employees with the option to invest in our common stock. Employees may contribute up to 75.0% of +their salary, subject to certain limitations. We match employees’ contributions to the Plan up to a maximum of 4.0% of eligible compensation. We expensed $5.8 million, $4.6 million and $3.3 million in the years ended December 31, 2012, +2011 and 2010, respectively, for our employee match contributions to the Plan. +Advertising —Advertising costs are expensed +as incurred and production costs are generally expensed when the advertising is run. Total advertising, marketing and promotional costs reflected in selling, general, and administrative expenses on the consolidated statement of operations were $39.8 +million, $39.8 million and $44.1 million for the years ended December 31, 2012, 2011 and 2010, respectively. +Research +and Development —Research and development costs are expensed as incurred. Research and development expenses amounted to $12.0 million, $10.8 million and $7.8 million for the years ended December 31, 2012, 2011 and 2010, +respectively, and are included in selling, general, and administrative expenses in the consolidated statement of operations. +Foreign +Currency Translation and Foreign Currency Transactions —Our reporting currency is the U.S. dollar. Assets and liabilities of 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 applicable period. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are included in the foreign +currency translation adjustment, a component of accumulated other comprehensive income in stockholders’ equity. +Gains and losses +generated by transactions denominated in currencies other than the local functional currencies are reflected in the consolidated statement of operations in the period in which they occur and are primarily associated with payables and receivables +arising from intercompany transactions. +F-12 +Table of Contents +Derivative Foreign Currency Contracts —We are directly and indirectly affected by +fluctuations in foreign currency rates which may adversely impact our financial performance. To mitigate the potential impact of foreign currency exchange rate risk, we may employ derivative financial instruments including forward contracts and +option contracts. Forward contracts are agreements to buy or sell a quantity of a currency at a predetermined future date and at a predetermined rate. An option contract is an agreement that conveys the purchaser the right, but not the obligation, +to buy or sell a quantity of a currency at a predetermined rate during a period or at a time in the future. These derivative financial instruments are viewed as risk management tools and are not used for trading or speculative purposes. We recognize +derivative financial instruments as either assets or liabilities in the consolidated balance sheets and measure those instruments at fair value. Changes in the fair value of derivatives not designated or effective as hedges are recorded in +“foreign currency transaction (gains)/losses, net” in the consolidated statements of operations. We had no derivative instruments that qualified for hedge accounting during any of the periods presented. See Note 7—Fair Value +Measurements and Financial Instruments for further discussion. +Income Taxes —Income taxes are accounted for using the asset +and liability method which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of other assets and liabilities. We provide +for income taxes at the current and future enacted tax rates and laws applicable in each taxing jurisdiction. We use a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures +regarding uncertainties in income tax positions. We recognize interest and penalties related to income tax matters in income tax expense in the consolidated statement of operations. See Note 11—Income Taxes for further discussion. +Taxes Assessed by Governmental Authorities —Taxes assessed by governmental authorities that are directly imposed on a +revenue transaction, including value added tax, are recorded on a net basis and are therefore excluded from sales. +Application of Recent +Accounting Pronouncements +Recently Adopted Accounting Pronouncements +In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04, +“Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”).” This pronouncement was issued to provide a consistent definition of fair +value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and IFRS. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for level 3 fair +value measurements. This pronouncement is effective for reporting periods beginning on or after December 15, 2011. The adoption of ASU 2011-04 did not have a material impact to our consolidated financial position, results of operations or cash +flows. +In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income.” ASU 2011-05 eliminates the +option to report other comprehensive income and its components in the statement of changes in stockholders’ equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other +comprehensive income either in a single continuous statement or in two separate but consecutive statements. This pronouncement was effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Due +to the fact that ASU 2011-05 concerns presentation and disclosure only, our adoption of this standard in 2012 did not have a material impact on the consolidated financial position, results of operations or cash flows. +In September 2011, the FASB issued ASU No. 2011-08, “Testing Goodwill for Impairment.” This pronouncement was issued to allow companies to +assess qualitative factors to determine if it is more-likely-than- +F-13 +Table of Contents +not that goodwill might be impaired and whether it is necessary to perform the two-step goodwill impairment test required under current accounting standards. This pronouncement was effective for +reporting periods beginning after December 15, 2011. The adoption of ASU 2011-08 did not have a material impact to our consolidated financial position, results of operations or cash flows. +In December 2011, the FASB issued ASU No. 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of +Items out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” This pronouncement was issued due to Stakeholders raising concerns that the new presentation requirements about reclassifications of items out +of accumulated other comprehensive income would be difficult for preparers and may add unnecessary complexity to financial statements and was issued with the intent for companies to defer only those changes in ASU 2011-05 that relate to the +presentation of reclassification adjustments until the Board is able to reconsider certain paragraphs. This pronouncement was effective for reporting periods beginning after December 15, 2011. The adoption of ASU 2011-12 did not have a material +impact to our consolidated financial position, results of operations or cash flows. +In July 2012, the FASB issued ASU No. 2012-02, +“Testing Indefinite-Lived Intangible Assets for Impairment.” This pronouncement was issued to simplify how an entity tests indefinite-lived intangible assets other than goodwill for impairment by providing entities with an option to +perform a qualitative assessment to determine whether further impairment testing is necessary. This pronouncement is effective for reporting periods beginning after September 15, 2012. The adoption of ASU 2012-02 did not have a material impact +to our consolidated financial position, results of operations or cash flows. +Recently Issued Accounting Pronouncements +In December 2011, the FASB issued ASU No. 2011-11, “Disclosures about Offsetting Assets and Liabilities.” This +pronouncement was issued to enhance disclosure requirements surrounding the nature of an entity’s right to offset and related arrangements associated with its financial instruments and derivative instruments. This new guidance requires +companies to disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to master netting arrangements. This pronouncement is +effective for reporting periods beginning on or after January 1, 2013. We do not anticipate the adoption of ASU 2011-11 to have a material impact to the consolidated financial position, results of operations or cash flows. +In January 2013, the FASB issued ASU No. 2013-01, “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” This +pronouncement was issued to address implementation issues about the scope of Accounting Standards Update No. 2011-11 and to clarify the scope of the offsetting disclosures and address any unintended consequences. This pronouncement is effective +for reporting periods beginning on or after January 1, 2013. We do not anticipate the adoption of ASU 2013-01 to have a material impact to the consolidated financial position, results of operations or cash flows. +In February 2013, the FASB issued ASU No. 2013-02, ‘Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” This +pronouncement was issued to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments in this update seek to attain that objective by requiring an entity to report the effect of significant +reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. GAAP to be reclassified in its entirety to net income. For other amounts that are not +required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. This +would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is reclassified to a balance sheet account (i.e. inventory) instead of directly to income or expense in the same reporting period. This +pronouncement is effective prospectively for reporting periods beginning after December 15, 2012. We do not anticipate the adoption of ASU 2013-02 to have a material impact to the consolidated financial position, results of operations or cash +flows. +F-14 +Table of Contents +2. INVENTORIES +The following table summarizes inventories by major classification as of December 31, 2012 and 2011: +December 31, +($ thousands) +2012 +2011 +Finished goods +$ +155,833 +$ +124,203 +Work-in-progress +911 +291 +Raw materials +8,060 +5,133 +Inventories +$ +164,804 +$ +129,627 +During the years ended December 31, 2012, 2011 and 2010, we donated certain inventory items to charitable +organizations consisting primarily of end of life units. The contributions made were expensed at their fair value of $1.7 million, $2.0 million and $0.8 million, respectively. Also during the years ended December 31, 2012, 2011 and 2010, +we recognized a gain of $0.6 million, $0.7 million and $0.2 million, respectively, and a net reduction of inventory of $1.1 million, $1.3 million and $0.6 million, respectively, as the fair value of the inventory contributed exceeded its +carrying amount. +3. PROPERTY AND EQUIPMENT +The following table summarizes property and equipment by major classification as of December 31, 2012 and 2011: +December 31, +($ thousands) +2012 +2011 +Machinery and equipment +$ +68,713 +$ +68,005 +Leasehold improvements +88,653 +65,338 +Furniture, fixtures and other +20,827 +16,196 +Construction-in-progress +8,766 +7,902 +Property and equipment, gross (1) +186,959 +157,441 +Less: Accumulated depreciation (2) +(104,718 +) +(89,757 +) +Property and equipment, net +$ +82,241 +$ +67,684 +(1) +Includes $0.1 million and $0.3 million of certain equipment held under capital leases and classified as equipment as of December 31, 2012 and +2011, respectively. +(2) +Includes $0.1 million and $0.3 million of accumulated depreciation related to certain equipment held under capital leases, as of December 31, 2012 +and 2011, respectively, which are depreciated using the straight-line method over the lease term. +During the years ended +December 31, 2012, 2011 and 2010, we recorded $23.1 million, $27.5 million and $29.5 million, respectively, in depreciation expense of which $4.6 million, $11.5 million and $14.7 million, respectively, was recorded in cost +of sales, with the remaining amounts recorded in selling, general and administrative expenses on the consolidated statements of operations. +We periodically evaluate all of our long-lived assets for impairment when events or circumstances would indicate the carrying value of a long-lived asset +may not be fully recoverable. During the year ended December 31, 2012, we recorded $1.4 million in impairment charges related to certain underperforming domestic stores in the Americas segment that were unlikely to generate sufficient cash +flows to fully recover the carrying +F-15 +Table of Contents +value of the stores’ assets over the remaining economic life of those assets. During the years ended December 31, 2011 and 2010, we recorded $0.5 million and $0.1 million, +respectively, in impairment charges which primarily related to obsolete molds which were previously depreciated to costs of sales. +4. GOODWILL & INTANGIBLE ASSETS +The following table summarizes the goodwill and identifiable intangible assets as of December 31, 2012 and 2011: +December 31, 2012 +December 31, 2011 +($ thousands) +Gross +Carrying +Amount +Accumulated +Amortization +Net +Carrying +Amount +Gross +Carrying +Amount +Accumulated +Amortization +Net +Carrying +Amount +Capitalized software +$ +87,426 +(1) +$ +(33,933 +) (2) +$ +53,493 +$ +66,530 +(1) +$ +(22,156 +) (2) +$ +44,374 +Customer relationships +7,145 +(6,222 +) +923 +6,321 +(5,641 +) +680 +Patents, copyrights, and trademarks +6,161 +(3,522 +) +2,639 +6,109 +(2,994 +) +3,115 +Core technology +4,856 +(4,856 +) +— +4,743 +(4,743 +) +— +Other +670 +(636 +) +34 +997 +(636 +) +361 +Total finite lived intangible assets +106,258 +(49,169 +) +57,089 +84,700 +(36,170 +) +48,530 +Indefinite lived intangible assets +113 +— +113 +111 +— +111 +Goodwill (3) +2,729 +— +2,729 +— +— +— +Intangible assets +$ +109,100 +$ +(49,169 +) +$ +59,931 +$ +84,811 +$ +(36,170 +) +$ +48,641 +(1) +Includes $4.1 million of software held under a capital lease classified as capitalized software as of December 31, 2012 and 2011. +(2) +Includes $1.3 million and $0.7 million of accumulated amortization of software held under a capital lease as of December 31, 2012 and +2011, respectively, which is amortized using the straight-line method over the useful life. +(3) +On July 16, 2012, our subsidiaries Crocs Europe B.V., Crocs Stores B.V. and Crocs Belgium N.V. (collectively referred to as Crocs Europe), which +are part of our Europe segment, acquired certain net assets and activities from Crocs Benelux B.V. (Benelux) pursuant to a sale and purchase agreement dated July 9, 2012. Prior to the acquisition, Benelux was a distributor of the +Company. The Company acquired Benelux’ retail business and wholesale business, including inventory, fixed assets, customer relationships, 10 retail stores and their associated leases. Total consideration paid was cash of +€ 3.6 million (approximately $4.6 million). +During the years ended December 31, 2012, 2011 and 2010, +amortization expense recorded for intangible assets with finite lives was $13.6 million, $9.8 million and $7.6 million, respectively, of which $4.3 million, $2.9 million and $2.3 million was recorded in cost of sales, +respectively. The remaining amounts were recorded in selling, general and administrative expenses. +The following table summarizes estimated +future annual amortization of intangible assets as of December 31, 2012: +Fiscal years ending December 31, +Amortization +($ thousands) +2013 +$ +14,956 +2014 +13,139 +2015 +10,003 +2016 +8,531 +2017 +5,689 +Thereafter +4,771 +Total +$ +57,089 +F-16 +Table of Contents +5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES +The following table summarizes accrued expenses and other current liabilities as of December 31, 2012 and 2011: +December 31, +($ thousands) +2012 +2011 +Accrued compensation and benefits +$ +19,714 +$ +28,680 +Fulfillment, freight and duties +8,621 +7,151 +Professional services +13,588 +8,429 +Sales/use and VAT tax payable +12,444 +9,642 +Entrusted loan payable (2) +7,943 +9,133 +Accrued rent and occupancy +10,226 +5,476 +Other (1) +8,835 +7,995 +Total accrued expenses and other current liabilities +$ +81,371 +$ +76,506 +(1) +The amounts in Other consist of various accrued expenses and no individual item accounted for more than 5% of the total balance at December 31, +2012 or December 31, 2011. +(2) +A corresponding entrusted loan receivable of $7.9 million and $9.1 million are recorded in Prepaid expenses and other current assets as of +December 31, 2012 and 2011, respectively, as amounts are related to our subsidiaries in China. +Asset Retirement +Obligations +We record a liability equal to the fair value of the estimated future cost to retire an asset, if the liability’s +fair value can be reasonably estimated. Our asset retirement obligation (“ARO”) liabilities are primarily associated with the disposal of property and equipment which we are contractually obligated to remove at the end of certain retail +and office leases in order to restore the facilities back original condition as specified in the related lease agreements. We estimate the fair value of these liabilities based on current store closing costs and discount the costs back as if they +were to be performed at the inception of the lease. At the inception of such leases, we record the ARO as a liability and also record a related asset in an amount equal to the estimated fair value of the obligation. The capitalized asset is then +depreciated on a straight-line basis over the useful life of the asset. Upon retirement of the ARO liability, any difference between the actual retirement costs incurred and the previously recorded estimated ARO liability is recognized as a gain or +loss in the consolidated statements of operations. Our ARO liability as of December 31, 2012 and 2011 was $2.4 million and $1.9 million, respectively. +F-17 +Table of Contents +6. FAIR VALUE MEASUREMENTS +Recurring Fair Value Measurements +The following tables summarize the financial instruments required to be measured at fair value on a recurring basis as of December 31, 2012 and 2011. See Note 1—Organization & Summary +of Significant Accounting Policies for additional detail regarding our fair value measurement determinations. +Fair Value as of December 31, 2012 +($ thousands) +Quoted prices in +active markets +for identical +assets or liabilities +(Level +1) +Significant +other +observable +inputs +(Level 2) +Significant +unobservable +Inputs +(Level +3) +Total +Balance Sheet Classification +Cash equivalents +$ +14,800 +$ +— +$ +— +$ +14,800 +Cash and cash equivalents +Derivative assets: +Foreign currency contracts +— +5,548 +— +5,548 +Prepaid expenses and other current +assets and other assets +Derivative liabilities: +Foreign currency contracts +$ +— +$ +295 +$ +— +$ +295 +Accrued expense and other current +liabilities +Fair Value as of December 31, 2011 +($ thousands) +Quoted prices in +active markets +for +identical +assets or liabilities +(Level 1) +Significant +other +observable +inputs +(Level 2) +Significant +unobservable +inputs +(Level +3) +Total +Balance Sheet Classification +Cash equivalents +$ +10,286 +$ +— +$ +— +$ +10,286 +Cash and cash equivalents +Derivative assets: +Foreign currency contracts +— +596 +— +596 +Prepaid expenses and other +current assets +Derivative liabilities: +Foreign currency contracts +$ +— +$ +1,035 +$ +— +$ +1,035 +Accrued expense and other current +liabilities and other liabilities +Non-Recurring Fair Value Measurements +The majority of our non-financial instruments, which include inventories, property and equipment and intangible assets, are not required to be carried at fair value on a recurring basis. However, if +certain triggering events occur such that a non-financial instrument is required to be evaluated for impairment and the carrying value is not recoverable, the carrying value would be adjusted to the lower of its cost or fair value and an impairment +charge would be recorded. See Note 3—Property and Equipment and Note 4—Goodwill & Intangible Assets for discussions on impairment charges recorded during the periods presented. +7. DERIVATIVE FINANCIAL INSTRUMENTS +We transact business in various foreign countries and are therefore exposed to foreign currency exchange rate risk inherent in +revenues, costs, and monetary assets and liabilities denominated in non-functional currencies. We have entered into foreign currency exchange forward contract and currency swap derivative instruments to selectively protect against volatility in the +value of non-functional currency denominated monetary assets and liabilities, and of future cash flows caused by changes in foreign currency exchange rates. We do not designate these derivative instruments as hedging instruments under the accounting +standards for derivatives and hedging. Accordingly, these instruments are recorded at fair value as a derivative asset or liability on the balance sheet with their corresponding change in fair value recognized in Foreign currency transaction (gains) +losses, net, in +F-18 +Table of Contents +our consolidated statements of operations. For purposes of the cash flow statement, the Company classifies the cash flows at settlement from undesignated instruments in the same category as the +cash flows from the related hedged items, generally within Cash provided by operating activities. +The following table summarizes the notional +amounts of the outstanding foreign currency exchange contracts at December 31, 2012 and 2011. The notional amounts of the derivative financial instruments shown below are denominated in their U.S. dollar equivalents and represent the amount of +all contracts of the foreign currency specified. These notional values do not necessarily represent amounts exchanged by the parties and, therefore, are not a direct measure of our exposure to the foreign currency exchange risks. +December 31, +($ thousands) +2012 +2011 +Foreign currency exchange forward contracts by currency: +Japanese Yen +$ +112,500 +$ +27,500 +Euro +5,159 +10,055 +Australian Dollar +4,178 +— +Mexican Peso +11,400 +6,500 +Pound Sterling +8,742 +6,345 +New Zealand Dollar +1,137 +— +Total notional value, net +$ +143,116 +$ +50,400 +Latest maturity date +December 2015 +December 2012 +The following table presents the amounts affecting the consolidated statements of income from derivative instruments for +the years ended December 31, 2012 and 2011: +Year ended December 31, +($ thousands) +2012 +2011 +Location of (Gain) Loss Recognized +in Income on +Derivatives +Derivatives not designated as hedging instruments: +Foreign currency exchange forwards +$ +(7,200 +) +$ +540 +Foreign currency transaction (gains) losses, net +8. BANK BORROWINGS AND CAPITAL LEASE OBLIGATIONS +Bank borrowings and capital lease obligations as of December 31, 2012 and 2011 consist of the following: +December 31, +($ thousands) +2012 +2011 +Bank borrowings +$ +6,582 +$ +— +Revolving credit facility +— +422 +Capital lease obligations for capitalized software bearing interest rates ranging from 8.7% to 12.4% and maturities through +2011 +— +640 +Capital lease obligations for equipment bearing interest rates of 5.3% and maturities through 2017 +53 +81 +Total bank borrowings and capital lease obligations +$ +6,635 +$ +1,143 +F-19 +Table of Contents +Long-term Debt Agreement +On December 10, 2012, Crocs, Inc. (“the Company”) entered into a Master Installment Payment Agreement (“Master IPA”) with PNC Bank National Association (“PNC”) in which +PNC will finance the Company’s purchase of software and services, which may include but are not limited to third party costs to design, install and implement software systems, and associated hardware described in the schedules defined within +the Master IPA. This agreement was entered into to finance the recent implementation of a new enterprise resource planning (“ERP”) system which began in October 2012 and is estimated to continue through early 2014. The terms of the +agreement consist of variable interest rates and payment terms based on amounts borrowed and timing of activity throughout the implementation of the ERP. As of December 31, 2012, we had $6.6 million of long-term debt outstanding, of which $2.0 +million represent current installments, under the agreement payable over the next four years bearing interest at rate of 2.63%. Interest rates and payment terms are subject to changes as further financing occurs under the Master IPA. +Revolving Credit Facility +On +December 10, 2012, Crocs, Inc. (the “Company”) and its subsidiaries, Crocs Retail, Inc., Ocean Minded, Inc., Jibbitz, LLC and Bite, Inc. (collectively with the Company, the “Borrowers”) entered into the +First Amendment to Amended and Restated Credit Agreement (the “First Amendment”) with the lenders named therein and PNC Bank, National Association (“PNC”), as a lender and administrative agent for the lenders, pursuant to which +certain terms of the Amended and Restated Credit Agreement (the “Credit Agreement”), dated December 16, 2011, were amended. The First Amendment, among other things, (i) extends the maturity date from December 16, 2016 to +December 16, 2017, (ii) increases the total commitments under the revolving credit facility from $70 million to $100 million, with the ability to increase commitments to up to $125 million subject to certain conditions, +(iii) decreases the revolving interest rate by 50 basis points for both domestic and LIBOR rate loans, (iv) increases the ability of the Company to make stock repurchases from up to $25 million per year to up to $150 million per year, +subject to certain conditions, (v) increases the limit for permitted acquisitions from up to $40 million per year to up to $100 million per year, subject to certain conditions, (vi) adds a covenant to maintain unrestricted cash of at least +$100 million at all times, subject to limitations, and (vii) amends certain restrictive covenants to be more favorable to the Borrowers. +The Credit Agreement is available for working capital, capital expenditures, permitted acquisitions, reimbursement of drawings under letters of credit, +and permitted dividends, distributions, purchases, redemptions and retirements of equity interests. Borrowings under the Credit Agreement are secured by all of our assets including all receivables, equipment, general intangibles, inventory, +investment property, subsidiary stock and intellectual property. Borrowings under the Credit Agreement bear interest at a variable rate. For domestic rate loans, the interest rate is equal to the highest of (i) the daily federal funds open rate +as quoted by ICAP North America, Inc. plus 0.5%, (ii) PNC’s prime rate and (iii) a daily LIBOR rate plus 1.0%, in each case there is an additional margin ranging from 0.25% to 1.00% based on certain conditions. For LIBOR rate +loans, the interest rate is equal to a LIBOR rate plus a margin ranging from 1.25% to 2.00% based on certain conditions. The Credit Agreement requires monthly interest payments with respect to domestic rate loans and at the end of each interest +period with respect to LIBOR rate loans and contains certain customary restrictive and financial covenants. We were in compliance with these restrictive financial covenants as of December 31, 2012. +As of December 31, 2012 and 2011, we had no outstanding borrowings and $0.4 million of outstanding borrowings, respectively, under the Credit +Agreement. As of December 31, 2012 and 2011, we had issued and outstanding letters of credit of $6.4 million and $6.0 million, respectively, which were reserved against the borrowing base under the terms of our revolving credit facility. +During the years ended December 31, 2012 and 2011, we capitalized $0.5 million and $0.4 million, respectively, in fees and third party costs which were incurred in connection with the Credit Agreement, as deferred financing costs. +F-20 +Table of Contents +Maturities of Debt and Capital Lease Obligations +Minimum future annual debt obligations for each of the five succeeding years as of December 31, 2012, are as follows (in thousands): +Fiscal years ending December 31, +2013 +$ +2,013 +2014 +1,623 +2015 +1,666 +2016 +1,280 +2017 +— +Thereafter +— +Total principal debt maturities +$ +6,582 +Minimum future annual rental commitments under capital leases for each of the five succeeding years as of +December 31, 2012, are as follows (in thousands): +Fiscal years ending December 31, +2013 +$ +27 +2014 +14 +2015 +7 +2016 +7 +2017 +2 +Thereafter +— +Total minimum lease payments, including interest +57 +Amounts representing interest +(4 +) +Total minimum lease payments, net of interest +$ +53 +Current portion +$ +26 +Noncurrent portion +$ +27 +9. EQUITY +Equity Incentive Plans +On August 15, 2005, we adopted the 2005 Equity Incentive Plan (the “2005 Plan”), which permitted the issuance of up to 14.0 million common shares in connection with the grant of +non-qualified stock options, incentive stock options, and restricted stock to eligible employees, consultants and members of our Board of Directors. As of December 31, 2012 and 2011, 0.9 million and 1.0 million stock options, +respectively, were outstanding under the 2005 Plan. No shares are available for future issuance under the 2005 Plan. +On July 9, 2007, we +adopted and on June 28, 2011 we amended the 2007 Equity Incentive Plan (the “2007 Plan”) which increased the allowable number of shares of our common stock reserved for issuance under the 2007 Plan from 9.0 million to +15.3 million (subject to adjustment for future stock splits, stock dividends and similar changes in our capitalization) in connection with the grant of non-qualified stock options, incentive stock options, restricted stock, restricted stock +units, stock appreciation rights, performance units, common stock or any other share-based award to eligible employees, consultants and members of our Board of Directors. As of December 31, 2012 and 2011, 3.5 million and 3.6 million +stock options, restricted stock awards and restricted stock units were outstanding under the 2007 Plan, respectively. As of December 31, 2012, 5.7 million shares were available for future issuance under the 2007 Plan. +F-21 +Table of Contents +Stock options under both the 2005 Plan and the 2007 Plan generally vest ratably over four years with the +first year vesting on a “cliff” basis followed by monthly vesting for the remaining three years. Restricted stock awards and units generally vest annually on a straight-line basis over three or four years depending on the terms of the +award agreement. +Stock Option Activity +The following table summarizes stock option transactions for the years ended December 31, 2012, 2011 and 2010. +Shares +Weighted +Average +Exercise +Price +Weighted +Average +Remaining +Contractual +Life +(Years) +Aggregate +Intrinsic +Value +($ thousands) +Outstanding at December 31, 2009 +7,755,254 +$ +7.67 +7.48 +$ +15,920 +Granted +342,250 +12.68 +Exercised +(2,133,806 +) +3.37 +Forfeited or expired +(956,361 +) +11.56 +Outstanding at December 31, 2010 +5,007,337 +9.10 +6.36 +47,009 +Granted +468,000 +19.81 +Exercised +(1,738,741 +) +6.28 +Forfeited or expired +(405,565 +) +10.46 +Outstanding at December 31, 2011 +3,331,031 +11.91 +6.35 +18,468 +Granted +208,400 +16.84 +Exercised +(613,691 +) +6.04 +Forfeited or expired +(304,054 +) +17.55 +Outstanding at December 31, 2012 +2,621,686 +$ +13.03 +5.55 +$ +11,373 +Exercisable at December 31, 2012 +1,992,151 +$ +12.36 +4.75 +$ +10,000 +Vested and expected to vest at December 31, 2012 +2,485,086 +$ +12.78 +5.37 +$ +11,330 +During the years ended December 31, 2012, 2011 and 2010, options issued were valued using the Black Scholes option +pricing model using the following assumptions. +Year Ended December 31, +2012 +2011 +2010 +Expected volatility +50 - 70% +50 - 60% +60% +Dividend yield +— +— +— +Risk-free interest rate +0.62% - 1.20% +0.87% - 2.31% +1.64% - 2.27% +Expected life (in years) +4.00 - 4.27 +4.35 - 4.89 +5.66 - 6.49 +The weighted average fair value of options granted during the years ended December 31, 2012, 2011 and 2010 was +approximately $7.76, $9.19 and $7.10, respectively. The aggregate intrinsic value of options exercised during the years ended December 31, 2012, 2011 and 2010 was $6.9 million, $27.3 million and $21.0 million, respectively. During the +year ended December 31, 2012, we received $3.7 million in cash in connection with the exercise of stock options with no income tax benefit due to our use of Accounting Standard Codification 740—‘Income Taxes’ (“ASC +740”) ordering for purposes of determining when excess benefits have been realized (see Note 11—Income Taxes). The total grant date fair value of stock options vested during the years ended December 31, 2012, 2011 and 2010 was +$2.8 million, $2.7 million and $5.4 million, respectively. +F-22 +Table of Contents +As of December 31, 2012, we had $4.3 million of total unrecognized share-based compensation +expense related to unvested options, net of expected forfeitures, which is expected to be amortized over the remaining weighted average period of 2.3 years. +Restricted Stock Shares and Units +From time to time, we grant restricted stock +shares (RSAs) and restricted stock units (RSUs) to our employees. Unvested RSAs have the same rights as those of common shares including voting rights and non-forfeitable dividend rights. However, ownership of unvested RSAs cannot be transferred +until they are vested. An unvested RSU is a contractual right to receive a share of common stock only upon its vesting. RSUs have dividend equivalent rights which accrue over the term of the award and are paid if and when the RSUs vest, but they +have no voting rights. +During 2012, the Board of Directors approved grants of 0.4 million of RSUs to certain executives as part of a +performance incentive program. Half of the these grants vest ratably on each of the first three anniversaries of the grant date; 25% will vest upon achievement of certain performance metrics; and the remaining 25% will vest one year from the date +upon which certain performance metrics were achieved. If actual performance metrics exceed the targeted performance metrics by a predetermined amount, the executives are eligible to receive up to 200% of the performance-based portion of their award. +Management has determined that the achievement of the performance benchmarks associated with the performance based RSUs granted in 2012 is probable and recorded $0.7 million in share-based payment expense related to such units. +During 2011, the Board of Directors approved grants of 0.4 million RSAs and RSUs to certain executives as part of a performance incentive program. +The vesting period for these grants is identical to that described above for 2012. +During 2010, the Board of Directors approved grants of +0.7 million RSAs to certain employees. Half of such grants vest ratably on each of the first four anniversaries of the grant date. The remaining half vest on a cliff basis on the fourth anniversary of the grant date, provided that certain +corporate performance metrics are achieved. We have not recognized any share-based payment expense related to the performance awards as the performance metrics to date have not been met. +The following table summarizes RSA and RSU activity during the years ended December 31, 2012, 2011 and 2010. +Restricted Stock Awards +Restricted Stock Units +Shares +Weighted +Average +Grant Date +Fair Value +Units +Weighted +Average +Grant Date +Fair Value +Nonvested at December 31, 2009 +1,322,240 +$ +3.04 +— +$ +— +Granted +637,557 +12.10 +116,400 +12.99 +Vested +(688,049 +) +3.93 +— +— +Forfeited +(318,325 +) +2.77 +— +— +Nonvested at December 31, 2010 +953,423 +8.54 +116,400 +12.99 +Granted +118,520 +19.10 +651,791 +24.89 +Vested +(352,150 +) +6.19 +(21,150 +) +17.25 +Forfeited +(148,618 +) +9.67 +(35,061 +) +15.41 +Nonvested at December 31, 2011 +571,175 +11.87 +711,980 +23.43 +Granted +18,813 +16.48 +1,010,559 +18.92 +Vested +(191,779 +) +9.22 +(133,555 +) +23.25 +Forfeited +(42,700 +) +13.25 +(174,323 +) +20.64 +Nonvested at December 31, 2012 +355,509 +$ +13.37 +1,414,661 +$ +20.61 +F-23 +Table of Contents +The total grant date fair value of RSAs vested during the years ended December 31, 2012, 2011 and 2010 +was $1.8 million, $2.2 million and $2.7 million, respectively. At December 31, 2012, we had $2.0 million of total unrecognized share-based compensation expense related to non-vested restricted stock awards, net of expected +forfeitures. The non-vested RSAs are expected to be amortized over the remaining weighted average period of 1.50 years. +The total grant +date fair value of RSUs vested during the years ended December 31, 2012, 2011 and 2010 was $3.1 million, $0.4 million, and $0.0 million, respectively. At December 31, 2012, we had $7.4 million of total unrecognized share-based +compensation expense related to non-vested restricted stock units, net of expected forfeitures. The non-vested RSUs are expected to be amortized over the remaining weighted average period of 1.54 years. +Share-based Compensation +During +the year ended December 31, 2012, we recorded $11.3 million of pre-tax share-based compensation expense of which $2.0 million was recorded in Cost of sales. No associated tax benefits were recognized in the year ended December 31, +2012, due to our use of ASC 740 ordering for purposes of determining when excess tax benefits have been realized (see Note 11—Income Taxes). +During the year ended December 31, 2011, we recorded $8.6 million of pre-tax share-based compensation expense of which $1.3 million was recorded in Cost of sales. No associated tax benefits were +recognized in the year ended December 31, 2011, due to our domestic tax loss position and valuation allowance (see Note 11—Income Taxes). +During the year ended December 31, 2010, we recorded $7.3 million of pre-tax share-based compensation expense of which $1.3 million was recorded in Cost of sales and $0.2 million of +accelerated vesting charges related to the separation agreement of a former officer was recorded as restructuring charges in the consolidated statements of operations. No associated tax benefits were recognized in the year ended December 31, +2010, due to our domestic tax loss position and valuation allowance (see Note 11—Income Taxes). +Separation Agreements +On March 31, 2010, we entered into a separation agreement with a former officer pursuant to which the vesting of +0.1 million stock options and 0.1 million shares of restricted stock were accelerated as of March 31, 2010. During the year ended December 31, 2010, we recorded $0.2 million amount to restructuring charges related to these +vesting accelerations. Also in connection with this separation agreement, 0.2 million stock options and 0.2 million shares of restricted stock were forfeited. +10. ALLOWANCES +The changes in the allowance for doubtful accounts and reserve for sales returns and allowances for the years ended December 31, +2012, 2011 and 2010, are as follows: +($ thousands) +Balance at +Beginning +of Year +Charged to +costs and +expenses +Reversals +and +Write-offs +Balance at +End of +Year +Year ended December 31, 2010: +Allowance for doubtful accounts +$ +3,973 +$ +2,204 +$ +(1,535 +) +$ +4,642 +Reserve for sales returns and allowances +5,866 +4,971 +(5,230 +) +5,607 +Year ended December 31, 2011: +Allowance for doubtful accounts +4,642 +(383 +) +(579 +) +3,680 +Reserve for sales returns and allowances +5,607 +9,965 +(3,744 +) +11,828 +Year ended December 31, 2012: +Allowance for doubtful accounts +$ +3,680 +$ +2,166 +$ +(2,405 +) +$ +3,441 +Reserve for sales returns and allowances +11,828 +5,111 +(7,065 +) +9,874 +F-24 +Table of Contents +11. INCOME TAXES +The following table sets forth income (loss) before taxes and the expense for income taxes for the years ended December 31, 2012, +2011 and 2010. +December 31, +($ thousands) +2012 +2011 +2010 +Income (loss) before taxes: +U.S. +$ +12,060 +$ +(12,057 +) +$ +(14,835 +) +Foreign +133,488 +148,747 +95,627 +Total income before taxes +145,548 +136,690 +80,792 +Income tax expense: +Current income taxes +U.S. federal +(6,364 +) +4,798 +47 +U.S. state +597 +165 +95 +Foreign +22,953 +19,758 +17,923 +Total current income taxes +17,186 +24,721 +18,065 +Deferred income taxes: +U.S. federal +(3,981 +) +(2,338 +) +— +U.S. state +(4,016 +) +— +— +Foreign +5,016 +1,519 +(4,999 +) +Total deferred income taxes +(2,981 +) +(819 +) +(4,999 +) +Total income tax expense +$ +14,205 +$ +23,902 +$ +13,066 +The following table sets forth income reconciliations of the statutory federal income tax rate to our actual rates based +on income or loss before income taxes as of December 31, 2012, 2011 and 2010. +December 31, +($ thousands) +2012 +2011 +2010 +Federal income tax rate +35.0 +% +35.0 +% +35.0 +% +State income tax rate, net of federal benefit +(2.7 +) +0.3 +(0.3 +) +Foreign income tax rate differential +(25.0 +) +(30.3 +) +(22.2 +) +Permanent items +4.6 +3.2 +12.5 +Permanent portion of equity compensation +0.5 +0.4 +1.6 +Charitable donations of inventory +(0.1 +) +— +(0.1 +) +Change in valuation allowance +(8.4 +) +3.6 +(34.2 +) +Unremitted foreign earnings of subsidiary +2.0 +— +21.7 +Uncertain tax positions +3.5 +8.7 +1.4 +Other +0.4 +(3.4 +) +0.8 +Effective income tax rate +9.8 +% +17.5 +% +16.2 +% +F-25 +Table of Contents +The following table sets forth deferred income tax assets and liabilities as of December 31, 2012 and +2011. +December 31, +($ thousands) +2012 +2011 +Current deferred tax assets: +Accrued expenses +$ +12,934 +$ +12,575 +Unrealized loss on foreign currency +2,026 +— +Other +8 +2,383 +Valuation allowance +(3,492 +) +(6,054 +) +Total current deferred tax assets +$ +11,476 +$ +8,904 +Current deferred tax liabilities: +Unremitted earnings of foreign subsidiary +$ +(7,596 +) +$ +(4,746 +) +Total current deferred tax liabilities. +$ +(7,596 +) +$ +(4,746 +) +Non-current deferred tax assets: +Stock compensation expense +$ +8,865 +$ +7,630 +Long-term accrued expenses +3,067 +— +Net operating loss and charitable contribution carryovers +23,255 +26,219 +Property and equipment +8,994 +8,641 +Future uncertain tax position offset +3,780 +13,638 +Unrealized loss on foreign currency +921 +5,644 +Foreign tax credit +5,392 +3,177 +Other +1,767 +190 +Valuation allowance +(22,406 +) +(33,889 +) +Total non-current deferred tax assets +$ +33,635 +$ +31,250 +Non-current deferred tax liabilities: +Intangible assets +$ +(779 +) +$ +(1,009 +) +Total non-current deferred tax liabilities +$ +(779 +) +$ +(1,009 +) +We do not provide for deferred taxes on the excess of the financial reporting basis over the tax basis in our investments +in foreign subsidiaries that are essentially permanent in duration. In general, it is our practice and intention to reinvest the earnings of our foreign subsidiaries in those operations. Generally, the earnings of our foreign subsidiaries become +subject to U.S. taxation upon the remittance of dividends and under certain other circumstances. Exceptions may be made on a year-by-year basis to repatriate current year earnings of certain foreign subsidiaries based on cash needs in the U.S. As of +December 31, 2012, we have provided for deferred U.S. income tax of $7.6 million on $38.6 million of foreign subsidiary earnings. No withholding tax is due with respect to the repatriation of these earnings to the U.S. and none has been +provided for. +At December 31, 2012 and 2011, U.S. income and foreign withholding taxes have not been provided on for approximately +$490.8 million and $371.0 million, respectively, of unremitted earnings of subsidiaries operating outside of the U.S. These earnings are estimated to represent the excess of the financial reporting over the tax basis in our investments in those +subsidiaries. These earnings, which are considered to be indefinitely reinvested, would become subject to U.S. income tax if they were remitted to the U.S. The amount of unrecognized deferred U.S. income tax liability on the unremitted earnings has +not been determined because the hypothetical calculation is not practicable. +We have deferred tax assets related to certain deductible +temporary differences in various tax jurisdictions for which we have recorded a valuation allowance of $25.9 million against these deferred tax assets because we do not believe that it is more likely than not that we will be able to realize +these deferred tax assets. The significant +F-26 +Table of Contents +components of the deferred tax assets for which a valuation allowance has been applied consist of net operating losses in certain tax jurisdictions for which management believes there is not +sufficient positive evidence that such net operating losses will be realized against future income and book expenses not deductible for tax purposes in the current year such as inventory impairment reserves, equity compensation and unrealized +foreign exchange loss that would increase such net operating losses in the same jurisdictions. These temporary differences are amounts which arose in jurisdictions where (i) current losses exist, (ii) such losses are in excess of any loss +carryback potential, (iii) no tax planning strategies exist with which to overcome such losses and (iv) no profits are projected for the following year. For these reasons it is determined that it is more likely than not that these deferred +tax assets will not be realized and a valuation allowance has been provided with respect to these deferred tax assets. +At December 31, +2012, we had U.S. federal net operating loss carryforwards of $0.7 million, state net operating loss carryforwards of $89.6 million, charitable contribution carryforwards of $23.3 million and foreign tax credits of $5.0 million which will +expire at various dates between 2014 and 2031. We do not believe that it is more likely than not that the benefit from certain state net operating losses will be realized. Consequently, we have a valuation allowance of $9.1 million on the +deferred tax assets relating to these state net operating loss carryforwards and charitable contribution carryforwards. +At December 31, +2012, we have a foreign deferred tax asset of $11.4 million reflecting the benefit of $43.8 million in foreign net operating loss carryforwards, some of which have an indefinite life. We do not believe it is more likely than not that the +benefit from certain foreign net operating loss carryforwards will be realized. Consequently, we have provided a valuation allowance of $7.7 million on the deferred tax assets relating to these foreign net operating loss carryforwards. +We had approximately $36.7 million in net deferred tax assets at December 31, 2012. Approximately $11.9 million of the net +deferred tax assets were located in foreign jurisdictions for which a sufficient history and expected future profits indicated that it is more likely than not that such deferred tax assets will be realized. Pre-tax profit of approximately +$47.4 million is required to realize the net deferred tax assets. +At December 31, 2012, approximately $3.8 million of net +deferred tax assets consists of deferred tax assets related to estimated liabilities for uncertain tax positions that would be realized if such liabilities are actually incurred. The deferred tax assets represent primarily the reduction in tax +expense that would occur upon an increase of intercompany royalty expense by various taxing authorities. Approximately $15.2 million of taxable income would have to be recognized to realize these deferred tax assets. +As a result of certain accounting realization requirements, the table of deferred tax assets and liabilities shown above does not include certain +deferred tax assets at December 31, 2012 that arose directly from tax deductions related to equity compensation in excess of compensation recognized for financial reporting. Equity will be increased by $11.8 million if and when such deferred +tax assets are ultimately realized. We use ASC 740 ordering for purposes of determining when excess tax benefits have been realized. +The +following table sets forth a reconciliation of the beginning and ending amount of unrecognized tax benefits during the years ended December 31, 2012, 2011 and 2010. +($ thousands) +2012 +2011 +2010 +Unrecognized tax benefit—January 1 +$ +44,537 +$ +33,042 +$ +29,163 +Gross increases—tax positions in prior period +— +8,332 +943 +Gross decreases—tax positions in prior period +(425 +) +— +— +Gross increases—tax positions in current period +4,310 +4,689 +3,086 +Settlements +(16,260 +) +(427 +) +— +Lapse of statute of limitations +(262 +) +(1,099 +) +(150 +) +Unrecognized tax benefit—December 31 +$ +31,900 +$ +44,537 +$ +33,042 +F-27 +Table of Contents +Unrecognized tax benefits of $31.9 million, $44.5 million, and $33.0 million at December 31, +2012, 2011 and 2010, respectively, if recognized, would reduce our annual effective tax rate. +Interest and penalties related to income tax +liabilities are included in income tax expense in the consolidated statement of operations. As of December 31, 2012, 2011 and 2010, we recorded approximately $0.6 million, $1.0 million, and $0.1 million, respectively, of penalties and +interest which resulted in a cumulative accrued balance of penalties and interest of $4.4 million, 3.9 million, and $2.9 million at December 31, 2012, 2011 and 2010, respectively. +Unrecognized tax benefits consist primarily of tax positions related to intercompany transfer pricing in multiple international jurisdictions. The gross +increase for tax positions in current and prior periods in 2012 of $3.9 million primarily includes specific transfer pricing exposures in various jurisdictions. We do not expect any significant changes in unrecognized tax benefits in the next +twelve months. +The following table sets forth the remaining tax years subject to examination for the major jurisdictions where we conduct +business as of December 31, 2012. +Netherlands +2006 to 2012 +Canada +2007 to 2012 +Japan +2007 to 2012 +Singapore +2008 to 2012 +United States +2010 to 2012 +State income tax returns are generally subject to examination for a period of three to five years after filing of the +respective return. The state impact of any federal changes remains subject to examination by various state jurisdictions for a period up to two years after formal notification to the states. +12. EARNINGS PER SHARE +The following table illustrates the basic and diluted earnings per share (“EPS”) computations for the years ended +December 31, 2012, 2011 and 2010. See Note 1—Organization & Summary of Significant Accounting Policies for additional detail regarding our EPS calculations. +Year Ended December 31, +($ thousands, except share and per share data) +2012 +2011 +2010 +Numerator +Net income attributable to common stockholders +$ +131,343 +$ +112,788 +$ +67,726 +Less: income allocated to participating securities +(645 +) +(1,014 +) +(863 +) +Net income attributable to common stockholders—basic and diluted +$ +130,698 +$ +111,774 +$ +66,863 +Denominator +Weighted average common shares outstanding—basic +89,571,105 +88,317,898 +85,482,055 +Plus: dilutive effect of stock options and unvested restricted stock units +1,017,311 +1,663,484 +2,113,563 +Weighted average common shares outstanding—diluted +90,588,416 +89,981,382 +87,595,618 +Net income attributable per common share: +Basic +$ +1.46 +$ +1.27 +$ +0.78 +Diluted +$ +1.44 +$ +1.24 +$ +0.76 +F-28 +Table of Contents +For the years ended December 31, 2012, 2011 and 2010, 1.4 million, 1.1 million, and +1.3 million options and RSUs, respectively, were not included in the calculation of diluted EPS as their effect would have been anti-dilutive. +Subject to certain restrictions on repurchases under our revolving credit facility, we have authorization to repurchase up to 5.5 million shares of our common stock under previous board +authorizations. In the fourth quarter of 2012, approximately 1.9 million shares were repurchased at an average price of $13.27 for a total of value of $25.0 million, excluding related commission charges. +13. COMMITMENTS AND CONTINGENCIES +We rent space for certain of our retail stores, offices, warehouses, vehicles, and equipment under operating leases expiring at +various dates through 2023. Certain leases contain rent escalation clauses (step rents) that require additional rental amounts in the later years of the term. Rent expense for leases with step rents or rent holidays is recognized on a straight-line +basis over the lease term. Deferred rent is included in the consolidated balance sheets in Accrued expenses and other current liabilities. +Future minimum annual rental commitments under non-cancelable operating leases for each of the five succeeding years as of December 31, 2012, are as +follows (in thousands): +Fiscal years ending December 31, +2013 +$ +80,020 +2014 +63,798 +2015 +53,737 +2016 +44,189 +2017 +36,770 +Thereafter +132,390 +Total minimum lease payments (1) +$ +410,904 +(1) +Minimum payments have not been reduced by minimum sublease rentals of 0.5 million due in the future under non-cancelable subleases. They also do +not include contingent rentals which may be paid under certain retail leases on a basis of percentage of sales in excess of stipulated amounts. +The following table summarizes the composition of rent expense under operating leases for the years ended December 31, 2012, 2011 and 2010 (in thousands): +Fiscal years ending December 31, +2012 +2011 +2010 +Minimum rentals +$ +84,671 +$ +68,675 +$ +57,989 +Contingent rentals +16,519 +13,639 +9,847 +Less: Sublease rentals +(619 +) +(573 +) +(553 +) +Total rent expense +$ +100,571 +$ +81,741 +$ +67,283 +As of December 31, 2012, we had purchase commitments with certain third party manufacturers for $152.8 million, +of which $5.9 million was for yet-to-be-received finished product where title passes to us upon receipt. As of December 31, 2011, we had purchase commitments with certain third party manufacturers for $138.2 million, of which +$12.5 million was for yet-to-be-received finished product where title passes to us upon receipt and a commitment to re-purchase $4.3 million of raw materials from a certain third party manufacturer. +In February 2011, we renewed and amended our supply agreement with Finproject S.r.l. which provides us the exclusive right to purchase certain +raw materials used to manufacture our products. The agreement also provides that we meet minimum purchase requirements to maintain exclusivity throughout the term of the agreement, +F-29 +Table of Contents +which expires December 31, 2014. Historically, the minimum purchase requirements have not been onerous and we do not expect them to become onerous in the future. Depending on the material +purchased, pricing is either based on contracted price or is subject to quarterly reviews and fluctuates based on order volume, currency fluctuations and raw material prices. Pursuant to the agreement, we guarantee the payment for certain third +party manufacturer purchases of these raw materials up to a maximum potential amount of €3.5 million (approximately $4.6 million as of December 31, 2012), through a letter of credit that was issued to Finproject S.r.l. +14. OPERATING SEGMENTS AND GEOGRAPHIC INFORMATION +We have three reportable operating segments: Americas, Europe and Asia. We also have an “Other businesses” category which +aggregates insignificant operating segments that do not meet the reportable threshold and represent manufacturing operations located in Mexico and Italy. The composition of our reportable operating segments is consistent with that used by our chief +operating decision maker (“CODM”) to evaluate performance and allocate resources. +Each of our reportable operating segments derives +its revenues from the sale of footwear, apparel and accessories to external customers. Revenues of the “Other businesses” category are primarily made up of intersegment sales which are eliminated when deriving total consolidated revenues. +The remaining revenues for the “Other businesses” represent non-footwear product sales to external customers. Segment assets consist of cash and cash equivalents, accounts receivable and inventory. +Segment operating income is the primary measure used by our CODM to evaluate segment operating performance and to decide how to allocate resources to +segments. Segment performance evaluation is based primarily on segment results without allocating corporate expenses, or indirect general, administrative and other expenses. Segment profits or losses of our reportable operating segments include +adjustments to eliminate intersegment profit or losses on intersegment sales. +During the first quarter of 2012, we changed the internal +reports used by our CODM to align the definition of our segment operating income with “Income from operations.” Previously, segment operating income excluded asset impairment charges and restructuring costs not included in cost of sales. +Segment operating income also reflects the reclassification of “Foreign currency transaction (gains) losses, net” from “Income from operations” on the consolidated statements of income. See Note 1—Organization & +Summary of Significant Accounting Policies for further discussion. Segment information for all periods presented has been reclassified to reflect these changes. +F-30 +Table of Contents +The following tables set forth information related to our reportable operating business segments as of and +for the years ended December 31, 2012, 2011 and 2010. +Year Ended December 31, +($ thousands) +2012 +2011 +2010 +Revenues: +Americas +$ +495,852 +$ +448,077 +$ +374,873 +Asia +457,411 +381,767 +285,017 +Europe +169,464 +170,868 +127,686 +Total segment revenues +1,122,727 +1,000,712 +787,576 +Other businesses +574 +191 +2,119 +Total consolidated revenues +$ +1,123,301 +$ +1,000,903 +$ +789,695 +Operating income: +Americas +$ +85,538 +$ +70,532 +$ +64,099 +Asia +140,828 +123,918 +89,248 +Europe +21,678 +37,106 +22,258 +Total segment operating income +248,044 +231,556 +175,605 +Reconciliation of total segment operating income to income before income taxes: +Other businesses +(10,805 +) +(14,128 +) +(23,321 +) +Intersegment eliminations +60 +66 +1,360 +Unallocated corporate and other (1) +(91,125 +) +(86,415 +) +(75,522 +) +Total consolidated operating income +146,174 +131,079 +78,122 +Interest expense +837 +853 +657 +Foreign currency transaction (gains) losses, net +2,500 +(4,886 +) +(2,326 +) +Other income, net +(2,711 +) +(1,578 +) +(1,001 +) +Income before income taxes +$ +145,548 +$ +136,690 +$ +80,792 +Depreciation and amortization: +Americas +$ +9,849 +$ +9,203 +$ +8,935 +Asia +6,922 +6,084 +6,772 +Europe +3,116 +2,584 +2,018 +Total segment depreciation and amortization +19,887 +17,871 +17,725 +Other businesses +7,003 +11,657 +13,351 +Unallocated corporate and other (1) +9,804 +7,735 +5,983 +Total consolidated depreciation and amortization +$ +36,694 +$ +37,263 +$ +37,059 +(1) +Includes a corporate component consisting primarily of corporate support and administrative functions, costs associated with share-based compensation, +research and development, brand marketing, legal, depreciation and amortization of corporate and other assets not allocated to operating segments and costs of the same nature related to certain corporate holding companies. +F-31 +Table of Contents +December 31, +($ thousands) +2012 +2011 +Assets: +Americas +$ +143,236 +$ +97,188 +Asia +282,211 +239,281 +Europe +85,756 +83,871 +Total segment current assets +511,203 +420,340 +Other businesses +14,489 +29,851 +Unallocated corporate and other (1) +25,738 +21,783 +Deferred tax assets, net +6,284 +7,047 +Income tax receivable +5,613 +5,828 +Other receivables +24,821 +20,295 +Prepaid expenses and other current assets +24,967 +20,199 +Total current assets +613,115 +525,343 +Property and equipment, net +82,241 +67,684 +Intangible assets, net +59,931 +48,641 +Deferred tax assets, net +34,112 +30,375 +Other assets +40,239 +23,410 +Total consolidated assets +$ +829,638 +$ +695,453 +(1) +Corporate assets primarily consist of cash and equivalents. +There were no customers who represented 10% or more of consolidated revenues during the years ended December 31, 2012, 2011 and 2010. The following table sets forth certain geographical and other +information regarding our revenues during the years ended December 31, 2012, 2011 and 2010. +Year Ended December 31, +($ thousands) +2012 +2011 +2010 +Product: +Footwear +$ +1,076,210 +$ +956,816 +$ +753,951 +Other +47,091 +44,087 +35,744 +Total revenues +$ +1,123,301 +$ +1,000,903 +$ +789,695 +Location: +United States +$ +396,121 +$ +355,560 +$ +299,026 +International +727,180 +645,343 +490,669 +Total revenues +$ +1,123,301 +$ +1,000,903 +$ +789,695 +Foreign country revenues in excess of 10% of total revenues: +Japan +$ +164,565 +$ +154,925 +$ +111,764 +The following table sets forth geographical information regarding our property and equipment assets as of +December 31, 2012 and 2011. +December 31, +($ thousands) +2012 +2011 +Location: +United States +$ +47,587 +$ +39,063 +International +34,654 +28,621 +Total long-lived assets (1) +$ +82,241 +$ +67,684 +(1) +Not more than 10% of our long-lived assets resided in any individual foreign country in 2012 or 2011. +F-32 +Table of Contents +15. LEGAL PROCEEDINGS +We and certain current and former officers and directors have been named as defendants in complaints filed by investors in the United +States District Court for the District of Colorado. The first complaint was filed in November 2007 and several other complaints were filed shortly thereafter. These actions were consolidated and, in September 2008, the district court appointed a +lead plaintiff and counsel. An amended consolidated complaint was filed in December 2008. The amended complaint purports to state claims under Section 10(b), 20(a), and 20A of the Exchange Act on behalf of a class of all persons who purchased +our common stock between April 2, 2007 and April 14, 2008 (the “Class Period”). The amended complaint also added our independent auditor as a defendant. The amended complaint alleges that, during the Class Period, the defendants +made false and misleading public statements about us and our business and prospects and, as a result, the market price of our common stock was artificially inflated. The amended complaint also claims that certain current and former officers and +directors traded in our common stock on the basis of material non-public information. The amended complaint seeks compensatory damages on behalf of the alleged class in an unspecified amount, including interest, and also added attorneys’ fees +and costs of litigation. On February 28, 2011, the District Court granted motions to dismiss filed by the defendants and dismissed all claims. A final judgment was thereafter entered. Plaintiffs subsequently appealed to the United States Court +of Appeals for the Tenth Circuit. We and those current and former officers and directors named as defendants have entered into a Stipulation of Settlement with the plaintiffs that would, if approved by the United States District Court for the +District of Colorado, resolve all claims asserted against us by the plaintiffs on behalf of the putative class, and plaintiffs’ appeal would be dismissed. Our independent auditor is not a party to the Stipulation of Settlement. The Stipulation +of Settlement is subject to customary conditions, including preliminary court approval, and final court approval following notice to stockholders. If the settlement becomes final, all amounts required by the settlement will be paid by our insurers. +There can be no assurance that the settlement will be finally approved by the District Court, or that approval by the District Court will, if challenged, be upheld by the Tenth Circuit. +On October 27, 2010, Spectrum Agencies (“Spectrum”) filed suit against our subsidiary, Crocs Europe B.V. (“Crocs Europe”), in the High Court of Justice, Queen’s Bench +Division, Royal Courts of Justice in London, United Kingdom (“UK”). Spectrum acted as an agent for Crocs products in the UK from 2005 until Crocs Europe terminated the relationship on July 3, 2008 due to Spectrum’s breach of its +duty to act in good faith towards Crocs Europe. Spectrum alleges that Crocs Europe unlawfully terminated the agency relationship and failed to pay certain sales commissions. A trial on the liability, not quantum (compensation and damages), was held +at the High Court in London from November 30, 2011 to December 5, 2011. On December 16, 2011, the High Court of Justice issued a judgment that found that although Spectrum’s actions were a breach of its duty to act in good faith +towards Crocs Europe the breach was not sufficiently severe to justify termination. We believe that the trial judge erred in his findings and subsequently appealed the judgment. On October 30, 2012, the Court of Appeal handed down its judgment +confirming the trial judge’s findings. We submitted a request to the Supreme Court seeking permission to appeal and anticipate that a decision by the Supreme Court on permission to appeal will be rendered in the first quarter of 2013. Given +that this phase of the proceedings only pertains to liability, there have been no findings in relation to the amount of compensation or damages other than with respect to legal fees. Under English law, the prevailing party is entitled to +reimbursement of reasonable legal fees incurred in the liability proceedings. Spectrum has not quantified its claim for compensation and damages and the amount will be assessed later in the proceedings. Proceedings on quantum may be stayed until a +decision on permission to appeal has been handed down or in the event that permission is granted, until a final decision on the merits. +We +are currently subject to an audit by U.S. Customs & Border Protection (“CBP”) in respect of the period from 2006 to 2010. CBP issued a draft audit report to which Crocs filed comments and objections. The Company believes that +a final report (and notice of a formal claim) will not be issued until sometime in mid-2013. CBP has provided the Company with preliminary projections and a draft audit report that reflect unpaid duties totaling approximately $14.3 million +during the period under review. The Company has responded that these projections are erroneous and provided arguments that demonstrate the amount due in connection with this matter is considerably less than the preliminary projection. CBP is +currently reviewing this response. It is not possible at +F-33 +Table of Contents +this time to predict whether the Company’s arguments will be successful in eliminating or reducing the amount in dispute. Likewise, it is not possible to predict whether CBP may seek to +assert a claim for penalties in addition to any loss of revenue claim. +We are currently subject to an audit by Mexico’s Federal Tax +Authority (“SAT”) for the period from January 2006 to July 2011. There are two phases to the audit, the first for capital equipment and finished goods and the second for raw materials. The first phase is complete and no major discrepancies +were noted by the SAT. On January 9, 2013, Crocs received a notice for the second phase in which the SAT proposed a tax assessment (taxes and penalties) of roughly 280 million pesos (approximately $22.0 million) based on the value of all +of Crocs’ imported raw materials during the audit period. We believe that the proposed penalty amount is unfounded and without merit. We have retained local counsel to handle the matter and who will argue that the amount due in connection with +the matter, if any, is substantially less than that proposed by the SAT. We expect it to take between two and three years for resolution of this matter in the Mexican courts. It is not possible at this time to predict the outcome of this matter or +reasonably estimate any potential loss. +As of December 31, 2012, we have accrued a total of $5.9 million related to these legal matters. +Although we are subject to other litigation from time to time in the ordinary course of business, including employment, intellectual property +and product liability claims, we are not party to any other pending legal proceedings that we believe will have a material adverse impact on our business. +16. UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION +2012 +($ thousands, except per share data) +Quarter +Ended +March 31 +Quarter +Ended +June 30 +Quarter +Ended +September 30 +Quarter +Ended +December 31 +Revenues +$ +271,798 +$ +330,942 +$ +295,569 +$ +224,992 +Gross profit +144,799 +196,085 +160,743 +106,350 +Asset impairment charges +713 +106 +— +591 +Income (loss) from operations +39,796 +71,261 +40,014 +(4,897 +) +Net income (loss) +$ +28,346 +$ +61,524 +$ +45,080 +$ +(3,607 +) +Basic income (loss) per common share +$ +0.32 +$ +0.68 +$ +0.50 +$ +(0.04 +) +Diluted income (loss) per common share +$ +0.31 +$ +0.68 +$ +0.49 +$ +(0.04 +) +2011 +($ thousands, except per share data) +Quarter +Ended +March 31 +Quarter +Ended +June 30 +Quarter +Ended +September 30 +Quarter +Ended +December 31 +Revenues +$ +226,708 +$ +295,585 +$ +274,897 +$ +203,713 +Gross profit +119,206 +170,218 +147,175 +99,811 +Asset impairment charges +32 +— +495 +1 +Income from operations +28,248 +64,774 +37,068 +6,415 +Net income +$ +21,504 +$ +55,506 +$ +30,207 +$ +5,571 +Basic income per common share +$ +0.24 +$ +0.62 +$ +0.34 +$ +0.06 +Diluted income per common share +$ +0.24 +$ +0.61 +$ +0.33 +$ +0.06 +F-34 \ No newline at end of file diff --git a/raw/filings/0001334036/2012/0001193125-13-072829/filing_metadata.csv b/raw/filings/0001334036/2012/0001193125-13-072829/filing_metadata.csv new file mode 100644 index 0000000000000000000000000000000000000000..815af1be41caed366b8fc25bb36e61c8323e2e79 --- /dev/null +++ b/raw/filings/0001334036/2012/0001193125-13-072829/filing_metadata.csv @@ -0,0 +1,2 @@ +cik,ticker,company_name,form,filing_date,report_date,acceptance_datetime,accession_number,primary_document,primary_doc_description,size,is_xbrl,is_inline_xbrl,document_url,filing_index_url,year,fiscal_year,is_primary_filing +0001334036,CROX,"Crocs, Inc.",10-K,2013-02-25,2012-12-31,2013-02-25T13:34:44.000Z,0001193125-13-072829,d445683d10k.htm,FORM 10-K,14571325,1,0,https://www.sec.gov/Archives/edgar/data/1334036/000119312513072829/d445683d10k.htm,https://www.sec.gov/Archives/edgar/data/1334036/000119312513072829/,2012,2012,1 diff --git a/raw/filings/0001334036/2012/0001193125-13-072829/item1.txt b/raw/filings/0001334036/2012/0001193125-13-072829/item1.txt new file mode 100644 index 0000000000000000000000000000000000000000..abd082b68970a79217c612c3134a23c316c5cd6b --- /dev/null +++ b/raw/filings/0001334036/2012/0001193125-13-072829/item1.txt @@ -0,0 +1,213 @@ +ITEM 1. +Business +The Company +Crocs, Inc. and its consolidated subsidiaries (collectively the “Company,” “we,” “our” or “us”) is a +designer, manufacturer and distributor of footwear and accessories for men, women and children. We strive to be the global leader in the sale of molded footwear featuring fun, comfort, color and functionality. Our primary products utilize our +proprietary closed cell-resin, called Croslite. The use of this unique material allows us to produce innovative, lightweight, non-marking and odor-resistant footwear. We currently sell our products in more than 90 countries through domestic and +international retailers and distributors and directly to end-user consumers through our company-operated retail stores, outlets, kiosks and webstores. In 2002, we launched the marketing and distribution of our original clog style footwear in the +United States. The unique characteristics of Croslite enabled us to offer consumers a shoe unlike any other footwear model then available. +Since the initial introduction and popularity of the Beach and Crocs Classic designs, we have expanded our Croslite products to include a variety of new +styles and products and have further extended our product reach through the acquisition of brand platforms such as Jibbitz, LLC (“Jibbitz”) and Ocean Minded, Inc. (“Ocean Minded”). We continue to branch out into other types +of footwear so as to bring a unique and original perspective to the consumer in styles that may be unexpected from Crocs. We believe this will help us to continue to build a stable year-round business as we look to offer more styles oriented for +cold weather. Our marketing efforts surround specific product launches and employ a fully integrated approach utilizing a variety of media outlets, including print and online. Our marketing efforts drive business to both our wholesale partners and +our company-operated retail and internet stores, ensuring that our presentation and story are first class and drive purchasing at the point of sale. +We were organized in 1999 as a limited liability company. In January 2005, we converted to a Colorado corporation and subsequently re-incorporated as a Delaware corporation in June 2005. In February 2006, +we completed our initial public offering and trading of our common stock on NASDAQ commenced. +Products +While the majority of our products consist of footwear, we also offer accessories and apparel which generated approximately 3.5% and 0.1%, respectively, +of our total revenues during the year ended December 31, 2012. Our footwear products are divided into four product offerings: Core-Comfort, Active, Casual and Style. The Core-Comfort product offering primarily includes molded and unisex +products targeted toward a wide range of consumers established through core Crocs attributes which include comfort, easy on-and-off capability, and color. The Active product offering is comprised of footwear intended for healthy living and includes +sport inspired products and footwear suited for activities such as boating, walking, hiking and even recovery after workouts. The Casual product offering includes sporty and relaxed styles appealing to a broad range of customers. The Style product +offering includes stylish products which are intended to broaden the wearing occasion for Crocs lovers. +We have an active licensing program +that includes licensing various marks from companies such as Disney, Marvel and Viacom, among others, for Crocs branded footwear and Jibbitz branded shoe charms. We also license certain of our own marks to third parties in connection with a strategy +to extend the Crocs brand into new product types. +Footwear +Our footwear product offering has grown significantly since we first introduced the Crocs single style clog in six colors, in 2002. We currently offer a wide product line of footwear, some of which +include boots, sandals, sneakers, mules and flats which are made of materials like leather and textile fabrics as well as Croslite. +1 +Table of Contents +A key differentiating feature of our footwear products is the Croslite material, which is uniquely suited +for comfort and functionality. Croslite is carefully formulated to be of a density that creates extremely lightweight, comfortable and non-marking footwear which conforms to the shape of the foot and increases comfort. Croslite is a closed cell +resin material which is water resistant, virtually odor free and allows many of our footwear styles to be cleaned simply with water. As we have expanded our product offering, we have incorporated traditional materials such as textile fabric and +leather into many new styles. However, we continue to utilize the Croslite material for the foot bed, sole and other key structural components for many of these styles. +As a global leader in casual footwear, we recognize the responsibility we have to our employees and the global communities we serve. We strive to maintain a spirit of “giving back” as a part of +the Crocs culture and worldwide reputation. With the help of our donation partners, we are able to provide a basic necessity—shoes—to millions of individuals that may not otherwise have a pair. As of December 31, 2012, we have donated +over 3 million pairs of shoes to individuals in need both domestically and internationally in more than 40 countries including Democratic Republic of The Congo, Haiti, Iraq, and Malawi. These donations and other social responsibility +initiatives, form the Crocs Cares program. Crocs is dedicated to providing robust programs, donations, and community work opportunities designed to make a difference in the lives of our employees as well as both local and global communities. +Footwear sales made up 95.8%, 95.6% and 95.5% of total revenues for the years ended December 31, 2012, 2011 and 2010, respectively. +During the years ended December 31, 2012, 2011 and 2010, approximately 75.3%, 73.1% and 75.5% of unit sales consisted of products geared towards adults, respectively, compared to 24.7%, 26.9% and 24.5% of unit sales of products geared towards +children, respectively. +Accessories +In addition to our footwear brands, we own the Jibbitz brand, a unique accessory product-line with colorful snap-on charms specifically suited for Crocs shoes. We acquired Jibbitz in December 2006 and +have expanded the product-line to include a wide variety of charms in varying shapes and sizes, with designs such as flowers, sports gear, seasonal and holiday designs, animals, symbols, letters and rhinestones. Crocs licensing agreements also +extend to Jibbitz, which allows Jibbitz to create designs bearing logos and emblems of Disney, Nickelodeon and the Crocs collegiate line, among others. Jibbitz designs allow Crocs consumers to personalize their footwear to creatively express their +individuality. As of December 31, 2012, more than 3,000 unique Jibbitz charm designs were sold to consumers for personalizing their Crocs footwear. Sales from Jibbitz designs made up 3.5%, 3.7% and 3.5% of total revenues for the years ended +December 31, 2012, 2011 and 2010, respectively. +Sales and Marketing +The broad appeal of our footwear has allowed us to market our products in a wide range of distribution channels, including department stores, traditional footwear retailers and a variety of specialty and +independent retail channels. Each season, we focus on presenting a compelling “brand story and experience” for our new product collections and our broader casual lifestyle assortment. Our marketing efforts center on multi-level story +telling across diverse wearing occasions and product silhouettes. +As we are a global brand, our model is based on global relevance while +still allowing for regional flexibility in execution and message. At the regional or market level, campaigns are initiated using a mix of digital, social, and traditional media outlets that align with local marketplaces and target consumer dynamics. +This strategy allows for relevant cross-channel input coordinated through our global brand objectives to drive an aligned global marketing and brand strategy. +We utilize an in-house creative team to execute our marketing efforts. Local marketing teams focus on localizing campaigns by establishing and executing marketing programs to effectively engage target +customers in a +2 +Table of Contents +meaningful manner. We utilize a proprietary Brand Performance System to help prioritize demand generation initiatives and optimize local marketing activities. The Brand Performance System +integrates multiple research and consumer database platforms across key markets to provide guidance on highest yielding customer growth opportunities and market performance analysis. +We have three primary sales channels: wholesale, retail and internet (discussed at a more detailed level below). Our marketing efforts are aimed toward driving business to both our wholesale partners and +our company-operated retail and internet stores. Our marketing efforts in the wholesale and retail channels are focused on visual product merchandising with alignment on key stories, activation materials and creative materials. Retail stores provide +a unique opportunity to engage with customers in a three-dimensional manner. Strong emphasis is placed on making the store experience a meaningful and memorable showcase of our larger assortment of casual lifestyle footwear and key new product +launches. Our marketing, merchandising, and visual merchandising departments work closely together to ensure the store environment and merchandise are aligned to support key seasonal product stories while promoting the larger product lines and +iconic product collections. +We have an in-house digital marketing team that oversees digital marketing programs and platforms that include +paid-and-organic search, display, re-targeting, email and affiliate marketing to drive new customers to the brand and retain existing customers. Under our universal seasonal brand campaign, the team helps to adapt key brand story content and +produces additional web-specific content for our internet channel. +Wholesale Channel +During the years ended December 31, 2012, 2011 and 2010, approximately 57.5%, 59.8% and 60.8% of net revenues, respectively, were derived from sales +through the wholesale channel which consists of sales to distributors and third party retailers. Wholesale customers include national and regional retail chains, department stores, sporting goods stores, independent footwear retailers and family +footwear retailers, such as Dick’s Sporting Goods, Famous Footwear, Academy, Kohl’s, Nordstrom, Xebio and Murasaki Sports, as well as on-line retailers such as Zappos and Amazon. No single customer accounted for 10% or more of our revenues +for the years ended December 31, 2012, 2011 and 2010. +We use third party distributors in select markets where we believe such +arrangements are preferable to direct sales. These third party distributors purchase products pursuant to a price list and are granted the right to resell the products in a defined territory, usually a country or group of countries. Our typical +distribution agreements have terms of one to four years, are generally terminable on 30 days prior notice and have minimum sales requirements. Many of our agreements allow us to accept returns from wholesale customers at our discretion for +defective products, quality issues and shipment errors on an exception basis or, for certain wholesale customers, extend pricing discounts in lieu of defective product returns. We also may accept returns from our wholesale customers, on an exception +basis, for the purpose of stock re-balancing to ensure that our products are merchandised in the proper assortments. Additionally, we may provide markdown allowances to key wholesale customers to facilitate in-channel product markdowns where +sell-through is less than anticipated. +Consumer Direct Channels +Consumer direct sales channels include retail and internet channels and serve as an important and effective means to enhance our product and brand awareness as they provide direct access to our consumers +and an opportunity to showcase our entire line of footwear and accessory offerings. Consequently, we view the consumer direct channels to be complementary to our wholesale channel. +3 +Table of Contents +Retail Channel +During the years ended December 31, 2012, 2011 and 2010, approximately 33.4%, 30.6% and 29.7%, respectively, of our net revenues were derived from sales through our retail channel, which consists of +kiosks/store in stores, company-operated retail and outlet stores. +Retail Stores As of December 31, 2012, +2011 and 2010, we operated 287, 180 and 136 global retail stores, respectively. Our retail stores allow us to effectively market the full breadth and depth of our new and existing products and interact with customers in order to enhance brand +awareness. +Outlet Stores As of December 31, 2012, 2011 and 2010, we operated 129, 92 and 78 global outlet +stores, respectively. Outlet stores help us move older products in an orderly fashion. We also sell full priced products in our outlet stores. +Kiosks/Store in Stores As of December 31, 2012, 2011 and 2010, we operated 121, 158 and 153 global retail kiosks and store in stores, respectively, located in malls and other high foot traffic +areas. +Of our 537 global stores, 199 stores operated in our Americas segment, including 170 located in the U.S. and 12 located in Canada; 241 +stores operated in our Asia segment, including 63 located in Korea, 43 located in Taiwan, 40 located in Japan, 39 located in China and 17 located in Hong Kong; and 97 stores operated in our Europe segment, including 29 located in Russia, 18 located +in Germany, and 16 located in Great Britain. The remaining stores were located throughout Asia, Europe, Australia, the Middle East, South America and South Africa. +Internet Channel +As of December 31, 2012, 2011 and 2010, we offered our products +through 43, 42 and 37 company-operated internet webstores, respectively, worldwide. During the years ended December 31, 2012, 2011 and 2010, approximately 9.1%, 9.6% and 9.5%, respectively, of our net revenues were derived from sales through +our internet channel. Our internet presence enables us to have increased access to our customers and provides us with an opportunity to educate them about our products and brand. We continue to expand our web-based marketing efforts to increase +consumer awareness of our full product range and have begun expanding the implementation of locally executed internet web stores at the regional level. +Business Segments and Geographic Information +We have three reportable operating segments: +Americas, Europe and Asia. Revenues of each of our reportable operating segments represent sales to external customers. We also have an “Other businesses” category which aggregates insignificant operating segments that do not meet the +reportable threshold and represent manufacturing operations located in Mexico and Italy. Revenues of the “Other businesses” category are primarily made up of intersegment sales which are eliminated when deriving total consolidated +revenues. The remaining revenues for the “Other businesses” represent non-footwear product sales to external customers. Financial information relating to our operating segments as well as foreign country revenues and long-lived assets is +provided in Note 14—Operating Segments and Geographic Information in the accompanying notes to the consolidated financial statements. +Americas +The Americas segment +consists of revenues and expenses related primarily to product sales in the North and South America geographic regions. Regional wholesale channel customers consist of a broad range of sporting goods and department stores as well as specialty +retailers. The regional retail channel sells directly to the consumer through 199 company-operated store locations as well as through webstores. During the years ended December 31, 2012, 2011 and 2010, revenues from the Americas segment +constituted approximately 44.1%, 44.8% and 47.5% of our consolidated revenues, respectively. +4 +Table of Contents +Asia +The Asia segment consists of revenues and expenses related primarily to product sales throughout Asia, Australia, New Zealand, the Middle East and South Africa. The Asia wholesale channel consists of +sales to a broad range of retailers similar to the wholesale channel we have established in the Americas. We also sell products directly to the consumer through 241 company-operated stores as well as through our webstores. During the years ended +December 31, 2012, 2011 and 2010, revenues from the Asia segment constituted 40.7%, 38.1% and 36.1% of our consolidated revenues, respectively. +Europe +The Europe segment consists of revenues and expenses related primarily to +product sales throughout Europe and Russia. Europe segment wholesale channel customers consist of a broad range of retailers, similar to the wholesale channel we have established in the Americas. We also sell our products directly to the consumer +through 97 company-operated stores including kiosks and retail stores as well as through our webstores. During the years ended December 31, 2012, 2011 and 2010, revenues from the Europe segment constituted 15.1%, 17.1% and 16.2% of our +consolidated revenues, respectively. +Distribution and Logistics +On an ongoing basis, we look to enhance our distribution and logistics network so as to further streamline our supply chain, increase our speed to market and lower operating costs. During the year ended +December 31, 2012, we stored our raw material and finished goods inventories in company-operated warehouse and distribution facilities located in the United States, Mexico, the Netherlands, Japan, Finland, South Africa, Russia and Italy. We +also utilize distribution centers which are operated by third parties located in the United States, China, Japan, Hong Kong, Australia, Korea, Singapore, India, Taiwan, the United Arab Emirates, Russia, Brazil, Argentina, Chile, Puerto Rico and +Italy. Throughout 2012, we continued to engage in efforts to consolidate our global warehouse and distribution facilities to maintain a lean cost structure. As of December 31, 2012, 2011 and 2010, our company-operated warehouse and distribution +facilities provided us with approximately 1.0 million square feet, 1.0 million square feet and 1.3 million square feet, respectively, and our third party operated distribution facilities provided us with approximately 0.3 million +square feet, 0.5 million square feet and 0.3 million square feet, respectively. We also ship a portion of our products directly to our customers from our internal and third party manufacturers. We are actively pursuing initiatives aimed at +shipping more of our product directly to our customers in an effort to lower future cost of sales. +Raw Materials +“Croslite”, our branded proprietary closed-cell resin, is the primary raw material used in the majority of our footwear and some of our +accessories. Croslite is soft and durable and allows our material to be non-marking in addition to being extremely lightweight. We continue to invest in research and development in order to refine our materials to enhance these properties and to +target the development of new properties for specific applications. +Croslite material is produced by compounding elastomer resins that we or +one of our third party processors purchase from major chemical manufacturers together with certain other production inputs such as color dyes. At this time, we have identified multiple suppliers that produce the elastomer resins used in the Croslite +material. We may, however, in the future identify and utilize materials produced by other suppliers as an alternative to the elastomer resins we currently use in the production of our proprietary material. All of the other raw materials that we use +to produce the Croslite products are readily available for purchase from multiple suppliers. +Since our inception, we have substantially +increased the number of footwear products that we offer. Many of our new products are constructed using leather, textile fabrics or other non-Croslite materials. We, or our third party manufacturers, obtain these materials from a number of third +party sources and we believe these materials are +5 +Table of Contents +broadly available. We also outsource the compounding of the Croslite material and continue to purchase a portion of our compounded raw materials from a third party in Europe. +Design and Development +We continue to +dedicate significant resources to product design and development as we develop footwear styles based on opportunities we identify in the marketplace. Our design and development process is highly collaborative, as members of the regional design +teams, including our EXO Italia (“EXO”) location, which specializes in EVA (Ethylene Vinyl Acetate) based finish products for the footwear industry, frequently meet with sales and marketing staff, production and supply managers and certain +of our retail customers to further refine our products to meet the particular needs of our target market. We continually strive to improve our development function so we can bring products to market quickly and reduce costs while maintaining product +quality. We spent $12.0 million, $10.8 million and $7.8 million in research, design and development activities for the years ended December 31, 2012, 2011 and 2010, respectively. +Manufacturing and Sourcing +Our +strategy is to maintain a flexible, globally diversified, low-cost manufacturing base. We currently have company-operated production facilities in Mexico and Italy. We also contract with third party manufacturers to produce certain of our footwear +styles or provide support to our internal production processes. We believe that our internal manufacturing capabilities enable us to rapidly make changes to production, providing us with the flexibility to quickly respond to orders for high demand +models and colors throughout the year, while outsourcing allows us to capitalize on the efficiencies and cost benefits of using contracted manufacturing services. We believe this strategy will continue to minimize our production costs, increase +overall operating efficiencies and shorten production and development times. +In the years ended December 31, 2012, 2011 and 2010, we +manufactured approximately 21.1%, 20.6% and 21.0%, respectively, of our footwear products internally. We sourced the remaining footwear production from multiple third party manufacturers primarily in China, Vietnam, Eastern Europe and South America. +During the years ended December 31, 2012, 2011 and 2010, our largest third party manufacturer in China produced approximately 31.7%, 33.1% and 38.8%, respectively, of our footwear unit volume. We do not have written supply agreements with our +primary third party manufacturers in China. +Intellectual Property and Trademarks +We rely on a combination of trademark, copyright, trade secret, trade dress and patent protection to establish, protect and enforce our intellectual +property rights in our product designs, brand, materials and research and development efforts, although no such methods can afford complete protection. We own or license the material trademarks used in connection with the marketing, distribution and +sale of all of our products, both domestically and internationally, in most countries where our products are currently either sold or manufactured. Our major trademarks include the Crocs logo and the Crocs word mark, both of which are registered or +pending registration in the U.S., the European Union, Japan, Taiwan, China and Canada among other places. We also have registrations or pending trademark applications for the marks Jibbitz, Jibbitz Logo, YOU by Crocs, YOU by Crocs Logo, Ocean +Minded, Tail Logo, Bite, Bite Logo, Crocband, Crocs Tone and Crocs Littles, “ Croslite” and the Croslite logo, as well as other marks in various countries around the world. +In the U.S., our patents are generally in effect for up to 20 years from the date of the filing of the patent application. Our trademarks registered within and outside of the U.S. are generally valid +as long as they are in use and their registrations are properly maintained and have not been found to become generic. We believe our trademarks are crucial to the successful marketing and sale of our products. We intend to continue to strategically +register, both domestically and internationally, the trademarks and copyrights we utilize today and those we develop in the future. We will also continue to aggressively police our patent, trademarks and copyrights and pursue those who infringe upon +them, both domestically and internationally, as we deem necessary. +6 +Table of Contents +We consider the formulations of the materials covered by our trademark Croslite and used to produce our +shoes to be a valuable trade secret. Croslite material is manufactured through a process that combines a number of components in various proportions to achieve the properties for which our products are known. We use multiple suppliers to source +these components but protect the formula by using exclusive supply agreements for key components, confidentiality agreements with our third party processors and by requiring our employees to execute confidentiality agreements concerning the +protection of our confidential information. Other than our third party processors and a third party licensee, we are not aware of any third party that has independently developed the formula or that otherwise has the right to use the formula. We +believe the comfort and utility of our products depend on the properties achieved from the compounding of Croslite material and constitute a key competitive advantage for us, and we intend to continue to vigorously protect this trade secret. +We also actively combat counterfeiting through monitoring of the global marketplace. We use our employees, sales representatives, +distributors and retailers, as well as outside investigators and attorneys, to police against infringing products by encouraging them to notify us of any suspect products and to assist law enforcement agencies. Our sales representatives and +distributors are also educated on our patents, pending patents, trademarks and trade dress to assist in preventing potentially infringing products from obtaining retail shelf space. The laws of certain countries do not protect intellectual property +rights to the same extent or in the same manner as do the laws of the U.S., and, therefore, we may have difficulty obtaining legal protection for our intellectual property in certain jurisdictions. +Seasonality +Due to the seasonal nature +of our footwear which is more heavily focused on styles suitable for warm weather, revenues generated during our first and fourth quarters are typically less than revenues generated during our second and third quarters, when the northern hemisphere +is experiencing warmer weather. We continue to expand our product line to include more winter oriented styles to mitigate some of the seasonality of our revenues. Our quarterly results of operations may also fluctuate significantly as a result of a +variety of other factors, including the timing of new model introductions or general economic or consumer conditions. Accordingly, results of operations and cash flows for any one quarter are not necessarily indicative of results to be expected for +any other quarter or year. +Backlog +We receive a significant portion of orders as preseason orders, generally four to six months prior to shipment date. We provide customers with price incentives to participate in such preseason programs to +enable us to better plan our production schedule, inventory and shipping needs. Unfulfilled customer orders as of any date are referred to as backlog and represent orders scheduled to be shipped at a future date. Backlog as of a particular date is +affected by a number of factors, including seasonality, manufacturing schedule and the timing of product shipments. Further, the mix of future and immediate delivery orders can vary significantly period over period. Due to these factors and since +the unfulfilled orders can be canceled at any time prior to shipment by our customers, backlog may not be a reliable measure of future sales and comparisons of backlog from period to period may be misleading. In addition, our historical cancellation +experience may not be indicative of future cancellation rates. Backlog as of December 31, 2012 and 2011 was $354.3 million and $307.4 million, respectively. +Competition +The global casual, athletic and fashion footwear markets are highly +competitive. Although we believe that we do not compete directly with any single company with respect to the entire spectrum of our products, we believe portions of our wholesale business compete with companies such as, but not limited to, Deckers +Outdoor Corp., Skechers USA Inc., Steve Madden, Ltd., Wolverine World Wide, Inc. and VF Corporation. Our company-operated retail locations also compete with footwear retailers such as Genesco, Inc., Macy’s, Dillard’s, Dick’s +Sporting Goods Inc., The Finish Line, Inc and Footlocker, Inc. +7 +Table of Contents +The principal elements of competition in these markets include brand awareness, product functionality, +design, quality, pricing, customer service, marketing and distribution. We believe that our unique footwear designs, the Croslite material, our prices, expanded product-line and our distribution network continue to position us well in the +marketplace. However, some companies in the casual footwear and apparel industry have greater financial resources, more comprehensive product lines, broader market presence, longer standing relationships with wholesalers, longer operating histories, +greater distribution capabilities, stronger brand recognition and greater marketing resources than we have. Furthermore, we face competition from new players who have been attracted to the market with imitation products similar to ours as the result +of the unique design and success of our footwear products. +Employees +As of December 31, 2012, we had approximately 4,900 full-time, part-time and seasonal employees, none of which were represented by a union. +Available Information +Our internet address is www.crocs.com on which we post the +following filings, free of charge, as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our +current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Copies of any of these documents will +be provided in print to any stockholder who submits a request in writing to Integrated Corporate Relations, 761 Main Avenue, Norwalk, CT 06851. \ No newline at end of file diff --git a/raw/filings/0001334036/2012/0001193125-13-072829/item13.txt b/raw/filings/0001334036/2012/0001193125-13-072829/item13.txt new file mode 100644 index 0000000000000000000000000000000000000000..5f33ad653505a377cbc774f04018ddd7bb87d90b --- /dev/null +++ b/raw/filings/0001334036/2012/0001193125-13-072829/item13.txt @@ -0,0 +1,4 @@ +ITEM 13. +Certain Relationships and Related Transactions, and Director Independence +The information required by this item is incorporated herein by reference to our definitive proxy statement for the 2013 Annual Meeting of Stockholders to be filed with the SEC within 120 days after +December 31, 2012. \ No newline at end of file diff --git a/raw/filings/0001334036/2012/0001193125-13-072829/item9a.txt b/raw/filings/0001334036/2012/0001193125-13-072829/item9a.txt new file mode 100644 index 0000000000000000000000000000000000000000..092a64d7f5637b762da2c7102ce49ab64328f335 --- /dev/null +++ b/raw/filings/0001334036/2012/0001193125-13-072829/item9a.txt @@ -0,0 +1,52 @@ +ITEM 9A. +Controls and Procedures +Evaluation of Disclosure Controls and Procedures +Under the supervision and with the participation of our senior management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design +and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of December 31, 2012 (the “Evaluation Date”). Based on this evaluation, our Chief Executive Officer +and Chief Financial Officer concluded that as of the Evaluation Date, our disclosure controls and procedures were effective such that the information relating to us, including our consolidated subsidiaries, required to be disclosed in our Securities +and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our Chief +Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. +Management’s Annual Report on Internal Control Over Financial Reporting +Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our management assessed the +effectiveness of our internal control over financial reporting as of December 31, 2012, using the criteria set forth in the Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway +Commission (COSO). Based on this assessment, management has concluded that our internal control over financial reporting was effective as of December 31, 2012. +45 +Table of Contents +Deloitte & Touche LLP, our independent registered public accounting firm, has issued a report +on our internal control over financial reporting, which is included herein. +Changes in Internal Control Over Financial Reporting +There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially +affected, or is reasonably likely to materially affect, our internal control over financial reporting. +46 +Table of Contents +REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM +To the Board of Directors and Stockholders of +Crocs, Inc. +Niwot, Colorado +We have audited the internal control over financial reporting of Crocs, Inc. and subsidiaries (the Company) as of December 31, 2012, based on criteria +established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial +reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Annual Report on Internal Control Over Financial Reporting”. Our responsibility is to +express an opinion on the Company’s internal control over financial reporting based on our audit. +We conducted our audit in accordance +with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was +maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of +internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. +A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive +and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and +the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the +maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of +financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide +reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. +Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override +of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to +the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. +In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal Control +— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission . +We have also audited, +in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2012 of the Company and our report dated February 25, 2013 +expressed an unqualified opinion on those financial statements. +/s/ Deloitte & Touche LLP +Denver, Colorado +February 25, 2013 +47 +Table of Contents \ No newline at end of file diff --git a/raw/filings/0001334036/2012/0001193125-13-072829/rp_note.txt b/raw/filings/0001334036/2012/0001193125-13-072829/rp_note.txt new file mode 100644 index 0000000000000000000000000000000000000000..e69de29bb2d1d6434b8b29ae775ad8c2e48c5391 diff --git a/raw/filings/0001334036/2012/0001193125-13-072829/rpt_disclosure.txt b/raw/filings/0001334036/2012/0001193125-13-072829/rpt_disclosure.txt new file mode 100644 index 0000000000000000000000000000000000000000..cb097520fec7b843c392791b18c70937d4d3b539 --- /dev/null +++ b/raw/filings/0001334036/2012/0001193125-13-072829/rpt_disclosure.txt @@ -0,0 +1,18 @@ +CERTAIN RELATIONSHIPS AND RELATED PERSON TRANSACTIONS +Related Person Transactions +We had no transactions with related persons during 2012 which are required to be disclosed by the rules of the SEC. +Policy on Transactions with Related Persons +Our Code of Business Conduct and Ethics requires that any transaction involving us in which one of our directors, nominees for director, executive +officers, or greater than five percent stockholders, or one of the aforementioned's immediate family members (each, a "related person"), have a material interest be approved or ratified by the Audit +Committee if the amount involved, when aggregated with the amount of all other transactions between the related person and us, exceeds $100,000 in a fiscal year. The full Board reviews ordinary course +of business transactions in which directors have an interest as part of the Board's annual director independence review, and our Code of Business Conduct and Ethics permits the full Board to waive any +conflicts of interest between us and any director or officer. In determining whether to approve or ratify any such transaction, the Audit Committee must consider, in addition to other factors it deems +appropriate, whether the transaction is on terms no less favorable to us than those involving unrelated parties. +13 +Table of Contents +Director and Officer Indemnification +We have entered into agreements to indemnify certain directors and executive officers in addition to the indemnification provided for in our +certificate of incorporation and bylaws. These agreements, among other things, provide for indemnification of our directors and executive officers for certain expenses (including attorneys' fees), +judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by us or in our right, arising out of such person's services as a director or +executive officer of ours, any subsidiary of ours or any other company or enterprise to which the person provided services at our request. We believe that these provisions and agreements are necessary +to attract and retain qualified persons as directors and executive officers. \ No newline at end of file