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COMPANY NOTE Company Update USA | Consumer | Apparel, Footwear & Textiles January 3, 2012 Deckers Outdoor (DECK) Conviction List EQUITY RESEARCH AMERICAS BUY Deep Dive Ahead of 2012 Price target $125.00 Price $75.57 Key Takeaway While DECK remains a favorite name of ours into 2012, we see a scenario where management guides initial FY12 EPS up to 50c below consensus but ultimately reports FY12 EPS well above. Our call is specific to how we see the Financial Summary company guiding margins. We would be buyers on related (if any) weakness as Book Value (MM): $656.0 management has a history of guiding conservatively and ultimately crushing Book Value/Share: $16.69 expectations. See our 20 page report for details. Net Debt (MM): $21.0 2012 Buy Thesis. Our view continues to be based on upward sales bias from accelerating Return on Avg. Equity: 24.2% UGG store growth and the Sanuk acquisition. We also see SG&A leverage opportunity from Long-Term Debt (MM): $0.0 the anniversary of one-time expenses. We expect retail growth and Sanuk alone to account LTD/Cap: 0.0% for 15% sales growth next year. With consensus currently calling for 20% sales growth next Dividend Yield: 0.0% year, the implied global wholesale assumption appears very conservative. We think 30% + sales growth and SG&A leverage are achievable in FY12 but unlikely to be reflected in Cash & ST Invest. (MM): $90.0 management's initial (conservative) guidance. Market Data Thoughts on Initial FY12 Guidance. Consistent with our published research, we think 52 Week Range: $118.90 - $71.18 management may guide FY12 below consensus on conservative margin assumptions. We Total Entprs. Value (MM): $2,990.9 provide numerous scenarios for sales & EPS growth in the attached report. The most likely Market Cap. (MM): $2,969.9 case, in our opinion, will be an initial FY12 guide of 15-20% sales growth and 5% EPS Insider Ownership: 4.2% growth. This compares to consensus, which is calling for 20% sales growth and 17% EPS growth. While consensus GM% expectations (down 210 bps) have become more realistic, Institutional Ownership: 100.9% the operating margin line (down 40 bps) appears too aggressive versus where management Shares Out. (MM): 39.3 may ultimately guide. Recall the 3Q call where the company spoke to investments such as Float (MM): 37.0 new stores and personnel. This, to us, suggests that the initial guide will not call for SG&A Avg. Daily Vol.: 1,427,245 leverage. That said, there is a very strong case to be made for SG&A leverage in FY12. Three Important EPS Numbers. In forecasting DECK's FY12 initial guidance, there are three important numbers to consider: consensus ($5.91), potential guidance range ($5.50- $5.75) and EPS power ($6.50). Our FY12 estimate of $6.10 is at the mid-point of the potential initial guidance and EPS power figures. Valuation/Risks DECK trades at 15x forward EPS and 10x EV/EBITDA. These metrics are a discount to history. Our PT reflects a premium multiple as justified by a stronger growth profile and upward Taposh Bari, CFA, CPA * EPS bias. We arrive at $125 using a blended average of 25x P/E and 15.5x EV/EBITDA. Risks Equity Analyst (212) 708-2712 TBari@jefferies.com include cost inflation, execution (retail, international), and fashion trends. * Jefferies & Company, Inc. USD Prev. 2009A Prev. 2010A Prev. 2011E Prev. 2012E Price Performance EBITDA (MM) -- 192.0 -- 262.0 -- 309.0 -- 361.0 120 EV/EBITDA 15.6x 11.4x 9.7x 8.3x Consensus -- -- -- -- -- 4.83 -- 5.86 110 EPS Mar -- 0.31 -- 0.46 -- 0.49A -- -- 100 Jun -- 0.09 -- 0.23 -- (0.19)A -- -- Sep -- 0.86 -- 1.07 -- 1.59A -- -- 90 Dec -- 1.74 -- 2.27 -- 3.25 -- -- FY Dec -- 2.98 -- 4.04 -- 5.16 -- 6.10 80 FY P/E 25.4x 18.7x 14.6x 12.4x 70 JAN-11 MAY-11 AUG-11 DEC-11 Jefferies does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Jefferies may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see analyst certifications, important disclosure information, and information regarding the status of non-US analysts on pages 15 to 20 of this report. DECK Company Update Deckers Outdoor January 3, 2012 Buy: $125 Price Target THE LONG VIEW Scenarios Target Investment Thesis Upside Scenario Downside Scenario Inherent EPS upside to management Better than expected sales driven by UGG Deceleration of the boot cycle would have guidance and consensus given company’s retail, UGG wholesale and Teva wholesale. an adverse effect on ASP’s and sales. history of easily exceeding expectations. Margin leverage, particularly in the back Lack of sales upside would disrupt the EPS Sales growth led by retail expansion, half of 2011, as incremental sales come beat + raise story that is expected and international growth, men’s initiatives and from accretive international and retail priced into the stock. apparel & handbags growth. channels. 2011 EPS: $4.90; Target Multiple: 16x Best in class management team and strong 2011 EPS: $5.35; Target Multiple: 27x; Target Price: $78 net cash balance. Target Price: $145 2011 EPS: $5.16; Target Multiple: 25x P/E, 15x EV/EBITDA; Target Price $125 Long Term Analysis 1 Year Forward P/E Long Term Financial Model Drivers Other Considerations LT Earnings CAGR 20% DECK has accumulated a significant cash Organic revenue growth 15% balance that is well in excess of its Operating Margin Expansion 5% operational needs. The company has been shopping for a lifestyle brand but has yet to find one given the stringent set of criteria. Ultimately, we believe an increased share repurchase bodes well for investors and provides a positive signal to Source: Capital IQ, Jefferies estimates the market in management’s confidence behind the core brands’ growth prospects. Peer Group Group P/Es Earnings Growth vs P/E Recommendation / Price Target Ticker Rec. PT DECK Buy $125 WWW Hold $40 UA Hold $75 LULU Hold $54 NKE Buy $115 Source: Capital IQ, Jefferies estimates Source: Capital IQ, Jefferies estimates Catalysts Company Description February 2012: 4Q11 earnings results Deckers is a leading designer and wholesaler of footwear brands based in Goleta, California. The company’s portfolio of brands includes UGG, Teva, Sanuk, Simple, Tsubo February 2012: 2012 preliminary guidance and Ahnu. UGG accounts for 90% of sales and is the leading driver of the investment story. UGG is mainly sold at wholesale through a limited distribution network that includes better department stores (Nordstrom being its largest account), specialty store chains and independent retailers. Going forward, we view UGG as a brand that represents comfort, first and foremost, with growth levers that include: 1) U.S. expansion, 2) retail, and 3) international (which replicates the U.S. model). page 2 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 Laying Out the Parts for 2012 Guidance Deckers is set to provide initial FY12 guidance with 4Q11 earnings in late February. Management has a history of guiding conservatively and ultimately crushing expectations. Despite this pattern, management’s initial FY guidance has rarely been below consensus with FY09 being a recent exception. We believe a below consensus guide is possible for FY12 and would use any related weakness as a major buying opportunity. 4Q, which is still to be reported, will play a key role in the absolute level of FY12 EPS guidance. Historically, the company’s out-year sales and EPS growth forecasts have been on the lighter side but more than offset by a strong 4Q beat. The combination of conservative out-year EPS growth and a strong 4Q has, in most cases, led to above consensus out-year EPS guidance. This coming year, we believe the margin headwinds are too strong to be offset by a 4Q beat. As a result, there is a chance that management’s initial FY12 EPS outlook could fall below consensus. The last time this happened at Deckers was in 2009 with the stock declining 22% the following trading day. We see three important EPS figures to consider ahead of 2012: 1. 2012 consensus EPS = $5.91 2. 2012 potential EPS guidance range = $5.50 - $5.75 3. 2012 EPS power = $6.50 Bottom line, we think management could guide up to $0.50 below consensus but ultimately report FY12 $1.00 above guidance. In analyzing consensus estimates, we believe assumptions for gross margin (down 210 bps) and operating margin (down 40 bps), while possible when all said and done, are above where management will likely guide. Gross margins face ongoing pressure from product cost inflation and limited pricing power while SG&A faces the ongoing challenge of ‚investments.‛ Coming out of the 3Q11 call in October, our impression was that gross margins would be down a few hundred basis points (at least 200, in our opinion) and SG&A will not achieve leverage. While these assumptions should ultimately prove conservative, we think it’s fair to assume that management will, at least initially, guide within the confines of its 3Q commentary. Although consensus margin expectations appear to be too aggressive (at least versus where management will initially guide) we strongly believe that consensus sales estimates are too conservative. Deckers has a number of highly visible revenue catalysts in 2012 including the opening of 25 new retail stores, full year of the Sanuk acquisition, and global wholesale growth. We (conservatively) model new retail store openings and Sanuk to contribute around 15% of revenue growth alone. Consensus is currently forecasting 20% total revenue growth in 2012, which implies global organic wholesale growth of 3-4%. To put this figure in greater perspective, 2011 year-to-date wholesale growth is >25% (excluding international transition benefit of $50m) and was 20% in 2010 and 13% in 2009. Bottom line – the implied 3-4% wholesale growth assumption in consensus estimates appears very conservative. page 3 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 Scenario Analysis We believe management’s initial FY12 EPS outlook could fall within the range of $5.50 - $5.75. The table below details the numerous possible outcomes based on a function of 4Q11 actual results and FY12 sales / EPS growth assumptions. Our estimated range is based on a ~10% 4Q11 beat vs. guidance (DECK exceeded its last two 4Q guides by 20%, each) and 5% EPS growth for FY12. Chart 1: Scenarios Based on 4Q11 Actuals and FY12 Sales, EPS Growth 2012 Sales % / EPS % Growth Scenarios 10% / 0% 15% / 0% 15% / 5% 20% / 5% 20% / 10% 2.85 4.75 4.75 5.00 5.00 5.23 4Q11 EPS Scenarios 2.95 4.85 4.85 5.10 5.10 5.32 guidance 3.02 4.92 4.92 5.17 5.17 5.41 consensus 3.13 5.03 5.03 5.28 5.28 5.58 JEF 3.25 5.15 5.15 5.41 5.72 5.72 3.35 5.25 5.25 5.51 5.51 5.83 3.45 5.35 5.35 5.62 5.62 5.94 3.55 5.45 5.45 5.73 5.73 6.05 consensus FY12 EPS = $5.91 Source: Jefferies estimates Our assumption throughout this report is that management will guide FY12 to 20% revenue growth and 5% EPS growth. 20% sales growth would be comparable to FY11’s initial guide, which comprised 15% organic growth and 5% from the international transition. FY12 has a similar 5% benefit, this time from the full year benefit of Sanuk. The lower EPS growth assumption is based on around 300 bps of operating margin compression. We arrive at this figure using around 250-300 bps of gross margin pressure and 0-50 bps of SG&A pressure. Again, this is how we expect management to initially guide FY12 with 4Q11 earnings in late February. The following table illustrates the different scenarios in a more detailed manner versus the table above. What’s evident is that even in the case of a strong 4Q11 beat, there is still a likelihood that FY12 guidance will be below consensus of $5.91. Our baseline assumption is Chart 2: FY12 EPS Guidance Scenarios management initially guiding fiscal 4Q11 JEF Guidance BETTER Case BEST Case consensus 2012 revenues to grow 20% and EPS sales 569 555 577 590 560 5%. sales growth 32.3% 29.0% 34.0% 37.0% 30.2% margins (30) (185) 40 165 (110) EPS 3.25 3.02 3.35 3.55 3.12 2011 JEF Guidance BETTER Case BEST Case consensus sales 1,343 1,329 1,351 1,364 1,336 EPS 5.16 4.93 5.26 5.46 5.01 2012 Initial Guide JEF Off of FY11 Guidance Off of FY11 BETTER Off of FY11 BEST consensus sales 1,679 1,595 1,621 1,637 1,606 sales growth 25.0% 20.0% 20.0% 20.0% 20% operating margins (153) (300) (300) (300) (40) EPS 6.10 5.16 5.51 5.73 5.91 EPS growth, % 18% 5% 5% 5% 18% Source: Jefferies estimates page 4 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 DECK Initial FY Guidance History It is no secret that Deckers management is notorious for guiding conservatively. That said, the initial fiscal year outlook (with 4Q earnings) is often above consensus as a strong 4Q beat offsets an initially modest EPS growth rate. The table below lists guidance statistics for 2009, 2010 and 2011 along with how we think 2012 could materialize. 2009 stands out as the year which management guided below consensus with a corresponding 22% decline in the stock on the following day. Ironically, the company ultimately not only exceeded its initial guidance by 25% but also the initial consensus estimate by 11%. We see a similar situation occurring in 2012 with a below-consensus guide and ultimately a result that is above (original) consensus. Chart 3: Stock Reaction to Initial FY Guidance fiscal year report date consensus guidance guide vs. cons stock move actual FY reported actual vs. guide 2009 2/26/09 2.69 2.38 below -22% 2.98 25% 2010 2/25/10 2.79 3.13 above -2% 4.01 28% 2011 2/24/11 4.25 4.44 above 11% $5.03 (consensus) 13% 2012E* 2/1/12 5.91 5.50 - 5.75 below $6.50 (EPS power) 15% *2012E line based on JEF estimates Source: Jefferies estimates The table below illustrates the company’s initial sales and EPS growth forecasts going back to 2003. The conclusion here is obvious but worth mentioning nonetheless. The company’s actual results have exceeded management’s initial outlook in every single year (including the recession years in 2008, 2009). This further supports our belief that a below-consensus guide combined with a stock sell- off would create an attractive entry point for investors. Actual results have exceeded initial Chart 4: DECK Guidance History guidance every single year since 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E* 2003, including the recession (2008, out-year initial guide sales growth, % 3% 7% 5% -2% 15% 25% 8% 11% 20% 20% 2009). EPS growth, % 15% 20% 5% -15% 5% 20% -1% 5% 10% 5% actual results sales growth, % 22% 77% 23% 15% 48% 54% 18% 23% 34% 30% EPS growth, % 118% 175% 23% 32% 56% 43% 23% 35% 29% 25% Beat sales growth, % 19% 70% 18% 17% 33% 29% 10% 12% 14% 10% EPS growth, % 103% 155% 18% 47% 51% 23% 24% 30% 19% 20% *2012E b ased on JEF estimates Source: Jefferies estimates page 5 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 Revenue Growth Our 2012 outlook assumes a robust and visible sales outlook. Anchoring this forecast is retail store acceleration with 25 new stores planned for 2012 (from 17 new stores in 2011). We model these new stores to add about $120 million in sales next year. Sanuk is another visible sales driver next year as DECK records its first spring/summer season for the newly acquired brand. This represents another $60 million of revenues. Combined, we model retail and Sanuk to contribute 15% to DECK’s fiscal 2012 sales growth. Additionally, we also model wholesale to grow 15% globally. This equates to 11% contribution to net sales growth (wholesale = 2/3 of sales). The table below illustrates the aforementioned sales levers and their collective contribution to our 25% revenue growth forecast for 2012. Retail and Sanuk alone should Chart 5: (Visual) 2012 Revenue Growth Levers contribute 15% points of sales 1% 25% growth in 2012. Consensus is 350 5% currently forecasting 20% growth, 300 implying that global wholesale will 5% 2012 Sales Growth, $m grow 3-4% in 2012 (we think this is 250 too low). 200 6% 150 9% 100 50 0 retail wholesale (int'l) wholesale (U.S.) Sanuk e-commerce 2012 sales Source: Jefferies estimates The following table outlines Deckers’ 2012 revenue growth drivers numerically. The important take-away from this presentation: our modeled 25% revenue forecast for fiscal 2012 is above consensus’ 20% but still implies conservative assumptions around global wholesale. Specifically, we are modeling global wholesale to grow 15% (9% U.S.). For context, Deckers’ wholesale division is up 25% year-to-date (after excluding the $50 million benefit from the international transition) and grew 31% and 19% in 2010 and 2009, respectively. We think a 15% global wholesale growth rate in 2012 is fair given the distribution opportunities the recent UK / Benelux investments created. Meanwhile, our 9% modeled U.S. wholesale growth rate compares to a business that is up 20% year-to-date. Our 25% sales growth assumption Chart 6: (Numerical) 2012 Revenue Growth Levers for FY12 assumes global wholesale 2012 growth growth of 15% vs. consensus of 3- % of sales dollars, $m percent, % growth contribution 4%. retail 20% 121 57% 9% 2011 YTD organic wholesale growth wholesale (int'l) 22% 75 25% 6% is running up 25%+. wholesale (U.S.) 46% 66 9% 5% Sanuk 5% 61 25% 5% e-commerce 7% 16 15% 1% 100% 338 25% 25% Source: Jefferies estimates page 6 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 Retail Growth One of the core pillars of our Buy thesis is DECK’s positively inflecting retail store trajectory. We find that investors typically gravitate towards these types of stories that often provide highly visible and tangible growth. In 2012, we expect the company to open 25 new UGG stores, increasing the total from 44 in 2011 to 69 by year-end. A margin accretive UGG retail Chart 7: Retail Growth Forecast strategy is just now beginning to 150 accelerate for DECK. 125 2011 = retail growth inflection 100 Stores 75 50 25 0 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E Store Base New Stores Source: Jefferies, company data The following table outlines the math behind our retail assumptions. Simply put, we applied last year’s same sales/average store productivity to the 2012 average store count. Our model yields $121 million of new store sales associated with the 25 new store growth. This represents around 9% sales growth contribution on 2011’s base. Chart 8: Retail Model (in millions, $) 2007 2008 2009 2010 2011E 2012E retail sales $18 $38 $79 $126 $212 $332 change 20 40 47 86 121 retail stores 7 10 17 27 44 69 new stores 2 3 7 10 17 25 average # of stores 6 9 14 22 36 57 sales per average store 3.1 4.5 5.8 5.7 6.0 5.9 Source: Jefferies, company data Our assumptions for 2012 also include 15% organic e-commerce growth. page 7 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 Sanuk Acquisition Deckers acquired Sanuk on July 1, 2011, the first day of its fiscal 3Q11. As a result, it did not report Sanuk operations in its 1H11 financial statements. 1H is Sanuk’s higher volume, more profitable selling season and will be nicely accretive to sales and EPS in 2012. Assuming Sanuk grows 25% in 2012, we arrive at $61 million of incremental sales for DECK. This includes $43 million of unrecorded 1H11 sales and $18 million of organic growth. At $61 million, Sanuk contributes another 5% to DECK’s sales growth profile for 2012. Chart 9: Sanuk Revenue Model (in millions, $m) 2010 2011E 2012E 1H sales -- 43 54 2H sales -- 28* 35 Sanuk full year sales $48 $71 $89 growth, % 48% 25% Sanuk sales reported by DECK $0 $28 $89 change, $m $28 $61 *DECK acquired Sanuk on July 1, 2011. Source: Jefferies estimates Wholesale Growth Wholesale accounts for 70% of Deckers’ business and is one of the least visible channels for investors. There is a perennial fear that this channel, especially in the U.S., is saturated and lacks the catalysts to grow further. In 2012, we believe international wholesale has an opportunity to surprise (positively) with the company now directly operating its two largest markets, the UK and Benelux. Currency and macro headwinds constrain the upside, but we still think a 25% growth rate is achievable outside the U.S. Domestically, we are modeling 9% organic growth (excluding Sanuk). This compares to an implied consensus estimate of 3-4%, at most (this is the global growth estimate). Year- to-date, DECK’s U.S. wholesale business is running up 20%. In aggregate, we think 14% global wholesale growth is achievable for DECK in 2012. Our $141 million incremental revenue growth represents an 11% contribution to revenue 2012 growth. Chart 10: Wholesale Model 2011E Sanuk reported organic organic 2012E (in millions, $) % of sales sales growth ($) growth ($) growth (%) sales United States 70% 716 61 66 9% 842 International 30% 307 -- 75 25% 382 Total 1,023 61 141 14% 1,225 Source: Jefferies estimates page 8 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 Gross Margin Contraction Deckers’ 3Q11 earnings call (late October 2011) suggested continued pressure from product costs. Sheepskin costs, in particular, are set to increase 40% in 2012 after rising 30% in 2011. In net, Deckers’ cost of goods will grow another 10% (after a 10% increase in 2011). Importantly, management has made it clear that investors should not expect the entire COGS headwind to be offset like it was in 2011. This is because 2011’s gross margins had the one-time benefit of Deckers taking over its higher gross margin UK/Benelux owned wholesale businesses. The positive gross margin accretion from this event fully offset what should have been around 400 bps of cost-related gross margin compression. 2012 gross margins: Looking out to 2012, the company’s gross margins will face the same amount of - -500 bps = 10% COGS growth inflationary pressure as in 2011 but without the offsetting one-time benefit. As a result, - +100 bps = retail mix we expect to see a more meaningful contraction to gross margins. As we explain in the - +50 bps = price increases SG&A section that follows, there should also be a corresponding leveraging benefit. - +100 bps = other (brand, product mix) The following are important considerations in modeling gross margins for 2012. Our existing outlook of 250 bps of contraction incorporates -500 bps of COGS inflation offset by +50 bps from price increases, +100 bps from retail mix and 100 bps from other factors like Sanuk, international and product mix. 10% COGS Inflation (-500 bps). Management’s 10% COGS inflation outlook for 2012 should itself drive 400-500 bps of gross margin compression (calculated as a 10% discount to 50% gross margin in 2011). This actually took place in 2011 as well, but was obscured by an offsetting benefit of ~425 bps from the integration of the gross margin accretive UK/Benelux wholesale businesses. This benefit will not repeat in 2012. Retail Mix (+100 bps). DECK is deploying an aggressive store growth strategy with the roll-out of UGG stores worldwide. These stores carry a much higher gross margin than the wholesale business. We model the spread to be about 25 points (75% retail vs. 50% wholesale). We expect DECK’s direct-to- consumer (retail + e-commerce) sales mix to grow 300-400 basis points in 2012. The resulting mix benefit is around 75-100 bps to DECK’s 2012 gross margins. Price Increases (+50 bps). The company will have to balance price increases carefully next year as it looks to retain its accessible price points and compete with lower-priced competition. As a result, the benefit to gross margins will only partially offset the inflationary pressure. Our 50 bps assumption is in-line with what we believe to have been the benefit in 2011. Other Mix (+100 bps). Having good visibility into the aforementioned gross margin variables, this will be the ‘wild card’ for 2012. There is a host of other potential mix benefits like brand mix (Sanuk’s 1H is margin accretive), product mix (shift away from sheepskin), international mix, etc. In aggregate, we model this benefit to account for +100 bps to Deckers’ 2012 gross margins. page 9 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 SG&A: Should Lever but Probably not in Guidance In light of the cost pressure expected in 2012, there is a view that DECK should be able to offset gross margin contraction with SG&A leverage. We agree and make a strong case in the following bullets. However, management, on the 3Q11 earnings call, explicitly stated that they will not compromise the long-term strategy by trying to manage to a single year’s earnings estimate. As such, we expect the company to initially guide to some SG&A de-leverage but ultimately exceed that plan and post SG&A leverage. The following table summarizes our SG&A view into 2012. It is important to note that while the company is likely to de-lever SG&A by around 350 bps in 2011 (management guidance), this entire amount is being driven by the company’s UK/Benelux wholesale business transition. In fact, if we were to exclude that event and the Sanuk banker fees ($4.1 million), Deckers would have actually achieved 96 basis points of SG&A leverage in 2011. This is before adjusting for an $11 million increase in marketing spend, $7m legal and 17 new stores. This tells us that the company should be able to achieve leverage in 2012. After normalizing 2011’s one-time Chart 11: SG&A Summary charges and mix shifts, it becomes 2006 2007 2008 2009 2010 2011E 2012E evident that DECK would have SG&A 24.3% 22.7% 22.1% 23.2% 25.4% 28.9% 27.9% achieved around 100 bps leverage reported change (bps) 192 (160) (57) 109 214 354 (100) on SG&A. 2011 factors (bps): higher SG&A UK/Benelux business model (350) $9m international transition (70) $4.1m Sanuk transaction fees (30) 2011 change (adjusted) (96) 2012 factors (bps): $3 million less legal spend (20) no repeat of $9m international transition (55) no repeat of Sanuk transaction fees (25) 25 new retail stores 50 Sanuk earn-out & amortization 25 organic leverage on 25% sales growth (75) 2012 change (expected) (100) Source: Jefferies estimates Impact from UK / Benelux Ownership in 2011 A lot has been made of DECK’s international transition mix helping consolidated GM% by 425 bps in 2011. This amount, which offset the 10% COGS inflation in 2011, will not anniversary in 2012. As such, DECK’s repeated 10% COGS inflation in 2012 will be fully exposed and likely result in a significant GM% contraction versus 2011. There is a corresponding SG&A moving piece, however, that the company has been less vocal about. Recall that the UK/Benelux business, which DECK took over in 2011, is margin accretive. As such, if this business helped GM% by 425 bps in 2011, it should have elevated SG&A by somewhere near that figure (we estimate 350 bps). This excludes the one-time $9m transition fees the company paid to the former operators. As a result, we think it’s fair to imply that the 350 bps of de-leverage in 2011 is being driven by this event. After backing out the $9 million one-time transition charge and $4.1 million Sanuk banker fees, we find that DECK would have actually levered SG&A in 2011. This despite $11 million more marketing spend, $7 million more legal spend and new store growth. page 10 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 Anniversary of One-Time Expenses 2011 was an investment year for DECK with the tuck-in of the UK/Benelux wholesale UGG business and Sanuk acquisition. The expenses associated with these events were included in management guidance and consensus estimates for 2011. As we enter 2012, we do not expect any significant investments to play a materially de-leveraging role in SG&A. That said, the company did say on its 3Q11 call that there will be an ongoing commitment to marketing (more on this below) and international personnel. Specific expenses to consider include: $9 million international transition. This was a fee that DECK paid the incumbent distributors of the UK and Benelux businesses in 1Q and 2Q of 2011. This expense will not recur in 2012. $4.1 million Sanuk transaction fee. DECK’s 2011 EPS includes $4.1 million of fees related to the Sanuk transaction. These were one-time in nature and will not repeat in 2012. $3 million less legal spend. DECK’s legal expenses increased $7 million in 2011. This expense is set to decline in 2012 by around $3 million. Simple closure. By discontinuing the Simple brand, the company will relieve itself of a $2 million operating loss. Part of that is likely to benefit SG&A in 2012. Sanuk Accretion As we outlined earlier, the acquisition of Sanuk in 3Q11 creates an accretive revenue event in the first half of 2012. This brand is also set to make a strong (organic) EBIT contribution as it makes most of its money in the first half of the year. Earn-out and amortization charges should be considered, however, as they cut into the accretion by around 21c. Sanuk considerations in 2012: $43 million acquisitive sales at a high margin. 1H12 sales will include a baseline of $43 million in Sanuk sales, which is what the company made in 1H11. Assuming a 35% 1H operating margin, this equates to a 30c EPS contribution. 25% organic sales growth. Under this assumption (and 25% operating margins, flat to last year), we expect another 10c of organic EPS growth from Sanuk. Earn-out and amortization. The terms of the Sanuk deal include an earn-out to management over the next five years and are outlined in DECK’s 3Q 10Q. There is also a component of goodwill amortization that will be incurred as well (i.e. purchase accounting). In sum, management is guiding 2012 earn-out and amortization to be around $12 million. This is a $4.3 million increase to the $7.7 million to be recorded in 2011 (all in the second half). Bottom line: the 40c of EPS accretion from Sanuk needs to be offset by 21c of earn-out and accretion charges. page 11 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 Marketing A lot has been made of DECK’s marketing spend in 2011 between the Tom Brady men’s campaign and efforts to broaden UGG awareness into a lifestyle brand. At the beginning of 2011, management originally guided marketing to increase by $11-12 million, which based on 15% sales growth implied around 50 bps of de-leverage to SG&A. Management alluded that this ‘one-time’ ramp in marketing would ultimately stabilize at a higher percentage of sales as UGG has historically under-spent on marketing versus its peers. If we fast forward a year and look back at 2011, there are some interesting observations to be made. First, and most important – marketing expense will not increase as a percent of sales in 2011. The $11.5 million increase in marketing spend implies 35% growth YoY, which is the same as our forecasted revenue growth. This suggests that marketing will be flat to sales in 2011 at 3.3% (same as 2010). In fact, throughout 2011, DECK managed to hold its advertising budget while its sales growth expanded (originally guided up 20%, will ultimately be up 35%). As we enter 2012, we expect marketing to again be an area of focus. However, it is hard to expect a scenario where it grows more than the 35% we saw in 2011. In fact, we think management grows marketing closer to 20-25% next year and ultimately achieves leverage on that expense (by growing sales >25%). 25 New Retail Stores DECK’s retail growth strategy is set to inflect further in 2012 with the opening of 25 new retail stores, an increase from 17 new stores in 2011. As with the international wholesale operations, retail is a business that carries higher GM% (about 25% points more than wholesale) and SG&A. In net, it is accretive to operating margins by around 10% (our estimate). This means that SG&A is around 15% higher for retail versus wholesale. Assuming this math, we model new retail store openings to dilute DECK’s SG&A line by around 50-60 bps in 2012. This assumes retail sales mix increasing by 400 bps (from 16% to 20%) and a 15% point spread in SG&A between wholesale and retail. As we stated in the previous GM% section, there is an associated benefit to the gross margin line that more than offsets the SG&A de-leverage. page 12 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 Chart 12: Income Statement ($ Millions, except per share amounts) 2009 2010 2011E 2012E 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E Total Sales $813 $1,001 $1,343 $1,681 $156 $137 $278 $430 $205 $154 $414 $569 Cost of Goods Sold 442 499 662 872 78 76 148 197 102 88 212 260 Gross Profit 371 502 680 809 78 61 130 233 102 66 203 309 SG&A 189 254 388 469 49 48 65 93 74 77 112 125 Operating Income 182 248 293 341 29 13 65 141 28 (11) 91 184 Other (income) expense, net (2.0) (1.0) (0.2) (0.8) (0.1) (0.5) (0.2) (0.2) (0.1) (0.0) 0.1 (0.1) Pretax Income 184 249 293 341 29 14 66 141 28 (11) 91 185 Income Taxes 67 90 91 102 11 5 25 50 9 (3) 28 57 Net Income 118 159 202 239 18 9 41 91 20 (7) 62 127 minority interest (0) (2) (0) 0 (0) 0 0 (2) (1) 0 0 0 Fully Diluted EPS $2.98 $4.01 $5.16 $6.10 $0.46 $0.23 $1.05 $2.27 $0.49 ($0.19) $1.59 $3.25 Fully Diluted Shares Outstanding 39.4 39.2 39.1 39.2 39.1 39.1 39.2 39.3 39.4 38.7 39.2 39.2 % of Sales 2009 2010 2011E 2012E 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E Gross Profit 45.6% 50.1% 50.7% 48.1% 50.0% 44.3% 46.8% 54.2% 50.0% 42.8% 49.0% 54.3% SG&A 23.2% 25.4% 28.9% 27.9% 31.5% 34.7% 23.3% 21.5% 36.3% 49.7% 27.1% 21.9% Operating Income 22.4% 24.8% 21.8% 20.3% 18.5% 9.6% 23.5% 32.7% 13.7% -6.9% 21.9% 32.4% Tax Rate (% of Pretax) 36.2% 36.0% 31.0% 30.0% 37.2% 35.0% 37.5% 35.2% 30.1% 30.2% 31.2% 31.0% % Growth, YoY 2009 2010 2011E 2012E 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E Sales 17.9% 23.1% 34.1% 25.2% 16.2% 33.7% 21.7% 23.6% 31.3% 12.6% 49.1% 32.3% Gross Profit 21.5% 35.3% 35.5% 19.0% 32% 49% 33% 35% 31% 9% 56% 32% SG&A 23.8% 34.4% 52.7% 20.9% 24% 30% 44% 37% 51% 61% 74% 34% Operating Income 19.3% 36.1% 17.9% 16.4% 49% 213% 23% 33% -2% -181% 39% 31% Net Income 22.6% 35.6% 26.8% 18.3% 47% 163% 21% 34% 9% -184% 52% 39% Diluted EPS 23.0% 34.5% 28.5% 18.2% 47% 160% 22% 31% 6% -182% 52% 43% BPs Change, YoY 2009 2010 2011E 2012E 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E Gross Profit 135 451 53 (253) 607 455 388 440 5 (155) 219 5 SG&A 109 214 352 (100) 199 (98) 362 204 479 1,504 381 35 Operating Income 26 237 (299) (153) 409 552 27 237 (474) (1,659) (162) (30) Marketing expense 2009 2010 2011E 2012E Marketing expense 29 33 45 56 % of revenues 3.5% 3.3% 3.3% 3.3% % growth 15.5% 15.2% 34.7% 25% % of SG&A 15.2% 13.0% 11.5% 11.9% Source: Jefferies estimates, company data page 13 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 Chart 13: Segment Details Sales by Category 2009 2010 2011E 2012E 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E Total Sales 813 1,049 1,343 1,681 156 137 278 430 205 154 414 569 Ugg 712 873 1,170 1,430 104 100 256 413 148 108 377 537 Teva 78 101 122 140 43 31 14 13 50 40 15 17 Sanuk -- 48 27 87 -- -- -- -- -- -- 16 11 Other 24 26 24 24 8 6 8 4 6 6 7 5 Sales Growth, % 2009 2010 2011E 2012E 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E Total Sales 18% 29% 28% 25% 16% 34% 22% 24% 31% 13% 49% 32% Ugg 22% 23% 34% 22% 14% 35% 20% 24% 42% 8% 47% 30% Teva -10% 31% 20% 15% 21% 38% 52% 26% 17% 29% 7% 25% Sanuk -- -- 20% 15% -- -- -- -- -- -- -- -- Other 13% 12% -10% 0% 15% 1% 26% -4% -28% 1% -12% 20% other metrics 2009 2010 2011E 2012E 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E Same-store sales, % 27.6% 16.6% 28.2% 19.2% 17.9% 11.6% 2.6% 23.6% 15.4% Retail: Sales per average store 5.3 5.6 weighted avg selling price / pair, $ 45.80 47.71 30.71 35.41 58.61 34.24 38.28 change, % 8% 4% 7.0% 1.8% 0.1% #DIV/0! 11.5% 8.1% -100.0% #DIV/0! footwear volume (million pairs) 15.7 18.0 4.0 3.6 4.5 5.9 4.7 3.6 change, % 6.8% 14.6% 5.3% 28.6% 18.4% 7.3% 17.5% 0.0% -100.0% -100.0% Stores 18 27 44 69 18 19 24 27 27 30 37 44 UGG retail (U.S.) 6 10 Outlet (U.S.) 7 9 UGG (International) 5 8 new stores (YoY) 6 9 17 25 1 1 5 3 0 3 7 7 sales / average store 1.3 0.5 0.9 2.8 1.3 0.7 1.0 2.8 Sales by Region 2009 2010 2011E 2012E 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E Total Sales 813 1,001 156 137 278 430 206 154 414 569 U.S. 646 764 117 65 205 377 149 83 258 471 International 167 237 39 72 73 53 57 72 156 98 Sales Mix, % 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% U.S. 79% 76% 75% 48% 74% 88% 72% 54% 62% 83% International 21% 24% 25% 52% 26% 12% 28% 46% 38% 17% Sales Growth, % 18% 23% 16% 34% 22% 24% 32% 13% 49% 32% U.S. 11% 18% 15% 16% 14% 22% 27% 27% 26% 25% International 55% 42% 21% 55% 48% 35% 46% 0% 114% 85% Source: Jefferies estimates, company data page 14 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 Company Description Deckers is a leading designer and wholesaler of footwear brands based in Goleta, California. The company's portfolio of brands includes UGG, Teva, Simple, Tsubo and Ahnu. Analyst Certification I, Taposh Bari, CFA, CPA, certify that all of the views expressed in this research report accurately reflect my personal views about the subject security(ies) and subject company(ies). I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report. As is the case with all Jefferies employees, the analyst(s) responsible for the coverage of the financial instruments discussed in this report receives compensation based in part on the overall performance of the firm, including investment banking income. We seek to update our research as appropriate, but various regulations may prevent us from doing so. Aside from certain industry reports published on a periodic basis, the large majority of reports are published at irregular intervals as appropriate in the analyst's judgement. Jefferies & Company, Inc makes a market in the securities or ADRs of Deckers Outdoor. Jefferies & Company, Inc makes a market in the securities or ADRs of Lululemon Athletica. Meanings of Jefferies Ratings Buy - Describes stocks that we expect to provide a total return (price appreciation plus yield) of 15% or more within a 12-month period. Hold - Describes stocks that we expect to provide a total return (price appreciation plus yield) of plus 15% or minus 10% within a 12-month period. Underperform - Describes stocks that we expect to provide a total negative return (price appreciation plus yield) of 10% or more within a 12-month period. The expected total return (price appreciation plus yield) for Buy rated stocks with an average stock price consistently below $10 is 20% or more within a 12-month period as these companies are typically more volatile than the overall stock market. For Hold rated stocks with an average stock price consistently below $10, the expected total return (price appreciation plus yield) is plus or minus 20% within a 12-month period. For Underperform rated stocks with an average stock price consistently below $10, the expected total return (price appreciation plus yield) is minus 20% within a 12- month period. NR - The investment rating and price target have been temporarily suspended. Such suspensions are in compliance with applicable regulations and/ or Jefferies policies. CS - Coverage Suspended. Jefferies has suspended coverage of this company. NC - Not covered. Jefferies does not cover this company. 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The price targets are based on several methodologies, which may include, but are not restricted to, analyses of market risk, growth rate, revenue stream, discounted cash flow (DCF), EBITDA, EPS, cash flow (CF), free cash flow (FCF), EV/EBITDA, P/E, PE/growth, P/CF, P/FCF, premium (discount)/average group EV/EBITDA, premium (discount)/average group P/E, sum of the parts, net asset value, dividend returns, and return on equity (ROE) over the next 12 months. Conviction List Methodology 1. The aim of the conviction list is to publicise the best individual stocks ideas from the Jefferies Global Research.2. Only stocks with a Buy rating are allowed to be included in the recommended list. 3. Stocks are screened for minimum market capitalisation and adequate daily turnover. Furthermore, a valuation, correlation and style screen is used to ensure a well-diversified portfolio. 4. Stocks are sorted to a maximum of 30 stocks with the maximum country exposure at around 50%. Limits are also imposed on a sector basis. 5. Once a month, analysts are invited to recommend their best ideas. Analysts’ stock selection can be based on one or more of the following: non- Consensus investment view, difference in earnings relative to Consensus, valuation methodology, target upside/downside % relative to the current stock price.These are then assessed against existing holdings to ensure consistency. Stocks that have either reached their target price, been downgraded over the course of the month or where a more suitable candidate has been found are removed. 6. All stocks are inserted at the last closing price and removed at the last closing price. There are no changes to the conviction list during the month. 7. Performance is calculated in US dollars on an equally weighted basis and is compared to MSCI World AC US$. 8. The conviction list is published once a month whilst global equity markets are closed 9. Transaction fees are not included page 15 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 10. All corporate actions are taken into account. Risk which may impede the achievement of our Price Target This report was prepared for general circulation and does not provide investment recommendations specific to individual investors. As such, the financial instruments discussed in this report may not be suitable for all investors and investors must make their own investment decisions based upon their specific investment objectives and financial situation utilizing their own financial advisors as they deem necessary. Past performance of the financial instruments recommended in this report should not be taken as an indication or guarantee of future results. The price, value of, and income from, any of the financial instruments mentioned in this report can rise as well as fall and may be affected by changes in economic, financial and political factors. If a financial instrument is denominated in a currency other than the investor's home currency, a change in exchange rates may adversely affect the price of, value of, or income derived from the financial instrument described in this report. In addition, investors in securities such as ADRs, whose values are affected by the currency of the underlying security, effectively assume currency risk. Other Companies Mentioned in This Report • Lululemon Athletica (LULU: $46.66, HOLD) • Nike (NKE: $96.37, BUY) • Under Armour (UA: $71.79, HOLD) • Wolverine World Wide (WWW: $35.64, HOLD) page 16 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 page 17 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 Distribution of Ratings IB Serv./Past 12 Mos. Rating Count Percent Count Percent BUY 762 53.00% 107 14.04% HOLD 579 40.30% 58 10.02% UNDERPERFORM 96 6.70% 2 2.08% Other Important Disclosures Jefferies Equity Research refers to research reports produced by analysts employed by one of the following Jefferies Group, Inc. (“Jefferies”) group companies: United States: Jefferies & Company, Inc., which is an SEC registered firm and a member of FINRA. page 18 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. 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This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of page 19 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report. DECK Company Update January 3, 2012 Jefferies. Neither Jefferies nor any officer nor employee of Jefferies accepts any liability whatsoever for any direct, indirect or consequential damages or losses arising from any use of this report or its contents. For Important Disclosure information, please visit our website at https://javatar.bluematrix.com/sellside/Disclosures.action or call 1.888.JEFFERIES © 2011 Jefferies Group, Inc. page 20 of 20 Taposh Bari, CFA, CPA, Equity Analyst, (212) 708-2712, TBari@jefferies.com Please see important disclosure information on pages 15 - 20 of this report.
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