Brand Equity Analysis of Nike by thn11561

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									Accounting 712 Financial Statement Analysis
    Professor Russell James Lundholm

        Skechers USA, Inc.
        Analyst Report Dec 8, 2003

            by Kenneth Chan
             Alfonso Chang
           Carlos Enrique Perez
               Peter Smith
                                   Business Description and Strategy
Skechers U.S.A., Inc. designs and markets a full product line collection of branded contemporary
footwear for men, women and children, as well as a designer line for women branded separately. While
the core customers groups are 12- to 25-year old consumer, substantially all of the lines appeal to the
broader range of 5- to 40-year old consumers, with an exclusive selection to infants and toddlers.

 Business          Sells contemporary, progressive and comfortable products at reasonable price
 Strategy           by building brand equity.
 Functional        R&D - Recognize lifestyle trends and translate it into designing reasonably priced
 Strategy           footwear with comfortable, contemporary and progressive styles.
                   Production – Use independent manufacturers with proven track record to increase
                    production flexibility and capacity while at the same time substantially reduce
                    capital expenditures and avoid the costs of managing a large production work force.
                   Inventory – Keeping stocks to fill customers orders but estimating demand to
                    reduce risk of overstocking.
                   Distribution - Products are packaged in shoe boxes bearing barcodes and are
                    shipped to distribution centers in California and Belgium or directly to other
                    international customers. Sales channels include a network of wholesale accounts, in
                    company-own retail stores and company website. Company owned retail stores are
                    organized in three formats — concept stores, factory outlet stores and warehouse
                    outlet stores.
                   Marketing – Maintain and enhance recognition of the Skechers brand name as a
                    casual, active youthful brand that stands for quality, comfort and design innovation,
                    through heavy but efficient spending (8%-10% of annual sales) on advertising,
                    sponsorship to celebrities, in-store promotions, cooperative marketing, public
                    relation, licensing and others
                   Services – Work closely with wholesalers to ensure the style and inventory levels of
                    products carrying at each store are correct. Then utilize such information to forecast
                    sales and determine production and inventory level.

1.1 Sustainability of Profitability
However, Skechers’ strategy did not work well in the past 12 months. They overestimated their sales,
kept excessive inventory and opened a lot of stores. Furthermore, due to increased competition and fast
change in fashion, and Skechers inability to follow, the accumulation of excessive inventory had to be
liquidated at clearance price leading to much thinner margins. Compared Q3 2003 to Q3 2002, sales
dropped 15% and margin dropped 5% (Q3 2003) but SG&A and depreciation and amortization remained
at the same level, leading to a drop in operating margin from 9.2% to -2.5%.
Based on the factors in the table on the next page, we expect Skechers’ stock price and performance not to
improve significantly unless there is solid evidence that management will be able to increase sales by
differentiating their products effectively or cut costs significantly by streamlining their retail stores. We
believe that Skechers’s will be able to improve their negative ROE of the LTM, and will revert to a
positive ratio near their approximate cost of capital of 20%. This is based on our assumption that general
economy improvements will pull sales up and the firm will improve margins once they stop selling lower
priced excess inventory. However, the days of 30% ROE ratios are over for this firm.
                                                                 Management Team
                         Given the recovery in the economy in the first three quarters of 2003 and shown improvement
                          by their competitors while Skechers’ performance was declining, we think the management
                          was either unable to execute its strategy or chose an ineffective strategy.
                         The decline in margin reflects the fact that Skechers’ brand was not as appealing to customers
                          as other brands. Therefore the margin will continue to be under pressure given the fierce
                                                               Product Differentiation
Unfavorable Factors

                         Skechers have seen more competition at their basic price point and an increase in clearance
                          price product purchase versus full retail merchandise. Skechers believe this will continue to be
                          a factor in the fourth quarter.
                         Skechers’ competitors are faster in following fashion trends and delivering new differentiated
                                                         Manufacturing and Logistics Cost
                         The weakening US dollar caused unfavorable currency translation and increased production
                         Oil price is still relatively high (around $30).
                         High electricity bill in California increased their distribution operating cost and current
                          economic situation (i.e $38B deficit) might increase operating expense
                                                              Customer Demographics
                         From 1990 census conducted by US Department of Commerce, Population Series P. 25, the
                          population between 5 to 24 years old will decrease from 28.3% in 2003 to 27.4% in 2010 to
                          26.7% in 2015. Such a decline in population for the core customers will reduce the market size.
                                                                 Macro Environment
                         2003 Q3 US GDP annual growth was 8.2%.
                         November Consumer Confidence Index was up to 91.7 from 81.7 in October.
                         November Michigan's index of consumer sentiment is expected to 94
Favorable Factors

                          November ISM index rose to 62.8 percent from 57 percent in October.
                         The U. S. Conference of Mayors has released a report that an economic expansion will end the
                          "jobless recovery" with job growth of 1.3 percent in 2004 and 1.7 percent in 2005.
                         Due to wholesalers’ conservative approach, Skechers has excessive inventory which hurt
                          margin due to clearing. Once the clearing is finished, margin is expected to improve.
                         Skechers plans to cut cost by opening fewer stores (four) in 2004, and has no plan for new
                          international expansion. This move is good for improving the margin and harvest the
                          investment in the new 28 stores opened in last 12 months.
                                                             New Product Development
                         Launch of new product line, Michelle K, Mark Nason, 310 footwear and Marc Ecko footwear

In general the firm’s accounting reflects the underlying business reality. However, we believe two
adjustments needed to be made to fully represent the liabilities and contingencies the company faces and
to assess more accurately the company’s future earnings:
       The company has a strong outflow commitment in operating leases for each of the following
          five years that is not reflected in the balance sheet. If we discount the future minimum
          operating lease payments at the average interest rate of their Capital Lease Obligations of
          8.42% (comparable secured debt), we get a PV liability of $129.7M as of December 2002,
          which represents 1.08X their 2002 Total Debt. To consider this liability we restate the
           company’s Balance Sheet, by increasing PP&E $90.8M (applying a liability multiplier of 0.7),
           increased Other Liabilities by $129.7M and reduced Retained Earnings by $38.9M.

                                                     Capital       Operating
                                                     Leases         Lease
                   Year ending December 31;
                                            2003        3,065           23,634
                                            2004        3,065           23,461
                                            2005        2,714           22,237
                                            2006        4,721           20,630
                                            2007               1        18,692
                   Thereafter                                           19,667        Assuming their $78.6M
                                                                                      thereafter will be paid in four
                                                                                      equal payments.

                                                       13,566          187,320
                   Less inputed interest                 2,180
                   PV of minimum lease pmts            11,386
                   Operating Leases PV as of
                   12/2002                                             129,689
                   rd                                   8.42%
                   7.25% -9.59% Capital Lease Obl

          As well, future contingencies through stock options can make significant impact in their
           earnings. In December 2002, the number of options outstanding and exercisable below the
           closing market price as of December 31, 2002 of $8.49 were 1,852,078 and 668,121
           respectively. To consider this contingent liability, we compared the weighted strike price of the
           options ―in the money‖ with the Stock Price as of Dec. 5, 2003 ($7.20), and multiplied the
           difference by the number of outstanding stock options ―in the money‖ to get a liability of
           $1.907M, which we consider a contingent claim on equity (see below).

     Table 1
                                  Number of Outstanding                                 Stock Pr Dec 05,                Contingent
         Range of X Price            Dec. 31, 2002                 Weighted X                2003                        Liability
     $2.78-$9.28                                    1,852,078      $           6.17     $                  7.20           (1,907,640)
                                   Number of Exercisable
         Range of X Price             Dec. 31, 2002                Weighted X
     $2.78-$9.28                                     668,121       $           5.14     $                  7.20           (1,376,329)

2.1 Summary of Significant Accounting Policies:

Revenue Recognition
       Recognizes revenue when the products are shipped
       Revenues from royalty agreements are recognized as earned
       Stated at lower of cost (FIFO method) or market
       Estimated losses from obsolete or slow-moving inventories
Income Taxes
       Accounts for income taxes through the asset and liability method
Depreciation and Amortization
       Using the straight line method
       Trademarks are amortized on a straight-line basis over ten years
Advertising Costs
        Advertising costs are expensed in the period in which the advertisements are first run or over
         the life of the endorsement contract
Product Design and Development
       All costs of product design and development are expense when incurred
Stock Option Plan
       For pro forma purposes, the fair value of each option is estimated on the date of grant using the
         Black-Scholes option pricing model.
       A contingent claim on common equity of these stock options must be adjusted.
       The company leases facilities, equipment and automobiles under operating lease agreements.
         The PV of the future minimum payments was adjusted in the B.S.
       The company also leases certain property and equipment under capital lease

Although Skechers USA Inc’s (―SKX‖) had very high ROE ratios in the past (30+%) due to their high
Asset Turnover ratios, their sales volume has decreased substantially and when combined with their low
cost / low margin strategy, their ROE became negative the Last Twelve Months ―LTM‖.
                                     NIKE INC CL B         K-SWISS INC CL A     TIMBERLAND CO        SKECHERS USA INC
                                        2001       2002       2001      2002       2001     2002       2001     2002     LTM
Basic Dupont Model
  Net Profit Margin                     0.062      0.067      0.099     0.099      0.090     0.080      0.049    0.050   (0.010)
x Total Asset Turnover                  1.625      1.614      1.484     1.685      2.413     2.283      2.702    1.923    1.830
x Total Leverage                        1.761      1.672      1.301     1.305      1.451     1.425      2.134    2.340    1.734
= Return on Equity                      0.178      0.181      0.191     0.217      0.316     0.260      0.284    0.224   (0.031)

Advanced Dupont Model
  Net Operating Margin                  0.066      0.070      0.099     0.099      0.091     0.080      0.058    0.056   (0.007)
x Net Operating Asset Turnover          2.025      2.032      1.922     2.199      3.502     3.254      3.595    2.882    2.184
= Return on Net Operating Assets        0.134      0.143      0.190     0.218      0.319     0.261      0.209    0.161   (0.016)
Net Borrowing Cost (NBC)                0.027      0.026      0.000   #DIV/0!    #DIV/0!   #DIV/0!      0.086    0.047    0.017
Spread (RNOA - NBC)                     0.106      0.117      0.190   #DIV/0!    #DIV/0!   #DIV/0!      0.124    0.113   (0.033)
Financial Leverage (LEV)                0.413      0.328      0.004     0.000      0.000     0.000      0.604    0.562    0.453
ROE = RNOA + LEV*Spread                 0.178      0.181      0.191   #DIV/0!    #DIV/0!   #DIV/0!      0.284    0.224   (0.031)

      The driver for Skechers’ ROE is its high Net Operating Asset Turnover

3.1 Return in Net Operating Assets
Net Profit Margin (―NPM‖) of 5.0% is low compared among its peer group. Moreover, its optimistic
forecasts in the 1Q’03 (when inventories balloon up) force Skechers to lower its prices in order to
decrease its high inventory levels. This caused its gross margin to decline 220bp from 2001 to the LTM
gross margin of 41.7%, for these same LTM its Net Profit Margin is -1.0%.

                                     NIKE INC CL B         K-SWISS INC CL A     TIMBERLAND CO        SKECHERS USA INC
                                        2001       2002       2001      2002       2001     2002       2001     2002     LTM
Margin Analysis
Gross Margin                            0.413      0.421      0.422     0.453      0.458     0.454      0.439    0.429    0.417
EBITDA Margin                           0.129      0.136      0.164     0.166      0.156     0.135      0.108    0.106
EBIT Margin                             0.107      0.108      0.156     0.160      0.138     0.117      0.092    0.087   (0.003)
Net Operating Margin (b4 non-rec.)      0.068      0.071      0.094     0.097      0.091     0.076      0.058    0.054
Net Operating Margin                    0.066      0.070      0.099     0.099      0.091     0.080      0.058    0.056   (0.007)

Skechers, through its fast growing sales until 2001, had one of the highest Net Operating Asset Turnover
(―NOAT‖). Yet in the past two years, due to inefficient management of some assets (e.g. receivables,
inventory) and declining sales its NOAT came from an industry high 3.595 in 2001 to 2.184 in the Last
Twelve Months (―LTM‖). Further, its NWC turnover has decrease from an industry high 5.166 in 2001
to a 2.864 ratio in the LTM.
                                      NIKE INC CL B          K-SWISS INC CL A       TIMBERLAND CO          SKECHERS USA INC
                                         2001       2002        2001      2002         2001     2002         2001     2002      LTM
Turnover Analysis
Net Operating Asset Turnover             2.025      2.032       1.922      2.199       3.502      3.254       3.595     2.882     2.184
Net Working Capital Turnover             3.699      3.597       1.963      2.306       4.608      4.230       5.166     3.661     2.864
Avge Days to Collect Receivables        61.369     63.247      43.266     42.434      36.770     40.589      42.053    44.155    51.737
Avge Inventory Holding Period           94.025     89.142     117.348    111.732      73.671     70.065      91.222   103.519   104.399
Avge Days to Pay Payables               31.842     29.574      27.420     30.095      25.424     20.710      55.667    55.256    42.155
PP&E Turnover                            5.926      6.119      28.618     35.023      15.797     15.923      12.301     7.253

Combining its Net Operating Margin and NOAT, Skechers has a Return in Net Operating Assets in 2002
(―RNOA‖) only higher than Nike among its peer group. Yet it shows the most rapidly declining RNOA,
reaching a negative RNOA of 1.6% in the LTM.
3.2 Spread and Financial Leverage
Its Borrowing Spread (RNOA – NBC) is lower than Nike (K-Swiss and Timberland did not have a debt
as of December 2002). Furthermore, in the LTM its spread turns to be negative as its RNOA declines.
Among peer group, SKX has the highest financial leverage. In 2002 its Financial Leverage of 56.2%
allows them to boost up its RNOA to achieve a higher ROE. Yet in the LTM, because of the negative
spread, the high Financial Leverage caused SKX’s ROE to deteriorate even further.
3.3 Default Risk
Although highly leverage compared with its peers, in 2002 Skechers had a low default probability of
3.1%. But as sales and earnings have decreased Skechers’ Cash from Operating Activities, of $116.8M in
2002 decreased in the last 9 months of 2003 to ($22.6M) increasing its Average Implied Default
Probability in the LTM to 4.7% (see table below.)
3.4 View
Skechers has come to be a company of low net profit margins (among its peer comparison group) with
declining sales and operating asset turnover. In the past, although having a low NPM, Skechers had high
operating assets turnover and growth in sales, putting it as high growth company. However, as of the third
quarter of 2003, Skechers did not stand out from its peers in operating margins or in operating asset
turnover. Thus we believe, Skechers is at a crossroads between continuing to invest in high growth with
the risk of not generating an acceptable return to its investors, or investing to grow slightly above the
economy and focus in reducing costs and improving its operating margins.
Its 1.04 (7.20/6.95) Market Price to Unadjusted Book Ratio reflects the market view of a Skechers as a
company, worth only its Book Value that lacks positive NPV projects in which to invest.
                                      NIKE INC CL B          K-SWISS INC CL A       TIMBERLAND CO          SKECHERS USA INC
                                         2001       2002        2001      2002         2001     2002         2001     2002      LTM
Analysis of Leverage
- Short-Term Liquidity
Current Ratio                            2.029      2.264       6.423      5.305       3.156      2.836       1.783     3.687     4.924
Quick Ratio                              1.078      1.298       4.197      3.389       1.855      1.755       0.775     2.155     2.652
EBIT Interest Coverage                  17.278     22.435     #DIV/0!    493.234     104.547    157.042       6.410     9.146    (0.255)
EBITDA Interest Coverage                20.925     28.246     #DIV/0!    513.819     118.718    182.498       7.515    11.170

Analysis of Credit Risk
Net Income to Total Assets                0.101      0.103       0.145      0.156       0.212      0.177      0.116     0.082     -0.018
  implied default probability             2.0%       2.0%        2.0%       2.0%        2.0%       2.0%       2.0%       2.0%       4.5%
Total Liabilities to Total Assets         0.400      0.404       0.227      0.240       0.288      0.308      0.512     0.616      0.418
  implied default probability             3.0%       3.0%        2.2%       2.2%        2.5%       2.5%       3.5%       4.5%       3.0%
Quick Ratio                              1.078      1.298       4.197      3.389       1.855      1.755      0.775     2.155      2.652
  implied default probability             4.0%       3.5%        1.5%       1.5%        2.5%       2.5%       5.0%       2.0%       1.8%
EBIT to Interest Expense                 17.28      22.43     #DIV/0!     493.23      104.55     157.04       6.41       9.15      (0.26)
  implied default probability             1.5%       1.5%        1.0%       1.0%        1.0%       1.0%       1.8%       1.8%       8.5%
Inventory Holding Period                  93.31      87.54      117.59     122.34       72.32      68.73     106.78    100.24    112.23
  implied default probability             5.5%       4.9%        5.5%       6.0%        4.9%       4.5%       5.5%       5.5%       5.5%
Annual Sales Growth                       5.5%       4.3%        6.5%      23.0%        8.4%       0.6%      42.3%      -1.7%    -14.0%
  implied default probability             3.0%       3.2%        3.0%       3.2%        3.0%       3.2%       5.0%       4.2%       5.0%
Average Implied Default Probability       3.2%       3.0%        2.5%       2.7%        2.7%       2.6%       3.8%       3.3%       4.7%
Forecasting Assumptions:

Income Statement:

Revenue: The revenue is modeled using three equally weighted scenarios to capture the uncertainty
surrounding the future of Skechers’ revenue stream as a result of its recent 15% drop in revenues. In the
first scenario, which most closely corresponds to company guidance and equity analysts, the revenue is
expected to increase by 10% the first year, erasing just over half of the drop off from this year, and then
grow at a fairly steady 5%. This reflects the belief that the company has become relatively mature, is
encountering new pressure in its chosen segments, and will be able to maintain its market share, but will
only grow at the rate of the overall economy. This rate of growth (5%) closely matches the forecast for
GDP growth over the coming 10 years (the forecast horizon). Even more importantly, there is a clear
relationship between the change in GDP and the change in expenditures on goods such as shoes (see
Exhibit 1 below). In scenario 2, we have taken a more conservative view of the future growth and
eliminated the 10% rebound in 2004, and simply utilized the GDP growth forecasts to project growth
from the current expected 2003 revenues of approximately 800MM. Finally, we created a third scenario
that captures the domestic versus international component of revenue growth in the firm. Domestic
revenues are forecasted as a percentage of the US retail footwear market (mean of 2.1% with a standard
deviation of 0.32% based on SKX’s share from 2000 to 2003). The retail market is forecasted based on
GDP using linear regression analysis (1990 to 2001) and GDP forecast (2003 to 2013) provided by CBO
(Exhibit 1). As used by Tucker Anthony Sutro Capital Markets, the retail market is assumed to have a
45% mark up to manufacturer’s prices (i.e., SKX’s domestic wholesale prices). International revenues
are forecasted based on the percentage of international revenues of total revenues. This percentage for
2013 is based the penetration of the international market by SKX and its competitors and has a triangular
distribution of 17% (2002 SKX estimate), 33% (2002 Timberland estimate), and 50% (2002 Nike
estimate). The percentages for years 2003 to 2012 are linearly interpolated from 2002 SKX estimate to
2013 assumption from Nike, SKX, and Timberland.

     Exhibit 1:

    US                        Regression Analysis                                US                      Domestic Footwear Industry
    Fo 60                                                                        Fo 70                                                                                  0.6%
    ot                                                                                                          Actual                              Forecast
                                                                                 ot                                                                                         Ma
    we                                                                           we                                                                                60
                                                                                      60                                                                      57            rke
    ar 50                                                                        ar                                                                      54             0.5%t
    Ex                                                                           Ex                                                                 52
                                                                                                                                          49   50                           as
    pe                                                                           pe 50                                              46 47                                   a
    ndi 40                                                                                                                     45                                       0.4%Pe
                                                                                 ndi                                      42
    tur                                                                          tur                                39 40                                                   rce
    es                                                                           es 40                         37
                                                                                                       34 36                                                                nt
    ($ 30                                                                        ($         32 31 33                                                                    0.3%of
    US                                                                           US 30                                                                                      No
    ,                                                                            ,                                                                                          mi
    Bill 20                                                                      Bill                                                                                   0.2%nal
    ion                       y = 0.0038x + 9.0682                               ion 20
                                       2                                                                                                                                    US
    s)                             R = 0.9967                                    s)                                                                                         GD
         10                                                                                                                                                             0.1%P

         0                                                                            0                                                                                 0.0%
              0                5,000           10,000           15,000                     1990    1993         1996       1999         2002         2005
                        Nominal US GDP ($US, Billions)                                                                    Year
                                                                             , Bureau of Economic Analysis, and American Apparel & Footwear A
                  Sources: Congressional Budget Office, US Department of Commerce                                                       ssociation
                                           Revenue Forecast

                     1.6           Scenario 1                  Scenario 2
                                   Scenario 3                  Expected Value







                       2003        2005        2007       2009       2011       2013

COGS: The COGS for Skechers has historically been near 57% of the gross sales. However, in 2002,
this figure approached 63% as Skechers disposed of an inventory backlog and suffered competition at its
price points for sales. The factors when combined contributed to the worst gross margin in the recent
history of the firm. For future forecasts, we assumed one of two scenarios would take precedence. First,
we believed that COGS, as a percent of Sales, would remain elevated from their previous levels due to the
increased competition at the Skechers price points, but would decrease from the previous high in 2002.
Therefore, we decided to start the COGS at 60% and allow it to decrease over the 10 year horizon back to
the historical average of 57%. The source of this decrease is the increased presence of retail outlets that
increase the average sales price of Skechers goods, thus reducing the associated COGS percentage. Our
second methodology is a conditional formula that essentially captures the same data as above, but
specifically allows the COGS percentage to float with the revenues for 2004. Thus, if revenues return to
their historical levels (1Bn in sales), then it is assumed that the retail outlets have allowed the ASP to
increase and the COGS percentage is allowed to decline faster toward 57%.

SG&A: The SG&A for Skechers is composed of both fixed general and administrative changes and
variable selling / marketing charges. Historically it has run at approximately 32% of sales. However, in
2003, this figure has increased to 38% of sales since the fixed expenses have increased with the opening
of new stores and revenues have fallen to three year lows. Therefore, we forecast SG&A based on a fixed
component tied to general and administrative expenses and a variable component tied to 10% of revenues,
or the typical selling / marketing expense of Skechers. Recently, management has made comments that it
will attempt to reduce costs in the coming quarters to reign in SG&A expense and reduce the current rate
of 38% of SG&A. We believe that many of the expenses were due to the opening of new stores and that
the company should be successful in trimming half of the expense in the coming year, returning to
approximately 35%. Thereafter, the firm should be able to slowly return to it’s historical norm of 32%.
Finally, as a sanity check, we compared our results with industry statistics for projected growth in net
income and found that Skechers in our model will grow Net Income at approximately 13% per year, or
slightly less than the expected industry Net Income growth of 13.7%.

Balance Sheet:

The balance sheet assumptions are not altered from their 2002 ratios. Skechers took on 90MM in debt in
2002 to finance its expansion and has stated that they will slow that growth substantially to digest the
store openings. The company has become a more mature firm that has begun to see attacks in their ―low
cost‖ niche. As a mature firm their growth is expected to be relatively constant in the coming years and
substantial changes in their balance sheet are unexpected. They may pay down some of the debt that they
took on, but with their high cost of equity, retaining the additional debt will keep their WACC lower and
will thereby increase their overall firm value. Therefore, we expect the debt to equity ratio to remain
relatively constant.


By adding Monte Carlo analysis with @Risk into eVal and utilizing the above assumptions, the potential
value for each share of SKX common stock ranges from $2.99 to $7.65 (Exhibit 2) by both residual
income and discounted cash flow valuation techniques with an expected price of $5.05. Thus, with a
current price of $7.20 (as of Friday, December 5, 2003), SKX’s share price does lie in the range of
calculated values. However, it is currently trading at a 42.6% premium over the expected value, leading
to the conclusion that it may be over-valued presently since there is only a 5% chance that the ―true‖
value of each share lie at least $6.55.

                          Distribution for Forecast Price/Share /
                           Exhibit 2: Distribution of SKX Share Price
                                SKECHERS USA INC/B26

                     Prob of
                      Value    0.600
                     X-axis    0.400

                                   2.50 3.00 3.50 4.00 4.50 5.00 5.50 6.00 6.50 7.00 7.50 8.00
The differences between the expected value and the current value may be explained by examining the
valuation drivers in Exhibit 3 and Table 1 below.

         Exhibit 3: Valuation Drivers
           Correlations for Forecast Price/Share / SKECHERS
                                         USA INC/B26

             -.785   Enter Cost of Equity Capital:/J9

Cost of Goods Sold (2004) / Actual/B36

Rev Scenario / Actual/F16                               .104

Intl Sales as a % of Total Sales (2013) / Actual/B34
     1                                                                      Corr Coeff
                                                                            calculated at
                                                                            end of bars
US Retail Footwear Market Share / Actual/B26
     -1.00                  -.50                 .00           .50           1.00
                                     Coefficient Value

Table 1:
                   Driver                                                                  Assumption
Revenue Forecast                                                 34% scenario 1, 33% scenario 2, 33% scenario 3
COGS (% of net revenues)                                         Uniform distribution between 57.1% (2002 value) and 60.1%
                                                                 (average of 2002 and 2003 values)
Intl Sales as a % of Total Sales                                 Triangular distribution with min of 17.7% (2002 value), most
                                                                 likely of 33% (2002 Timberland value), and max of 50%
                                                                 (2002 Nike value)
Market Share of US Retail Footwear (2013)                        Normal distribution with mean of 2.1% and standard deviation
                                                                 of 0.3% (based on 2002 to 2003 values)
Cost of Equity Capital                                           Uniform distribution between 15.1% (equity premium of
                                                                 5.2%--all publicly traded companies between 1964 to 1994)
                                                     and 20.1%(equity premium of 7.6%--S&P between 1926 to

As seen in the above exhibit, the two main valuation drivers are SPX’s cost of equity capital and COGS
assumptions. Investors may be using lower cost of equity capital and/or lower COGS assumptions to
value SPX. These lower figures may be driven by investors’ believes that the SPX is less risky than
expected and that SPX’s COGS will be lower due to several cost cutting initiatives launched by the
company. Additionally, investors may be more optimistic about SPX’s revenue growth.

In summary, Skechers is at a difficult point in its life cycle and is transitioning from a growth stock to a
mature one that needs to be more efficient in its delivery of a product to the market. As additional
competition arrives in Skechers’ price points, Skechers ability to enhance margins where possible is
critical to its long term survival. However, even if Skechers is able to make this change and grow with
the broader economy as a whole, its stock is overvalued at this time and should adjust downward in the
coming months.

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