| Item 1A Risk Factors This report contains statistical data that we obtained from industry publications and reports |
| These industry publications generally indicate that they have obtained their information from sources believed to be reliable, but do not guarantee the accuracy and completeness of their information |
| Although we believe that the publications are reliable, we have not independently verified their data |
| This report contains forward-looking statements that involve a number of risks and uncertainties |
| These forward-looking statements include, but are not limited to, statements and predictions as to our expectations regarding our operating expenses, sales and operations, anticipated cash needs, capital requirements and capital expenditures, needs for additional financing, use of working capital, the benefits of our Italian operations, plans for future products and services and for enhancements of existing products and services, anticipated growth strategies, ability to attract customers, sources of net sales, anticipated trends and challenges in our business and the markets in which we operate, the adequacy of our facilities, the impact of economic and industry conditions on our customers and our business, customer demand, our competitive position, critical accounting policies and the impact of recent accounting pronouncements |
| Additional forward-looking statements include, but are not limited to, statements pertaining to other financial items, plans, strategies or objectives of management for future operations, our financial condition or prospects, and any other statement that is not historical fact, including any statement which is preceded by the word “may,” “might,” “will,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “estimate,” “predict,” “potential,” “plan,” or any similar word |
| Actual events or results may differ materially from our expectations |
| Important factors that could cause actual results to differ materially from those stated or implied by our forward-looking statements include, but are not limited to, those discussed below |
| These forward-looking statements represent our judgment as of the date hereof and you are cautioned not to place undue reliance on forward-looking statements |
| We disclaim any intent or obligation to update these forward-looking statements |
| Risks Related to Our Business If we are unable to continue to develop innovative and stylish products, demand for our products may decrease |
| The action sports and youth lifestyle markets are subject to constantly changing consumer preferences based on fashion and performance trends |
| Our success depends largely on the continued strength of our brands and our ability to continue to introduce innovative and stylish products that are accepted by consumers in our target markets |
| We must anticipate the rapidly changing preferences of consumers and provide products that appeal to their preferences in a timely manner while preserving the relevancy and authenticity of our brands |
| Achieving market acceptance for new products may also require substantial marketing and product development efforts and expenditures to create consumer demand |
| Decisions regarding product designs must be made several months in advance of the time when consumer acceptance can be measured |
| If we do not continue to develop innovative and stylish products that provide greater performance and design attributes than the products of our competitors and that are accepted by our targeted consumers, we may lose customer loyalty, which could result in a decline in our net sales and market share |
| We may not be able to compete effectively, which will cause our net sales and market share to decline |
| The action sports and youth lifestyle markets in which we compete are intensely competitive |
| We compete with sunglass and goggle brands in various niches of the action sports market including Von Zipper, Arnette, Oakley and Smith Optics |
| We also compete with broader youth lifestyle brands that offer eyewear products, such as Hurley International and Quiksilver, and in the broader fashion sunglass sector of the eyewear market, which is fragmented and highly competitive |
| We compete with a number of brands in these sectors of the market, including Armani, Christian Dior, Dolce & Gabbana, Gucci, Prada and Versace |
| In both markets, we 14 ______________________________________________________________________ [41]Table of Contents compete primarily on the basis of fashion trends, design, performance, value, quality, brand recognition, marketing and distribution channels |
| The purchasing decisions of consumers are highly subjective and can be influenced by many factors, such as marketing programs, product design and brand image |
| Several of our competitors enjoy substantial competitive advantages, including greater brand recognition, a longer operating history, more comprehensive lines of products and greater financial resources for competitive activities, such as sales and marketing, research and development and strategic acquisitions |
| Our competitors may enter into business combinations or alliances that strengthen their competitive positions or prevent us from taking advantage of such combinations or alliances |
| They also may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or consumer preferences |
| If our marketing efforts are not effective, our brands may not achieve the broad recognition necessary to our success |
| We believe that broader recognition and favorable perception of our brand by persons ranging in age from 11 to 28 is essential to our future success |
| Accordingly, we intend to continue an aggressive brand strategy through a variety of marketing techniques, including athlete sponsorship, sponsorship of surfing, snowboarding, skateboarding, wakeboarding, BMX, downhill mountain biking and motocross events, vehicle marketing, internet and print media, action sports industry relationships, sponsorship of concerts and music festivals and celebrity endorsements, to foster an authentic action sports and youth lifestyle company culture |
| If we are unsuccessful, these expenses may never be offset, and we may be unable to increase net sales |
| Successful positioning of our brand will depend largely on: • the success of our advertising and promotional efforts; • preservation of the relevancy and authenticity of our brands in our target demographic; and • our ability to continue to provide innovative, stylish and high-quality products to our customers |
| To increase brand recognition, we must continue to spend significant amounts of time and resources on advertising and promotions |
| These expenditures may not result in a sufficient increase in net sales to cover such advertising and promotional expenses |
| In addition, even if brand recognition increases, our customer base may decline or fail to increase and our net sales may not continue at present levels and may decline |
| If we are unable to leverage our business strategy successfully to develop new products, our business may suffer |
| We are evaluating potential entries into or expansion of new product offerings, such as handmade fashion sunglasses and prescription eyewear frames |
| In expanding our product offerings, we intend to leverage our sales and marketing platform and customer base to develop these opportunities |
| While we have been successful promoting our sunglasses and goggles in our target markets, we cannot predict whether we will be successful in gaining market acceptance for any new products that we may develop |
| In addition, expansion of our business strategy into new product offerings will require us to incur significant sales and marketing expenses |
| These requirements could strain our management and financial and operational resources |
| Additional challenges that may affect our ability to expand our product offerings include our ability to: • increase awareness and popularity of our existing Spy brand; • establish awareness of any new brands we may introduce or acquire; • increase customer demand for our existing products and establish customer demand for any new product offering; 15 ______________________________________________________________________ [42]Table of Contents • attract, acquire and retain customers at a reasonable cost; • achieve and maintain a critical mass of customers and orders across all of our product offerings; • maintain or improve our gross margins; and • compete effectively in highly competitive markets |
| We may not be able to address successfully any or all of these challenges in a manner that will enable us to expand our business in a cost-effective or timely manner |
| If new products we may develop are not received favorably by consumers, our reputation and the value of our brands could be damaged |
| The lack of market acceptance of new products we may develop or our inability to generate satisfactory net sales from any new products to offset their cost could harm our business |
| Our business could be impacted negatively if our sales are concentrated in a small number of popular products |
| If sales become concentrated in a limited number of our products, we could be exposed to risk if consumer demand for such products were to decline |
| In the fiscal years ended December 31, 2003, 2004 and 2005, 58prca, 59prca and 62prca, respectively, of our net sales were derived from sales of our sunglass products and 33prca, 32prca and 29prca, respectively, of our net sales were derived from sales of our goggle products |
| In addition, in the fiscal years ended December 31, 2003, 2004 and 2005, 14prca, 17prca and 15prca, respectively, of our net sales related to our sunglass products were derived from two models of our product line |
| As a result of these concentrations in net sales, our operating results could be harmed if sales of any of these products were to decline substantially and we were not able to increase sales of other products to replace such lost sales |
| Our business could be harmed if we fail to maintain proper inventory levels |
| We place orders with our manufacturers for some of our products prior to the time we receive orders for these products from our customers |
| We do this to minimize purchasing costs, the time necessary to fill customer orders and the risk of non-delivery |
| We also maintain an inventory of selected products that we anticipate will be in high demand |
| We may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory |
| Inventory levels in excess of customer demand may result in inventory write-downs, and the sale of excess inventory at discounted prices could significantly impair our brand image and harm our operating results and financial condition |
| Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply the quality products that we require at the time we need them, we may experience inventory shortages |
| Inventory shortages might delay shipments to customers, negatively impact retailer and distributor relationships and diminish brand loyalty, thereby harming our business |
| For example, in fiscal 2003 and 2005, we experienced delays of two months in the delivery of goggle shipments, which we believe may have reduced our net sales in the third quarters of both fiscal 2003 and 2005 by less than 5prca and 6prca, respectively |
| If we are unable to recruit and retain key personnel necessary to operate our business, our ability to develop and market our products successfully may be harmed |
| We are heavily dependent on our current executive officers and management |
| The loss of any key employee or the inability to attract or retain qualified personnel, including product design and sales and marketing personnel, could delay the development and introduction of, and harm our ability to sell, our products and damage our brands |
| We believe that our future success is highly dependent on the contributions of Barry Buchholtz, our Chief Executive Officer |
| We have entered into an employment agreement with Mr |
| Buchholtz; however, we cannot be certain that he will not be recruited by our competitors or otherwise terminate his relationship with us |
| Buchholtz would be very difficult to replace |
| Our future 16 ______________________________________________________________________ [43]Table of Contents success may also depend on our ability to attract and retain additional qualified management, design and sales and marketing personnel |
| We do not carry key man insurance |
| If we are unable to retain the services of our primary product designer, our ability to design and develop new products likely will be harmed |
| We are heavily dependent on our primary product designer, Jerome Mage, for the design and development of our eyewear products |
| Mage provides his services to us as an independent consultant through his business, Mage Design, LLC We cannot be certain that Mr |
| Mage will not be recruited by our competitors or otherwise terminate his relationship with us |
| Mage terminates his relationship with us, we will need to obtain the services of another qualified product designer to design our eyewear products, and even if we are able to locate a qualified product designer, we may not be able to agree on commercially reasonable terms acceptable to us, if at all |
| If we were to enter into an agreement with a qualified product designer, we could experience a delay in the design and development of new sunglass and goggle product lines, and we may not experience the same level of consumer acceptance with any such product offerings |
| Any such delay in the introduction of new product lines or the failure by customers to accept new product lines could reduce our net sales |
| If we are unable to maintain and expand our endorsements by professional athletes, our ability to market and sell our products may be harmed |
| A key element of our marketing strategy has been to obtain endorsements from prominent action sports athletes to sell our products and preserve the authenticity of our brands |
| We generally enter into endorsement contracts with our athletes for terms of one to three years |
| There can be no assurance that we will be able to maintain our existing relationships with these individuals in the future or that we will be able to attract new athletes or public personalities to endorse our products in order to grow our brands or product categories |
| Further, we may not select athletes that are sufficiently popular with our target demographics or successful in their respective action sports |
| Even if we do select successful athletes, we may not be successful in negotiating commercially reasonable terms with those individuals |
| If we are unable in the future to secure athletes or arrange athlete endorsements of our products on terms we deem to be reasonable, we may be required to modify our marketing platform and to rely more heavily on other forms of marketing and promotion which may not prove to be as effective as endorsements |
| In addition, negative publicity concerning any of our sponsored athletes could harm our brands and adversely impact our business |
| Any interruption or termination of our relationships with our manufacturers could harm our business |
| We do not have long-term agreements with any of our manufacturers |
| We cannot be certain that we will not experience difficulties with our manufacturers, such as reductions in the availability of production capacity, errors in complying with product specifications, insufficient quality control, failures to meet production deadlines or increases in manufacturing costs and failures to comply with our requirements for the proper utilization of our intellectual property |
| If our relationship with any of our manufacturers is interrupted or terminated for any reason, including the failure of any manufacturer to be able to perform its obligations under our agreement or the termination of our agreement by any of our manufacturers, we would need to locate alternative manufacturing sources |
| The establishment of new manufacturing relationships involves numerous uncertainties, and we cannot be certain that we would be able to obtain alternative manufacturing sources in a manner that would enable us to meet our customer orders on a timely basis or on satisfactory commercial terms |
| If we are required to change any of our major manufacturers, we would likely experience increased costs, substantial disruptions in the manufacture and shipment of our products and a loss of net sales |
| Historically, we have purchased substantially all of our products from two manufacturers, LEM and Intersol |
| In the fiscal years ended December 31, 2003, 2004 and 2005, we purchased approximately 78prca, 64prca and 72prca, respectively, of these products from LEM and approximately 15prca, 17prca and 7prca, respectively, of these products from Intersol |
| 17 ______________________________________________________________________ [44]Table of Contents In January 2006, we acquired all of the quota (a stake in an Italian limited liability company (Sr |
| ), which, pursuant to Italian law, does not issue shares) of LEM As a result, we expect in the future that the majority of our sunglass and goggle products will be manufactured by LEM and the portion of our products manufactured by Intersol will decrease |
| Our manufacturers must be able to continue to procure raw materials and we must continue to receive timely deliveries from our manufacturers to sell our products profitably |
| The capacity of our manufacturers to manufacture our products is dependent upon the availability of raw materials used in the fabrication of eyeglasses |
| Our manufacturers have experienced in the past, and may experience in the future, shortages of raw materials, which have resulted in delays in deliveries of our products by our manufacturers of up to several months |
| For example, in fiscal 2003 and 2005, we experienced delays in the delivery of goggle shipments due to manufacturing problems |
| We believe the delays may have reduced our net sales in the third quarters of both fiscal 2003 and 2005 by less than 5prca and 6prca, respectively |
| Any shortage of raw materials or inability of a manufacturer to manufacture or ship our products in a timely manner, or at all, could impair our ability to ship orders of our products in a timely manner and could cause us to miss the delivery requirements of our customers |
| As a result, we could experience cancellation of orders, refusal to accept deliveries or a reduction in purchase prices, any of which could harm our net sales, results of operations and reputation |
| Any failure to maintain ongoing sales through our independent sales representatives or maintain our international distributor relationships could harm our business |
| We sell our products to retail locations in the United States and internationally through retail locations serviced by us through our direct sales team and a network of 44 independent sales representatives in the US, and through our international distributors |
| We rely on these independent sales representatives and distributors to provide customer contacts and market our products directly to our customer base |
| Our independent sales representatives are not obligated to continue selling our products, and they may terminate their arrangements with us at any time with limited notice |
| We do not have long-term agreements with our international distributors |
| Our ability to maintain or increase our net sales will depend in large part on our success in developing and maintaining relationships with our independent sales representatives and our international distributors |
| It is possible that we may not be able to maintain or expand these relationships successfully or secure agreements with additional sales representatives or distributors on commercially reasonable terms, or at all |
| Any failure to develop and maintain our relationships with our independent sales representatives or our international distributors, and any failure of our independent sales representatives or international distributors to effectively market our products, could harm our net sales |
| We face business, political, operational, financial and economic risks because a significant portion of our operations and sales are to customers outside of the United States |
| Our European operations are located in Italy, and our primary manufacturers are located in Italy |
| In the fiscal years ended December 31, 2003, 2004 and 2005, we derived 76prca, 74prca and 76prca of our net sales in the United States based on attributing sales using customer location (as opposed to shipping point) and 24prca, 26prca and 24prca of our net sales in the rest of the world, primarily in Australia, Canada, France, Japan and Spain |
| We are subject to risks inherent in international business, many of which are beyond our control, including: • difficulties in obtaining domestic and foreign export, import and other governmental approvals, permits and licenses and compliance with foreign laws, including employment laws; • difficulties in staffing and managing foreign operations, including cultural differences in the conduct of business, labor and other workforce requirements; • transportation delays and difficulties of managing international distribution channels; 18 ______________________________________________________________________ [45]Table of Contents • longer payment cycles for, and greater difficulty collecting, accounts receivable; • ability to finance our foreign operations; • trade restrictions, higher tariffs or the imposition of additional regulations relating to import or export of our products; • unexpected changes in regulatory requirements, royalties and withholding taxes that restrict the repatriation of earnings and effects on our effective income tax rate due to profits generated or lost in foreign countries; • political and economic instability, including wars, terrorism, political unrest, boycotts, curtailment of trade and other business restrictions; and • difficulties in obtaining the protections of the intellectual property laws of other countries |
| Fluctuations in foreign currency exchange rates could harm our results of operations |
| We sell a majority of our products in transactions denominated in US dollars; however, we purchase a substantial portion of our products from our manufacturers in transactions denominated in Euros |
| As a result, if the US dollar were to weaken against the Euro, our cost of sales could increase substantially |
| We also are exposed to gains and losses resulting from the effect that fluctuations in foreign currency exchange rates have on the reported results in our consolidated financial statements due to the translation of the operating results and financial position of our Italian subsidiary, Spy Optic, Sr |
| Between January 1, 2003 and December 31, 2005, the Euro to US dollar exchange rate has ranged from 1dtta03 to 1dtta37 |
| Between January 1, 2003 and December 31, 2005, the Canadian dollar to US dollar exchange rate has ranged from 0dtta63 to 0dtta87 |
| For the fiscal years ended December 31, 2003, 2004 and 2005, we had an unrealized foreign currency gain of approximately dlra290cmam000, dlra528cmam000 and dlra118cmam000, representing 1prca, 2prca and 0prca of our net sales, respectively |
| As of December 31, 2005, we had purchased a total of 10dtta5 million Euro foreign currency contracts at an average Euro rate of 1dtta22 Euro to US dollar |
| The effect of the translation of foreign currencies on our financial results can be significant |
| We therefore engage in certain hedging activities to mitigate over time the impact of the translation of foreign currencies on our financial results |
| Our hedging activities reduce, but do not eliminate, the effects of foreign currency fluctuations |
| Factors that could affect the effectiveness of our hedging activities include the volatility of currency markets and the availability of hedging instruments |
| For the effect of our hedging activities during the current reporting periods, see “Quantitative and Qualitative Disclosures about Market Risk |
| ” The degree to which our financial results are affected will depend in part upon the effectiveness or ineffectiveness of our hedging activities |
| We may experience conflicts of interest with our significant stockholder, No Fear, Inc, which could harm our other stockholders |
| beneficially owns approximately 11prca of our outstanding common stock |
| As a result of No Fear’s ownership interest, No Fear has the ability to influence who is elected to our board of directors each year and, through those directors, to influence our management, operations and potential significant corporate actions |
| In addition, as a purchaser of our products, No Fear accounted for approximately dlra660cmam000, dlra927cmam000 and dlra1cmam025cmam000 of our net sales for the fiscal years ended December 31, 2003, 2004 and 2005, respectively |
| No Fear may have interests that conflict with, or are different from, the interests of our other stockholders |
| These conflicts of interest could include potential competitive business activities, corporate opportunities, indemnity arrangements, registration rights, sales or distributions by No Fear of our common stock and the exercise by No Fear of its ability to influence our management and affairs |
| Further, this concentration of ownership may discourage, delay or prevent a change of control of our company, which could deprive our other stockholders of 19 ______________________________________________________________________ [46]Table of Contents an opportunity to receive a premium for their stock as part of a sale of our company, could harm the market price of our common stock and could impede the growth of our company |
| Our certificate of incorporation does not contain any provisions designed to facilitate resolution of actual or potential conflicts of interest or to ensure that potential business opportunities that may become available to both No Fear and us will be reserved for or made available to us |
| If these conflicts of interest are not resolved in a manner favorable to our stockholders, our stockholders’ interests may be substantially harmed |
| In addition, Mark Simo, the Chairman of our board of directors, serves as the Chief Executive Officer and Chairman of the board of directors of No Fear and owns approximately 32prca of No Fear’s outstanding common stock |
| As a result of his position in No Fear, Mr |
| Simo may face conflicts of interest in connection with transactions between us and No Fear |
| If we fail to secure or protect our intellectual property rights, competitors may be able to use our technologies, which could weaken our competitive position, reduce our net sales or increase our costs |
| We rely on patent, trademark, copyright, trade secret and trade dress laws to protect our proprietary rights with respect to product designs, product research and trademarks |
| Our efforts to protect our intellectual property may not be effective and may be challenged by third parties |
| Despite our efforts, third parties may have violated and may in the future violate our intellectual property rights |
| In addition, other parties may independently develop similar or competing technologies |
| If we fail to protect our proprietary rights adequately, our competitors could imitate our products using processes or technologies developed by us and thereby potentially harm our competitive position and our financial condition |
| We are also susceptible to injury from parallel trade (ie, gray markets) and counterfeiting of our products, which could harm our reputation for producing high-quality products from premium materials |
| Infringement claims and lawsuits likely would be expensive to resolve and would require substantial management time and resources |
| Any adverse determination in litigation could subject us to the loss of our rights to a particular patent, trademark, copyright or trade secret, could require us to obtain licenses from third parties, could prevent us from manufacturing, selling or using certain aspects of our products or could subject us to substantial liability, any of which would harm our results of operations |
| Since we sell our products internationally and are dependent on foreign manufacturing in Italy and China, we also are dependent on the laws of foreign countries to protect our intellectual property |
| These laws may not protect intellectual property rights to the same extent or in the same manner as the laws of the United States |
| Although we will continue to devote substantial resources to the establishment and protection of our intellectual property on a worldwide basis, we cannot be certain that these efforts will be successful or that the costs associated with protecting our rights abroad will not be extensive |
| As of the date of this report, we have been unable to register Spy as a trademark for our products in a few selected markets in which we do business |
| In addition, although we have filed applications for federal registration, we have no trademark registrations for Spy for our accessory products currently being sold |
| We may face significant expenses and liability in connection with the protection of our intellectual property rights both inside and outside of the United States and, if we are unable to successfully protect our intellectual property rights or resolve any conflicts, our results of operations may be harmed |
| We may be subject to claims by third parties for alleged infringement of their proprietary rights, which are costly to defend, could require us to pay damages and could limit our ability to use certain technologies in the future |
| From time to time, we may receive notices of claims of infringement, misappropriation or misuse of other parties’ proprietary rights |
| Some of these claims may lead to litigation |
| Any intellectual property lawsuit, whether or not determined in our favor or settled, could be costly, could harm our reputation and could divert our management from normal business operations |
| Adverse determinations in litigation could subject us to significant liability and could result in the loss of our proprietary rights |
| A successful lawsuit against us could also force us to cease sales or to develop redesigned products or brands |
| In addition, we could be required to seek a license from the holder of the intellectual property to use the infringed technology, and it is possible that we 20 ______________________________________________________________________ [47]Table of Contents may not be able to obtain a license on reasonable terms, or at all |
| If we are unable to redesign our products or obtain a license, we may have to discontinue a particular product offering |
| If we fail to develop a non-infringing technology on a timely basis or to license the infringed technology on acceptable terms, our business, financial condition and results of operations could be harmed |
| On March 7, 2005, Oakley, Inc, one of our major competitors, filed a lawsuit alleging patent trade dress and trademark infringement, unfair competition, and false designation of origin |
| The lawsuit specifically identifies three of our product styles which accounted for approximately 4prca and 5prca of our total net sales for fiscal years 2004 and 2005, respectively |
| While management believes the lawsuit is without merit, litigation is subject to inherent uncertainties and an unfavorable outcome could negatively affect our operating results |
| If we fail to manage any growth that we might experience, our business could be harmed and we may have to incur significant expenditures to address this growth |
| We have experienced significant growth, which has placed, and may continue to place, a significant strain on our management and operations |
| If we continue to experience growth in our operations, our operational and financial systems, procedures and controls may need to be expanded and we may need to train and manage an increasing number of employees, any of which will distract our management team from our business plan and involve increased expenses |
| Our future success will depend substantially on the ability of our management team to manage any growth effectively |
| These challenges may include: • maintaining our cost structure at an appropriate level based on the net sales we generate; • implementing and improving our operational and financial systems, procedures and controls; • managing operations in multiple locations and multiple time zones; and • ensuring the distribution of our products in a timely manner |
| We incur significant expenses as a result of being a public company |
| We incur significant legal, accounting, insurance and other expenses as a result of being a public company |
| The Sarbanes-Oxley Act of 2002, as well as new rules subsequently implemented by the SEC and Nasdaq, have required changes in corporate governance practices of public companies |
| These new rules and regulations have, and will continue, to increase our legal and financial compliance costs and make some activities more time-consuming and costly |
| These new rules and regulations have also made, and will continue to make, it more difficult and more expensive for us to obtain director and officer liability insurance |
| We may not address successfully problems encountered in connection with our acquisition of LEM or any future acquisitions, which could result in operating difficulties and other harmful consequences |
| In January 2006, we acquired 100prca of the capital stock of LEM The aggregate purchase price was 3dtta3 million Euro or approximately dlra3cmam960cmam000 in cash, plus a two year earn-out based on LEM’s future sales |
| Under the terms of the earn-out, we are obligated to make quarterly payments based on unit sales, up to a maximum of €1cmam400cmam000, through December 31, 2005 |
| We expect to continue to consider other opportunities to acquire or make investments in other technologies, products and businesses that could enhance our capabilities, complement our current products or expand the breadth of our markets or customer base, although we have no specific agreements with respect to potential acquisitions or investments |
| We have limited experience in acquiring other businesses and technologies |
| Potential and completed acquisitions, including LEM, and strategic investments involve numerous risks, including: • problems assimilating the purchased technologies, products or business operations; • problems maintaining uniform standards, procedures, controls and policies; 21 ______________________________________________________________________ [48]Table of Contents • unanticipated costs associated with the acquisition; • diversion of management’s attention from our core business; • harm to our existing business relationships with manufacturers and customers; • risks associated with entering new markets in which we have no or limited prior experience; and • potential loss of key employees of acquired businesses |
| If we fail to properly evaluate and execute acquisitions and strategic investments, our management team may be distracted from our day-to-day operations, our business may be disrupted and our operating results may suffer |
| In addition, if we finance acquisitions by issuing equity or convertible debt securities, our stockholders would be diluted |
| In addition, in accordance with Statement of Financial Accounting Standards (SFAS) Nodtta 142, Goodwill and Other Intangible Assets, we are required to test goodwill for impairment at least annually, or more frequently if events or circumstances exist which indicate that goodwill may be impaired |
| As a result of changes in circumstances after valuing assets in connection with acquisitions, we may be required to take write-downs of intangible assets, including goodwill, which could be significant |
| Our eyewear products may subject us to product liability claims, which are expensive to defend and may require us to pay damages |
| Due to the nature of our products and the activities in which our products may be used, we may be subject to product liability claims, including claims for serious personal injury |
| Although we are not involved presently in any product liability claim, successful assertion against us of one or a series of large claims could harm our business |
| We could incur substantial costs to comply with foreign environmental laws, and violations of such laws may increase our costs or require us to change certain business practices |
| Because we manufacture a wide variety of eyewear products at our Italian manufacturing facility, we use and generate numerous chemicals and other hazardous by-products in our manufacturing operations |
| As a result, we are subject to a broad range of foreign environmental laws and regulations |
| These environmental laws govern, among other things, air emissions, wastewater discharges and the acquisition, handling, use, storage and release of wastes and hazardous substances |
| Such laws and regulations can be complex and change often |
| Contaminants have been detected at some of our present facilities, principally in connection with historical practices conducted at LEM We have undertaken to remediate these contaminants |
| Although we currently do not expect that these remediation efforts will involve substantial expenditure of resources by us, the costs associated with this remediation could be substantial, which would reduce our cash available for operations, consume valuable management time, reduce our profits or impair our financial condition |
| Risks Related to the Market for Our Common Stock Our stock price may be volatile, and you may not be able to resell our shares at a profit or at all |
| The trading price of our common stock fluctuates due to the factors discussed in this section and elsewhere in this report |
| The trading market for our common stock also is influenced by the research and reports that industry or securities analysts publish about us or our industry |
| If one or more of the analysts who cover us were to publish an unfavorable research report or to downgrade our stock, our stock price likely would decline |
| If one or more of these analysts were to cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline |
| Our operating results fluctuate from quarter to quarter as a result of changes in demand for our products, our effectiveness in managing our suppliers and costs, the timing of the introduction of new products and weather patterns |
| Historically, we have experienced greater net sales in the second half of the fiscal year as a result of the seasonality of our customers and the markets in which we sell our products, and our first and fourth quarters have traditionally been our weakest operating quarters due to seasonality |
| We generally sell more of our sunglass products in the first half of the fiscal year and a majority of our goggle products in the last half of the fiscal year |
| We anticipate that this seasonal impact on our net sales is likely to continue |
| As a result, our net sales and operating results have fluctuated significantly from period to period in the past and are likely to do so in the future |
| These fluctuations could cause the market price of our common stock to decline |
| You should not rely on period-to-period comparisons of our operating results as an indication of our future performance |
| In future periods, our net sales and results of operations may be below the expectations of analysts and investors, which could cause the market price of our common stock to decline |
| Our expense levels in the future will be based, in large part, on our expectations regarding net sales and based on acquisitions we may complete |
| For example, in January we completed the acquisition of our primary manufacturer LEM Sr |
| We may not be able to decrease our expenses in a timely manner to offset any shortfall of sales |
| Future sales of our common stock in the public market could cause our stock price to fall |
| Sales of our common stock in the public market, or the perception that such sales might occur, could cause the market price of our common stock to decline |
| As of March 9, 2006, we have 8cmam084cmam314 shares of common stock outstanding and 930cmam780 shares subject to unexercised options to purchase shares of common stock that are fully vested |
| In addition, in connection with our initial public offering, we issued warrants to purchase up to 147cmam000 shares of common stock to Roth Capital Partners, LLC, and an affiliate |
| Delaware law and our corporate charter and bylaws contain anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable |
| Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management |
| These provisions include the following: • the establishment of a classified board of directors requiring that not all directors be elected at one time; • the size of our board of directors can be expanded by resolution of our board of directors; • any vacancy on our board can be filled by a resolution of our board of directors; • advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted upon at a stockholders’ meeting; • the ability of the board of directors to alter our bylaws without obtaining stockholder approval; • the ability of the board of directors to issue and designate the rights of, without stockholder approval, up to 5cmam000cmam000 shares of preferred stock, which rights could be senior to those of common stock; and • the elimination of the right of stockholders to call a special meeting of stockholders and to take action by written consent |
| 23 ______________________________________________________________________ [50]Table of Contents In addition, because we reincorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, or Delaware law |
| These provisions may prohibit large stockholders, in particular those owning 15prca or more of our outstanding voting stock, from merging or combining with us |
| The provisions in our charter, bylaws and under Delaware law could discourage potential takeover attempts and could reduce the price that investors might be willing to pay for shares of our common stock in the future, resulting in the market price being lower than it would without these provisions |
| We are party to securities litigation that distracts our management, is expensive to conduct and seeks a damage award against us |
| We, our directors and certain of our officers have been named as defendants in two stockholder class action lawsuits filed in the United States District Court for the Southern District of California |
| A consolidated complaint, filed October 11, 2005, purported to seek unspecified damages on behalf of an alleged class of persons who purchased our common stock pursuant to our registration statement we filed in connection with our public offering of stock on December 14, 2004 |
| The complaint alleged that we and our officers and directors violated federal securities laws by failing to disclose in the registration statement material information about plans to make a distribution change in our European operations, our dealings with one of our customers and whether certain of our products infringe on the intellectual property rights of Oakley, Inc |
| We filed a motion to dismiss the complaint which the court granted on March 29, 2006 |
| The court allowed plaintiffs to file an amended complaint only with respect to their claim about a European distribution change |
| Plaintiffs filed an amended complaint dated April 7, 2006 |
| No discovery has been conducted |
| However, based on the facts presently known, management believes we have meritorious defenses to this action and intends to vigorously defend the action |
| In December 2005, two stockholders filed derivative lawsuits in state court in San Diego, purportedly on our behalf, against eight of our current or former directors and officers and against one of our stockholders, No Fear |
| A consolidated amended complaint was filed in March 2006 alleging that the defendants breached their fiduciary duties and injured us by allowing us to issue a misleading registration statement and prospectus in connection with our December 2004 public offering and alleging that No Fear sold Orange 21 stock while having knowledge of material, non-public information |
| The derivative plaintiffs seek compensatory damages, disgorgement of profits, treble damages and other relief |
| The case is still in the pretrial stage |
| For the stockholder lawsuits, the Company has accrued an amount up to the maximum to be paid of dlra250cmam000 on its insurance deductible under its director and officer coverage |
| This litigation presents a distraction to our management and is expensive to conduct |
| This could negatively affect our operating results |