WEEK 6 Questions

Contents: Synopsis · Mission and Vision · Corporate Social Responsibility · To Our Stockholders · Past and Present Performance · SWOT Analysis · Consolidated Financial Statements (income statement, balance sheet, cash flows) · Future Outlook, Years 14-18

C CrossFit Footwear grew net revenues from $496.9 million in Year 11 to $770.1 million in Year 13 and lifted earnings per share from $2.77 to $6.83, return on equity to 50.4% and stock price to $173.08, the highest in Industry 14. We finished first on the Year 13 scoreboard (106 points) and second on the cumulative score (105, one point behind Blueprint’s 106). Credit rating slipped from A to A- and image recovered from 68 to 81 after a dip in Year 12. The three years taught us three things: higher prices hold share only when quality rises with them (Year 12 raised prices without better products and lost share, while Year 13 raised them alongside a better S/Q rating and gained it), growth must be funded without running cash to zero, and every decision should be tested against the investor expectations that score us. The pages below set out our mission, social responsibility, results, SWOT, consolidated statements and the Year 14-18 plan.

To design and sell championship-level training footwear that athletes in every region can trust, delivering the best quality for the price while earning a strong return for our stockholders and treating our workers, partners and communities fairly.

To be the world’s most trusted functional-fitness footwear brand, first in image, quality and shareholder value in North America, Europe-Africa, Asia-Pacific and Latin America by Year 18.

Our CSR program rests on four standing commitments, which we carry into Year 14: an ethics code, a supplier code of conduct, continued improvement of working conditions, and energy-efficiency investment in our plants. The people side adds yearly base-wage increases (+1%), $800 per worker of best-practices training, and one supervisor for every 30 workers in North America and Asia-Pacific.

Our reported energy-efficiency and citizenship outlay was $0.8 million in Year 11 (industry average $9.1 million) and $11.8 million in Year 12 (average $7.5 million), which included $11.0 million for improved working conditions. In Year 13 we spent $1.0 million against an industry average of $7.5 million (high $10.1 million). In Year 14 we are raising this to $6.1 million: a $5.0 million charitable contribution and $1.1 million of energy-efficiency initiatives. We will keep checking whether each year’s charitable gift moves projected image (roughly one point per $2 million) and scale it back in Year 15, when new celebrity contracts make image points cheaper to win, if it does not.

Dear Stockholders,

Thank you for your confidence in C CrossFit Footwear. Your support let us grow quickly, and Year 13 rewarded it: we posted the highest EPS ($6.83), ROE (50.4%) and stock price ($173.08, up from $60.52 in Year 12) in the industry, and we finished first on the Year 13 scoreboard.

Financially, the company is strong. Net revenues reached $770.1 million, net profit $128.0 million (a 16.6% net margin), and operating profit $191.0 million. We returned $28.1 million in dividends ($1.50 a share) and repurchased $39.2 million of stock. We also owe you candor on two points: we ended Year 13 with no cash and $81.5 million of long-term loans, which cost us a notch of credit rating (A to A-), and our revenue and EPS fell short of our own forecast by 6.9% and 17.4%.

In Year 14 we are fixing both. We are adding production capacity to meet demand we could not fill, raising prices modestly ($3-6 a pair wholesale and $3 online) while lifting our S/Q rating to 7.0-7.1, repaying $70.9 million of debt with no new borrowing (including $32.0 million of early repayment on a five-year loan), and raising the dividend to $2.25 a share while still ending the year with about $35 million of cash. Our Year 14 projection is EPS of $8.62, ROE of 46.9% and an A+ credit rating (debt-to-assets down from 0.36 to 0.19, default risk back to Low), against investor expectations of $4.00, 24.0% and A-.

Thank you for your continued support.

The C CrossFit Footwear management team: Manoj Khatri, Karen Macklin, Justin Stanford, Sarata Traore and Caroline Lee

We finished Year 13 above every investor expectation except credit rating, where we came out one notch below Year 12.

Net revenues: $496.9 million in Year 11, $460.0 million in Year 12 and $770.1 million in Year 13, up 67% on Year 12. Year 12 fell 7.4%: we raised prices, market share fell 3-6 points in every region, and exchange-rate losses took $9.7 million. Year 13 jumped as Internet sales doubled ($99.9 million to $206.7 million), wholesale rose 56% ($341.5 million to $531.7 million) and exchange rates added $31.6 million; private-label sales ($28.3 million in Year 12) were dropped.

· Year 11: repaid $15.9 million of long-term loans, paid a $1.00 dividend ($19.8 million), repurchased 200,000 shares at $30.30 ($6.1 million), spent $0.8 million on energy efficiency, and added no equipment or facility space, leaving 11,000 pairs of facility space and 8,000 pairs of equipment in North America and Asia-Pacific. We priced wholesale at $50-56 and Internet at $73-79 a pair and held 23-27% market share in every region and segment. In production we made 8.0 million regular-time and 0.7 million overtime branded pairs (119% of capacity) at $24.77 a pair, with a 5.1% reject rate, using 1,943 workers. Marketing totaled $82.4 million ($27.2 million Internet, including $17.5 million of search-engine advertising, and $55.2 million wholesale, including $11.9 million of retailer support), plus $17.1 million of administrative expense. We ended the year with $24.7 million of cash and an A credit rating.

· Year 12: paid a $2.50 dividend ($48.4 million, 88% of earnings), repurchased 446,000 shares at $49.59 ($22.1 million) and spent $11.8 million on corporate citizenship ($11.0 million on improved working conditions and $0.8 million on energy efficiency), again with no new capacity. To cover the shortfall we took a $23.5 million overdraft loan at 7.8% and ended the year with $0 cash. We raised wholesale prices to $52-60 and Internet prices to $74-80, and market share fell to 18-22% in every region and segment, even though we spent $76.7 million on marketing ($25.4 million Internet, with search ads cut to $15.5 million, and $51.3 million wholesale, with retailer support raised to $13.3 million); administrative expense was $16.4 million. In production we made 8.0 million regular-time and 0.75 million overtime branded pairs (120% of capacity) at $24.76 a pair, with the reject rate up to 5.4%. We cut the workforce to 1,837 as North America productivity rose to 5,236 pairs per worker. Image fell to 68.

Year 13

· Production and quality: we ran 100% new equipment in North America, 60% superior materials in North America and 80% in Asia-Pacific, $3.50 per pair of TQM/6-Sigma spending, $35.0 million for 1,750 pairs of new equipment (750 in North America and 1,000 in Asia-Pacific, lifting equipment to 9,750 pairs) and $15.6 million of production improvement options. Our S/Q rating of 6.6-6.8 beat the industry’s 6.0. The price was higher cost: branded production cost rose to $31.71 a pair (from $24.76), the reject rate to 7.5% and the workforce to 2,277, with plants at 117% of capacity.

· Pricing and marketing: Internet prices of $82-88 and wholesale prices of $63-66, with brand advertising of $17-22 million per region, search ads of $4,500-5,500 and 4.00 rebates. Total marketing rose about 71% to roughly $131 million ($88.6 million wholesale, including $15.2 million of retailer support, and about $42.8 million Internet), and administrative expense was $20.2 million. We won 29-34% of Internet sales and 25-29% of wholesale sales in every region.

· Workforce: +1% base wages, $0.50 / $0.25 incentive pay, 800 per worker of best-practices training, and 30:1 supervision.

· Finance: $1.50 dividend ($28.1 million), a $39.2 million repurchase of 626,000 shares at $62.54, and $55.0 million of new borrowing (a $40.0 million five-year loan and a $15.0 million overdraft loan), ending the year with no cash and $81.5 million of long-term loans.

· Celebrities: we won Billy Eyelash (offer $2.0 million) and Chef Curry (offer $1.0 million) for Year 14, so their appeal does not count until then.

· EPS $6.83: net profit of $128.0 million on 18.7 million shares, with a 24.8% operating margin. It is 17.4% below our $8.27 forecast because wholesale and internet volumes came in under plan.

· ROE 50.4%: high profits on a small equity base ($224 million at the start of the year, $284 million at the end), shrunk further by the $39.2 million buyback. Blueprint, at 28.0%, had a much larger equity base.

· Stock price $173.08: the market priced in a profit surge (more than double Year 12) and ROE above 50%. It is the best in the industry; Blueprint is $142.91 and DFive $119.81.

· Credit rating A-: cash at zero after $39.2 million of buybacks, $28.1 million of dividends and $50.6 million of capital spending, a $15.0 million overdraft loan, $81.5 million of long-term loans, a debt-to-assets ratio of 0.36 and a default-risk ratio of 3.83 (rated Medium, down from 4.67 and Low in Year 12). Blueprint and DFive hold A+ with ratios of 9.41 and 7.89.

· Image 81: image fell from 77 to 68 in Year 12, then rebounded to 81, helped by an S/Q rating of 6.6-6.8 against an industry 6.0. Our three-year average (75) still trails Blueprint’s 82 because Blueprint held 87 and 84 in Years 12 and 13 and we had no celebrity appeal in Year 13 (0, against DFive’s 215-230).

We were third in profit in Years 11 and 12 and lowest in revenue in Year 12, then led the industry on both in Year 13.

Our product and profits are strong; cash, image and rivals’ celebrity appeal are where we are exposed.

· Best-in-industry profitability: EPS $6.83, ROE 50.4% and stock price $173.08 in Year 13, with a 24.8% operating margin.

· Product quality and breadth: S/Q rating of 6.6-6.8 against an industry 6.0, and 370-382 models against an industry 279-282.

· Marketing reach: 25-34% market share in every region and segment, with brand advertising and Internet search ads rated strengths in the FIR.

· Efficient production: TQM/6-Sigma spending and total production cost rated strengths in North America and Asia-Pacific, with workforce productivity of 5,103 pairs per worker in North America.

· No cash cushion: we ended Year 13 with $0 cash and $81.5 million of long-term loans, which cost a notch of credit rating (A to A-).

· Image and celebrity appeal: our three-year image average is 75 against Blueprint’s 82, and celebrity appeal was rated a major weakness in all four regions because our Year 13 contracts do not start until Year 14.

· Reject rates: a 6.5% reject rate in North America and 8.4% in Asia-Pacific, rated a major weakness.

· Forecasting: Year 13 revenue was 6.9% and EPS 17.4% below forecast, and we missed the Bull’s Eye bonus.

· Footprint: we produce only in North America and Asia-Pacific, so Europe-Africa and Latin America carry high branded cost per pair ($40.13 and $36.78).

· Growing demand: forecast branded demand of 41.0 million pairs in Year 14, growing 7-9% a year through Year 15 and 5-7% after.

· Unfilled orders: we are about 720 pairs short of Year 14 demand plus required inventory, so added capacity converts directly to sales.

· Celebrity market: Lady HaHa is open this year, Billy, Taylor, Bronko and Jay open in Year 15 and Chef Curry in Year 16; appeal is capped at 300 points per region and at two contracts awarded per year.

· Credit and image gains: with A+ credit and a rising image average, our Year 14 projection is $8.62 EPS and image 90, and Year 12’s score of 68 drops out of the image average in Year 15.

· Industry overcapacity: potential supply is 18.8% above forecast demand, which invites price cutting.

· Rivals’ strengths: Blueprint holds A+ credit and an 84-87 image with $36.8 million cash; DFive holds A+ credit, 210-230 celebrity appeal in three regions and a $2.00 dividend.

· Inventory dumping: AKinetix carries about 3.2 million pairs (157 days of inventory) and may cut prices to clear them.

· Cost and currency risk: exchange-rate swings and materials-price increases (superior materials up 9.2%) hit exports to Europe-Africa and Latin America.

Consolidated results for all four regions are below, taken from the Company C income statement, balance sheet and cash flow pages. The Year 11 and Year 12 columns sit beside Year 13 in each table.

All three years, in $000s. Year 13 cash flow ended at zero after a $40.0 million five-year loan and a $15.0 million overdraft loan funded $35.0 million of new equipment, $15.6 million of improvement options, $39.2 million of stock repurchases and $28.1 million of dividends.

We will turn Year 13’s profit lead into a lead on all five scoring measures by adding capacity we can sell, protecting cash and credit, and building image.

· Capacity: buy new equipment for 250 pairs in North America and 1,000 in Asia-Pacific and produce 6.0 million and 7.2 million pairs, each including the 20% overtime maximum, for 12.3 million net pairs after rejects, closing a shortfall of about 720,000 pairs.

· Quality and cost: 60% superior materials in North America and 80% in Asia-Pacific, 400 models, $22,000 per model of enhanced styling and $3.50 per pair of TQM/6-Sigma spending in both plants. This lifts our S/Q rating to 7.0 in North America and 7.1 in Asia-Pacific (from 6.6-6.8) and cuts reject rates to 5.7% and 7.3% (from 6.5% and 8.4%), at a branded production cost of $32.25 and $29.84 a pair.

· Pricing and marketing: raise wholesale prices to $69 / $69 / $66 / $68 (NA / EA / AP / LA) (from $63-66) and Internet prices to $89 / $91 / $85 / $90 (from $82-88), backed by the quality gains above, with wholesale brand advertising of $24 / $19 / $21 / $20 million, a $4.00 rebate, 3-week delivery and $4,000-4,500 of retailer support per outlet. We expect a wholesale S/Q rating of 6.9-7.0 against an assumed industry 6.2-6.4, retail outlets rising to 1,118-1,427 per region, and wholesale operating margins of 27.8% / 19.7% / 26.2% / 17.4%. Online, we spend $5.5 million on search advertising in North America and Europe-Africa and $4.5 million in Asia-Pacific and Latin America, with no free shipping, and project Internet market share of 33.7% / 35.5% / 34.4% / 40.0% (up from 29.0-33.5% in Year 13), about 2.8 million pairs sold online, and Internet operating margins of 30.8-36.5%.

· Image: bid $1.8 million a year for Lady HaHa (with a $1.8 million spending cap), the only celebrity open this year and nearly triple the highest rival offer of $651,000. Billy Eyelash and Chef Curry give us celebrity appeal of 140 / 155 / 125 / 175 this year; Lady HaHa would add 85 / 65 / 60 / 40 from Year 15, taking us to 225 / 220 / 185 / 215, and keep ethics, supplier-code and working-conditions programs.

· Finance: borrow nothing new, repay $70.9 million of debt (the $15.0 million overdraft, $15.9 million of scheduled ten-year payments, and $40.0 million on five-year loans, $32.0 million of it early), raise the dividend to $2.25 a share ($42.1 million) and make no repurchase, ending the year with about $35.2 million of cash.

· Projected result: EPS $8.62, ROE 46.9%, credit A+, image 90, revenues $948.7 million (+23.2%) and net profit $161.4 million (+26.1%). We built it assuming rivals price $9-14 below us in wholesale ($55.00-58.94) and $7-9 below us on the Internet ($78.25-83.13), a cautious but not extreme case.

· Add up to 500 pairs of new facility space in North America and Asia-Pacific in Year 15 if Year 14 sell-through confirms unfilled demand.

· Renew Billy Eyelash and bid on Taylor Sluggish, Bronko Mars or Jay XYZ when they open in Year 15, and renew Chef Curry in Year 16, to lift celebrity appeal from 125-175 (185-225 with Lady HaHa) toward the 300-point cap. Year 12’s image score of 68 also drops out of our three-year average in Year 15.

· Keep cutting reject rates (projected at 5.7% in North America and 7.3% in Asia-Pacific for Year 14, down from 6.5% and 8.4%) with continued TQM spending.

· Resume stock repurchases only when ending cash is above $65 million and credit stays A+.

· Review a Latin America or Europe-Africa plant, where branded cost per pair is $36.78-$40.13, if exchange rates or tariffs keep eroding margin.

· Raise the dividend gradually, keep long-term debt falling, and hold price and quality gaps over rivals.

These are the investor expectations. Our goal is to beat each by at least 25%, keep credit at A+, and hold image at 88 or higher every year.

· If Blueprint or DFive cuts wholesale prices by more than $3, we will trim our prices toward the industry average rather than lose volume, as long as ending cash stays positive and we avoid an overdraft loan.

· If AKinetix dumps its 3.2 million pairs of inventory, we will protect Internet share with search advertising before cutting wholesale price.