Deckers Outdoor Corp: Form 10-Q for the period ended Dec 31, 2014

SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS

This report and the information incorporated by reference in this report contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that concern matters that involve risks and uncertainties that could cause actual results to differ materially from those anticipated or projected in the forward-looking statements. These forward-looking statements are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact contained in this interim report, including statements regarding future events, our future financial performance, our future business strategy and the plans and objectives of management for future operations, are forward-looking statements. We have attempted to identify forward-looking statements by using words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “project,” ‘plan”, “predict”, “should,” “will,” and similar expressions, or the negative of these expressions, as they relate to us, our management and our industry. Specifically, this report and the information incorporated by reference in this report contain forward-looking statements relating to, among other things:

• our global business, growth, operating, investing, and financing strategies;
• our product, distribution channel, and geographic mix;
• the success of new products, new brands, and other growth initiatives;
• the impact of seasonality on our operations;
• expectations regarding our net sales and earnings growth and other financial metrics;
• our development of worldwide distribution channels;
• trends affecting our financial condition, results of operations, or cash flows;
• our expectations for expansion of our retail and E-Commerce capabilities;
• information security and privacy of customer, employee or company information;
• overall global economic trends;
• reliability of overseas factory production and storage; and
• the availability and cost of raw materials.

We have based our forward-looking statements on our current expectations and projections about trends affecting our business and industry and other future events. Although we do not make forward-looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy.

Some of the risks, uncertainties and assumptions that may cause actual results to differ from these forward-looking statements are described in Part II, Item 1A of this interim report in the section entitled “Risk Factors,” as well as in our other filings with the Securities and Exchange Commission (SEC). In addition, actual results may differ as a result of additional risks and uncertainties of which we are currently unaware or which we do not currently view as material to our business. We operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and we cannot predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. As a result, actual results may differ materially from the results stated in or implied by our forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements, which reflect our opinions only as of the date of this quarterly report, as a prediction of actual results.

You should read this report in its entirety, together with our Annual Report on Form 10-K for the fiscal year (FY) ended December 31, 2013 filed with the SEC on March 3, 2014 (Annual Report), and the documents that we file as exhibits to these reports and the documents that we incorporate by reference in these reports, with the understanding that our future results may be materially different from what we currently expect. We qualify all of our forward-looking statements by these cautionary statements and we expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations, except as required by applicable law or the rules of the New York Stock Exchange.

References to “Deckers,” “we,” “us,” “our,” or similar terms refer to Deckers Outdoor Corporation together with its consolidated subsidiaries. Unless otherwise specifically indicated, all amounts herein are expressed in thousands, except for share quantity, per share data, and selling prices per pair. The following discussion of our financial condition and results of operations should be read together with our condensed consolidated financial statements and the accompanying notes to those statements included elsewhere in this document.

Overview

We are a global leader in designing, marketing and distributing innovative footwear, apparel and accessories developed for both everyday casual lifestyle use and high performance activities. We market our products primarily under three proprietary brands:

• UGG®: Premier brand in luxurious comfort footwear, handbags, apparel, home and cold weather accessories;
• Teva®: Born from the outdoors, active lifestyle footwear for the adventurous spirit; and
• Sanuk®: Innovative action sport footwear brand rooted in the surf community.

In addition to our primary brands, our other brands include Ahnu®, an authentic performance footwear brand that makes footwear for fashion-minded people who prefer trails, yoga mats, and hybrid fitness workouts; Hoka One One® (Hoka), a line of footwear for all capacities of runner designed with a unique performance midsole geometry, oversized midsole volume and active foot frame; MOZO®, a line of footwear crafted for culinary professionals that redefines the industry dress code; and TSUBO®, a line of mid and high-end dress and dress casual comfort footwear that incorporates style and function with maximum comfort.

We sell our brands through quality domestic retailers and international distributors and retailers, as well as directly to our end-user consumers through our E-Commerce business and our retail stores. Independent third parties manufacture all of our products.

Our business has been impacted by, what we believe are, several important trends and we expect that it will continue to be impacted:

• Sales of our products are highly seasonal and are sensitive to weather conditions, which are beyond our control. Even though we are creating more year-round styles for our brands, the effect of favorable or unfavorable weather on sales can be significant.
• Continuing uncertainty surrounding US and global economic conditions has adversely impacted businesses worldwide. Some of our customers have been, and more may be, adversely affected, which in turn has, and may continue to, adversely impact our financial results.
• The sheepskin used in certain UGG products is in high demand and limited supply, and there have been significant fluctuations in the price of sheepskin over the years as the demand from competitors for this material has changed. However, our sheepskin costs are expected to decrease for the fiscal year ending March 31, 2015 compared to the trailing twelve months ended March 31, 2014 due to lower pricing negotiated through our sheepskin contracts.
• Our use of UGGpureTM, real wool woven into a durable backing used as an alternative to table grade sheepskin, in select products, primarily in linings and footbeds, continues to grow.
• The markets for casual, outdoor, and athletic footwear have grown significantly during the last decade. We believe this growth is a result of the trend toward casual dress in the workplace, increasingly active outdoor lifestyles, and a growing emphasis on comfort.
• Consumers are more often seeking footwear designed to address a broader array of activities with the same quality, comfort, and high performance attributes they have come to expect from traditional athletic footwear.
• Consumers have narrowed their footwear product breadth, focusing on brands with a rich heritage and authenticity as market category creators and leaders.
• Consumers have become increasingly focused on luxury and comfort, seeking out products and brands that are fashionable while still comfortable.
• There is an emerging sustainable lifestyle movement happening all around the world, and consumers are demanding that brands and companies become more environmentally and socially responsible.
• Consumers are following a recent trend of buy now, wear now. This trend entails the consumer waiting to purchase shoes until they will actually wear them, contrasted with a tendency in the past to purchase shoes they did not plan to wear until later.

By emphasizing our brands' images and our focus on comfort, performance and authenticity, we believe we can continue to maintain a loyal consumer following that is less susceptible to fluctuations caused by changing fashions and changes in consumer preferences. We have also responded to consumer focus on sustainability by establishing objectives, policies, and procedures to help us drive key sustainability initiatives around human rights, environmental sustainability, and community affairs.

We have experienced significant cost fluctuations, most over the past several years, notably with respect to sheepskin. We attempt to cover the full amount of our sheepskin purchases under fixed price contracts. We continually strive to contain our material costs through increasing the mix of non-sheepskin products, exploring new footwear materials and new production technologies, and utilizing lower cost production. Also, refer to Part I, Item 3. Quantitative and Qualitative Disclosures about Market Risk for further discussion of our commodity price risk.

Below is an overview of the various components of our business, including some key factors that affect each business and some of our strategies for growing each business.

UGG Brand Overview

The UGG brand is one of the most iconic and recognized brands in the global footwear industry and highlights our successful track record of building niche brands into lifestyle market leaders. With loyal consumers around the world the UGG brand has proven to be a highly resilient line of premium footwear, with an expanding product offering and a growing global audience that attracts women, men and children. UGG brand footwear continually earns media exposure from numerous outlets both organically and from strategic public relations efforts, including an increasing amount of exposure internationally. The UGG brand has invested in creating holistic, impactful integrated campaigns across paid, earned and owned media channels, including mobile, digital, social, out-of-home (OOH) and print, which are globally scalable, contributing to broader public awareness of the brand.

We believe the increased global media focus and demand for UGG products has been driven by the following:

• High consumer brand loyalty, due to over 35 years of delivering quality and luxuriously comfortable UGG footwear;
• Continued innovation of new product categories and styles, including those beyond footwear such as loungewear, handbags, cold-weather accessories and a new home offering;
• A more robust footwear offering, including transitional product that bridges the seasons between spring and fall;
• Expanded slipper category showing incremental growth with added styles for both women and men;
• Growing Direct-to-Consumer platform and enhanced OmniChannel capabilities that enable us to increasingly engage existing and prospective consumers in a more connected environment to introduce our evolving product lines;
• Product customization with our UGG by You program allows for a deeper connection with the brand and products;
• Focus on mobile consumers with responsive site design, providing shoppers access to the brand from their mobile device;
• Year-round holistic paid advertising approach for women, men and kids in targeted digital, high-end print, OOH, digital and across multiple social platforms;
• Holiday and winter focused advertising campaign to drive important seasonal sales;
• Continued creation of targeted UGG for Men campaigns featuring brand ambassador Tom Brady;
• Targeted E-Commerce based marketing to existing and prospective consumers through integrated outreach including email blasts, interactive site design and search engine optimization based content;
• Continued partnership with high-end retailers such as Nordstrom;
• Expanded product assortments from existing accounts;
• Adoption by high-profile celebrities as a favored footwear brand;
• Continued media attention that has enabled us to introduce the brand to consumers much faster than we would have otherwise been able to;
• Increased exposure to the brand driven by our concept stores that showcase all of our product offerings; and
• Continued expansion of worldwide retail through new UGG stores.

We believe the luxurious comfort of UGG products will continue to drive long-term consumer demand. Recognizing that there is a significant fashion element to UGG footwear and that footwear fashions fluctuate, our key strategies include presenting UGG as a year-round global, premium lifestyle brand with a broad product line suitable for wear in a variety of climates and occasions and limiting distribution to select higher-end retailers. As part of this strategic approach, we have increased our product offering, including growing transitional collections and our spring line, an expanded men’s line, a fall line that consists of a range of luxurious collections for both genders, an expanded kids’ line, as well as home, handbags, cold weather accessories, and apparel. An additional key strategy is to grow casual boots by expanding retail offerings in women's casual boots and cold weather products. We have also recently expanded our marketing and promotional efforts, which we believe has contributed, and will continue to contribute, to our growth. We believe that the evolution of the UGG brand and our strategy of product diversification will also help decrease our reliance on sheepskin, which is in high demand and subject to price volatility. Nonetheless, we cannot assure investors that our efforts will continue to provide UGG brand growth.

Teva Brand Overview

For 30 years Teva has fueled the expression of freedom through the adventure lifestyle around the globe. Teva pioneered the sport sandal category in 1984 and today our mission remains steadfast: to enable spontaneous adventure with versatile, utility-centered footwear for active consumers. By designing simple, functional footwear, Teva is driving growth by extending our established global platforms in sandals and water-related products and by leveraging our authenticity with active lifestyle consumers.

We believe that Teva’s Originals collection is a key platform in driving market penetration for the brand. The Originals Collection honors the heritage of Teva by revamping the styles the brand was founded on, blending their original simplicity with modern sophistication. In the US, our focus will be to bolster our leadership position in sandals and grow our market share through casual category extensions. Globally, we seek to establish the Originals collection as a beachhead for the Teva brand across warm-weather climates.

Within the US, we expect that Teva will grow its position as a market leader within the sport sandal category. Growth opportunities within our current core channels of distribution - outdoor specialty, sporting goods, and family footwear retail chains - will be pursued through deepening penetration with evolved and expanded product offerings. Teva plans to support its channel expansion beyond present distribution with focused investments in targeted, solution-driven marketing programs in order to attract new lifestyle consumers to the brand. However, we cannot assure investors that these efforts will be successful.

Sanuk Brand Overview

The Sanuk brand was founded 16 years ago, and from its origins in the Southern California surf culture, has grown into a global brand with an expanding fanbase and growing presence in the casual sneaker and sandal categories. The Sanuk brand’s use of unexpected materials and unconventional constructions combined with its fun and funky branding has contributed to the brand’s identity and growth since its inception, and led to successful products such as the Yoga MatTM sandal collection and the patented SIDEWALK SURFERS®. We believe that the Sanuk brand provides substantial growth opportunities, especially within the casual sneaker markets, supporting our strategic initiatives spanning new product launches, OmniChannel development and global expansion. However, we cannot assure investors that our efforts to grow the brand will be successful.

Other Brands Overview

Our other brands consist of Ahnu, Hoka, MOZO and TSUBO. Our other brands are all sold through most of our distribution channels, with the majority sold through wholesale channels.

Ahnu is an authentic performance footwear brand that makes footwear for fashion-minded people who prefer trails, yoga mats, and hybrid fitness workouts. Ahnu's products feature après-yoga styling, innovative trail and city hikers, and everyday casual shoes and sandals. Ahnu’s go-anywhere approach blurs the lines between performance and fashion through modern color and material stories infused with Numentum® performance technology.

The Hoka brand focuses on designing shoes with a unique performance midsole geometry, oversized midsole volume and an active foot frame. We believe runners from around the world are experiencing the benefits of Hoka brand products. These shoes are used by marathon runners, and even ultra-marathon runners as well as every day runners to enjoy running.

With respect to Ahnu and Hoka, we expect to leverage our design, marketing, and distribution capabilities to continue to grow them over the next several years, consistent with our mission to build niche brands into global market leaders. Nevertheless, we cannot assure investors that our efforts to grow these brands will be successful.

With respect to MOZO and TSUBO, we recently made the decision to seek strategic alternatives for these businesses.

E-Commerce Overview

Our E-Commerce business, which sells all of our brands, allows us to build our relationship with the consumer and is a key component of our integrated OmniChannel strategy. E-Commerce enables us to meet the growing demand for our products, sell the products at retail prices, and provide significant incremental operating income. The E-Commerce business provides us an opportunity to communicate to the consumer with a consistent brand message that is in line with our brands' promises, drives awareness of key brand initiatives, and offers targeted information to specific consumer segments. Our websites also drive wholesale and distributor sales through brand awareness and directing consumers to retailers that carry our brands, including our own retail stores. In recent years, our E-Commerce business has had significant revenue growth, much of which occurred as the UGG brand gained popularity and as consumers continued to increase internet usage for footwear and other purchases.

Managing our E-Commerce business requires us to focus on the latest trends and techniques for web design and marketing, to generate internet traffic to our websites, to effectively convert website visits into orders, and to maximize average order sizes. We plan to continue to grow our E-Commerce business through improved website features and performance, increased marketing, expansion into more international markets, and utilization of mobile and tablet technology. Nevertheless, we cannot assure investors that revenue from our E-Commerce business will continue to grow.

Retail Stores Overview

Our retail stores are predominantly UGG concept stores and UGG outlet stores. In 2013 we expanded our fleet and opened our first Sanuk (two concept, one outlet) stores. Our retail stores enable us to directly impact our customers' experience, meet the growing demand for these products, sell the products at retail prices and generate strong annual operating income. In addition, our UGG concept stores allow us to showcase our entire product line including footwear, accessories, handbags, home, outerwear, lounge and retail exclusive items; whereas, a wholesale account may not represent all of these categories. Through our outlet stores, we sell some of our discontinued styles from prior seasons, as well as full price in-line product, and products made specifically for the outlet stores. Within our OmniChannel strategy, we believe that consumers try on product in our retail stores, perform further online research and order product online and, conversely, E-Commerce fuels our retail locations. As a result, we believe that our stores and websites are interconnected in a way that will allow us to view them on a combined basis. Further, our stores will allow the consumer to buy through our E-Commerce channel using internet capable devices in our stores.

As of December 31, 2014, we had a total of 138 retail stores worldwide. These stores are company-owned and operated. During the remainder of fiscal year 2015, we plan to open additional retail stores worldwide. During the nine months ended December 31, 2014, we converted seven of our retail stores in China to partner retail stores, whereby, upon conversion, the stores became wholly-owned and operated by local, third party companies within China. These conversions included the assignment of the lease and the sale of both our on-hand inventory and store leasehold improvements to the operator. As of the date of conversion, partner retail stores sales are included in our UGG brand wholesale segment and not included in our retail stores segment.

Seasonality

Our business is seasonal, with the highest percentage of UGG brand net sales occurring in the quarters ending September 30 and December 31 and the highest percentage of Teva and Sanuk brand net sales occurring in the quarters ending March 31 and June 30 of each year. Our other brands do not have a significant seasonal impact.

In February 2014, our Board of Directors approved a change in our fiscal year end from December 31 to March 31. The change is intended to better align our planning, financial and reporting functions with the seasonality of our business.

The following table summarizes our quarterly net sales and (loss) income from operations:

With the large growth in the UGG brand over the past several years, net sales in the quarters ending September 30 and December 31 have exceeded net sales in the quarters ending March 31 and June 30. We currently expect this trend to continue. Nonetheless, actual results could differ materially depending upon consumer preferences, availability of product, competition, and our wholesale and distributor customers continuing to carry and promote our various product lines, among other risks and uncertainties.

Results of Operations

Three Months Ended December 31, 2014 Compared to Three Months Ended December 31, 2013

The following table summarizes our results of operations:

Overview. Overall net sales increased for all distribution channels of all segments, except for the Sanuk and Teva brands wholesale sales. The increase in income from operations resulted from increased sales and gross margin, partially offset by higher selling, general and administrative expenses (SG&A).

Net Sales. The following tables summarize net sales by location, brand, and distribution channel:

In order to provide a framework for assessing how our underlying businesses performed, excluding the effect of foreign currency rate fluctuations, we provide certain financial information on a “constant currency basis,” which is in addition to the actual financial information presented. In order to calculate our constant currency information, we translate the current period financial information using the foreign currency exchange rates that were in effect during the previous comparable period. However, constant currency measures should not be considered in isolation or as an alternative to US dollar measures that reflect current period exchange rates, or to other financial measures calculated and presented in accordance with US generally accepted accounting principles.

The increase in overall net sales was primarily due to an increase in our UGG brand sales through our E-Commerce sites and retail stores as well as an increase in our other brands and UGG brand wholesale sales. These increases in net sales were slightly offset by decreases in Sanuk and Teva brand sales through the wholesale channel. On a constant currency basis, net sales increased 8.2% to approximately $796,000. We experienced an increase in the number of pairs sold in the E-Commerce, retail and other brands wholesale segments, partially offset by a decrease in the number of pairs sold in the Teva brand, Sanuk brand and UGG brand wholesale segments. This resulted in an increase in the overall volume of footwear sold for all brands of 3.2% to approximately 9.6 million pairs sold for the three months ended December 31, 2014 from approximately 9.3 million pairs for the three months ended December 31, 2013.

Wholesale net sales of our UGG brand were comparable to the prior year period. On a constant currency basis, wholesale sales of our UGG brand increased 1.7% to approximately $406,000.

Wholesale net sales of our Teva brand decreased primarily due to a decrease in the volume of pairs sold, partially offset by an increase in the weighted-average wholesale selling price per pair. The increase in average selling price was primarily due to a shift in product mix. For Teva wholesale net sales, the decrease in volume had an impact of approximately $2,000 and the increase in average selling price had an impact of approximately $1,000.

Wholesale net sales of our Sanuk brand decreased primarily due to a decrease in the weighted-average wholesale selling price per pair as well as a decrease in the volume of pairs sold. The decrease in average selling price was primarily due to a shift in product mix. For Sanuk wholesale net sales, the decrease in average selling price had an impact of approximately $1,000 and the decrease in the volume of pairs sold had an impact of approximately $1,000.

Wholesale net sales of our other brands increased primarily due to an increase in the weighted-average wholesale selling price per pair as well as an increase in the volume of pairs sold. The increase in the average selling price was primarily due to a shift in product mix. For other brand wholesale net sales, the increase in average selling price had an impact of approximately $3,000 and the increase in volume of pairs sold had an impact of approximately $3,000.

Net sales of our E-Commerce business increased primarily due to an increase in the number of pairs sold, partially offset by a decrease in the weighted-average selling price per pair. The decrease in the average selling price was primarily due to a shift in product mix and increased sales discounts. For E-Commerce net sales, the increase in volume had an impact of approximately $36,000 and the decrease in average selling price had an impact of approximately $5,000.

Net sales of our retail store business, which are primarily UGG brand sales, increased largely due to the addition of new stores opened since December 31, 2013, partially offset by the negative impact of foreign currency exchange rate fluctuations. On a constant currency basis, net sales of our retail store business increased by 11.2% to approximately $198,000. A large majority of the new stores were in the US and China, with the remaining new stores in Japan, Canada, Hong Kong and Europe. Same store sales for the thirteen weeks ended December 28, 2014 decreased by 7.2% compared to the same period in 2013. The decrease in same store sales is primarily due to a shift in product mix whereby we sold more casual styles, which generally carry lower price points, as compared to the prior year period, as well as a shift in sales of our Classic styles to online from in-store. For retail same store sales, we experienced a decrease in the weighted-average selling price which had an impact of approximately $8,000 on retail store net sales and a decrease in the volume of pairs sold which had an impact of approximately $2,000 on retail store net sales. As we continue to increase the number of retail stores, each new store will have less significant impact on our growth rate.

International sales, which are included in the segment sales above, for all of our products combined increased by 14.6% for the three months ended December 31, 2014 as compared to the three months ended December 31, 2013. On a constant currency basis, international sales increased by 19.8% to approximately $270,000. International sales represented 32.9% and 30.6% of worldwide net sales for the three months ended December 31, 2014 and 2013, respectively. The increase in international sales as a percentage of worldwide net sales was primarily due to the continued growth in our UGG brand internationally across all channels of approximately $36,000.

Foreign income before income taxes was $73,001 and $47,902 and worldwide income before income taxes was $213,316 and $200,397 for the three months ended December 31, 2014 and 2013, respectively. Foreign income before income taxes represented 34.2% and 23.9% of worldwide income before income taxes for the three months ended December 31, 2014 and 2013, respectively. The increase in foreign income before income taxes as a percentage of worldwide income before income taxes was primarily due to the increase in international sales as well as a decrease in domestic income before income taxes, partially offset by an increase in foreign operating expenses of approximately $7,000. The increase in foreign operating expenses were primarily related to the expansion of our international retail and E-Commerce operations.

We expect that our foreign income before income taxes will continue to fluctuate from year to year based on several factors, including our expansion initiatives. In addition, we believe that the continued evolution and geographic scope of the UGG brand, our continuing strategy of enhancing product diversification, and our expected growth in our international retail and E-Commerce business, will result in increases in foreign income before income taxes as a percentage of worldwide income before income taxes in future years.

Gross Profit. As a percentage of net sales, gross margin increased primarily due to increased margins of 2.6 percentage points from our UGG brand wholesale segment. The increase in our UGG brand wholesale segment gross margin was due in part to our acquisition of our distributor in Germany. An increase in the mix of retail and E-Commerce sales, which generally carry higher margins than our wholesale segments, contributed approximately 50 basis points to the increase in the overall gross margin.

Additionally, closeout sales decreased as a percentage of overall sales and had higher margins compared with the same period last year. These factors were partially offset by decreased margins of 2.5 percentage points from our E-Commerce segment primarily due to increased discounts and promotions compared to the same period last year. The factors discussed above include the negative impact of foreign currency exchange rate fluctuations. Our gross margins fluctuate based on several factors, and we expect our gross margin to increase for the fiscal year ending March 31, 2015 compared to the fiscal year ended December 31, 2013, primarily due to the factors discussed above as well as reductions in average sheepskin prices.

Selling, General and Administrative (SG&A) Expenses. The change in SG&A expenses was primarily due to:

• increased E-Commerce costs of approximately $6,000, largely related to the expansion of our E-Commerce business and increased expenses related to marketing and advertising;
• expenses of approximately $4,000 related to the negative impact of foreign currency exchange rate fluctuations in the current year, compared to approximately $2,000 of benefit related to the positive impact of foreign currency exchange rate fluctuations in the prior year;
• increased expenses of approximately $5,000 for marketing and promotions, largely related to the UGG and Hoka brands;
• increased retail costs of approximately $4,000, largely related to new retail stores that were not open as of December 31, 2013 and related corporate infrastructure; and
• increased distribution center costs of approximately $3,000, largely driven by the increase in sales and our new distribution center.

Income (Loss) from Operations. Refer to note 10 to our accompanying condensed consolidated financial statements for a discussion of our reportable segments. The following table summarizes operating income (loss) by segment:

Income from operations increased primarily due to the increase in sales and gross margin, partially offset by the increase in SG&A expenses and the negative impact of foreign currency exchange rate fluctuations. On a constant currency basis, income from operations increased by 8.0% to approximately $218,000.

The increase in income from operations of UGG brand wholesale was primarily the result of a 2.6 percentage point increase in gross margin, partially offset by an increase in operating expenses of approximately $4,000 and includes the negative impact of foreign currency exchange rate fluctuations. The increase in gross margin was primarily due to a greater mix of higher margin wholesale sales compared to lower margin distributor sales, due in part to our acquisition of our distributor in Germany, as well as a decreased impact from closeout sales. The increase in operating expenses was primarily due to amortization expense from our purchase of intangible assets. On a constant currency basis, income from operations of UGG brand wholesale increased 6.4% to approximately $137,000.

The decrease in loss from operations of Teva brand wholesale was primarily the result of a decrease in operating expenses of approximately $1,000.

Sanuk brand wholesale had a loss from operations for the three months ended December 31, 2014, compared to income from operations for the three months ended December 31, 2013. This change was primarily the result of the decrease in net sales.

Loss from operations of our other brands wholesale was comparable to the prior year period.

The increase in income from operations of our E-Commerce business was primarily due to the increase in net sales, partially offset by a 2.5 percentage point decrease in gross margin as well as an increase in operating expenses of approximately $3,000. The decrease in gross margin was primarily due to increased sales discounts. The increase in operating expenses was primarily due an increase of approximately $6,000 largely related to expansion and marketing costs. The increase in operating expenses of approximately $3,000 includes the positive impact of foreign currency exchange rate fluctuations in the current year of approximately $2,000 compared to the negative impact of foreign currency exchange rate fluctuations of approximately $1,000 in the prior year.

Income from operations of our retail store business, which primarily relates to the UGG brand, increased primarily due to the increase in net sales, partially offset by increased operating expenses of approximately $4,000, and includes the negative impact of foreign currency exchange rate fluctuations. The increase in operating expenses was primarily due to our new store openings and related corporate infrastructure. On a constant currency basis, income from operations of our retail store business increased 13.0% to approximately $76,000.

The increase in unallocated overhead costs was primarily due to expense related to the negative impact of foreign currency exchange rate fluctuations of approximately $6,000 in the current year compared to a benefit related to the positive impact of foreign currency exchange rate fluctuations of approximately $3,000 in the prior year, as well as increased distribution center costs of approximately $3,000.

Other Expense, Net. Other expense, net was comparable to the prior period.

Income Taxes. Income taxes for the interim periods are computed using the effective tax rate estimated to be applicable for the full fiscal year, which is subject to ongoing review and evaluation by management and can vary from quarter to quarter. Income tax expense and effective income tax rates were as follows:

The decrease in the effective tax rate was primarily due to a change in the jurisdictional mix of expected annual pre-tax income. Unremitted earnings of non-US subsidiaries are expected to be reinvested outside of the US indefinitely. Such earnings would become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. As of December 31, 2014, we had approximately $136,000 of cash and cash equivalents outside the US that would be subject to additional income taxes if it were to be repatriated. We anticipate our effective tax rate for the fiscal year ending March 31, 2015 to be lower than the full year rate of 29.1% for the fiscal year ended December 31, 2013.

Net Income. Our net income increased as a result of the items discussed above. Our diluted earnings per share increased primarily due to the increase in net income as well as a reduction in the diluted weighted-average common shares outstanding. The reduction in the diluted weighted-average common shares outstanding was the result of our share repurchases made during the three months ended December 31, 2014. The weighted-average impact of the share repurchases was a reduction of approximately 100,000 shares.

Nine Months Ended December 31, 2014 Compared to Nine Months Ended December 31, 2013

The following table summarizes our results of operations:

Overview. Overall net sales increased for all distribution channels of all segments. The increase in income from operations resulted from increased sales and gross margin, partially offset by higher SG&A expenses.

Net Sales. The following tables summarize net sales by location, brand, and distribution channel:

The increase in overall net sales was primarily due to an increase in our UGG brand sales through our wholesale channel, E-Commerce sites and retail stores as well as increases in our other brands and Teva brand wholesale sales. On a constant currency basis, net sales increased 14.8% to approximately $1,485,000. We experienced an increase in the number of pairs sold across all segments. This resulted in an increase in the overall volume of footwear sold for all brands of 13.5% to approximately 22.7 million pairs sold for the nine months ended December 31, 2014 from 20.0 million pairs for the nine months ended December 31, 2013.

Wholesale net sales of our UGG brand increased primarily due to an increase in the volume of pairs sold as well as an increase in the weighted-average wholesale selling price per pair. On a constant currency basis, wholesale sales of our UGG brand increased 11.2% to approximately $818,000. The increase in average selling price was primarily due to a shift in product mix as well as an increase in wholesale sales of approximately $75,000 versus an increase in sales to distributors of approximately $5,000, as selling prices through our wholesale channel are generally higher than selling prices through our distributor channel. For UGG wholesale net sales, the increase in volume had an impact of approximately $65,000 and the increase in average selling price had an impact of approximately $12,000.

Wholesale net sales of our Teva brand increased primarily due to an increase in volume of pairs sold as well as an increase in the weighted-average wholesale selling price per pair. The increase in average selling price was primarily due to a shift in product mix. For Teva wholesale net sales, the increase in volume had an impact of approximately $7,000 and the increase in average selling price had an impact of approximately $1,000.

Wholesale net sales of our Sanuk brand increased primarily due to an increase in the volume of pairs sold, partially offset by a decrease in the weighted-average wholesale selling price per pair. The decrease in average selling price was primarily due to a shift in product mix. For Sanuk wholesale net sales, the increase in volume of pairs sold had an impact of approximately $5,000 and the decrease in average selling price had an impact of approximately $4,000.

Wholesale net sales of our other brands increased primarily due to an increase in the volume of pairs sold as well as an increase in the weighted-average wholesale selling price per pair. The increase in the average selling price was primarily due to a shift in product mix as well as a decreased impact of closeout sales. For other brand wholesale net sales, the increase in volume of pairs sold had an impact of approximately $17,000 and the increase in average selling price had an impact of approximately $2,000.

Net sales of our E-Commerce business increased primarily due to an increase in the number of pairs sold, partially offset by a decrease in the weighted-average selling price per pair. The decrease in the average selling price was primarily due to a shift in product mix and increased sales discounts. For E-Commerce net sales, the increase in volume had an impact of approximately $46,000 and the decrease in average selling price had an impact of approximately $5,000.

Net sales of our retail store business, which are primarily UGG brand sales, increased largely due to the addition of new stores opened since December 31, 2013, partially offset by the negative impact of foreign currency exchange rate fluctuations. On a constant currency basis, net sales of our retail store business increased by 15.2% to approximately $303,000. A large majority of the new stores were in the US and China, with the remaining new stores in Japan, Canada, Hong Kong and Europe. Same store sales for the thirty-nine weeks ended December 28, 2014 decreased by 8.2% compared to the same period in 2013. The decrease in same store sales is primarily due to a shift in product mix whereby we sold more casual styles, which generally carry lower price points, as well as a shift in sales of our Classic styles to online from in-store. For retail same store sales, we experienced a decrease in the weighted-average selling price which had an impact of approximately $17,000 on retail store net sales, partially offset by an increase in the volume of pairs sold which had an impact of approximately $2,000 on retail store net sales. As we continue to increase the number of retail stores, each new store will have less significant impact on our growth rate.

International sales, which are included in the segment sales above, for all of our products combined increased by 22.0% for the nine months ended December 31, 2014 as compared to the nine months ended December 31, 2013. On a constant currency basis, international sales increased 24.0% to approximately $537,000. International sales represented 35.8% and 33.5% of worldwide net sales for the nine months ended December 31, 2014 and 2013, respectively. The increase in international sales as a percentage of worldwide net sales was primarily due to the continued growth in our UGG brand internationally across all channels of approximately $92,000.

Foreign income before income taxes was $73,443 and $60,622 and worldwide income before income taxes was $220,188 and $203,047 for the nine months ended December 31, 2014 and 2013, respectively. Foreign income before income taxes represented 33.4% and 29.9% of worldwide income before income taxes for the nine months ended December 31, 2014 and 2013, respectively. The increase in foreign income before income taxes as a percentage of worldwide income before income taxes was primarily due to the increase in international sales as well as a 1.1 percentage point increase in gross margin, partially offset by increased foreign operating expenses of approximately $42,000 and an increase in domestic income before income taxes. The increase in foreign operating expenses was primarily related to the expansion of our international retail and E-Commerce operations.

We expect that our foreign income before income taxes will continue to fluctuate from year to year based on several factors, including our expansion initiatives. In addition, we believe that the continued evolution and geographic scope of the UGG brand, our continuing strategy of enhancing product diversification, and our expected growth in our international retail and E-Commerce business, will result in increases in foreign income before income taxes as a percentage of worldwide income before income taxes in future years.

Gross Profit. As a percentage of net sales, gross margin increased primarily due to increased margins of 4.1 percentage points from our UGG brand wholesale segment. The increase in our UGG brand wholesale segment gross margin was primarily due to a greater mix of higher margin wholesale sales compared to lower margin distributor sales, due in part to our acquisition of our distributor in Germany. An increase in the mix of retail and E-Commerce sales, which generally carry higher margins than our wholesale segments, contributed approximately 40 basis points to the increase in the overall gross margin. Additionally, average sheepskin prices decreased compared to the same period last year and closeout sales decreased as a percentage of overall sales and had higher margins compared with the same period last year. These factors were partially offset by decreased margins of 3.4 percentage points from our E-Commerce segment primarily due to increased discounts and promotions compared to the same period last year. The factors discussed above include the negative impact of foreign currency exchange rate fluctuations. Our gross margins fluctuate based on several factors, and we expect our gross margin to increase for the fiscal year ending March 31, 2015 compared to the fiscal year ended December 31, 2013, primarily due to the factors discussed above.

Selling, General and Administrative (SG&A) Expenses. The change in SG&A expenses was primarily due to:

• increased retail costs of approximately $25,000, largely related to new retail stores that were not open as of December 31, 2013 and related corporate infrastructure;
• increased expenses of approximately $16,000 for marketing and promotions, largely related to the UGG and Hoka brands;
• expenses of approximately $9,000 related to the negative impact of foreign currency exchange rate fluctuations in the current year, compared to approximately $3,000 of benefit related to the positive impact of foreign currency exchange rate fluctuations in the prior year;
• increased E-Commerce costs of approximately $11,000, largely related to increased expenses related to marketing and advertising and the expansion of our E-Commerce business;
• increased expenses of approximately $8,000 for corporate infrastructure to support our international wholesale expansion;
• increased information technology costs of approximately $6,000, in part due to accelerating the expense for certain software projects that will not be used;
• increased sales and commission expenses of approximately $5,000 largely driven by the increase in wholesale sales;
• increased distribution center costs of approximately $4,000, largely driven by the increase in sales and our new distribution center;
• increased amortization expense of approximately $4,000 related to our purchase of intangible assets; and
• increased infrastructure improvements of approximately $3,000 to support our OmniChannel transformation.

Income (Loss) from Operations. Refer to note 10 to our accompanying condensed consolidated financial statements for a discussion of our reportable segments. The following table summarizes operating income (loss) by segment:

Income from operations increased primarily due to the increase in sales and gross margin, partially offset by the increase in SG&A expenses and the negative impact of foreign currency exchange rate fluctuations. On a constant currency basis, income from operations increased by 10.3% to approximately $226,500.

The increase in income from operations of UGG brand wholesale was the result of a 4.1 percentage point increase in gross margin as well as the increase in net sales, partially offset by an increase in operating expenses of approximately $13,000. The increase in gross margin was primarily due to a decreased impact from closeout sales as well as an increase in the proportion of wholesale sales versus sales to distributors, as wholesale sales generally carry higher margins. Overall wholesale sales increased by approximately $75,000 while overall distributor sales increased by approximately $5,000. The change in sales mix was partially due to the acquisition of our UGG brand distributor in Germany and the corresponding conversion to a wholesale business. The increase in operating expenses was primarily due to marketing and promotions, amortization and sales and commissions.

Teva brand wholesale had income from operations for the nine months ended December 31, 2014, compared to a loss from operations for the nine months ended December 31, 2013. This change was primarily the result of a decrease in operating expenses of approximately $3,000 as well as the increase in net sales.

The decrease in income from operations of Sanuk brand wholesale was primarily the result of a 4.1 percentage point decrease in gross margin, partially offset by the increase in net sales. The decrease in gross margin was primarily due to an increased impact from closeout sales.

The increase in loss from operations of our other brands wholesale was primarily the result of an increase in operating expenses of approximately $9,000, partially offset by the increase in net sales as well as a 3.5 percentage point increase in gross margin. The increase in operating expenses was primarily due to increased marketing and promotions as well as increased sales and commission expenses largely due to the increase in sales. The increase in gross margin was primarily due to a decreased impact from closeout sales.

The increase in income from operations of our E-Commerce business was primarily due to the increase in net sales. This increase was partially offset by a 3.4 percentage point decrease in gross margin as well as an increase in operating expenses of approximately $4,000. The decrease in gross margins was primarily due to increased sales discounts. The increase in operating expenses includes the positive impact of foreign currency exchange rate fluctuations in the current year of approximately $5,000 compared to the negative impact of foreign currency exchange rate fluctuations of approximately $2,000 in the prior year.

Income from operations of our retail store business, which primarily relates to the UGG brand, decreased primarily due to increased operating expenses of approximately $24,000, largely offset by the increase in net sales, and includes the negative impact of foreign currency exchange rate fluctuations. The increase in operating expenses largely related to our new store openings and related corporate infrastructure. On a constant currency basis income from operations of our retail store business decreased 1.8% to approximately $54,000.

The increase in unallocated overhead costs was primarily due to expense related to the negative impact of foreign currency exchange rate fluctuations of approximately $14,000 in the current year compared to a benefit related to the positive impact of foreign currency exchange rate fluctuations of approximately $6,000 in the prior year, increased corporate infrastructure of approximately $11,000 to support our OmniChannel transformation and international wholesale expansion, increased information technology costs of approximately $6,000 and increased distribution center costs of approximately $4,000.

Other Expense, Net. The increase in other expense, net was primarily due to an increase in interest expense.

Income Taxes. Income taxes for the interim periods are computed using the effective tax rate estimated to be applicable for the full fiscal year, which is subject to ongoing review and evaluation by management and can vary from quarter to quarter. Income tax expense and effective income tax rates were as follows:

The decrease in the effective tax rate was primarily due to a change in the jurisdictional mix of expected annual pre-tax income. This decrease was partially offset by overall discrete tax liabilities of approximately $1,400 recognized during the nine months ended December 31, 2014 compared to overall discrete tax benefits of approximately $1,700 recognized during the nine months ended December 31, 2013. The discrete tax liabilities relate to provisions recorded for unrecognized tax benefits as well as prior year US federal and state tax adjustments. The discrete tax benefits relate to a combination of prior year US federal, state and foreign tax adjustments. Unremitted earnings of non-US subsidiaries are expected to be reinvested outside of the US indefinitely. Such earnings would become taxable upon the sale or liquidation of these subsidiaries or upon the remittance of dividends. As of December 31, 2014, we had approximately $136,000 of cash and cash equivalents outside the

US that would be subject to additional income taxes if it were to be repatriated. We anticipate our effective tax rate for the fiscal year ending March 31, 2015 to be lower than the full year rate of 29.1% for the fiscal year ended December 31, 2013.

Net Income. Our net income increased as a result of the items discussed above.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements other than our guarantee contracts. See “Contractual Obligations” below.

Liquidity and Capital Resources

We finance our working capital and operating needs using a combination of our cash and cash equivalents balances, cash generated from operations, and, as needed, the credit available under our Second Amended and Restated Credit Agreement. In an economic recession or under other adverse economic conditions, our cash generated from operations may decline, and we may be unable to realize a return on our cash and cash equivalents, secure additional credit on favorable terms, or renew or access our existing credit. These factors may impact our working capital reserves and have a material adverse effect on our business.

Our cash flow cycle includes the purchase of or deposits for raw materials, the purchase of inventories, the subsequent sale of the inventories, and the eventual collection of the resulting accounts receivables. As a result, our working capital requirements begin when we purchase, or make deposits on, raw materials and inventories and continue until we ultimately collect the resulting receivables. The seasonality of our UGG brand business requires us to build fall and winter inventories in the quarters ending June 30 and September 30 to support sales for the UGG brand’s major selling seasons, which historically occur during the quarters ending September 30 and December 31; whereas, the Teva and Sanuk brands build inventory levels beginning in the quarters ending December 31 and March 31 in anticipation of the spring selling season that occurs in the quarters ending March 31 and June 30. Given the seasonality of our UGG, Teva, and Sanuk brands, our working capital requirements fluctuate significantly throughout the year. The cash required to fund these working capital fluctuations has been provided using our internal cash flows and short-term borrowings. As needed, we borrow funds under our Second Amended and Restated Credit Agreement.

The following table summarizes our cash flows:

Cash from Operating Activities. Net cash provided by operating activities for the nine months ended December 31, 2014 resulted primarily from net income and an increase in trade accounts payable. The increase in trade accounts payable was primarily due to the timing of inventory purchases and payments. This increase in cash provided by operating activities was partially offset by an increase in trade accounts receivable and inventories. The increase in trade accounts receivable was primarily related to increased wholesale sales in the three months ended December 31, 2014 as compared to the three months ended March 31, 2014. The increase in inventory was primarily related to expected future sales and the timing of our inventory purchases and payments. Net cash provided by operating activities for the nine months ended December 31, 2013 resulted primarily from net income and increases in trade accounts payable. The increase in trade accounts payable was primarily due to the timing of inventory purchases and payments. This increase in cash provided by operating activities was partially offset by an increase in trade accounts receivable and prepaid expenses and other current assets. The increase in trade accounts receivable was primarily related to increased wholesale sales during the three months ended December 31, 2013 as compared to the three months ended March 31, 2013. The increase in prepaid expenses and other current assets was primarily related to additional deposits paid in accordance with our contracts to purchase sheepskin.

Net working capital increased as of December 31, 2014 from March 31, 2014, primarily as a result of higher cash and cash equivalents balances, increased trade accounts receivable and increased inventories, partially offset by increased trade accounts payable and increased other current liabilities. Changes in working capital are due to the items discussed above, as well as our normal seasonality and timing of cash receipts and cash payments.

Wholesale accounts receivable turnover and inventory turnover both improved in the twelve months ended December 31, 2014 compared to the twelve months ended December 31, 2013, and do not have a material impact on our liquidity.

Cash from Investing Activities. Net cash used in investing activities for the nine months ended December 31, 2014 resulted primarily from the purchases of property and equipment and purchase of intangible and other assets, net. The capital expenditures were primarily related to infrastructure improvements to support our OmniChannel transformation and international expansion, the build out of our distribution center and retail stores, and purchases of computer hardware and software. The purchase of intangible and other assets, net was related to the acquisition of our UGG brand distributor that sold to retailers in Germany. For the nine months ended December 31, 2013, net cash used in investing activities resulted primarily from the purchases of property and equipment. The capital expenditures included the build out of our new corporate facilities and retail stores, and purchases of computer hardware and software.

As of December 31, 2014, we had approximately $7,000 of material commitments for future capital expenditures primarily related to equipment costs of our new distribution center and build out of retail stores. We estimate that the remaining capital expenditures for fiscal year 2015, including the aforementioned commitments will be approximately $30,000 to $35,000. We anticipate these expenditures will primarily include information technology and related infrastructure improvements to support our OmniChannel transformation and international expansion, equipment costs of our new distribution center, and the build out of retail stores. The actual amount of capital expenditures may differ from this estimate, largely depending on the timing of new store openings or any unforeseen needs to replace existing assets and the timing of other expenditures.

Cash from Financing Activities. For the nine months ended December 31, 2014, net cash provided by financing activities was comprised primarily of short-term borrowings provided by our lines of credit and funding received from the mortgage obtained on our corporate headquarters property. This was partially offset by repayments of short-term borrowings, cash paid for repurchases of common stock, and cash used to pay for shares withheld for taxes from employee stock unit vestings. For the nine months ended December 31, 2013, net cash used in financing activities was comprised primarily of repayments of short-term borrowings as well as cash used to pay for shares withheld for taxes from employee stock unit vestings, largely offset by short-term borrowings.

In June 2012, our Board of Directors approved a stock repurchase program to repurchase up to $200,000 of our common stock in the open market or in privately negotiated transactions, subject to market conditions, applicable legal requirements, and other factors. The program does not obligate us to acquire any particular amount of common stock and the program may be suspended at any time at our discretion. Under this program, during the nine months ended December 31, 2014 we repurchased approximately 157,000 shares, for approximately $13,300, or an average price of $84.69. Through December 31, 2014, we have repurchased approximately 2,922,000 shares under this program, for approximately $134,000, or an average price of $45.87, leaving the remaining approved amount at approximately $66,000. Between January 1, 2015 and February 6, 2015, we repurchased approximately 468,000 shares under the stock repurchase program approved in June 2012 for approximately $34,000, or an average price of $72.55 per share, leaving the remaining approved amount at approximately $32,000. Also subsequent to December 31, 2014, our Board of Directors approved a new stock repurchase program to repurchase up to $200,000 of the Company’s common stock in the open market or in privately negotiated transactions, subject to market conditions, applicable legal requirements, and other factors.

In August 2011 we entered into a Credit Agreement (Credit Agreement) with JPMorgan Chase Bank, National Association (JPMorgan) as the administrative agent, Comerica Bank (Comerica) and HSBC Bank USA, National Association (HSBC), as co-syndication agents, and the lenders party thereto. In August 2012 we amended and restated in its entirety the Credit Agreement (Amended and Restated Credit Agreement). In June 2013 we amended the Amended and Restated Credit Agreement to permit additional borrowings in China of $12,500 and revised certain financial covenants including an increase in the maximum amount permitted to be spent on the headquarters building from $75,000 to $80,000. In August 2013 one of our subsidiaries entered into a new credit agreement in China (China Credit Facility). In November 2014 we entered into a second Amended and Restated Credit Agreement with JPMorgan as the administrative Agent, Comerica and HSBC as co-syndication agents, and the lenders party thereto. The Second Amended and Restated Credit Agreement amends and restates, in its entirety, the Amended and Restated Credit Agreement. The Second Amended and Restated Credit Agreement is a five-year, $400,000 secured revolving credit facility. Refer to note 4 and to our accompanying condensed consolidated financial statements for further information on our Second Amended and Restated Credit Agreement and China Credit Facility. At December 31, 2014, we had no outstanding borrowings under the Second Amended and Restated Credit Agreement and outstanding letters of credit of approximately $100, leaving an unused balance of approximately $399,900 under the Second Amended and Restated Credit Agreement. At December 31, 2014, we had approximately $4,900 of outstanding borrowings under the China Credit Facility. As of December 31, 2014, we were in compliance with all covenants and we remain in compliance as of the date of this report.

In July 2014, we obtained a mortgage on our corporate headquarters property for approximately $33,900. At December 31, 2014 the outstanding balance under the mortgage is $33,800. The mortgage has a fixed interest rate of 4.928%. Payments include interest and principal in an amount that will amortize the principal balance over a 30 year period. Minimum principal payments over the next 5 years are approximately $2,700. The loan will mature and have a balloon payment due in 15 years of approximately $23,400. The loan will be used for working capital and other general corporate purposes. In December 2014 the mortgage financial covenants were amended to be consistent with the financial covenants of the Second Amended and Restated Credit Agreement.

Contractual Obligations. There were no material changes to the contractual obligations or contingent consideration liabilities reported in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed with the SEC on March 3, 2014, other than those which occurred in the ordinary course of business and the mortgage secured by our corporate headquarters property referred to in note 4.

We believe that internally generated funds, the available borrowings under our existing credit facilities, mortgage proceeds, and our cash and cash equivalents will provide sufficient liquidity to enable us to meet our working capital requirements for at least the next 12 months and the foreseeable future. However, risks and uncertainties that could impact our ability to maintain our cash position include our growth rate, the continued strength of our brands, our ability to respond to changes in consumer preferences, the impact of commodity costs including for sheepskin, our ability to collect our receivables in a timely manner, our ability to effectively manage our inventories, our ability to generate returns on our acquisitions of businesses, and market volatility, among others. See Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for a discussion of additional factors that may affect our working capital position. Furthermore, we may require additional cash resources due to changed business conditions or other future developments, including any investments or acquisitions we may decide to pursue. If these sources are insufficient to satisfy our cash requirements, we may seek to sell debt securities or additional equity securities or to obtain a new credit agreement or draw on our existing Second Amended and Restated Credit Agreement. The sale of convertible debt securities or additional equity securities could result in additional dilution to our stockholders. Additional indebtedness could further result in incurring additional debt service obligations and could result in additional operating and financial covenants that would restrict our operations. In addition, there can be no assurance that any additional financing will be available on acceptable terms, if at all. Although there are no other material present understandings, commitments or agreements with respect to the acquisition of any other businesses, we may evaluate acquisitions of other businesses or brands.

Critical Accounting Policies and Estimates

For a discussion of accounting policies that we consider critical to our business operations and understanding of our results of operations, and that affect the more significant judgments and estimates used in the preparation of our condensed consolidated financial statements, see Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates” contained in the Annual Report.

Recent Accounting Pronouncement

On May 28, 2014, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in US GAAP when it becomes effective. The new standard is effective for us on April 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. We are evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. We have not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.

Commodity Price Risk. We purchase certain materials that are affected by commodity prices, the most significant of which is sheepskin. The supply of sheepskin used in certain UGG products is in high demand and there are a limited number of suppliers able to meet our expectations for the quantity and quality of sheepskin required. There have been significant changes in the price of sheepskin in recent years as the demand from our competitors, as well as the demand from our customers, for this commodity has changed. Other significant factors affecting the price of sheepskin include weather patterns, harvesting decisions, global economic conditions, and additional factors which are not considered predictable or within our control. We use purchasing contracts, pricing arrangements, and refundable deposits to attempt to reduce the impact of price volatility as an alternative to hedging commodity prices. The purchasing contracts and pricing arrangements we use may result in unconditional purchase obligations, which are not reflected in our condensed consolidated balance sheets. In the event of significant commodity cost increases, we will likely not be able to adjust our selling prices sufficiently to mitigate the impact on our margins.

Foreign Currency Exchange Rate Risk. We face market risk to the extent that changes in foreign currency exchange rates affect our foreign assets, liabilities, revenues and expenses. We hedge certain foreign currency forecasted transactions and exposures from existing assets and liabilities. Other than as a result of an increasing amount of sales, expenses, and financial positions denominated in foreign currencies, as discussed above, we do not believe that there has been a material change in the nature of our primary market risk exposures, including with respect to the categories of market risk to which we are exposed or the particular markets that present the primary risk of loss. As of the date of this Quarterly Report on Form 10-Q, we do not know of or expect there to be any material change in the general nature of our primary market risk exposure in the near term.

We utilize forward contracts and other derivative instruments to mitigate exposure to fluctuations in the foreign currency exchange rate for a portion of the amounts we expect to purchase and sell in foreign currencies. As of December 31, 2014, we had no foreign currency forward contracts designated as cash-flow hedges and had no non-designated derivative contracts. As our international operations grow and we increase purchases and sales in foreign currencies, we will continue to evaluate our hedging policy and may utilize additional derivative instruments, as needed, to hedge our foreign currency exposures. We do not use foreign currency contracts for trading purposes. Subsequent to December 31, 2014, we entered into non-designated derivative contracts with notional amounts totaling approximately $54,000.

Although the majority of our sales and inventory purchases are denominated in US currency, these sales and inventory purchases may be impacted by fluctuations in the exchange rates between the US dollar and the local currencies in the international markets where our products are sold and manufactured. Our foreign currency exposure is generated primarily from our European and Asian operations. Approximately $425,000, or 28.8%, of our total net sales for the nine months ended December 31, 2014 were denominated in foreign currencies. As we hold more cash and other monetary assets and liabilities in foreign currencies, we are exposed to financial statement transaction gains and losses as a result of remeasuring the financial positions held in foreign currencies into US dollars for subsidiaries that are US dollar functional and also from remeasuring the financial positions held in US dollars and foreign currencies into the functional currency of subsidiaries that are non-US dollar functional. We remeasure monetary assets and liabilities denominated in foreign currencies into US dollars using the exchange rate as of the end of the reporting period. In addition, certain of our foreign subsidiaries’ local currency is their designated functional currency, and we translate those subsidiaries’ assets and liabilities into US dollars using the exchange rates at of the end of the reporting period, which results in financial statement translation gains and losses in other comprehensive income. Changes in foreign exchange rates affect our reported profits and can distort comparisons from year to year. In addition, if the US dollar strengthens, it may result in increased pricing pressure on our foreign distributors, and retailers, which may have a negative impact on our net sales and gross margins.

Interest Rate Risk. Our market risk exposure with respect to financial instruments is tied to changes in the prime rate in the US and changes in London Interbank Offered Rate (LIBOR). Our Second Amended and Restated Credit Agreement provides for interest on outstanding borrowings at rates tied to the prime rate or, at our election, tied to LIBOR. Our China Credit Facility provides for interest on outstanding borrowings at rates based on the People’s Bank of China rate, which was 5.6% at December 31, 2014.

Disclosure Controls and Procedures

The Company maintains a system of disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act) which are designed to provide reasonable assurance that information required to be disclosed in the reports that the Company files or submits under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. These disclosure controls and procedures include, among other processes, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognized that any system of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

The Company carried out an evaluation, under the supervision and with the participation of management, including the principal executive officer and the principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2014 pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the principal executive officer and the principal financial officer concluded that the Company’s disclosure controls and procedures were effective at the reasonable assurance level as of the end of the period covered by this report to ensure that the information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and to ensure that the information required to be disclosed by us in reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including the principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the quarter ended December 31, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes from the risk factors disclosed in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed with the SEC on March 3, 2014.