Acquisition of Mercury Athletic

Acquisition of Mercury AthleticJB Gough

Active Gear, Inc.

Table of Contents

Mercury Background……………………………...............3

Complimentary Business Structures…………………….4

Stalled Growth Potential: Ratios…………………………5

Active Gear and Its Competitors…………………………6

Acquisition Benefits and Concerns………………………7

Mercury Valuation Summary……………………………..8

Discounted Cash Flow Analysis…………………………9

DCF Assumptions: Determining WACC……………….10

What Happens If…?...................................................11-12

Public Companies Analysis…………………….............13

Synergy Analysis………………………………………...14

Value Added Through Synergies………………………15

Acquisition Recommendation…………………………..16

Appendix………………………………………………...17-20

Mercury Background

2003 - acquired by West Coast Fashions (WCF)

Attempted brand extension through apparel line

Business stalled

Mercury CEO eager to return exclusively to footwear

Four footwear product lines

Men’s/Women’s athletic

Men’s/Women’s casual

2006:

Revenue - $431.1 million

EBITDA - $51.8 million

Complimentary Business StructuresCompany Features Active Gear, Inc. Mercury Athletic

Diversified contract manufacturer base (Asia)

Athletic and Casual Footwear Lines

Geographically diversified sale networks

Strong market research experience

Efficient inventory management system

Well-developed product designs

Suburban customer base

Urban customer base

Strong brand recognition

Staff oversight of manufacturing process

Higher athletic line revenue

Higher casual line revenue

Stalled Growth Potential: Ratios

Slightly declined performance for both companies (2004-2006)

Financially stable, but growth potential of combined businesses is high

Acquisition to restore financial growth

Synergies from complementary business structures

Active Gear, Inc. Mercury AthleticIncreasing Inventory

Stalled Margin GrowthYear 2004 2005 2006

EBIT Margin 13.4% 14.2% 12.8%

Net Income Margin 7.7% 8.8% 7.6%

Return on Assets 15.0% 17.4% 14.5%

EBITDA Margin 15.0% 15.7% 14.6%

Year 2004 2005 2006

Current Ratio 3.97 3.96 3.91

Quick Ratio 1.90 2.03 1.87

Inventory Turnover 6.36 5.07 5.89

Days Sales Outstanding 31.20 39.32 38.87

EBIT Margin 9.5% 8.7% 9.8%

Net Income Margin 5.8% 5.3% 6.0%

Return on Assets 13.9% 7.4% 9.6%

EBITDA Margin 11.8% 10.9% 12.0%

Stagnant Overall GrowthYear 2004 2005 2006

Current Ratio 2.87 2.53 2.36

Quick Ratio 2.30 1.84 1.67

Inventory Turnover 11.69 9.37 8.39

Days Sales in Inventory 31.21 38.96 43.49

Active Gear and Its Competitors

Low leverage relative to competition

AGI needs revenue/earnings boost

Stalled revenue growth (2004-2006)

Stronger profitability margins

But stagnant since 2004

*For complete list of comps and reasons for inclusion/exclusion, see Appendix

Revenue

Equity Net LTM LTM CAGR EBIT EBITDA Net Inc.

Company Market Value Debt (1) D/E Revenue Earnings 2000-06 Margin Margin Margin

D&B Shoe Company 420,098 125,442 29.9% 2,545,058 67,679 6.6% 4.4% 6.1% 2.7%

General Shoe Corp. 533,463 171,835 32.2% 1,322,392 64,567 11.2% 8.8% 11.5% 4.9%

Kinsley Coulter Products 165,560 82,236 49.7% 552,594 27,568 4.6% 6.9% 8.9% 5.0%

Surfside Footwear 570,684 195,540 34.3% 1,241,529 73,124 10.1% 9.3% 10.8% 5.9%

Alpine Company 1,056,033 300,550 28.5% 1,614,648 112,015 6.2% 10.4% 12.2% 6.9%

Heartland Outdoor Footware 1,454,875 (97,018) -6.7% 1,176,144 86,156 8.5% 10.8% 12.6% 7.3%

Templeton Athletic 397,709 169,579 42.6% 516,182 79,170 14.4% 19.9% 20.2% 15.3%

Average 656,917 135,452 30.1% 1,281,221 72,897 8.8% 10.1% 11.8% 6.9%

AGI 100,496 25.0% 470,286 35,949 1.5% 12.8% 14.6% 7.6%

Primed for

Acquisition

Opportunity

Acquisition Benefits and Concerns

1) Larger size can better compete with

rival firms

2) Prime position to renegotiate

manufacturing contracts

3) Broaden customer base

4) Expansion of customer demographic

5) Inventory management system easily

integrated with Mercury’s products

6) High operating margins of Men’s

athletic line for Mercury

7) Incorporate Mercury’s advanced

market research

8) Men’s casual/Women’s athletic lines

for Mercury should recover financially

1) Rebranding of Active Gear

Discount retailers

Loss of previous customer

base?

2) Return on Net Assets, and DSI

ratios for Mercury well below

industry average

3) Underperforming Women’s

casual line

*For complete analysis of these pros and cons, see the Appendix

Pros Cons

($ in Millions)

Selected Public Companies Analysis

5.0x - 7.5x 2008P EBITDA ($62.8MM)

Discounted Cash Flow Analysis

(3.0% - 4.0% Perpetuity Growth), (9.86% - 11.86% WACC)

5.1x - 7.4x 2008P EBITDA ($62.8MM)


(5% - 7% Cost of Debt), (11.67% - 13.67$ Cost of Equity)

5.4x - 6.8x 2008P EBITDA ($62.8MM)

Discounted Cash Flow Analysis (10% - 30% Debt in Capital Structure)

5.4x - 6.3x 2008P EBITDA ($62.8MM)

Discounted Cash Flow Analysis (10.8% - 14.8% EBITDA Margin)

4.6x - 7.4x 2008P EBITDA ($62.8MM)

6.0xEnterprise Value / 2008P EBITDA 7.0x5.0x 5.5x4.5x 6.5x 7.5x 8.0x

Implied Enterprise Value

Mercury Valuation Summary

$314.1 $471.1

$319.2 $463.3

Averaging the valuation methodologies:

Mercury Athletic Enterprise Value = $381,962,651

$336.7 $428.5

$337.0 $397.4

$289.0 $463.1

$381.9


Operating Results: 2007E 2008P 2009P 2010P 2011P CAGR

Net Revenue 479,329.1 489,028.1 532,137.0 570,319.2 597,716.8 6.9%

% Growth 11.2% 2.0% 8.8% 7.2% 4.8%

EBITDA 56,592.3 62,816.5 68,247.5 73,092.7 76,565.9 6.8%

% Margin 11.8% 12.8% 12.8% 12.8% 12.8%

EBIT 47,005.7 53,036.0 57,604.8 61,686.3 64,611.6 6.8%

Less: Taxes (40%) 18,802.3 21,214.4 23,041.9 24,674.5 25,844.6

Tax-Adjusted EBIT 28,203.4 31,821.6 34,562.9 37,011.8 38,767.0

Plus: Depreciation & Amortization 9,586.6 9,780.6 10,642.7 11,406.4 11,954.3

Less: CapEx (11,983.2) (12,225.7) (13,303.4) (14,258.0) (14,942.9)

Less: NOWC changes (4,567.0) (2,649.1) (9,804.8) (8,687.4) (6,233.3)

Free Cash Flow $21,239.8 $26,727.3 $22,097.4 $25,472.8 $29,545.0 3.4%

Financial Projections

Accepting all assumptions:

Enterprise Value = $376,659,336

*For complete DCF calculations, see the Appendix

NPV of Free Cash Flows $101,585.85

Terminal Value $415,478.0

PV of Terminal Value $275,073.5

Enterprise Value $376,659.3

Unlevered Beta 1.35 (from Comps list)

Levered Beta 1.55

Market Risk Premium (MRP) 5%

Risk Free Rate 4.93% (20-yr Treasury Rate)

Mercury Capital Structure

Debt 20%

Equity 80%

Cost of Debt 6%

Cost of Equity 12.67%

WACC 10.86%

WACC Assumptions

DCF Assumptions: Determining WACC

Terminal Value growth rate = 3.5%.....Why?

Free Cash Flow compound annual growth rate (CAGR)

(2008-2011)

Women’s line to be discontinued after 2007

More accurate representation of future to use CAGR of free

cash flows after women’s line is discontinued (i.e. 2008-2011)

Calculated from:

𝑟𝑠 = 𝑟𝑓 +𝑀𝑅𝑃 ∗ (𝐿𝑒𝑣𝑒𝑟𝑒𝑑 𝛽)

𝑟𝑓

𝑟𝑠

What Happens If…? Change in Mercury’s Capital Structure

Change in Mercury’s WACC, Growth Rate

Percent Debt 10% 15% 20% 25% 30%

Percent Equity 90% 85% 80% 75% 70%

Cost of Equity 12.11% 12.38% 12.67% 13.01% 13.40%

WACC 11.77% 11.06% 10.86% 10.66% 10.46%

2011 Free Cash Flows 29,545.0 29,545.0 29,545.0 29,545.0 29,545.0

Terminal Value 369,872.1 404,485.6 415,478.0 427,082.6 439,355.1

PV of Terminal Value 237,022.6 265,871.9 275,073.5 284,806.0 295,117.9

PV of Free Cash Flows 100,020.0 101,236.4 101,585.8 101,937.8 102,292.3

Implied Enterprise Value $337,042.6 $367,108.2 $376,659.3 $386,743.8 $397,410.2

Sensitivity Analysis: Capital Structure

Discount Rate

Perpetuity Growth Rate 3.00% 3.50% 4.00% 3.00% 3.50% 4.00% 3.00% 3.50% 4.00%

2011 Free Cash Flow $29,545.0 $29,545.0 $29,545.0 $29,545.0 $29,545.0 $29,545.0 $29,545.0 $29,545.0 $29,545.0

Terminal Value 443,606.2 480,803.7 524,348.8 387,167.8 415,478.0 447,913.1 343,469.4 365,778.9 390,926.7

PV of Terminal Value 304,536.4 330,072.5 359,966.3 256,330.2 275,073.5 296,547.5 219,375.8 233,625.0 249,687.1

PV of Free Cash Flows 103,371.3 103,371.3 103,371.3 101,585.8 101,585.8 101,585.8 99,863.2 99,863.2 99,863.2

Implied Enterprise Value $407,907.7 $433,443.8 $463,337.6 $357,916.0 $376,659.3 $398,133.3 $319,239.0 $333,488.2 $349,550.2

11.86%

Sensitivity Analysis: WACC, Growth Rate

9.86% 10.86%

What Happens If…? Change in Mercury’s EBITDA Margin

Cost of Debt

Cost of Equity 11.67% 12.67% 13.67% 11.67% 12.67% 13.67% 11.67% 12.67% 13.67%

WACC 9.94% 10.74% 11.54% 10.06% 10.86% 11.66% 10.18% 10.98% 11.78%

Free Cash Flow 29,545.0 29,545.0 29,545.0 29,545.0 29,545.0 29,545.0 29,545.0 29,545.0 29,545.0

Terminal Value 475,126.1 422,596.9 380,526.5 466,429.4 415,478.0 374,927.8 458,045.4 409,030.4 369,491.5

PV of Terminal Value $325,273.8 $281,041.9 $245,880.8 $317,929.7 $275,073.5 $241,223.4 $310,856.9 $269,674.2 $236,706.5

PV of Free Cash Flows $103,233.3 $101,803.7 $100,414.6 $103,016.2 $101,585.8 $100,209.6 $102,800.1 $101,382.8 $100,005.5


Sensitivity Analysis: Cost of Capital

5.00% 6.00% 7.00%

Change in Mercury’s Cost of Capital

EBITDA Margin 10.8% 11.8% 12.8% 13.8% 14.8%

2011 Free Cash Flows 22,337.5 25,923.8 29,545.0 33,096.4 36,682.7

Terminal Value 314,121.8 364,554.7 415,478.0 465,419.6 515,852.1

PV of Terminal Value 207,969.1 241,359.0 275,073.5 308,138.1 341,527.7

PV of Free Cash Flows 81,076.1 91,206.7 101,585.8 111,467.9 121,598.5

Implied Enterprise Value $289,045.2 $332,565.7 $376,659.3 $419,606.0 $463,126.1

Sensitivity Analysis: EBITDA Margin

Public Companies Analysis

Equity LTM LTM EBITDA EV/EBITDA

Company Market Value Revenue Earnings Margin Multiple

D&B Shoe Company 420,098 2,545,058 67,679 6.1% 3.9x

General Shoe Corp. 533,463 1,322,392 64,567 11.5% 5.1x

Kinsley Coulter Products 165,560 552,594 27,568 8.9% 5.5x

Surfside Footwear 570,684 1,241,529 73,124 10.8% 6.3x

Alpine Company 1,056,033 1,614,648 112,015 12.2% 7.6x

Heartland Outdoor Footware 1,454,875 1,176,144 86,156 12.6% 10.1x

Templeton Athletic 397,709 516,182 79,170 20.2% 6.0x

Average 656,917 1,281,221 72,897 11.8% 6.3x

Enterprise value of most comps fall within 5x-8x EBITDA

Predicted 2008 EBITDA used to value Mercury

Women’s casual line discontinued after 2007

Misleading to use 2007 EBITDA with women’s casual

revenue included

EBITDA Industry Average EBITDA

Company 2008* EBITDA Multiple Multiple Range Minimum Maximum

Mercury Athletic Footwear $62,816.5 6.3x 5x - 7.5x $314,082.67 $471,124.01

Implied Valuation Range

Average Enterprise Value = $392,603,342

Synergies Analysis Synergies with AGI improve Mercury’s inventory

Lower inventories lower working capital changes

Higher cash flows, especially year after change (2008)

Higher terminal growth rate

Sensitivity analysis on WACC, Growth rate

New Enterprise Value range


Average from all WACC, Growth Rate outcomes

Discount Rate

Perpetuity Growth Rate 4.00% 4.50% 5.00% 4.00% 4.50% 5.00% 4.00% 4.50% 5.00%


Sensitivity Analysis: WACC, Growth Rate

9.86% 10.86% 11.86%


Tax-Effected EBIT 28,203.4 31,821.6 34,562.9 37,011.8 38,767.0 6.8%

Plus: Depreciation & Amortization 9,586.6 9,780.6 10,642.7 11,406.4 11,954.3 6.9%

Less: CapEx (11,983.2) (12,225.7) (13,303.4) (14,258.0) (14,942.9) 6.9%

Less: NOWC changes (4,567.0) 25,874.5 (7,290.4) (6,460.3) (4,635.3) 33.0%

Free Cash Flow $21,239.8 $55,250.9 $24,611.8 $27,699.9 $31,143.1 4.5%


Value Added Through Synergies

DCF without synergies


DCF with inventory management synergies


Synergy value added = $97,726,199

Significant value added

Profitable

Acquisition

Opportunity

Acquisition Recommendation Active Gear in prime position to acquire Mercury Athletic

AGI margins stagnant, but above industry averages

Acquisition to put AGI’s margins even more ahead of competitors

Easily integrated corporate structures

AGI’s business strengths compliment Mercury’s

Mercury: promising men’s casual, women’s athletic lines

Larger size = Better competition among rival firms

Expansion of customer base and consumer demographic

Mercury’s value/size comparable to rival firms

Synergies add significant value post-acquisition

Rebranding to revitalize AGI’s growth

Final Recommendation: ACQUIRE MERCURY

Appendix

Public Company Analysis

Excluded Marina and Victory

Victory’s firm size simply too large compared to AGI and rest of the comps

LTM Revenue/Earnings puts them well above industry average

Marina’s capital structure significantly different from the others

Marina’s profitability margins well above comp average

EBIT Multiples for Victory and Marina significantly larger than average

Revenue

Equity Net LTM LTM CAGR EBIT EBITDA Net Inc. EBIT

Company Market Value Debt (1) D/E Revenue Earnings 2000-06 Margin Margin Margin Multiple

D&B Shoe Company 420,098 125,442 29.9% 2,545,058 67,679 6.6% 4.4% 6.1% 2.7% 5.5x

Marina Wilderness 1,205,795 (91,559) -7.6% 313,556 41,923 17.8% 22.1% 23.1% 13.4% 18.0x

General Shoe Corp. 533,463 171,835 32.2% 1,322,392 64,567 11.2% 8.8% 11.5% 4.9% 6.8x

Kinsley Coulter Products 165,560 82,236 49.7% 552,594 27,568 4.6% 6.9% 8.9% 5.0% 7.3x

Victory Athletic 35,303,250 7,653,207 21.7% 15,403,547 1,433,760 7.9% 14.1% 16.0% 9.3% 22.1x

Surfside Footwear 570,684 195,540 34.3% 1,241,529 73,124 10.1% 9.3% 10.8% 5.9% 7.4x

Alpine Company 1,056,033 300,550 28.5% 1,614,648 112,015 6.2% 10.4% 12.2% 6.9% 9.0x

Heartland Outdoor Footware 1,454,875 (97,018) -6.7% 1,176,144 86,156 8.5% 10.8% 12.6% 7.3% 12.0x

Templeton Athletic 397,709 169,579 42.6% 516,182 79,170 14.4% 19.9% 20.2% 15.3% 6.2x

Average 4,567,496 945,535 24.9% 2,742,850 220,662 9.7% 11.9% 13.5% 7.9% 10.5x

AGI 100,496.34 25.0% 470,286.0 35,949.00 1.5% 12.8% 14.6% 7.6%

Mercury 10,058.29 25.0% 431,120.55 25,998.36 8.2% 9.8% 12.0% 6.0%

Appendix

Pros

1) Chinese contract manufacturers are

consolidating…benefiting larger firms in industry.

AGI needs to scale up to compete for continued

Chinese manufacturing

2) AGI’s largest contract manufacturer

accounts for no more than 12% of its total

inventory volume

3)-4) AGI sells to suburban 25-45 year olds.

Mercury sells to younger, more “hipster” 15-25

age group. Acquisition to increase

demographic and consumer base.

8) Bad weather and strikes by dockworkers

delayed shipments of Mercury’s highly-

anticipated holiday men’s casual line. Events

like these are rare and should not be expected

to repeat often. Mercury spent capital on

targeted advertising and promotional programs

for Women’s athletic line. Margins should

improve in the immediate future.

Cons

1) AGI does not like selling to discount

retailers. These retailers are a big part of

Mercury’s business/revenue. AGI would need

to accept a rebranding of their products.

Mercury’s revenue actually increased after

selling to discount retailers. Thus, AGI should

not be too worried about the prospect of

rebranding and discounting some of their

products.

Appendix

Discounted Cash Flow Calculations


Net Revenue 479,329.1 489,028.1 532,137.0 570,319.2 597,716.8 6.9%

Less: Cost of Goods Sold

Gross Profit

Less: Selling, General & Administrative

EBITDA 56,592.3 62,816.5 68,247.5 73,092.7 76,565.9 6.8%

Less: Depreciation & Amortization 9,586.6 9,780.6 10,642.7 11,406.4 11,954.3 6.9%

EBIT 47,005.7 53,036.0 57,604.8 61,686.3 64,611.6 6.8%

Less: Taxes (40%) 18,802.3 21,214.4 23,041.9 24,674.5 25,844.6 6.8%

Tax-Effected EBIT 28,203.4 31,821.6 34,562.9 37,011.8 38,767.0 6.8%

Plus: Depreciation & Amortization 9,586.6 9,780.6 10,642.7 11,406.4 11,954.3 6.9%

Less: CapEx (11,983.2) (12,225.7) (13,303.4) (14,258.0) (14,942.9) 6.9%

Less: NOWC changes (4,567.0) (2,649.1) (9,804.8) (8,687.4) (6,233.3) 33.0%

Free Cash Flow $21,239.8 $26,727.3 $22,097.4 $25,472.8 $29,545.0 3.4%


Year 2006 2007 2008 2009 2010 2011

NOWC 104,117.2 108,684.2 111,333.3 121,138.2 129,825.6 136,058.9

NOWC Changes 4,567.0 2,649.1 9,804.8 8,687.4 6,233.3

Net Operating Working Capital

(Current Assets - Current Liabilities)

Select Balance Sheet Accounts 2006 2007 2008 2009 2010 2011

Cash Used in Operations 10,676 4,161 4,195 4,566 4,894 5,130

Accounts Receivable 45,910 47,888 48,857 53,164 56,978 59,715

Inventory 73,149 83,770 85,465 92,999 99,672 104,460

Prepaid Expenses 10,172 14,474 14,767 16,069 17,222 18,049

Total Current Assets 139,908 150,293 153,284 166,798 178,766 187,354

Liabilities

Accounts Payable 16,981 18,830 18,985 20,664 22,149 23,214

Accrued Expenses 18,810 22,778 22,966 24,996 26,792 28,081

Total Current Liabilities 35,791 41,609 41,951 45,659 48,941 51,295

Appendix

Synergy Analysis Calculations

Year 2008 2009 2010 2011

Consolidated Revenue 489,028.1 532,137.0 570,319.2 597,716.8

Mercury Inventory (w/ new DSI) 56,941.6 61,961.2 66,407.0 69,597.2

Days Sales In Inventory 42.5 (Inventory/(Revenue * 365))

Mercury Inventory (w/ new DSI)

Year 2006 2007 2008 2009 2010 2011

NOWC 104,117.2 108,684.2 82,809.7 90,100.1 96,560.5 101,195.8

NOWC Changes 4,567.0 (25,874.5) 7,290.4 6,460.3 4,635.3

Net Operating Working Capital

(Current Assets - Current Liabilities)

Select Balance Sheet Accounts 2006 2007 2008 2009 2010 2011

Cash Used in Operations 10,676 4,161 4,195 4,566 4,894 5,130

Accounts Receivable 45,910 47,888 48,857 53,164 56,978 59,715

Inventory 73,149 83,770 56,942 61,961 66,407 69,597

Prepaid Expenses 10,172 14,474 14,767 16,069 17,222 18,049

Total Current Assets 139,908 150,293 124,761 135,760 145,501 152,491

Liabilities

Accounts Payable 16,981 18,830 18,985 20,664 22,149 23,214

Accrued Expenses 18,810 22,778 22,966 24,996 26,792 28,081

Total Current Liabilities 35,791 41,609 41,951 45,659 48,941 51,295

Acquisition of Mercury Athletic

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