DENBLEYKER United States

Footwear
FINANCIAL
12 January 2008
MERCURY SHOES
Ellen Blake Upgraded to Buy BUY

Reason for Report: Quarterly Results Volatility Risk:

MEDIUM

MERC; $29.56
12-Month Price Objective: $36.00; 24-Month Price Objective $42.00 (12-Jan-2008)
EPS : 2006A $2.45; 2007A $2.16; 2008E $2.50; 2009E $2.90
Mercury Shoes

P/E : 2006A 15.9x; 2007A 13.7x; 2008E 15x; 2009E 15x

Company Description
Mercury International Ltd. is a global company that designs and markets sports and fitness
products, including footwear, apparel and accessories. Mercury designs, markets and sells three
primary product lines worldwide: Boost Athletic shoes, TrailStep shoes, and SnowStep shoes, all
under the Mercury brand. They also sell insoles, apparel, and services.

Event and Recommendation

• Q4 earnings dropped slightly below expectations during 4Q due to a variety of small
economic and execution surprises. Management appears to have a good handle on these
issues now, and we believe that the stock is a good value at these prices. We are raising our
rating to Buy, with a 12-month price target of $36.00.

Analysis
• The Quarter. Mercury’s Q4 earnings came in just below management guidance of $2.20 -
$2.30. The balance sheet remains healthy, and cash flows are stable. Asian revenues have
continued to decline, but Europe has been strong the last two quarters, primarily due to
healthy sales of the SnowStep shoes there. While specific numbers were not discussed, the
apparel and insoles businesses are still running short of management expectations, and
changes are planned in those businesses.
• Expectations. Management outlined detailed plans for improvement in both revenue and
earnings through a combination of strategic improvement projects and some specific new
products that could be introduced in about a year. They are targeting 10% annual growth in
revenue and earnings, and these targets appear to be within reach. Although 4Q EPS was a
disappointment, we expect to see steady improvement during 2008, with year-end numbers
around $2.50. PE multiples are likely to move closer to the industry norm of 15, which
would drive a stock price of $37.50. Traditional weakness in the first half of the year could
put pressure on results (and prices) in the short-term, but we think MERC at the current price
level is too good to pass up.

Denbleyker Financial does and seeks to do business with companies covered in its research reports. As a result, investors
should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.

Investors should consider this report as only a single factor in making their investment decision.
Mercury Shoes – 14 January 2007
• International and Supply Chain. The Americas is
still the most consistently profitable region, although
Europe has recently been turning in some good
numbers. A new production line came on line late
last year in Europe, which should help to alleviate
any seasonal bottlenecks. Production lines are
currently running at utilization rates in the low 60’s,
which is not bad for this type of business.
• Marketing. We are encouraged by Mercury’s
reported plans to develop and support their brands
globally, with increased spending in advertising and
marketing. In conjunction with these statements, the
company announced the signing of Yao Ming of the
Houston Rockets to endorse the Mercury brand in the
U.S. and Asia. We believe this endorsement will
greatly enhance the growth of the brand, especially in
the Asian market.
• Research and Development. Mercury management
announced that they are currently evaluating
additional spending in R&D in order to speed the
time to market of two possible new products.
• Products. Mercury’s core products continue to
perform well, but it is clear that the Apparel and
Insole lines are still producing below expectations.
Management did not provide specific numbers for
these businesses, but noted that they were carefully
evaluating their strategies in these areas.
• Services. Mercury offers two services, and these
services have been marginal performers for a while.
Management is currently evaluating possible changes
in these services in order to improve performance.
• ShoeStuff bankruptcy implications. Mercury’s
sales to ShoeStuff were down 12% in the quarter.
While this was certainly a drag on Mercury’s
TrailStep and SnowStep brands, limiting U.S.
footwear revenue growth (up slightly), we think it is
a positive that Mercury already has a quarter of
ShoeStuff sales reductions (and bad debt accrual)
under its belt. Mercury management commented that
it will have some excess product as a result of
ShoeStuff’s bankruptcy, but it is optimistic that it will
be able to clear this product at good margins by
channeling inventory to new markets in Europe and
through Mercury’s own retail stores.
Financial Disclosures
Denbleyker Financial
• Cash. The company ended the quarter with $520
million in cash and cash equivalents, up from $319
million at the end of the same period a year ago.
Their operating cash flow came in at $56 million for
Q4 and $132 million for the year. For now, Mercury
has postponed stock repurchases under its stock
repurchase program.
Selected Financial Risks
• Geographic Risk. One thing to watch here is
Mercury’s reliance on manufacturing in politically
unstable locations. The heavy emphasis on
Indonesian and Czech Republic based manufacturing
will save costs in the short term, but if the stability of
these countries is jeopardized, it could have a
material impact on Mercury’s business worldwide.
• Exchange Rate Risk. Mercury does not currently
perform any hedging for exchange rate fluctuations,
believing that their worldwide diversification will
protect their earnings from normal currency
fluctuations. However, significant currency moves
(especially uncorrelated ones) could have a material
impact on future earnings.
• Indonesian Tax Holiday. Mercury’s Indonesian
operations currently benefit from a tax holiday, and is
therefore not paying any taxes on profits in that
region. This tax holiday is due to expire at the end of
the year. Companies can sometimes get extensions in
tax holidays by making additional investments of
certain types. Mercury management noted that
discussions in this area are still in progress, and is not
willing to discuss any specific plans at this time.
Analyst Certification
I, Ellen Blake, hereby certify that the views expressed in this
research report accurately reflect my personal views about the
subject securities and issuers. I also certify that no part of my
compensation was, is, or will be, directly or indirectly, related to
the specific recommendations or view expressed in this
research report.
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Mercury Shoes – 14 January 2007 Denbleyker Financial
<Financials to be provided at a later date>