111 N. Canal Street, Suite 1101Chicago, IL 60606

Oakley Inc. / (OO-NYSE) / $29.20

Note: This report contains substantially new material. Subsequent reports will have changeshighlighted.

Reason for Report: 3Q07 Earnings Update (4/9 brks. in cvg.) Previous Edition: September 03, 2007

Brokers’ Recommendations: Neutral: 100% (4 firms); Positive: 0% (0); Negative: 0% (0). Prev. Ed.: 5:2:0

Brokers’ Target Price: $29.15 (↑ from last edition of $28.38; 2 firms) Brokers’ Avg. Estimated Return: -0.2%

Recent Events - Summary

On October 18, 2007, Oakley Inc. announced its 3Q07 earnings.

Overview

Analysts have identified the following issues as critical to an evaluation of the investment merits of OO:

Key Positive Arguments / Key Negative Arguments
  • Strategic repositioning of the company
  • Strong brand power
  • Continues to buyback shares
  • Core sunglass business continues to improve
  • Continues to open additional sunglass Icon stores, and develop the newly acquired Optical shop of Aspen and Bright Eyes.
/
  • Heavy competition from recently emerging sunglass brands
  • High level of share concentration
  • Problems in non-optic segments could take a long time to resolve

Headquartered in Foothill Ranch, California, Oakley, Inc. (OO) is engaged in the design, manufacture, and distribution of consumer productsin the United States and internationally. It offers optics products, including sunglasses, prescription eyewear, goggles, and electronically enabled eyewear; men’s and women’s apparel, including styles designed for golf, mountain biking, surfing, snow sports, and other athletic lifestyles; footwear; watches; and accessories. The company distributes its products through optical stores; sunglass retailers; specialty sports stores, including bike, surf, snow, skate, golf, and motorcycle stores; sporting goods stores; and department stores. Oakley also retails its products under company-owned Oakley Stores and two sunglass specialty retail chains.

The company operates in two segments: Wholesale and U.S. Retail. The Wholesale segment designs, manufactures, and distributes the company’s products to wholesale customers in the United States and internationally. The U.S. Retail segment operates the company-owned specialty retail stores located in the United States. As of August 1, 2006, it owned and operated 56 Oakley Stores, 113 Sunglass Icon, and 18 Optical Shop of Aspen retail stores in the United States.

For more information on the Company, please visit its website at

NOTE: The Company’s fiscal year ends on December 31.

Recent Events - Details

On October 18, 2007, Oakley Inc. announced its 3Q07 earnings. Highlights are:

  • Net revenue increased 25.5% yoy to $263.8 million from $210.2 million in 3Q06.
  • Net income totaled $23.4 million, or $0.34 per diluted share, including $0.02 per diluted share impact of transaction costs related to the company's previously announced merger agreement with Luxottica Group.

On June 22, 2007, the potential termination fees of the merger agreement between Luxottica Group S.p.A. and Oakley Inc. was disclosed in a filing with the Securities and Exchange Commission. Should Oakley's Board of Directors change its recommendation, which includes backing a different offer for the company, Oakley would pay Luxottica $69 million. Should the deal not gain antitrust approval, Luxottica would pay Oakley $80 million.

On June 21, 2007, Luxottica Group S.p.A., global leader in eyewear, and Oakley, Inc. (NYSE:OO), worldwide specialist in sport performance optics, jointly announced that they have entered into a definitive merger agreement with the unanimous approval of both companies' Boards of Directors. Under the agreement, Luxottica Group will acquire all of the outstanding shares of Oakley for a cash purchase price of $29.30 a share together with the purchase of all outstanding options and other equity rights at the same price per share less the exercise price. The total purchase price will be approximately$2.1 billion, an 18% premium on Oakley's stock during the most recent 30-day average and approximately 24% over the most recent three-month average trading price.

Revenue

In 3Q07, the company reportednet revenueof $263.8 million, an increase of 25.5% y-o-y from $210.2 million in the prior-year period. The results were inline with the Zacks Digest average. One firm (Wedbush) believes that strong sales growth was largely driven by impressive organic growth in the core optics business, but that transaction expenses related to the upcoming merger with Luxottica moderated some of the earnings upside.

One firm (Merriman) believes that the increase in sales was driven by increased sales in its optic business, specifically sunglasses and prescription eyewear, as well as the addition of new businesses such as Bright Eyes and Eye Safety Systems (ESS).

In 3Q07, the company’s net revenue in the U.S. business (wholesale and retail) totaled $148.9 million, an increase of 27.6% y-o-y from $116.7 million in the prior-year period. Net sales to theU.S. wholesale customers totaled $85.6 million, up 22.4% y-o-y from $69.9 million in 3Q06, driven by significant double-digit optics growth offset by a moderate decrease in AFA (apparel, footwear and accessories) sales. The results were inline with the Zacks Digest average.

U.S. retail net sales in 3Q07 increased 35.2% y-o-y to $63.3 millionversus $46.8 million in 3Q06. The retail sales growth was driven by a strong increase in comparable store sales and the contribution of new Oakley and Sunglass Icon stores added during the last twelve months as well as an increase in Internet sales.

In 3Q07, the company's net revenues in the Internationalmarkets were $114.9 million, a 22.9% y-o-y increase from net revenues of $93.5 million in 3Q06. International revenues increased by 6.1% due to a weaker U.S. dollar relative to foreigncurrencies. The company's EMEA (Europe, Middle East and Africa) region experienced significant increase in netoptics sales growth and a slight increase in AFA sales. The Americas (non-U.S.) reported significant double-digit growth in optics and AFA. Asia Pacific saw a significant double-digit increase in its optics sales and a strong increase inAFA net sales. The results were inline with the Zacks Digest average.

3Q07net revenue of optics totaled $192.2million, up 29.1% y-o-y from $148.8million in the prior-year period, driven by significant double-digit increases in prescription eyewear, sunglasses, and goggles both in the U.S. and International markets.

3Q07net revenuefrom apparel, footwear and accessories (AFA) totaled $52.2million, up 12.8% y-o-y from $46.3 million in the prior-year period. AFA growth included significant double-digit contribution from watches, together with significant contributions from footwear and apparel sales.

3Q07 net revenuefrom other brands, which consist of non-Oakley products sold through thecompany's multi-branded Bright Eyes, Sunglass Icon and The Optical Shop of Aspen (OSA) retail stores,increased 28.7% y-o-y to $19.4 million from $15.1million in 3Q06. .

For 2007, the company reiterated its net sales guidance range of $930 million-$960 million.

FY ends Dec. / 3Q06A / 2006A / 2Q07A / 3Q07A / 4Q07E / 2007E / 1Q08E / 2008E / 2009E
US Revenue / $116.7 / $424.2 / $158.3 / $148.9 / $127.6 ↑ / $543.2↑ / $115.5 / $583.5 ↓
International Revenue / $93.5 / $338.0 / $104.9 / $114.9 / $103.2 ↓ / $413.7↓ / $98.0 / $452.9 ↑
Total Revenue($MM) / $210.2 / $761.9 / $263.2 / $263.8 / $242.1 ↑ / $961.4↑ / $213.5 / $1,072.7 / $1,206.7 ↑
Digest High / $210.2 / $762.4 / $263.2 / $263.8 / $264.0 ↑ / $963.4 ↑ / $213.5 / $1,095.6↓ / $1,206.7 ↑
Digest Low / $210.0 / $761.9 / $263.2 / $263.8 / $230.9 / $957.0 ↑ / $213.5 / $1,036.4↑ / $1,206.7 ↑
YoY Growth / 17.6% / 29.1% / 25.5% / 23.3%↑ / 26.2%↑ / 107.2% / 11.6%↓ / 12.5%↑
Quarterly Sequential Growth / 3.1% / 32.1% / 0.2% / -8.2%↓ / -11.8%

Apie chart analysis of the revenue segment is shown below:

Margins

According to the company,3Q07GAAP gross margin was 55.6% versus 53.8% in 3Q06. The non-GAAP gross margin in 3Q07 was 55.5% (in line with the Zacks Digest average) as compared to 54.0% in 3Q06. The increased non-GAAP gross margin versus the comparable prior-year quarter is primarily due to increased gross margins from Oakley sunglasses and prescription eyewear.

In 3Q07, OO’s operating expenses totaled $105.7 million, representing 40.1% of net sales, versus $87.0 million, or 41.4% of net sales, in 3Q06. The results were in line with the Zacks Digest average. Operating margin according to the Zacks Digest report was 15.5% as compared to 12.4% in 3Q06.

The increase in operating margin was attributed to lower SG&A which decreased 130 basis points to 40.1%of sales primarily due to lower rates of marketing growthand commission growth relative to sales growth.

Most of the firms (Merriman, BB&T) believe that the increase in gross margin was due to improved AFA margins and a mix shift to higher-margin eyewear, partially offset by weakermargins in Oliver Peoples, Sunglass Icon, and Bright Eyes.

Margins / 3Q06A / 2006A / 2Q07A / 3Q07A / 4Q07E / 2007E / 1Q08E / 2008E / 2009E
Gross / 53.8% / 54.4% / 57.6% / 55.5% / 53.8%↓ / 55.8%↓ / 54.4% / 56.2%↑ / 56.4%↓
Operating / 12.4% / 9.4% / 14.2% / 15.5% / 12.2%↓ / 12.2%↑ / 5.1% / 13.0%↑ / 14.2%↑
Pre-tax / 12.3% / 9.2% / 13.1% / 14.3% / 11.2%↓ / 11.1% / 4.2% / 12.2%↑ / 13.2%↑
Net / 8.3% / 6.2% / 8.2% / 9.0% / 7.1%↓ / 7.1% / 2.7% / 7.9%↑ / 8.5%

Earnings per Share

3Q07 net income totaled $23.7 million, or $0.34 per diluted share, including an approximate $0.02 per diluted share impact of transaction costs related to the company's previously announced merger agreement with Luxottica Group, versus $17.3 million, or $0.25 per diluted share, in 3Q06, as per the company. According to the Zacks Digest report, net income was $23.7 million or $0.36 per diluted share, as compared to $17.5 million or $0.25 per diluted share in 3Q06.

For FY07, the company reiterated its earnings per shareguidance range of $0.95-$0.98 per diluted share but noted that this EPS range now includes the expected impact of continuing transaction costs related to the company's previously announced merger agreement, which one firm (BB&T) estimates to be $5 million. This guidance excludes any impact from the adoption of Financial Accounting Standards Board issued Interpretation No. 48 Accounting for Uncertainty in Income Taxes'' (FIN 48) or substantial changes in foreign currency exchange rates or significant changes in estimated transaction costs related to the company's previously announced merger agreement.

One analyst (BB&T) increased the FY08 EPS estimatefrom $1.19 to $1.20 to reflect the partial 3Q07 upside.

EPS
FY ends Dec. / 3Q06A / 2006A / 2Q07A / 3Q07A / 4Q07E / 2007E / 1Q08E / 2008E / 2009E
Digest High / $0.26 / $0.70 / $0.31 / $0.36 / $0.25↓ / $0.98 / $0.08 / $1.24 / $1.46
Digest Low / $0.25 / $0.65 / $0.31 / $0.36 / $0.24↑ / $0.97↑ / $0.08 / $1.18↑ / $1.46
Digest Avg. / $0.25 / $0.68 / $0.31 / $0.36 / $0.24 / $0.97 / $0.08 / $1.21↑ / $1.46
Digest YoY growth / -22.1% / 8.1% / 43.4% / 116.3%↓ / 43.5%↓ / 1.4% / 23.9%↑ / 21.2%↑
Quarterly Sequential Growth / -12.4% / 292.7% / 16.1% / -32.6%↓ / -67.0%
Zacks Consensus / $0.24 / $0.97 / $0.09 / $1.21
AFTER FAS 123 (ESOE) / $0.95-$0.98

4Q07 EPS estimates range from $0.24to $0.25, with an average of $0.24. For FY07 estimated earnings per share range from $0.97 to $0.98, with an average of $0.97. For FY08, estimated earnings per share range from $1.18 to $1.24, with an average of $1.21. For FY09, theearnings per share estimate is $1.46.

Target Price/Valuation

Of the four analysts in the Digest surveyallgave neutral ratings.

Target prices given by analysts range from $29.00 (R W. Baird) to $29.30 (Wedbush). The Digest average target price is $29.15 (↑ from the previous published report of $29.38). The analyst (R W. Baird) with the lowest target price has used 20x forward 2-yearEPSestimate of $1.24. The analyst (Wedbush) with the highest target price has used 13x EV/EBITDAto calculate the target price.

Rating Distribution
Positive / 0.0%
Neutral / 100.0%↑
Negative / 0.0%
Digest High / $29.30
Digest Low / $29.00 ↑
Avg. Target Price / $29.15 ↑
No. of Analysts with Target Price/Total / 2/4

Capital Structure/Solvency/Cash Flow/Governance/Other

Cash at the end of the quarter was $53.7 million versus $30.7 million a year ago. Accounts receivable were $140.8 million, a 21.6% increase over last year. Inventory at the end of the quarter was $208.1 million, up 35% y-o-y. The increase was attributable to recent acquisitions, growth in retail stores, and increased AFA inventory due to better execution of inventory flow versus last year. Total debt was $205.0 million versus $41.6 million a year ago, primarily due to the acquisitions the company made in the past year. Accounts receivable increased 22% y-o-y.

Update on the Merger: In June, Oakley entered a definitive merger agreement to sell to Luxottica Group, the multi-billion dollar optics giant, for $29.30 per share in cash (total transaction value $2.1 billion). The November 7 meeting requires the affirmative vote of two-thirds of Oakley shareholders to approve the merger. Furthermore, Oakley Chairman Jim Jannard owns approximately 63.8% of outstanding shares and has agreed to vote in favor of the merger. The merger agreement has received approval from Germany, the United Kingdom, Australia, and CFIUS. The proposed transaction is still awaiting approval by South Africa. The potential obstacles at this point are regulatory hurdles; however, neither company foresees any major difficulties.

For 2007, the company plans to open 45-50 new retail stores, and capital expenditures are projected to be $70.0 million, up from $52 million in 2006. Capital expenditures for 2007include spending for a new US distribution center in Ontario, California, increased investments in new retail stores, continued re-branding of the Sunglass Icon stores, additional optical displays, increased tooling for new products, investments in facilities and IT infrastructure, and the re-configuration of floor space in existing Oakley stores to support the shift to open eyewear fixtures and to support the Oakley Custom program.

As per analysts, the company is expected to remain focused on the strategic repositioning of its optics business in 2007, and with the completion of the footwear restructuring program, it is expected to now focus on augmenting the international business, initiating with the acquisition of Bright Eyes, an Australian eyewear retailer similar to Sunglass Icon. Other initiatives include the launch of a men’s “Square O” collection and the Block program, which will target retailers tied to an action sports, music, and art customer base, and feature limited edition, unique versions of eyewear styles adapted from the Square O collection. Analysts believe that the successful women’s collection should be expanded, both in terms of stock-keeping units (SKUs) and distribution, and the company is expected to seek broader distribution to channels such as Nordstrom’s, Saks, and Federated department stores. OO is also expected to re-connect with its core customer, launching new and much-anticipated sports performance styles.

Accompanying these new initiatives will be a stepped up marketing effort, highlighted by the launch of the “Rolling O Lab,” a promotional vehicle that will showcase new Oakley products and demonstrate superior technologies for consumers at key sporting events and store openings.

Potentially Severe Problems

There are none other than those discussed in other sections of this report.

Long-Term Growth

The company’s long-term target includes annual sales growth of at least 10% with annual EPS and EBITDA exceeding topline growth.

Management is pleased that its strategic initiatives appear to be on a successful drive. Some of the initiatives involve restructuring the footwear business, realigning the apparel platform, and amplifying the communication of Oakley's performance and technology story. Itbelievesthe investment in these initiatives will position the company for sustainable, profitable growth.

Analysts believe that management is fulfilling its promise to return the company to its optical roots and to install a more disciplined and focused business model that should drive strong returns. Managementis using the strong revenue growth to compensate for extensive and critical inventory write-downs. Oakley’s strategic repositioning, focusing on its core competitive advantage, optics, should enhance brand awareness while providing long-term sustainable earnings growth and drive potential upside to both the top and bottom lines.

Upcoming Event

On February 7, 2008, 4Q07 and FY07 earnings are expected.

Individual Analyst Opinions

POSITIVE RATINGS

None at this time

NEUTRAL RATINGS

Merriman – Neutral (no target price): 10/19/07 – The brokerage firm maintainsa Neutral rating with no specific target price. INVESTMENT SUMMARY: The firm remains pleased with Oakley’s higher-than-anticipated results, particularly due to increased sales in its optics business. It believes the company should continue that momentum in the near term. However, based on the pending merger with Luxottica, the firm believes upside to the stock price is limited and the firm believes it should trade in line with its expected purchase price of $29.30.

Wedbush – Hold ($29.30- target price): 10/19/07 –The firmhas reiterated its target price of$29.30and a Hold rating on the stock.

BB&T- Hold (2) (no target price): 10/19/07 – The firm maintains a Hold (2) rating, with no specific target price. INVESTMENT SUMMARY: The firm remains optimistic on OO, based on its superior management execution and an improving profitable growth model. The potential obstacles it sees regarding the pending merger are the few regulatory hurdles; however, neither company foresees any major difficulties.

R W. Baird – Neutral ($29-target price): 10/19/07 – The firm reiterates a Neutral rating on Oakley, andatarget price of $29. INVESTMENT SUMMARY: OO has begun to implement a strategic plan that the firm believes is very appropriate for the brand and the company's core competency in optics. However, until signs of real improvement are seen, the firm sees no reason to award the shares more than a slight premium to the peer group.

NEGATIVE RATINGS

None

NOT RATED

None

Research Associate: Ruchika Drolia

Content Ed.: Deepa Agarwal

Copy Editor: Pushpanjali B.

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