Overview
Our mission is to maximize the work and outdoor experience for our consumers. To achieve this, we design, develop, manufacture and market premium-quality, high-performance footwear and apparel, supported by compelling marketing and superior customer service.
Within the domestic and international retail channel of distribution, we market footwear and apparel under the DANNERŽ and LACROSSEŽ brands. We also sell products through the safety and industrial distributor channel principally under the LACROSSEŽbrand for consumers who regard our specialized footwear as critical tools for the job. Additionally, we position the Danner brand as performance footwear built to meet the unique demands and specific requirements for multiple branches of the U.S. Armed Forces.
We focus on two types of consumers for our footwear and apparel lines: work and outdoor. Work customers include people in law enforcement, transportation, mining, oil and gas, military services and other occupations that need high-performance and protective footwear as a critical tool for the job. Outdoor customers include people active in hunting, outdoor cross training, hiking and other outdoor recreational activities.
Weather, especially in the fall and winter, has been, and will likely continue to be, a significant contributing factor impacting our financial performance. Sales are typically higher in the second half of the year due to stronger demand for our cold and wet weather outdoor product offerings. We augment these offerings by infusing innovative technology into all product categories with the intent to create additional demand in all four quarters of the year. We have achieved consistent growth in our core business in recent years, driven by our consumers' demand for our innovative footwear and apparel products. Our 2008 sales growth included our previously announced revenue of $9.6 million for shipments to the United States Marine Corps and the U.S. Army. In addition to our government channel, our net sales performance continues to be driven by the success of our new product lines, our ability to meet at-once demand and our ability to diversify and strengthen our portfolio of sales channels. During 2008, we experienced slight sequential declines in our gross margins. We anticipate continued pressure on gross margins during 2009 given the current economic and retail environment.

RESULTS OF OPERATIONS - FISCAL 2008 COMPARED TO FISCAL 2007
Financial Summary - 2008 versus 2007
The following table sets forth selected financial information derived from our consolidated financial statements. The discussion that follows the table should be read in conjunction with the consolidated financial statements.

     ($ in millions)                         2008        2007       $ Change     % Change
     Net Sales                             $ 128.0     $ 118.2       $  9.8           8 %
     Gross Profit                          $  50.7     $  46.9       $  3.8           8 %
     Gross Margin %                           39.6 %      39.7 %                 (10 bps)
     Selling and Administrative Expenses   $  40.5     $  35.9       $  4.6          13 %
     % of Net Sales                           31.7 %      30.4 %                 130 bps
     Non-Operating Income                  $   0.0     $   0.3      ($  0.3 )      (108 %)
     Income Before Income Taxes            $  10.1     $  11.3      ($  1.2 )       (10 %)
     Income Tax Provision                  $   3.9     $   4.0      ($  0.1 )        (1 %)
     Net Income                            $   6.2     $   7.3      ($  1.1 )       (15 %)

Consolidated Net Sales: Consolidated net sales for 2008 increased 8%, to $128.0 million, from $118.2 million in 2007. In the work market, net sales increased 23%, to $74.9 million, from $60.9 million in 2007. The strong annual growth in work market sales reflects shipments related to military orders and continued penetration into a variety of targeted, niche work markets. During 2008, we shipped approximately $9.6 million of previously announced orders to the United States Marine Corps and the U.S. Army.
In the outdoor market, net sales declined 7%, to $53.1 million, from $57.3 million in 2007. While we continued to see growth in at-once demand in certain segments and geographies of the outdoor market, the overall decline in outdoor sales reflected the widespread decline in retail sales during 2008. Net sales by our European subsidiary to the outdoor market were approximately $2.9 million of the total $53.1 million for 2008.
Gross Profit: Gross profit for 2008 was 39.6% of consolidated net sales, compared to 39.7% in 2007. The margin decline of 10 basis points was due to an increase in markdown sales (40 basis points), offset by price increases during 2008 and improvements in sales returns, discounts and allowances (30 basis points).
Selling and Administrative Expenses: Selling and administrative expenses in 2008 increased $4.6 million, or 13%, to $40.5 million from $35.9 million in 2007. Selling and administrative expenses as a percent of net sales increased from 30.4% in 2007 to 31.7% in 2008. The $4.6 million growth in selling and administrative expenses included expenses related to the establishment and operation of our European subsidiary ($2.6 million), increased expenses in sales and product development activities ($1.8 million) and other expenses ($0.2 million).
Non-operating Income: Non-operating income was negligible in 2008 compared to $0.3 million during 2007. The decline was due to a decrease in interest income due to lower rates in 2008 and realized losses on foreign currency exchange rate transactions.
Income Taxes: We recognized income tax expense at an effective rate of 38.9% in 2008 compared to an effective tax rate of 35.2% in 2007. The higher effective rate for 2008 was due to the impact of a rate differential on our European pre-tax results of operations offset by adjustments to our unrecognized tax benefits for tax positions taken in prior years and certain one-time tax benefits received during 2007.
Net Income: Net income recognized during 2008 was $6.2 million, or $0.96 diluted earnings per common share, compared to $7.3 million, or $1.15 diluted earnings per common share, in 2007. The net income decline of $1.1 million is attributable to a decline in the gross margin rate, increased selling and administrative expenses

of $4.6 million (of which $2.6 million is attributable to the establishment and operation of our European subsidiary) and a $0.3 million increase in non-operating expense, offset by additional gross profit of $3.8 million resulting from 8% net sales growth.

RESULTS OF OPERATIONS - FISCAL 2007 COMPARED TO FISCAL 2006
Financial Summary - 2007 versus 2006
The following table sets forth selected financial information derived from our
consolidated financial statements. The discussion that follows the table should
be read in conjunction with the consolidated financial statements.

     ($ in millions)                         2007        2006       $ Change      % Change
     Net Sales                             $ 118.2     $ 107.8      $   10.4           10 %
     Gross Profit                          $  46.9     $  42.3      $    4.6           11 %
     Gross Margin %                           39.7 %      39.2 %                   50 bps
     Selling and Administrative Expenses   $  35.9     $  33.5      $    2.5            7 %
     % of Net Sales                           30.4 %      31.0 %                  (60 bps)
     Non-Operating Income                  $   0.3     $   0.1      $    0.2          229 %
     Income Before Income Taxes            $  11.3     $   8.9      $    2.3           26 %
     Income Tax Provision                  $   4.0     $   2.6      $    1.4           54 %
     Net Income                            $   7.3     $   6.3      $    1.0           15 %

Consolidated Net Sales: Consolidated net sales for 2007 increased 10%, to $118.2 million, from $107.8 million in 2006. In the work market, net sales increased 11%, to $60.9 million, from $54.7 million in 2006. Year-over-year growth in work sales reflected the continued penetration into a variety of general and specialized work boot markets. In the outdoor market, net sales increased 8%, to $57.3 million, from $53.1 million in 2006. Growth in the outdoor market sales reflected increased penetration into the rugged outdoor boot markets.
Gross Profit: Gross profit for 2007 was 39.7% of consolidated net sales, compared to 39.2% in 2006. Margin improvement of 50 basis points was due to price increases and improvements in sales returns, discounts and allowances (130 basis points), partially offset by an increase in markdown sales (80 basis points).
Selling and Administrative Expenses: Selling and administrative expenses in 2007 increased $2.5 million, or 7%, to $35.9 million from $33.5 million in 2006. Selling and administrative expenses as a percentage of net sales declined from 31.0% in 2006 to 30.4% in 2007. The $2.5 million growth in selling and administrative expenses included increased sales, marketing, and product development expenses of $1.7 million. The remaining $0.8 million included costs of our Portland distribution center and offices opened during 2006 ($0.3 million) and other general and administrative costs ($0.5 million). Non-operating Income: Non-operating income in 2007 was $0.3 million, a $0.2 million increase from 2006. The increase was the result of greater cash balances generating higher interest income than in the prior year.
Income Taxes: We recognized income tax expense at an effective rate of 35.2% in 2007 compared to a lower effective tax rate of 28.9% in 2006 resulting from research and development tax credits of approximately $0.6 million recognized in 2006.
Net Income: As a result of consolidated net sales growth, gross profit improvements and operating expenses noted above, we realized net income for 2007 of $7.3 million, or $1.15 diluted earnings per common share, compared to $6.3 million, or $1.02 diluted earnings per common share, in 2006.

LIQUIDITY AND CAPITAL RESOURCES
We have historically funded working capital requirements and capital expenditures with cash generated from operations and borrowings under a revolving credit agreement or other long-term lending arrangements. We require working capital to support fluctuating accounts receivable and inventory levels caused by our seasonal business cycle. Working capital requirements are generally the lowest in the first quarter and the highest during the third quarter.
We have a line of credit agreement with Wells Fargo Bank, N.A., which expires on June 30, 2009. Amounts borrowed under the agreement are secured by all of our assets. The maximum aggregate principal amount of borrowings allowed from January 1 to May 31 is $17.5 million and from June 1 to December 31, the total available is $30 million. There are no borrowing base limitations under the credit agreement. At our option, the credit agreement provides for interest rate options of prime rate minus 0.50% or LIBOR plus 1.50%. No amounts were outstanding under this agreement during 2008. See Note 4, "Financing Arrangements" to the accompanying consolidated financial statements for additional information.
In June 2006, we received a grant of $0.2 million and a non-interest bearing loan of $0.6 million from the Portland Development Commission, which were used to finance certain leasehold improvements at our Portland distribution facility. The grant is recorded as deferred revenue and is being amortized as a reduction of operating expenses on a straight-line basis over five years, which is the estimated useful life of the associated leasehold improvements. In the third quarter of 2008, the loan was forgiven by the Portland Development Commission as we met certain facility usage requirements and employment criteria, including maintaining a minimum number of employees in the city of Portland, Oregon and paying those employees a competitive specified wage and benefits package. Given the forgiveness of this loan, we have reclassified the remaining unamortized long-term debt to deferred revenue and will continue to amortize the balance until 2011. See Note 4, "Financing Arrangements" to the accompanying consolidated financial statements for additional information.
Net cash provided by operating activities was $13.3 million in 2008, compared to $4.1 million for 2007. The 2008 amount consisted of net income of $6.2 million, and adjustments for non-cash items including depreciation and amortization totaling $1.9 million and $0.6 million of stock-based compensation expense, and changes in working capital components, consisting primarily of an decrease in inventories of $1.7 million (excluding inventory related to acquisition), and an increase in accounts payable of $3.0 million. The increase in accounts payable is primarily related to the timing of payments related to inventory. Net cash provided by operating activities was $4.1 million in 2007, compared to $9.7 million for 2006. The 2007 amount consisted of net income of $7.3 million, adjustments for non-cash items including depreciation and amortization totaling $1.8 million and $0.5 million of stock-based compensation expense, and changes in working capital components, consisting primarily of an increase in accounts receivable of $2.7 million, an increase in inventories of $5.1 million, partially offset by an increase in accounts payable of $2.0 million. Net cash used in investing activities was $6.3 million in 2008 compared to $1.5 million in 2007. We purchased property and equipment of $3.2 million and $1.5 million in 2008 and 2007, respectively. In 2008, we also paid $3.2 million to acquire the inventories and operations of our former European distributor to establish our new European subsidiary. We anticipate spending $6.1 million on capital expenditures during 2009.
Net cash used in financing activities was $8.3 million in 2008 compared to net cash provided by financing activities of $0.1 million in 2007. Proceeds from the exercise of stock options were $1.1 million in 2008,

compared to $1.0 million for 2007. We paid cash dividends of $9.3 million in 2008 compared to $0.9 million in 2007.
As previously noted, on February 2, 2009, we announced a first quarter cash dividend of twelve and one-half cents ($0.125) per common share which will be paid on March 18, 2009 to shareholders of record on February 22, 2009 and will approximate $0.8 million in aggregate.
At December 31, 2008 and 2007, our pension plan had accumulated benefit obligations in excess of the respective plan assets of $5.6 million and $1.7 million, respectively. This obligation in excess of plan assets and accrued liabilities resulted in a cumulative reduction of equity, net of tax, of $3.7 million and $1.0 million as of December 31, 2008 and 2007, respectively. We expect to contribute $1.3 million to the pension plan in 2009.
We will consolidate our two La Crosse, Wisconsin distribution facilities in the second quarter of 2009 to one location in Indianapolis, Indiana for increased capacity and operating efficiencies. We anticipate spending approximately $4.0 million by the end of the second quarter of 2009 for capital assets related to building out this new Midwest consolidated distribution facility including racking, computer systems and other build-out costs. We have evaluated the capital assets in our two distribution centers in La Crosse and have determined that no impairment exists as of December 31, 2008. In the first half of 2009, we expect approximately $0.8 million in additional operating expenses related to our new Midwest distribution center.
OFF BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS We do not have any off-balance sheet financing arrangements, other than property operating leases that are disclosed in the contractual obligations table below and in our consolidated financial statements, nor do we have any transactions, arrangements or other relationships with any special purpose entities established by us, at our direction or for our benefit.
A summary of our contractual cash obligations at December 31, 2008 is as follows:

(In Thousands) Payments due by period Contractual Obligations Total 2009 2010 2011 2012 2013 Thereafter

Operating leases (1) $ 20,223 $ 2,227 $ 2,305 $ 2,106 $ 2,129 $ 2,151 $ 9,305

See Part I, Item 2 - Properties for a description of our leased facilities.

1) In June 2008, we signed a Single Tenant Industrial Lease to move from our La Crosse, Wisconsin distribution operation to a newly constructed, 380,000 square foot building in Indianapolis, Indiana. The monthly base rent on the lease is scheduled for 124 months beginning March 1, 2009. Additionally, in December, 2008, we signed a lease agreement for 3,600 square feet of office space in Copenhagen, Denmark as our sales, marketing and customer service headquarters for our European operations.

From time to time, we enter into purchase commitments with our suppliers under customary purchase order terms. Any significant losses implicit in these contracts would be recognized in accordance with generally accepted accounting principles. At December 31, 2008, no such losses existed.

We also have a commercial line of credit as described below, which is more fully described under the caption "Liquidity and Capital Resources":

    (In Thousands)
   Other Commercial   Maximum Amount
      Commitment        Committed      Outstanding at 12/31/08   Date of Expiration

    Line of credit       $30,000                 $-                June 30, 2009

We believe that our existing resources and anticipated cash flows from operations will be sufficient to satisfy our working capital needs for the foreseeable future.
CRITICAL ACCOUNTING ESTIMATES
Our significant accounting policies and estimates are summarized in our annual consolidated financial statements. Some of our accounting policies require management to exercise significant judgment in selecting the appropriate assumptions for calculating financial estimates. Such judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, known trends in our industry, terms of existing contracts and other information from outside sources, as appropriate.
Allowances for Doubtful Accounts, Cash Discounts and Non-Defective Returns:
According to our standard sales agreement, ownership of our products transfers to the customer when the product is delivered to a third-party carrier at one of our distribution facilities. Therefore, the amount of revenue recognized does not require a material level of judgment or subjectivity. However, significant judgment is required when determining the allowances for doubtful accounts, cash discounts, and non-defective returns, each of which reduces the amount of accounts receivable and operating income reported in the accompanying consolidated financial statements.
Our historical experience of write-offs of uncollectible accounts has been insignificant. However, based on our assessments of payment histories and current creditworthiness of our customers, we have recorded an allowance for doubtful accounts of $0.4 million at December 31, 2008 and $0.2 million at December 31, 2007.
In addition to an allowance for doubtful accounts, we maintain allowances for anticipated cash discounts to be taken by customers and for non-defective returns. Cash discounts are provided under certain customer service programs and are estimated based on available programs and historical usage rates. Reserves for non-defective returns are estimated based on historical rates of return. These combined reserves total $0.4 million at December 31, 2008 and $0.5 million at December 31, 2007.
Allowance for Slow-Moving Inventory: Provision for potentially slow-moving or excess inventories is made based on our analysis of inventory levels, future sales forecasts and current estimated market values. Actual customer requirements in any future periods are inherently uncertain and thus may differ from our estimates. These reserves total $0.4 million at both December 31, 2008 and 2007.
Product Warranty: We provide a limited warranty for the replacement of defective products for a specified time period after sale. We estimate the costs that may be incurred under our limited warranty and record a liability in the amount of such costs at the time product revenue is recognized. Factors that affect our warranty liability include the number of units sold and historical and anticipated future rates of warranty claims. We also utilize information received from customers to assist in determining the appropriate warranty accrual levels, which were $1.3 million and $0.9 million at December 31, 2008 and 2007, respectively.

Valuation of Long-Lived and Intangible Assets:
As a matter of policy, we review our major assets for impairment at least annually, and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our major long-lived and intangible assets are goodwill, and property and equipment. We depreciate our property and equipment over their estimated useful lives. In assessing the recoverability of our goodwill of $10.8 million and the investments we have made in property and equipment, we have analyzed our market capitalization together with assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective operating units or assets. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets not previously recorded.
Please refer to the "Risk Factors" in Part I, Item 1A for a discussion of factors that may have an effect on our ability to attain future levels of product sales and cash flows.
Pension and Other Postretirement Benefit Plans: The determination of our obligation and expense for pension and other postretirement benefits is dependent on our selection of certain assumptions used by actuaries in calculating such amounts. Those assumptions are described in Note 7, "Compensation and Benefit Agreements" to our annual consolidated financial statements and include, among others, the 6.25% discount rate and the 8.0% expected long-term rate of return on plan assets. Actual results that differ from our assumptions are accumulated and amortized over future periods and therefore, generally affect our recognized expense and recorded obligation in such future periods. While we believe that our assumptions are appropriate, significant differences in our actual experience or material changes in our assumptions may affect our pension and other postretirement obligations, our future expense and shareholders' equity. See "Quantitative and Qualitative Disclosures About Market Risk" in Item 7A in this annual report on Form 10-K for further sensitivity analysis regarding our estimated pension obligation. Deferred Tax Asset Valuation Allowance: Our deferred taxes are reduced by a valuation allowance when, in our opinion, we believe that it is more likely than not that some portion or all of the deferred tax assets will not be realized. The valuation allowance at December 31, 2008 and 2007 of $1.1 million and $1.0 million, respectively, is related to the state of Wisconsin net operating loss ("NOL") carryforwards, realization of which is dependent upon having taxable income in Wisconsin in future periods. Given our planned relocation of our Midwest distribution center during the second quarter of 2009, the remaining balance of the deferred taxes after such valuation allowance represents the portion of Wisconsin NOL's which management believes is more likely than not to be realized prior to the relocation.
We also have a deferred tax asset related to our European subsidiary losses incurred in 2008. Such NOL's have an indefinite carryforward. No valuation allowance has been provided as we believe that the future realization of this asset is more likely than not.
Stock-Based Compensation: We adopted the provisions of SFAS 123(R), Share-Based Payment on January 1, 2006. SFAS 123R requires companies to estimate the fair value of share-based awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense in our consolidated statements of income over the requisite service periods. Because share-based compensation expense is based on awards that are ultimately expected to vest, share-based compensation expense is reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
To calculate the share-based compensation expense under SFAS 123R, we use the Black-Scholes option-pricing model. Our determination of fair value of option-based awards on the date of grant is impacted by our stock price as well as assumptions regarding certain highly subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, the anticipated risk-free interest rate,

anticipated future dividend yields and the expected life of the options. The anticipated risk-free interest rate is based on a treasury instrument whose term is consistent with the expected life of the stock options granted. The expected volatility, life of options and dividend yield are based on historical experience.
Recently Issued Accounting Pronouncements In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations which replaces SFAS No. 141 and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51. SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS 141R and SFAS 160 are effective as of the beginning of an entity's fiscal year beginning after December 15, 2008.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 was effective for financial instruments for 2008 but had no impact on our financial statements presented herein. For nonfinancial instruments, SFAS 157 will be effective in 2009. In February 2007, the FASB issued SFAS No. 159, The Fair Value Option For Financial Assets and Financial Liabilities. SFAS 159 was effective for us in . . .