Danier Leather Research Report (September 26th, 2004)

RESEARCH REPORT KYLE D’SILVA SEPTEMBER 26TH, 2004 TABLE OF CONTENTS SUMMARY (pg 2) INDUSTRY (pg 3) COMPANY (pg 4) PERFORMANCE (pg 5) MANAGEMENT (pg 6) VALUATION (pg 7) RISKS (pg 8) RECOMMENDATION (pg 9) EXHIBITS (pg 10-11) BIBLIOGRAPHY (pg 12) FINANCIAL ANALYSIS (See “Danier Leather.xls”) -1- DANIER LEATHER RESEARCH REPORT

SUMMARY Danier Leather is a vertically integrated manufacturer, designer, and retailer of leather and suede apparel and accessories. In business since 1972, and publicly traded since 1998 (TSX: DL), Danier Leather is the dominant player in the niche Canadian leather apparel retail industry.1 The apparel retail industry is extremely competitive, and is broken up into firms that 1) sell low-quality, low priced products 2) higher-quality, mid-priced products, and 3) high-quality, fashion-oriented, high-priced products. Firms in the industry regularly engage in price warfare, and one of the few ways to earn excess returns is through differentiation product offerings, and bringing value to customers on through service and assistance. The industry suffers from sizeable buyer power, low barriers to entry, and competition originating from established bricks-and-mortar firms, as well as budding online stores. Danier Leather has differentiated itself from most competitors because of its strict focus on leather and suede products, and its unique ability to leverage its brand, create high quality products at a low cost, and to pass on those savings to customers through lower prices. With thin margins that can be volatile, Danier has not had much competition from strict leather retailers in Canada, as it possesses a dominant market share. However, as Danier is expanding into the United States, it will face stiffer competition, cross-border issues, and new competitive challenges. Danier’s main growth strategy has been through geographic growth, product line growth, and proliferation of distribution channels (power centers, corporate sales, website). We believe that this strategy will be highly successful for the most part, although we have reservations about some of the methods used for growth. The management team at Danier Leather has performed exceptionally well during the rough general economic and firm-specific climate of the past few years. Jeffrey Wortsman, the CEO, has steered the firm through disasters such as September 11th, BSE (mad cow disease), hoof-and-mouth disease, a three year recession, and a $15 million lawsuit.2 While these negative incidents occurred, Danier Leather management successfully created a high-margin accessories product line, a corporate sales division, the www.danier.com website, and invested in various operational efficiency technologies. While performance was clearly affected by adverse situations, Danier is now well positioned to benefit from its investments due to its astute management. Our few reservations regarding management involve ownership structure and management compensation. In our analysis of Danier Leather, we utilized various DCF models, and time-series and cross-sectional relative models. In summary, our valuation of Danier Leather produced a range of values from $8-$13, with most values falling in the $10-$12 range. The major risks for Danier Leather on a go-forward basis are: 1) The appeal failing, and the $15 million lawsuit having to be paid out to past shareholders. 2) The power centre growth strategy yielding sub-par results, and the international expansion leaving Danier over-extended in a competitive U.S. market. 3) Erroneous, misleading, or misinterpreted financial statements. 4) Off-balance sheet leverage adversely affecting the ability of Danier to continue as a going-concern. We believe that only the first two pose major realistic risks for Danier Leather, as they are tangible risks that have been taken, and are dependent on extrinsic factors. Our analysis of Danier Leather indicates that the business is fairly good, and poses few, if any, catastrophic risks, and is well positioned for future growth and prosperity. As well, the Danier Leather management team has proven their hardiness and ability to create value for the firm and its shareholders. However, the price of Danier Leather, which is trading in the $11-$12 range and yields about 2.1% currently, fully values the firm. With no margin of safety evident, we cannot rationally recommend a purchase of Danier Leather at this price. Assuming that our valuation of Danier Leather is close to fair value, we believe that a $7 share price will facilitate a purchase of a decent business at a bargain price. 1 Danier Leather 2004 Annual Information Form 2 Danier Leather 2002-2004 Annual Reports -2- DANIER LEATHER RESEARCH REPORT

INDUSTRY The North American retail industry is one of the most competitive industries across the globe. The retail apparel industry is particularly difficult, as there is much internal competition amongst industry players, as well as much pressure from outside forces. In addition, the apparel industry, while fairly inelastic in nature, ebbs and flows with the business cycle, as consumers spend more on discretionary clothing items when credit is easy and times are good, and reigning back on spending when a recession is looming. A brief Porter’s Five Forces will elicit valuable information: Competitors – Competition in the retail/apparel industry is extremely fierce, with price competition being the main weapon of choice. With globalization, China, India, Bangladesh, and other cheap-labour nations are able to produce and export items at a fraction of the North American cost, thereby leading to massive amounts of cheap clothing being sold in the North American market. As well, during critical times during the year such as Christmas, back-to-school, and summer, competitors engage in price cutting in order to move products. In essence, they must price-cut in order to eliminate inventory that is not moving. Danier is fortunate in that it only has one major competitor across North America: Wilson’s Leather, which operates 453 stores throughout the U.S., and has been consistently unprofitable for the last three years.3 Threat of New Entrants – Entry into the retail industry is fairly simple and does not require many resources. Retail space can be leased, and outlets can be franchised fairly quickly, which can lead to quick expansion if ideas are successful. As well, inventory can be purchased and created in a matter of months; with turn-around times decreasing as new knowledge is gained about the customer base and operations. Both new and established entrants have also been able enter the industry rapidly through the internet, and have been able to gain scale and additional sales. However, as the leather retail industry is very specialized, the threat of entry is not as great at the general apparel industry. Substitutes – The apparel industry scores well on this measure, as clothing is a necessity. However, the further up the price/fashion chain a company goes, the lower the switching costs and power the company wields with consumers. While substitute products are simply not available for the apparel industry, the breadth of the market and the low barriers to entry ensure that major competition will always be present. Specifically, the leather apparel industry faces substitute apparel products, including denim, wool, cotton, suede, silk, and various outer-wear materials and products. Suppliers – The apparel industry is largely supplied by low-cost firms from foreign countries. There are many choices of suppliers, and few switching costs between suppliers for textile products, as most textile suppliers produce an undifferentiated product that adds little value. Specialty products, such as leather, suede, etc, are faced with the risk of a higher volatility in input prices because of a smaller demand from consumers, and a supply base that has been affected by such things as mad-cow disease, hoof-and-mouth disease, and global beef consumption trends. Buyers – Purchasers of apparel have a wide range of options in terms of quality, price, style, channel, etc. With so many options to choose from, buyers command a great deal of power, and can make or break the fortunes of an apparel company. In addition, buyers indirectly have power because of the business cycle, which gives them discretionary funds at times, and takes discretionary funds away at other times. Overall, Danier Leather is in an industry that is structurally unattractive, mainly due to buyer power, immense competitive pressures, and a constant threat of new entrants. With these drawbacks in mind, success in the retail industry demands a differentiated product line that allows for higher margins, or a low cost product line that allows for high inventory and asset turnover, resulting in better utilization of assets. Danier Leather has been able to achieve both through differentiating itself throughout the value chain, which has enabled it to compete effectively in a structurally unattractive industry. What sets Danier Leather apart from direct and indirect competitors in the apparel industry is their ability to control the value chain, all the way from procurement, to operations, to marketing and sales. With a hawk-like focus on every aspect of the value-chain, Danier Leather has invested in and pro-actively shaped it, which has resulted in efficient operations, excellent human resource management, and above-all, incredible product quality and delivery. Now we will briefly look at Danier Leather as a firm, and analyze aspects of its operations. 3 Wilson Leather’s 2003 Annual Report -3- DANIER LEATHER RESEARCH REPORT

COMPANY Danier Leather is a unique retail apparel firm in that it is a vertically integrated designer, manufacturer and retailer of high-quality and moderately priced leather and suede clothing and accessories for fashion conscious individuals in the 18-55 demographic group.4 As such, Danier is one of only two publicly traded firms in the leather apparel industry in North America, and the dominant player in a fragmented industry in Canada. Danier is experienced in every aspect of the creation and distribution of leather apparel, which is attractive given the few players in the industry, and the ability of the firm to capitalize on positive industry trends. Below, is a quick summary of the important aspects of the firm. Procurement – Danier’s procurement methods are top notch, as they use relationship management with hide suppliers, and counter-cyclical buying opportunities in the leather market to lower their input prices. As well, they have shown opportunistic purchases in the last few years with the onslaught of BSE (Mad Cow Disease), and Hoof-and-Mouth disease.5 Operations – Danier runs extremely efficient operations, which has been the result of ongoing capital expenditure programs. Especially over the last three years, Danier has shown their adeptness by generating positive cash flow through liquidating inventories, and in the last year, extracting just under $7 million from working capital. This positive trend may alter in the future if sales increase markedly, but with sales leveling off, this may be expected to continue, or more realistically, stabilize. As well, with quick turn-around times, Danier is able to supply greater amounts of “in-demand” products wherever and whenever necessary. Product Line – Danier has a line of traditional leather apparel, a high-end collection of leather apparel, a line of complimentary clothing, and a line of leather accessories. With a focus on promoting existing product lines, Danier has also been successful at creating new product lines, and re-inventing existing product lines with its staff of fashion designers. This has been a core reason for their success, as fashion is the main reason for existence. Distribution Channels – The firm originally began with street-front and mall stores, but after its IPO it moved into power centers, and more recently opened an online store. In addition, Danier has created a Corporate Sales division. With many distribution channels and the creation of new marketing opportunities, Danier is well positioned to create different purchasing opportunities for shoppers. Technology – Danier has invested in keeping up-to-date technology wise, which has allowed them to receive real-time sales information from retail channels, which in turn has allowed them to lower lead- times for popular products. In addition, investments in high-tech leather cutting and sewing machinery has reduced waste, and made production easier. Intangibles – Simply put, Danier controls one of the strongest brand names in leather apparel. Danier has increased the value of this asset with placements in various fashion events and venues such as The Academy Awards, The Grammy Awards, and The Juno Awards. On a go-forward basis, Danier continues to invest to achieve a wider dissemination and recognition of its brand name. Having illuminated the important characteristics of the firm, Danier’s main business strategy is to grow internationally, grow its product line through accessory sales, increase the number of power centre locations, and grow the corporate sales division. As with any growth strategy, Danier’s strategy is increasingly capital intensive, involving investments in operations, inventory, human resources, leasehold improvements, etc. We believe that senior management has a viable long-term strategy in place, except for the planned increase in the number of power center locations, which will be explained in the coming pages. Overall, Danier’s ability to mix high-fashion, moderate price, and unique product offering, makes it a niche player in it’s industry, and this is one of the features of the firm’s strategy that ensures future demand and customer retention. Finally, the holy-grail of every company is the creation and maintenance of a sustainable competitive advantage. While Danier’s position cannot be characterized as impenetrable, it is indeed extremely strong. Danier Leather covers many angles of the leather apparel industry, including various demographic groups, sales channels, and product lines, and its relative competitive advantage is the fact that it is completely vertically integrated, which gives it strength over most of its direct and indirect competitors. 4 Danier Leather 2004 Annual Report 5 Danier Leather 2001 Annual Report -4- DANIER LEATHER RESEARCH REPORT

PERFORMANCE Since it’s IPO, Danier Leather’s business and financial performance has been fairly steady, although performance over the last three fiscal years has waned. In particular, there has been a small growth in sales, decreased earnings, yet high cash flows. Below is a quick summary of performance variables. Please see Exhibits 1-3 for relevant financial variables. Sales – Over the past eight years, sales have grown at a CAGR of 12.4%, and over the past three years sales have grown at a CAGR of 2.5%, which indicates the slowing growth rate of the business. This slow growth is due to the recession seen over the past few years, as well as management’s decision to open mall and power centres at a slower rate. In 2005, management plans to open one power centre and one mall store in the U.S., and as well as renovations on nine stores, which should presumably increase sales. Going forward, we expect a similarly low growth rate due to management’s slow growth plans.6 Earnings – Net earnings for the firm has grown at a CAGR of 20.91% over the past eight years if the litigation charge is excluded, and 16.7% if the litigation charge is included. This figure is impressive, and show’s Danier’s long-term earnings ability, although earnings for the past three years have decreased substantially. We believe that this is only temporary, as Danier would have earned approximately $8.3 million in FY 2004, compared to $8.1 million in FY 2003, if litigation expenses and charges were deducted, which is stable at the very least.7 Return on Equity – ROE has averaged 14% over the past seven years, which is an indication of the ability of the assets to produce satisfactory earnings on the equity base. This ROE exceeds the average North American ROE of 11%-13% over long periods of time. Return on Invested Capital – After-tax ROIC for the past seven years has averaged 23.98%, which is indicative of the cash flow generating power of the assets of Danier Leather. This measure does not include change in net-working capital, which has had significant effects on free cash flows in the past. In general, cash has been consumed by operations (through working capital), but in the past year significant investments in information technology and time and waste-saving machinery has actually allowed Danier to pull $7 million out of working capital. We believe that the new technology will enable Danier to remain efficient, and because sales are projected to grow slowly, we believe that limited (if any) funds will be added to working capital.8 Book Value – Book value per share has grown at a CAGR of 13.3% over the last seven years, which includes the adverse effects of litigation expenses and charges. We expect this rate to decline slightly in the future as the capital base becomes larger, although with expansion possibilities in the U.S., earnings could add significant amounts to equity, and if the share price drops below book value in a meaningful way, management may activate the share buy-back program, and increase book value per share at a faster rate than in the past. Cash Flow – Cash flow from operations has increased at a CAGR of 132% since the IPO in 1998, and net cash inflow has been positive, albeit decreasing over the past three years. As mentioned previously cash flow from operations has grown by leaps and bounds, which is indicative of management’s ability to manage the business to create value. As well, cash flow from investing has been positive for the last three years, without diluting shareholder’s equity materially, and without leveraging the balance sheet. Finally, cash flow from financing has been the main drain on cash for the past eight years, as management has lead the company through a dramatic growth phase, increasing the number of stores from 43 in 1995 to 98 in 2004, and soon to be 100 in 2005. For FY 2005, management has planned $6.4 million in capital expenditures, mainly for maintenance, renovations, and technology, but also to acquire two more locations for the expansion project in the United States. On a go-forward basis, we expect similar amounts of capital expenditures, as management is seemingly focused on slow growth, but more efficient management of growth.9 In summary, Danier Leather’s financial performance has been solid, yet has been on the decline for the last three fiscal years. We believe that this is temporary in nature, and the business will pick up once many of the pressures facing it abate. 6 Danier Leather 2004 Annual Report 7 Danier Leather 2004 Annual Report 8 Danier Leather 2004 Annual Report 9 Danier Leather 2004 Annual Report -5- DANIER LEATHER RESEARCH REPORT

MANAGEMENT Danier Leather’s senior management has put forth tremendous efforts in growing the business and creating shareholder value, although there are a few concerns we have. Below, we will discuss positives and negatives of management. Composition of the Board of Directors - The eight directors of Danier Leather appear to be quite accomplished in business, however our main issue is that the directors appear to either have 1) no retail experience, 2) retail experience but limited retail apparel experience, or 3) retail apparel experience. The majority of the board members fall into the 2nd category, which is not entirely worrisome, but enough to question whether or not they have the industry-specific know-how to bring value to Danier Leather. We would venture to say that their variety of business experiences balance out and bring value, albeit, probably not directly, and probably not the optimal amount. Leadership – Jeffrey Wortsman has guided the firm through thick and thin, and despite the recent slow down in the business, new product lines, new sales channels, increased efficiencies, and better corporate governance have been created and implemented. The overall leadership of the firm has been excellent, and we see this continuing as long as Mr. Wortsman is actively involved with the company. Management / Performance – Danier has been through many trying times in recent years, including September 11th, BSE, a large lawsuit, and a three year recession. The end result has been a decrease in sales and profits over the past two years, but we believe that this is a result of several unfortunate circumstances, including but not limited to a business that has elastic demand for its products. In general, once most of these problems are alleviated, the business should return to higher profitability. Objectivity – One of our issues with the management of the firm is that it tends to be overly optimistic with regards to the outcome of all business decisions. We understand that this is quite normal for any firm, however, our one reservation is that management might be “sugar-coating” the future prospects and past performance of the firm. From our analysis of past history and actual results and initiatives, we have no reason to believe that management is being deceitful with shareholders, and on the contrary, we believe they are quite open about issues regarding the firm (see litigation). However, we would like to see greater emphasis on truly important performance criteria (i.e. – ROIC, ROE, FCF), greater disclosure and emphasis on certain internal aspects of the firm (i.e. – leases, accounting information and disclosures). Ownership – One of our biggest concerns with the firm is the dual-class share structure. As of the 2004 fiscal year end, management owned 18.29% of the firm, yet they controlled (primarily through Mr. Wortsman’s ownership of the 1 224 329 multiple voting shares) 68.41% of the firm. We realize that this is to maintain control over the firm, however, we believe that if Mr. Wortsman wishes to participate in the economic progress of the firm, it should be on equal footing with the subordinate voting common stock holders of the firm. Despite this drawback, we do believe that Mr. Wortsman is pro-shareholder as the Board of Directors has recently instituted a coat-tail agreement whereby the minority shareholders cannot be “side-stepped” when it comes to the transfer of ownership through M&A activity (in general). This is definitely a positive action, and characterizes the true intent of Mr. Wortsman. Compensation – Compensation for management, while not overtly conservative, appears to be reasonable given firm size. Growth in base compensation for the management team is around 3-4% on average for the last three fiscal years. Bonuses have averaged 10-15% of base salary for the past 3 years. On occasion bonuses have been paid when firm performance has decreased, which is questionable. All other compensation is reasonable, although there are a few occasions where management seems to be on the receiving end of various perks, such as memberships, forgiveness of loans, etc. Finally, options have been awarded in the past, which has diluted shareholder’s stakes, and we are skeptical of why management is receiving options when they already have such a large controlling stake. Director compensation is reasonable given the level of talent it has attracted and retained. Overall, compensation appears to be sensible, especially when compared to the excessive executive compensation that has occurred in the past few years. In general, management of Danier Leather has been superb through the troubling times in the recent past. Our issues with Danier’s management and board of directors, while not entirely serious in nature, do give us cause for concern, as many things appear to be weighted in favour of the controlling shareholder, Mr. Wortsman.10 10 All Information on this page has been taken from the Danier Leather 2004 Management Information Circular. -6- DANIER LEATHER RESEARCH REPORT

VALUATION In conducting our valuation of Danier Leather, we utilized discounted cash flow and comparable measures of valuation, as these are the most relevant valuation methodologies, given a going-concern assumption. We did look at liquidation value, although the relevance of this valuation metric was discounted heavily for obvious reasons. Below, you will find a histogram and chart which summarizes the sixteen different estimates of intrinsic value that we developed. Most were developed utilizing discounted cash flow, which involved various estimates of future cash flows, time periods, and discount rates. Some estimates of intrinsic value were developed using time-series comparable valuation, general industry cross-sectional valuation, and direct competitor cross- sectional valuations. Our valuation methodologies were initiated with conservatism in mind, given the business risk that is apparent in Danier Leather’s business model (volatility in ROIC and FCFE)11. Financial risk is limited due to the lack of on-balance sheet debt, although Danier is leveraged through its off-balance sheet leases. Our numerous valuations produced per share values of approximately $8-$13, with a few outliers. We believe that a mid-range value of approximately $10-12 is conservative, and reflects full value of the underlying business, and most peripheral non-business related assets. If additional information is needed, please refer to the Excel file for detailed information on valuations, and other pertinent information. Relative Frequency of Danier Leather's Intrinsic Value Estimations 30.00% 25.00% 20.00% 15.00% Relative Frequency 10.00% 5.00% 0.00% 6-7 7-8 8-9 9-10 10-11 11-12 12-13 13-14 Relative Frequency (# in $ range) DANIER LEATHER VALUE SUMMARY DCF DCF 1 $ 9.26 DCF 2 $ 11.72 DCF 3 $ 8.20 DCF 4 $ 10.63 DCF 5 $ 8.13 DCF 6 $ 10.20 DCF 7 $ 8.04 DCF 8 $ 11.35 DCF 9 $ 6.56 DCF 10 $ 7.38 Relative Book Value $ 8.83 P/BV of Industry $ 25.60 Avg Industry P/E x Avg 7 Year Earnings $ 13.74 Avg Industry P/EBIT x Avg 7 Year EBIT $ 7.83 Avg Industry P/S x 2004 Sales $ 16.70 Avg Industry P/S x Avg 7 Year Sales $ 13.84 11 ROIC = Return on Invested Capital, FCFE = Free Cash Flow to Equity -7- DANIER LEATHER RESEARCH REPORT

RISKS As listed in the annual report, Danier Leather faces several risks, including, but not limited to: Fashion and apparel and leather industry risks, consumer shopping patterns, seasonality, competition, risks of growth strategy, foreign sourcing and manufacturing, management information systems, senior management, foreign currency, inflation, weather, war and acts of terrorism, SARS, legal proceedings, etc.12 We believe that there are several additional risks which must be discussed. In no specific order, they are: Legal Proceedings – A lawsuit was brought against Danier Leather regarding the estimates that management published pre-IPO, which the plaintiffs believe altered their view of what the true value of the stock was. Recently, on May 7th, 2004, the judge presiding over the case granted the difference between the IPO price and the sale price for shareholders who sold between June 4th and 9th 1998, and $2.35 per share in cash to all plaintiffs who sold the stock after June 9th 1998, or who still hold it. Although the judge ruled in favor of the plaintiffs, Danier is pursuing an appeal. However, at this point in time, Danier recognized $15 million at FYE 2004 in recognition of this liability. $10 million is for actual payments, and $5 million for an estimated amount of interest. If Danier loses the appeal, this amount must be paid out, and could materially alter Danier’s operations, given its total asset base of $90 million. Conservatism is warranted, and we view the fact that Danier lost the trial as an indication that there was just cause for the case, and that the $15 million will eventually have to be paid out. Danier’s management has issued a statement declaring that the law utilized was highly controversial and that they have a strong basis for appeal, so the result of the appeal is murky at best.13 Growth Strategy - As noted earlier, Danier’s business strategy is expansion through four main methods. We believe that Danier is making a mistake when it comes to the utilization of power centres as a sales and distribution channel. Exhibits 1-2 show the “% of total retail square footage” contributed from power centres and mall stores, as well as “the % of total retail sales per square foot” contributed from power centres and mall stores. You will notice that as the “% of retail square footage” attributed to power centres increases, the “% of sales per square foot” attributed to power centres decreases. Combined with the fact that power centres are expensive to establish (high capital expenditures), and contribute low-margin sales to the firm, we believe that management is misguided in this method of expansion. Resources continue to be utilized in this fashion, and thus this method of expansion poses a major risk, as free cash flows from this aspect of the operation will be exceedingly low (relative to resources) in the future. Financial Statements – The audited financial statements provided by Danier Leather seem to be satisfactory. Although, the financial statements are not terribly detailed, and do not contain as much information as we would like, the financial statements have given us the ability to properly value the firm. One change that has affected the recording of accounting information is options expense, which is buried in SG&A.14 This has resulted in a decreasing operating margin. The fact that Danier has not undergone any major accounting changes is positive. However, the fact that the information provided is limited (i.e. – no break down of product line, SG&A, etc), may be negative or neutral. We believe that Danier is fairly conservative and truthful in their presentation of accounting information, and therefore are confident in our estimates of firm value. However, there is risk that the information is erroneous, misleading, or wrongly interpreted by us. Financial Risk – On the surface, it appears as though Danier is completely un-leveraged, however, when off-balance sheet financing is taken into consideration, Danier is under-writing large financial risks. In the past few years, Danier’s Debt (including operating leases)-To-Equity ratio has hovered around the 70% mark, which is a drastic increase from the 0% Debt-To-Equity ratio derived using standard on- balance sheet information. With recessions, litigation payments, and other negative business occurrences, Danier may be adversely affected if lease payments cannot be made.15 12 Danier Leather 2004 Annual Report 13 Danier Leather 2004 Management Information Circular 14 SG&A = Selling & General Administrative Expenses 15 Danier Leather 1998-2004 Annual Reports -8- DANIER LEATHER RESEARCH REPORT

RECOMMENDATION Our view of the attractiveness of Danier Leather, as in all publicly traded firms, is in the context of three qualitative and quantitative variables: 1. The Business & Industry 2. The Management Team 3. Price / Value Considerations Danier Leather is undoubtedly a high quality business. As a dominant niche player in a highly fragmented industry, Danier creates value for it’s customers through high-quality and moderately-priced items. In addition, growth has occurred through numerous sales channels, product lines, demographic expansion, and geographic expansion. Despite the problems of the last few years, we believe that the business is still attractive and has untapped potential. In short, Danier, as a business, has many of the bases covered which are necessary for success. The management team at Danier leather is top-quality for the most part. There are few qualms we have with the management team, the largest of them being ownership structure and compensation. Generally, the former is adequate given the new coat-tail agreement and a history of good shareholder relations (excluding the lawsuit), and the latter is satisfactory given historical performance and the relative compensation of other industry management teams, as well as general business management teams. In summary, we are generally satisfied with corporate performance given the difficulties in the business over the last few years, and are satisfied with the performance of the managers. In spite of the above-mentioned positive factors, with Danier Leather trading in the $11-$12 range currently, we feel that the business is fully valued, and therefore is not an attractive investment. With our estimate of fair value in the $8-$13 range, and the majority of our estimates in the $10-$12 range, Danier Leather, holding the quality of the business and the management team constant, will become attractive only in the $7 or below range. While this is far from the current price, a margin of safety is necessary given the potentially volatile nature of the business and industry. In addition, if the liability arising out of the lawsuit is factored out of the FYE 2004 financial statements, Danier Leather would have earned approximately $1.10 per fully diluted share (defined as shares outstanding plus options outstanding), which at current prices, gives it a P/E of 10.3. While this is on the low-end of most business, and in relation to North American markets, it is not a screaming bargain. We have no strong convictions regarding the future of the leather apparel business, and therefore cannot hazard an outlook over the short-term or long-term. We believe that all aspects of the history of the business are valid indicators of the future, and management signals their intentions and beliefs about what is likely to come. As such, we believe that prospects are adequate for Danier Leather, as they have new sales channels, promising products, and U.S. and international expansion opportunities. The recent slow down in growth in the number of stores indicates that the management team is either more cautious of growth, or is more focused on optimizing current operations while growing slowly. What should be noted is the marked increase in ERCF/Equity, as shown in Exhibit 3.16 This percentage indicates that Danier Leather is creating tremendous amounts of FCFE. Although net profit margin and after-tax ROIC have been moving in a downward trend over the last few years, this is the result of adverse circumstances, and should revert once the economic environment becomes more favorable for Danier. Finally, although SG&A has been increasing over the last few years, we believe that this is the result of Danier having to expense the fair-value of the options it has been granting, which is a peripheral matter.17 As well, Danier Leather’s Board of Directors recently initiated a $.06 quarterly dividend, which at current prices yields approximately 2.10% annually, and signals that management believes in the stability of future cash flows. Absent contradictory information, we side with management, and believe that this further cements Danier Leather’s pro-shareholder stance. With regards to catalysts, the recent coat-tail agreement instituted might be a signal that Danier Leather could be the subject of a negotiated take-over, or a management buyout. After reviewing the Annual Information Form, we believe that this was likely instituted either at the request of, or because of Howson Tatersall Investment Counsel Limited, a prominent Toronto based value-investment firm. The investment firm owns 19.8% of the outstanding shares of Danier Leather, and we believe that this fact prompted management to institute the coat- tail agreement, or was proposed by the investment firm itself. We view a hostile or friendly take-over as unlikely, and cannot perceive any major catalysts coming forth in the near future, although anything and everything is possible. 16 ERCF/Equity = Equity Residual Cash Flows / Equity -9- DANIER LEATHER RESEARCH REPORT

EXHIBITS EXHIBIT 1 This graph shows the growth in the contribution of retail space from both the shopping mall stores and the power centres. % of Total Re tail Square Footage 80.00% 70.00% 60.00% 50.00% Shopping Mall / Street-Front % 40.00% Power Centre 30.00% 20.00% 10.00% 0.00% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Year EXHIBIT 2 This graph displays the deterioration in the amount of sales per square foot contributed by the power centre, and the increasing importance of the amount of sales per square foot contributed by the shopping mall. % of Re tail Sale s Pe r Square Foot 80.00% 70.00% 60.00% Shopping Mall 50.00% / Street-Front % 40.00% Power Centre 30.00% 20.00% 10.00% 0.00% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Year - 10 - DANIER LEATHER RESEARCH REPORT

EXHIBIT 3 This graph shows the progression of numerous financial statistics. a. Net Profit Margin – This variable increases from 1997 to 1998, but tapers off, and turns negative for the last three years. This is due to September 11th, BSE, and the recession in the economy. b. A/T ROIC – This displays the return to all capital holders, and like Net Profit Margin, is decreasing over time. We believe that this variable will turn positive in the near future, as the past two years were affected by litigation charges which affected earnings. c. FCF From Operations / Invested Capital – Increases dramatically after 1999 due to higher generation of operating cash flow, slower growth, which translated into lower investing cash outflows, and very little financing cash inflows or outflows. d. ERCF / Equity – Same trend as c) due to the absence of debt in the capital structure. e. SG&A / Revenue – For the first six years of it’s existence, the firm’s SG&A / Revenue percentage was stable at around 40%, but then began an uptrend towards approximately 45% in 2004, and this is due to 1) the expensing of stock options, 2) an increase in the compensation of management, and 3) an increasing number of employees. This is also due to the compression of revenue growth, and total revenue in general. Various Financial Statistics 50.00% 40.00% Net Profit Margin 30.00% 20.00% A/T ROIC (Gross CF) 10.00% % FCF From Operations / 0.00% Invested Capital -10.00% 1997 1998 1999 2000 2001 2002 2003 2004 ERCF / Equity -20.00% -30.00% SG&A / Revenue -40.00% -50.00% Year - 11 - DANIER LEATHER RESEARCH REPORT

BIBLIOGRAPHY 1. Danier Leather website, www.danier.com 2. Danier Leather Annual Reports, 1998-2004. 3. Danier Leather Management Information Circular, 2004. 4. Danier Leather Annual Information Form, 2004. 5. Various filings with the Ontario Securities Commission, taken from www.edgar.com 6. Wilson Leather Annual Report, 2003. 7. Yahoo Finance, http://finance.yahoo.com/?u 8. Big Charts, http://bigcharts.marketwatch.com/avatar.asp - 12 - DANIER LEATHER RESEARCH REPORT

Danier Leather Research Report (September 26th, 2004)

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Danier Leather Research Report (September 26th, 2004) — Document Transcript