Comparable store sales increase/(decrease) (11%) (6%) (4%) (8%) 1%

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1 ANNUAL REPORT 2006

2 FINANCIAL HIGHLIGHTS (in thousands of dollars, except earnings per share and shares outstanding) Sales 148, , , , ,704 Gross Profit 71,398 83,487 86,528 85,275 86,776 Earnings loss before income tax, restructuring costs and litigation provision (6,953) 6,612 8,734 12,904 19,018 Adjusted EBITDA (1) (1,159) 12,488 14,487 18,730 24,388 Net Earnings (loss) (5,503) (185) (7,097) 5,394 10,725 Earnings Per Share Basic (0.84) (0.03) (1.03) Diluted (0.84) (0.03) (1.03) Shares Outstanding at year-end 6,553,254 6,546,154 6,944,554 6,919,554 6,908,204 Selected Balance Sheet Data Cash 11,833 21,193 22,576 7,081 3,581 Working Capital 36,380 44,285 44,202 36,873 33,602 Total Assets 82,210 83,365 89,869 81,487 75,695 Long-term Debt 1,829 nil nil nil nil Shareholders Equity 47,956 54,937 61,287 67,994 62,522 (1)See section entitled MD&A Non-GAAP Measures SELECTED FINANCIAL INFORMATION Comparable store sales increase/(decrease) (11%) (6%) (4%) (8%) 1% Sales ($000) Shopping Mall/Street-Front/Direct Sales $ 72,397 $ 81,280 $ 83,283 $ 79,720 $ 84,592 Power Centre 75,954 85,070 91,987 93,103 93,112 Total $ 148,351 $ 166,350 $ 175,270 $ 172,823 $ 177,704 Retail square footage Shopping Mall/Street-Front 115, , , , ,755 Power Centre 260, , , , ,672 Total 375, , , , ,427 Number of stores Shopping Mall/Street-Front Power Centre Total

3 TABLE OF CONTENTS 3 Letter to Shareholders 5 Review of Operations 9 Management s Discussion and Analysis 28 Management s Responsibility for Financial Statements 28 Auditors Report to Shareholders 29 Consolidated Financial Statements 32 Notes to Consolidated Financial Statements 44 Board of Directors

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5 LETTER TO SHAREHOLDERS Fiscal 2006 resulted in poor performance at Danier. Revenues stood at $148.4 million compared with $166.4 million in fiscal 2005, a decrease of 11%. With revenues $18 million lower, Danier posted a loss of $5.5 million for the year, compared with a loss of $185,000 in fiscal Poor results can create a sobering wake-up call and we came to realize many of the errors of our ways during fiscal I believe what got us here was a loss of focus on our customer because over the past few years we were trying to be everything to everyone. The saving grace is that we have a loyal following of customers who still believe in the brand. Our job is to focus on and to satisfy our customers needs. We have already begun to implement changes that we believe will turn results around. The Danier customer is looking for timeless and sophisticated merchandise at remarkable value. This focus makes decisions on what to make for our customers much easier. More importantly it provides better guidance on what not to make. Similarly, focus on our customer allows us to communicate to them in a more relevant way. No more should we hear statements such as 'that's for my daughter, not for me. Focused marketing can have a powerful impact on the business. Furthermore, the investments we continue to make in information systems for improved forecasting, allocations, replenishment and redistribution of merchandise will yield improved merchandise delivery and presentation performance. Making sure the right merchandise is in the right store at the right time and presented in a way that our customers relate to will make a clear merchandise statement to our customer and allow us to live up to our potential. With respect to retail distribution channels we believe that we need to separate the offering between malls and power centre outlets to better meet the needs of customers shopping those channels. In addition, we have been able to institute cost reduction measures aimed at streamlining our performance and improving the bottom line. We remain committed to providing superior returns for the company and for shareholders. I want to express my sincere thanks to our 1,200 employees for their commitment to Danier and their hard work throughout the year and together we look forward to providing better results to you in fiscal Jeffrey Wortsman President and CEO July 26, 2006 DANIER ANNUAL REPORT

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7 REVIEW OF OPERATIONS Danier owns and operates 95 stores in Canada, making us the leading specialty leather retailer in the country and among the largest in the world. The company operates 55 shopping mall and street front stores and 40 larger format stores located in power centres. Danier also sells its merchandise directly to corporate clients through its Corporate Sales Division. THE DANIER BRAND The Danier brand strongly resonates with consumers as a top-of-mind choice for those in search of leather and suede items. The Danier brand represents an aspirational lifestyle choice, because Danier delivers the brand promise of timeless leather sophistication at remarkable value. To reinforce our brand and deliver improved performance, we are continuing our work to align all elements of what we offer to serve our target consumer and meet our brand promise. FOCUS ON THE CUSTOMER Danier s most important relationship is with our core customers, who are sophisticated consumers looking for quality and style at great value. To better meet our customer needs, we are making changes to how we communicate to our customers to emphasize that Danier outerwear products can be associated with both warmth and style without any trade-off. In addition, we are revising product lines and accessories to ensure that we do not detract from our core outerwear offering that our customer is seeking. FOCUS ON MERCHANDISE In the recent past, we broadened our reach and appeal to try and capture a broader market and target a future customer base. We have realized that our core customers were not being properly served through this strategy. To bring these customers back, our efforts will be narrowed to our core strengths in outerwear and accessories. Furthermore, we are ensuring that our procurement process begins earlier in the season to buy the best available leather at competitive prices. This strategy, when effectively executed, will ensure that we have the best quality leather available and can offer our products at remarkable value. In addition, we are heightening our inventory management systems to provide for early warning when items need to be replenished so that they are available to meet customer demand. This approach will ensure that we have the right product, in the right store, at the right time. FOCUSING ON MARKETING One of Danier s most important assets is its solid brand identity an identity that must be supported proactively. We have made investments in building the brand over the past few years and we are leveraging that investment to increase store traffic and sales. The store continues to be the quintessential expression of the Danier brand. We are enhancing the customer experience at store level by revising our store layouts to ensure products are available on the floor, promote a better music system for shopping enjoyment, and ensure that our windows and signage are inviting to potential customers. DANIER ANNUAL REPORT

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9 The look and feel of our marketing communications will better reflect the identity and aspirations of our core customers. This will ensure that we have a consistent voice in our stores, signage, brochures, web presence and promotional flyers. In addition, we have continued to advance our customer relationship management capabilities to deliver effective and targeted electronic communications which, can be achieved at a fraction of the cost of traditional mass advertising methods. Furthermore, we are set to relaunch our Prestige customer loyalty program. This program will offer special events and promotions to select VIP customers, who are among our most influential brand ambassadors. ACCESSORIES GROWTH CONTINUES BUT OUTERWEAR SUCCESS IS KEY Danier has been expanding its accessory business over the past several years and now offers a range of products, from belts to purses to photo albums. In 1998, accessories accounted for 4% of total company revenue; in 2006, accessories represented 20% of the company s total revenue. While the accessories business is an important diversification of our revenue stream, it needs to be emphasized that outerwear represents 60% of sales. Furthermore, outerwear is the first purchase made by 65% of our customers. Clearly, a strong outerwear business is crucial to the company s success and ability to attract a new generation of customers. OPERATIONAL IMPROVEMENTS In fiscal 2006, Danier made a significant investment in its Information Technology systems and has completed the replacement of Danier s point-of-sale (POS) system. This investment will reduce the time it takes to process a transaction while working compatibly with our customer relationship manager system (CRM) to allow Danier to tailor offerings directly to individual customers. This marks the first major upgrade in several years and is the largest capital expenditure for the year. Upgrading now makes sense given recent advances in POS technology. Two new locations a shopping mall store at the Niagara Fallsview Casino and a power centre location at the Sunridge Mall in Calgary were opened during fiscal In the last half of the year, two underperforming shopping mall stores whose leases expired were closed. Danier does not plan to open any new stores in Fiscal Store closures in the coming year include one street-front store location and three underperforming power centre locations. These measures demonstrate our consistent approach to make appropriate real estate choices and ensure that we have the best footprint in key markets to best serve our customers. Danier continues to focus on creating shareholder value. There is a positive appetite for change at Danier. Company management understands that we must look forward but also remember our past as we return to the practices that made our company Canada s largest specialty leather goods retailer. DANIER ANNUAL REPORT

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11 MANAGEMENT S DISCUSSION AND ANALYSIS As at July 26, 2006 The following Management s Discussion and Analysis ( MD&A ) is based upon and should be read in conjunction with Danier Leather Inc. s ("Danier" or the "Company") consolidated financial statements and notes thereto for the 52-week periods ended June 24, 2006 and June 25, The consolidated financial statements and notes were prepared in accordance with Canadian generally accepted accounting principles ( GAAP ) and are reported in Canadian dollars. In the discussion that follows, 2006 refers to the 52-week period ended June 24, 2006 and 2005 refers to the 52 week period ended June 25, DANIER ANNUAL REPORT

12 FORWARD LOOKING STATEMENTS This Annual Report, including this MD&A, contains forward-looking statements which reflect the current view of Danier with respect to the Company s objectives, plans, goals, strategies, future growth, results of operations, financial and operating performance and business prospects and opportunities. Wherever used, the words "may", "will", "anticipate", "intend", "expect", "plan", "believe" and similar expressions identify forwardlooking statements. Forward-looking statements should not be read as guarantees of future performance or results, and will not necessarily be accurate indications of whether, or the times at which, such performance or results will be achieved. All of the statements in this Annual Report containing forward-looking information are qualified by these cautionary statements. Forward-looking statements are based on information available at the time they are made, underlying assumptions made by management and management s good faith belief with respect to future events, and are subject to inherent risks and uncertainties surrounding future expectations generally. Such risks and uncertainties include, but are not limited to, fashion and apparel and leather industry risks that can affect demand for the Company s products and inventory markdowns, change in consumer shopping patterns away from shopping malls and power centres, unseasonably hot weather or severe weather that prevents customers from going to the Company s stores, seasonality, heightened competition including new competitors and expansion of current competitors, foreign currency fluctuations which result in increased costs, leather availability and prices, risks associated with foreign sourcing and manufacturing, existing and potential class action legal proceedings, ability to successfully implement the Company s business strategy, ability to realize anticipated cost savings, war and acts of terrorism, higher utility and fuel prices which can result in increased costs, the ability of the Company to attract and retain key executives and key employees, the ability of vendors to maintain, support and upgrade management information systems, catastrophic or other events that impact the use of the Company s head office and distribution centre, increased inflation and interest rates, ability of the Company to obtain new locations or renew existing locations at existing or favourable lease terms, changes to the regulatory environment in which the Company operates now and in the future, changes in the Company s tax liabilities, either through changes in tax laws or future assessments, and performance of third party service providers. Danier cautions that this list of factors is not exhaustive. Danier cautions readers that should certain risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary significantly from those expected. There can be no assurance that the actual results, events or activities anticipated by the Company will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, the Company. Potential investors and other readers are urged to consider these factors carefully in evaluating forward looking statements and are cautioned not to place undue reliance on any forward looking statements. For additional information with respect to certain of these risks or uncertainties, reference should be made to Danier s continuous disclosure materials filed from time to time with Canadian Securities Regulatory Authorities, including the Company s annual information form, quarterly and annual reports, and supplementary information, which are available on SEDAR at and in the Investor Relations section of the Company s website at Additional risks and uncertainties not presently known to the Company or that Danier currently believes to be less significant may also adversely affect the Company. Danier disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. 10 DANIER ANNUAL REPORT 2006

13 BUSINESS OVERVIEW Danier has been in the leather apparel and accessory business for over 30 years and is one of the largest publicly traded specialty-apparel leather retailers in the world. As a vertically integrated designer, manufacturer and retailer, Danier is able to offer its customers high-quality, fashionable leather clothing and accessories at exceptional value. Danier s products are sold exclusively at its 95 shopping mall stores, street-front stores and large format power centre locations that are located in every province across Canada, except Prince Edward Island. Danier s products are also sold through its corporate sales division. STRATEGY During the first half of 2006 Danier focused on elevating the Danier brand through increased distribution of fashion oriented brochures, increased brand oriented advertising such as magazine, billboard and transit shelter, reduced distribution of promotional newspaper flyer inserts, and by offering more fashion oriented merchandise including a new product line called New Label. The retail market however became more price promotional, customers preferred merchandise at lower price points and the trend to shorter length jackets which have a lower average price point continued. During the third quarter Danier refocused its strategy on its core middle to upper income female customer between the age of 35 to 55 and upgraded the quality and look of its newspaper flyer inserts. The upgraded newspaper inserts offered great merchandise at remarkable value and these newspaper inserts performed well with sales and traffic increasing during these promotions. During fiscal 2007, Danier will continue to focus on providing customers with timeless and sophisticated products at remarkable value while making sure that the right sizes are in-stock when customers come to the store. In addition, advertising dollars will be focused on more frequent and better quality newspaper inserts that emphasize great merchandise at remarkable value. Danier also plans to reduce its selling, general and administrative expenses through reduced advertising expense, head office staff reductions which have already been implemented, no longer processing transactions through Danier s website and selective closure of under performing shopping mall and street-front stores and power centre locations. Danier s business strategy over the next several years will continue to focus on: 1. ITS CORE BUSINESS OF LEATHER GARMENTS As the leader in leather outerwear and sportswear, Danier will continue to focus on being the dominant destination for better leather outerwear and sportswear. Outerwear represents approximately 60% of Danier s total sales and sportswear represents another 20% of Danier s total sales. 2. CONTINUED GROWTH OF ACCESSORIES Accessory sales represented 20% of total Company revenue during Danier s long-term objective is to continue to grow this line of business. 3. SELECTIVELY OPEN NEW STORE LOCATIONS Danier operates 55 shopping mall and street-front stores and 40 power centre locations (large format stores). Shopping mall, street-front and power centre locations will be selectively added where sales, store profit and return on investment criteria are met. 4. CORPORATE SALES Sales of Danier products to corporations and other organizations for use as incentives and premiums for employees, suppliers and customers offers an incremental sales opportunity. Danier believes incremental sales can be achieved by providing corporate customers with unique, innovative and exciting merchandise. Danier's strong brand, expertise in leather design and manufacturing, and growing line of accessories provide a solid foundation for the development of a successful corporate sales business. 5. INTERNATIONAL Licensing opportunities for countries outside of North America will be explored. DANIER ANNUAL REPORT

14 SELECTED ANNUAL INFORMATION The following table sets forth selected annual income statement and financial position data in thousands of dollars except per share amounts for each of the last five years. In March 2005, the Company announced that it would close all three of its stores in the United States. Financial results for all of the periods presented below were restated to reflect the discontinuance of the U.S. operation Income Statement Data Revenue $ 148,351 $ 166,350 $ 175,270 $ 172,823 $ 177,704 Earnings (loss) before income tax, restructuring costs and litigation provision and related expenses (6,953) 6,612 8,734 12,904 19,018 Restructuring costs 1, Litigation provision and related expenses - 3,098 15,450 2,773 - Net earnings (loss) before discounted operations (5,503) 2,583 (5,910) 6,282 11,589 Discontinued operations - (2,768) (1,187) (888) (864) Net earnings (loss) (5,503) (185) (7,097) 5,394 10,725 Net earnings (loss) per share before discontinued operations: Basic ($0.84) $0.38 ($0.85) $0.91 $1.69 Diluted ($0.84) $0.38 ($0.85) $0.89 $1.65 Net earnings (loss) per share: Basic ($0.84) ($0.03) ($1.03) $0.78 $1.57 Diluted ($0.84) ($0.03) ($1.03) $0.76 $1.53 Dividends per share $0.24 $0.24 nil nil nil Financial Position Data Total assets $ 82,210 $ 83,365 $ 89,869 $ 81,487 $ 75,695 Long term debt 1,829 nil nil nil nil Shareholders equity 47,956 54,937 61,287 67,994 62,522 Significant factors which have caused variations in the results of operations over the three most recently completed financial years include: Revenue decreased 11% in 2006 and 5% in 2005 and is believed to have been affected by weak consumer spending on leather outerwear, a more promotional retail environment leading up to Christmas, customer preference for lower price point merchandise, the continued fashion trend to shorter length jackets which have a lower average price point, a weaker than expected response to the Company s promotions, and unseasonably hot weather during the first quarter of 2006 and the second quarter of Net earnings (loss) from continuing operations have been affected by the decrease in revenue, a decrease in gross margin during 2006 and higher advertising expenses. In addition, the Company incurred severance payments and outplacement counselling for 23 individuals that were part of the head office reduction that took place during the fourth quarter of Annual savings of approximately $1 million are expected to result in fiscal 2007 from this staff reduction. Accelerated amortization of approximately $0.8 million related to the write off of leasehold improvements and fixtures was also recorded in the fourth quarter in connection with the closure of one street-front store, one power centre location store and the downsizing of one shopping mall store. Net earnings (loss) were affected by the reasons outlined in the above paragraph and the discontinuance of the U.S. operation during During March 2005, the Company announced that it would discontinue its U.S. operations which consisted of three shopping mall stores. The $2.8 million loss in 2005 relates to operating losses, amortization of $1.1 million to bring the net book value of its U.S. fixed assets to zero and $0.4 million for lease termination costs and employee severance costs. 12 DANIER ANNUAL REPORT 2006

15 Factors which have caused variations in the Company s financial position over the three most recently completed financial years include: Capital expenditures of $9.0 million in 2006 compared with $2.6 million in 2005 and $2.7 million in The increase during 2006 was due to implementation of a new point-of-sale hardware, software and customer relationship management system, increase in the number of renovations in 2006 and increased purchases of mannequins, bust forms and other visual display equipment. Capital lease proceeds of $2.9 million were used to fund the point-of-sale hardware and software. Net loss of $5.5 million during Repurchase of 402,400 subordinate voting shares of the Company ( Subordinate Voting Shares ) in the 2005 fiscal year for $4.6 million under the Company s normal course issuer bid. Implementation of a quarterly cash dividend of $0.06 per share ($0.24 per year) in The annual cash cost of the dividend was approximately $1.6 million. RESULTS OF OPERATIONS The following tables sets forth the Company s consolidated statements of earnings (loss) and supplemental information in thousands of dollars and as a percentage of revenue for each of the last five years Revenue $ 148,351 $ 166,350 $ 175,270 $ 172,823 $ 177,704 Cost of sales 76,953 82,863 88,742 87,548 90,928 Gross profit 71,398 83,487 86,528 85,275 86,776 Selling, general and administrative expenses 78,796 77,215 77,812 72,305 67,297 Interest expense (income) (445) (340) (18) Earnings (loss) before undernoted item and income tax (6,953) 6,612 8,734 12,904 19,018 Restructuring costs 1, Litigation provision and related expenses - 3,098 15,450 2,773 - Earnings (loss) before discontinued operations and income taxes (8,342) 3,514 (6,716) 10,131 19,018 Provision for (recovery of) income taxes (2,839) 931 (806) 3,849 7,429 Net earnings (loss) before discontinued operations (5,503) 2,583 (5,910) 6,282 11,589 Loss from discontinued operations, net of income taxes - 2,768 1, Net earnings (loss) ($5,503) ($185) ($7,097) $5,394 $10,725 Supplemental information: Adjusted EBITDA (1) (1,159) 12,488 14,487 18,730 24,388 Adjusted net earings (loss) (1) (4,586) 4,849 5,466 7,900 11, Revenue 100.0% 100.0% 100.0% 100.0% 100.0% Cost of sales 51.9% 49.8% 50.6% 50.7% 51.2% Gross profit 48.1% 50.2% 49.4% 49.3% 48.8% Selling, general and administrative expenses 53.1% 46.4% 44.4% 41.8% 37.9% Interest expense (income) (0.3%) (0.2%) % Earnings (loss) before undernoted item and income tax (4.7%) 4.0% 5.0% 7.5% 10.7% Restructuring costs 0.9% Litigation provision and related expenses - 1.9% 8.8% 1.6% - Earnings (loss) before discontinued operations and income taxes (5.6%) 2.1% (3.8%) 5.9% 10.7% Provision for (recovery of) income taxes (1.9%) 0.5% (0.4%) 2.3% 4.2% Net earnings (loss) before discontinued operations (3.7%) 1.6% (3.4%) 3.6% 6.5% Loss from discontinued operations, net of income taxes - 1.7% 0.7% 0.5% 0.5% Net earnings (loss) (3.7%) (0.1%) (4.1%) 3.1% 6.0% Supplemental information: Adjusted EBITDA (1) (0.8%) 7.5% 8.3% 10.8% 13.7% Adjusted net earings (loss) (1) (3.1%) 2.9% 3.1% 4.6% 6.5% (1) See section entitled Non-GAAP Measures DANIER ANNUAL REPORT

16 The following summarized statistical data compare each of the last five fiscal years Comparable store sales increase/(decrease) (11%) (6%) (4%) (8%) 1% Sales ($000) Shopping Mall/Street-Front/Direct Sales $ 72,397 $ 81,280 $ 83,283 $ 79,720 $ 84,592 Power Centre 75,954 85,070 91,987 93,103 93,112 Total $ 148,351 $ 166,350 $ 175,270 $ 172,823 $ 177,704 Retail square footage Shopping Mall/Street-Front 115, , , , ,755 Power Centre 260, , , , ,672 Total 375, , , , ,427 Number of stores Shopping Mall/Street-Front Power Centre Total Revenue decreased 11% or $18.0 million to $148.4 million in 2006 from $166.4 million in Comparable store sales decreased 11%. Average sale decreased 8%, traffic decreased 5% and conversion (percentage of customers that come into the store and make a purchase) increased 3%. A more promotional retail environment leading up to Christmas, customer preference for lower price point merchandise, the continued fashion trend to shorter length jackets which have a lower average price point, a change in the marketing strategy placing more emphasis on elevating the Danier brand and less reliance on price promotions, and hot weather during the first quarter are believed to have affected sales. Fourth quarter revenues in 2006 decreased 13% or $3.5 million to $22.0 million from $25.5 million in the fourth quarter of Comparable store sales decreased 15%. Average sale decreased 3%, traffic decreased 15% and conversion (percentage of customers that come into the store and make a purchase) remained the same. The fourth quarter of 2005 included a newspaper insert promotion and other price oriented promotions whereas the fourth quarter of 2006 did not contain any newspaper insert promotions and there was less inventory of basic items especially during the beginning of the quarter. Inventory levels of basic items and next fall merchandise during the latter part of the quarter were increased as the Company started purchasing for next fall earlier than past years. Store openings during the first half of the year included one new shopping mall store at the Niagara Fallsview Casino and a power centre location at Sunridge Mall in Calgary, Alberta. During the last half of the year two under performing shopping mall stores whose leases expired were closed. During fiscal 2007, the Company does not plan to open any new stores. Store closures will include one street-front store during the first quarter, one under performing power centre location during the first quarter and two under performing power centre locations during the 4th quarter. Gross profit as a percentage of revenue decreased to 48.1% in 2006 compared with 50.2% in Gross profit dollars decreased $12.1 million or 14% to $71.4 million in 2006, compared with $83.5 million in The year-to-date decrease in gross margin was mainly experienced in the power centre locations as more promotional activity and discounts were offered to maximize traffic and conversion rate. The Company purchases a significant portion of its raw materials and finished goods in U.S. dollars. The benefit of the higher Canadian dollar during 2006 was mostly passed on to customers through lower prices or discounts. The gross profit dollar decrease was due to an 11% decrease in revenue as well as the decrease in gross margin. Gross profit as a percentage of revenue increased to 49.9% during the fourth quarter of 2006 compared with 49.6% during the fourth quarter of 2005 as there were less price oriented promotions during the fourth quarter of 2006 compared with the same period last year. Gross profit dollars decreased by $1.6 million or 13% to $11.0 million in the fourth quarter of 2006 compared with $12.6 million during the same period last year mainly due to the 13% decrease in revenue. Selling, general and administrative expenses increased by 2% or $1.6 million to $78.8 million in 2006, compared with $77.2 million in Advertising expense increased by $1.5 million over the prior year due to more brand related advertising such as billboard, transit shelter and magazine advertising as well as high quality fashion oriented brochures. Plans for Fiscal 2007 include a shift in promotional and advertising activities 14 DANIER ANNUAL REPORT 2006

17 to place a greater emphasis in favour of newspaper flyer inserts, and less transit shelter, billboard and magazine advertising. The Company expects to achieve advertising expense reductions of about $2.5 million during Fiscal SG&A for the fourth quarter of 2006 increased by 10% or $1.5 million to $16.8 million compared with $15.3 million during the same period last year. The fourth quarter last year included a $0.6 million year-end estimate to actual adjustment reversing bonuses for head office staff, which were estimated in the second quarter based on meeting certain financial targets which ultimately were not met in the second half of last year. The fourth quarter of 2006 also included higher rent expense and higher legal and professional fees. Restructuring costs for the fourth quarter and full year of 2006 represent approximately $0.6 million of severance payments and outplacement counselling for the 23 individuals that were part of the head office reduction that took place during the fourth quarter of Annual savings of approximately $1 million are expected to result in fiscal 2007 from this staff reduction. Accelerated amortization of approximately $0.8 million related to the write off of leasehold improvements and fixtures was also recorded in the fourth quarter in connection with the closure of one street-front store, one power centre location and the downsizing of one shopping mall store. Litigation provision and related expenses relate to the class action litigation and were NIL in 2006 and $3.1 million in In 2004 the Superior Court of Justice (Ontario) issued a judgment in favour of the Plaintiffs and awarded damages to Canadian shareholders who purchased Subordinate Voting Shares in Danier s initial public offering ( IPO ). The Company appealed this decision and in December 2005 the Ontario Court of Appeal unanimously allowed the appeal on three separate grounds, set aside the trial decision and dismissed the class proceeding. As a result, the Company and its Senior Officers are not required to pay any of the damages, interest or costs awarded by the trial judge. The Court of Appeal's decision stated that the Company had met its disclosure obligations in the Prospectus and during the IPO process and the trial judge erred in finding that any misrepresentation had occurred. In February 2006, the plaintiffs filed an Application for Leave to Appeal to the Supreme Court of Canada. In June 2006, the Supreme Court of Canada granted the plaintiff s application. The Company expects the appeal to be heard by the Supreme Court of Canada during March Although the Court of Appeal has set aside the trial judge s decision, the provision will remain until the Supreme Court of Canada makes a final determination. Based solely on the information available at the time, if the damages, costs and interest awarded by the trial judge had been paid at the fiscal 2005 year-end, the Company estimated this amount to be approximately $18 million. During the fourth quarter of 2004, the Company recorded an expense and set up a provision of $15 million to reflect the trial judge's decision. This provision was subsequently increased by $3 million to $18 million during the fourth quarter of 2005 to take into account the trial judge's award of costs which was released in May The provision for recovery of income taxes related to the trial judge's award was based on the entire $18 million provision and the provision did not take into account the potential results of the appeal, any possible insurance recoveries or future tax adjustments. The provision for the damages award, costs and interest and the income tax recovery were based on management's best estimate and is subject to adjustment when all facts are known and all issues are resolved. The possible adjustment could be significant. Interest income was $445,000 in 2006 compared with $340,000 in The increase in interest income is due to higher interest rates earned on cash balances. Effective income tax recovery was 34% in 2006 compared with effective income tax expense of 124.7% last year. The effective rate last year included unutilized losses from the U.S. operation and differences between tax accounting and financial accounting for legal provisions. Net earnings (loss) before discontinued operations for 2006 was a loss of $5.5 million ($0.84 per basic share) compared with net earnings of $2.6 million ($0.38 per basic share) in The decrease in net earnings was due to a 11% revenue decrease, a 2.1% decrease in gross margin and higher advertising expenses. Net loss before discontinued operations for the fourth quarter of 2006 was a loss of $4.6 million ($0.70 per basic share) compared with $3.2 million ($0.49 per basic share) in the fourth quarter of The fourth quarter of 2006 included a 13% revenue decrease, higher SG&A and a $1.4 million restructuring charge. The fourth quarter of 2005 included litigation provision and related expenses of $3.1 million. DANIER ANNUAL REPORT

18 Loss from discontinued operations, net of income taxes of $NIL in 2006 and $2.8 million in 2005 related to the closure of the U.S. operations in During March 2005, the Company announced that it would discontinue its U.S. operations which consisted of three shopping mall stores. The $2.8 million loss in 2005 relates to operating losses, amortization of $1.1 million to bring the net book value of its U.S. fixed assets to zero and $0.4 million for lease termination costs and employee severance costs. Net loss for 2006 was $5.5 million ($0.84 per basic share) compared with $0.2 million ($0.03 per basic share) in The increased loss was due to a 11% revenue decrease, a 2.1% decrease in gross margin, higher advertising expenses and a $1.4 million restructuring charge. Net loss for the fourth quarter of 2006 was $4.6 million ($0.70 per basic share) compared with $3.2 million ($0.49 per basic share) in the fourth quarter of The fourth quarter of 2006 included a 13% revenue decrease, higher SG&A and a $1.4 million restructuring charge. The fourth quarter of 2005 included litigation provision and related expenses of $3.1 million. SEASONALITY AND QUARTERLY FLUCTUATIONS The business of the Company is seasonal and results of operations for any interim period are not necessarily indicative of the results of operations for the full fiscal year. Generally, a significant portion of the Company s sales and earnings are generated during the second quarter, which includes the holiday selling season, and sales are lowest and losses are experienced in the period from April to September. SUMMARY OF QUARTERLY RESULTS ($000, EXCEPT PER SHARE AMOUNTS) Q1 Q2 Q3 Q4 FISCAL 2006 Revenue $ 20,831 $ 61,828 $ 43,664 $ 22,028 Net earnings (loss) before discontinued operations: Amount (dollars) ($5,291) $4,595 ($192) ($4,615) Basic (per share) ($0.81) $0.70 ($0.03) ($0.70) Diluted (per share) ($0.81) $0.70 ($0.03) ($0.70) Net earnings (loss): Amount (dollars) ($5,291) $4,595 ($192) ($4,615) Basic (per share) ($0.81) $0.70 ($0.03) ($0.70) Diluted (per share) ($0.81) $0.70 ($0.03) ($0.70) Supplemental information (1) : Adjusted EBITDA ($7,074) $9,014 $1,157 ($4,256) Adjusted net earings (loss) ($5,291) $4,595 ($192) ($3,698) FISCAL 2005 Revenue $ 24,277 $ 70,091 $ 46,527 $ 25,455 Net earnings (loss) before discontinued operations: Amount (dollars) ($2,952) $7,364 $1,353 ($3,182) Basic (per share) ($0.43) $1.08 $0.20 ($0.49) Diluted (per share) ($0.43) $1.07 $0.20 ($0.49) Net earnings (loss): Amount (dollars) ($3,413) $7,182 ($794) ($3,160) Basic (per share) ($0.49) $1.06 ($0.12) ($0.48) Diluted (per share) ($0.49) $1.04 ($0.12) ($0.48) Supplemental information (1) : Adjusted EBITDA ($3,704) $13,924 $3,636 ($1,368) Adjusted net earings (loss) ($2,952) $7,364 $1,353 ($916) (1) See section entitled Non-GAAP Measures 16 DANIER ANNUAL REPORT 2006

19 LIQUIDITY AND CAPITAL RESOURCES Cash flow from operations and bank borrowings have been the primary funding sources for working capital requirements and capital expenditures over the last several years. The 2006 net loss combined with $9.0 million of capital expenditures resulted in a decrease in the Company s cash position versus the prior year. The Company s financial position at the end of 2006 still continues to be strong with a working capital balance of $36.4 million compared with $44.3 million at the end of The ratio of current assets to current liabilities was 4.0:1 as at the end of 2006 compared with 6.4:1 at the end of Inventory at the end of 2006 was approximately $3.3 million higher than inventory at the end of Raw material and work-in-process inventory decreased by $1.4 million compared with Finished goods inventory increased by approximately $4.7 million. This increase was due to early purchases of fall outerwear and blazer merchandise. Total liabilities excluding the litigation provision and related expenses at the end of 2006 were approximately $5.8 million higher than at the end of The increase is due to a $2.5 million increase in accounts payable and accrued liabilities related to earlier inventory purchases and a $2.7 million capital lease obligation that was entered into during the fourth quarter of 2006 to fund point-of-sale equipment that was implemented during Income taxes recoverable increased by $1.5 million at the end of 2006 due to the increased loss from operations. LITIGATION PROVISION AND RELATED EXPENSES The provision relating to the class action lawsuit and related expenses at the end of 2006 was equal to the provision at the end of During the fourth quarter of 2004, the Company recorded an expense and set up a provision of approximately $15 million pursuant to a judgment issued by the trial judge against the Company and two of its Senior Officers in favour of the plaintiffs in connection with the class action lawsuit. This provision was subsequently increased by $3.0 million to $18 million in the fourth quarter of The Company and two of its Senior Officers filed a Notice of Appeal from the trial judge's decision and the appeal was heard by the Ontario Court of Appeal during the fourth quarter of During the second quarter of 2006, the Ontario Court of Appeal unanimously allowed the appeal on three separate grounds, set aside the trial decision and dismissed the class action. As a result, the Company and its Senior Officers are not required to pay any of the damages, interest or costs awarded by the trial judge. The Court of Appeal will determine the Company s and its Senior Officers' entitlement to costs for the trial and for the appeal at a later date. During February 2006, the plaintiffs filed an Application for Leave to Appeal to the Supreme Court of Canada. In June 2006, the Supreme Court of Canada granted the plaintiffs application. The Company expects the appeal to be heard by the Supreme Court of Canada during March Although the Court of Appeal has set aside the trial judge s decision, the provision will remain until the Supreme Court of Canada makes a final determination The provision for the damages award, costs and interest and the income tax recovery was based on management's best estimate and is subject to adjustment when all facts are known and all issues are resolved. The possible adjustment could be significant. Although the Court of Appeal has now set aside the trial judge's decision, the provision will remain until the Supreme Court of Canada makes a final determination. Further details of the class action litigation are provided in Note 11 of the 2006 consolidated financial statements. OPERATING ACTIVITIES Cash flow from operating activities decreased by $9.3 million during 2006 to a use of $1.8 million compared with proceeds of $7.4 million during Approximately $5.3 million of the decrease in cash resulted from a higher net loss and approximately $3.3 million of the decrease in cash was due to higher year-end inventory balances as the Company began earlier purchases of inventory for next fall. Cash flow from operating activities for the fourth quarter of 2006 was a use of $9.4 million compared with proceeds of $1.1 million for the fourth quarter of A higher net loss and earlier fall inventory purchases as compared with the prior year were the primary uses of cash. FINANCING ACTIVITIES The Company s business is seasonal with peak working capital needs expected to occur during the period from June to mid-december as inventory levels are increased in advance of the peak selling season from October to March. The Company funds inventory expenditures during normal and peak selling periods through a combination of cash flows provided by operations and bank credit facilities. DANIER ANNUAL REPORT

20 During June 2006, the Company renegotiated its credit agreement. The new credit agreement which became effective in July 2006 provides for an operating facility for working capital and for general corporate purposes to a maximum amount of $35 million and is committed until June 30, 2007 and bears interest at prime plus 0.25%. Standby fees are paid for any unused portion of the credit facilities. The credit facility is subject to certain covenants and other limitations that if breached could cause a default and may result in a requirement for immediate repayment of amounts outstanding. Security provided includes a security interest over all personal property of the business and a mortgage over the land and building, comprising the Company's head office/distribution facility. During the fourth quarter of 2006, the Company entered into a three year capital lease facility to fund the point-of-sale hardware and software that was implemented during The amount of the capital lease obligation at the end of 2006 was approximately $2.7 million. The normal course issuer bid approved by the Toronto Stock Exchange in 2005 expired on February 6, 2006 and has not been renewed. The bid permitted the Company to acquire up to 421,061 Subordinate Voting Shares, representing approximately 10% of the public float of the Subordinate Voting Shares, during the period from February 7, 2005 to February 6, During 2006, no Subordinate Voting Shares were purchased under the normal course issuer bid. During the 13 week and 52 week periods ended June 25, 2005, NIL and 402,400 Subordinate Voting Shares were repurchased, respectively. Proceeds from lease inducements were $286,000 during 2006 compared with NIL last year. Lease inducements have historically been received when opening a location at a recently constructed power centre or shopping mall. In 2005, the Company initiated a quarterly cash dividend. Cash dividends of $0.24 per share ($0.06 per quarter) were paid during each of 2006 and The dollar amount of the cash dividend was approximately $1.6 million per year ($0.4 million per quarter). Based on the Company s results for fiscal 2006, the Board of Directors has resolved to suspend the payment of dividends on Danier s Subordinate Voting Shares and Multiple Voting Shares commencing in the first quarter of The Board has determined that the suspension of dividends is in the best interests of the Company given current results of operations. The Board will consider reinstating dividend payments on the Subordinate Voting Shares and Multiple Voting Shares when financial conditions permit. However, the Board cannot determine at this time when a dividend resumption will occur. INVESTING ACTIVITIES Capital expenditures were $9.0 million in 2006 compared with $2.6 million during The increase was mainly due to: Implementation of a new point-of-sale hardware, software and customer relationship management system. Increase in number of renovations in 2006 to six stores compared with three stores in Increased purchases of mannequins, bust forms and other visual display equipment. Capital expenditures in 2006 included: approximately $3.5 million towards the addition of one new power centre outlet, one new shopping mall store, renovations at six existing shopping mall stores, purchase of mannequins, bust forms and fixtures and miscellaneous expenditures in the retail division; $5.3 million towards information technology including implementation of new point-of-sale hardware, software and customer relationship management system, upgrades to the sales audit system and upgrade of computer hardware and software at head office; and $0.2 million towards the addition of production machinery and equipment. For the full year of fiscal 2007, capital investments of approximately $3.6 million are planned. Approximately $2.2 million is anticipated to be used for renovations at seven existing stores, visual display equipment and miscellaneous expenditures in the retail division; $1.1 million for information technology including enhancement to the point-of-sale system and customer relationship management system, upgrading of merchandising and merchandise planning systems, and upgrade of computer hardware and software at head office; and $0.3 million for manufacturing equipment and building improvements. The Company intends to fund these capital investments from existing working capital, internally generated cash flow and available credit facilities. Based on the Company generating a moderate comparable store sales increase and reducing SG&A costs, management expects cash flows generated from operations along with available borrowing capacity under the Company's credit facility to be sufficient to fund its working capital needs and planned capital investment program for fiscal DANIER ANNUAL REPORT 2006

21 A list of material factors that may result in the Company being unable to fund its working capital needs and planned capital investment program include: Continued decreases in sales from existing stores. A material default or breach of a bank covenant that results in the Company s existing credit facility being withdrawn. The Supreme Court of Canada overturning the unanimous decision by the Ontario Court of Appeal setting aside the trial decision and dismissing the class proceeding and the Company being required to pay its portion of the trial judge s total award of damages, costs and interest in connection with the class action (see Risks and Uncertainties Legal Proceedings). Changes in consumer shopping patterns that results in lower traffic to the Company s stores. Any material disruption to the Company s operations. In addition, other factors not presently known to management could materially and adversely affect the Company s future cash flow. In such events, the Company would be required to obtain additional capital as is necessary to satisfy its working capital and planned capital investment program from other sources. Alternative sources of capital could result in increased dilution to shareholders and may be on terms that are not favourable to the Company. CONTRACTUAL OBLIGATIONS ($000) Operating leases for stores and equipment excluding percentage rent and capital leases are listed below. Payments Due By Period Operating Leases Capital Leases Total 2007 $11,615 $1,061 $12, $10,263 $1,061 $11, $8,675 $884 $9, $6,469 - $6, $5,253 - $5,253 After 2011 $8,084 - $8,084 Total $50,359 $3,006 $53,365 In addition, the Company may be obligated to pay percentage rent under certain of the store operating leases. As at June 24, 2006, the Company had open letters of credit for purchases of inventory of approximately $7,266 (June 25, $4,839). The Company sublet one location during fiscal 2004 and has provided the landlord with a guarantee in the event the subtenant defaults on its obligation to pay rent. The remaining term on the guarantee is approximately 2.5 years and the Company s maximum exposure is $102. RELATED PARTY TRANSACTION There were no related party transactions during During 2005, the Company expensed and paid fees of $28,000 to a corporation related to a director and officer of the Company. The transaction was measured at the exchange amount, which is the amount of consideration established and agreed to by the related parties. DISCLOSURE CONTROLS Based on an evaluation of the Company s disclosure controls and procedures, the Company s Chief Executive Officer and Chief Financial Officer have concluded that these controls and procedures operated effectively as of July 26, RISKS AND UNCERTAINTIES Danier is subject to certain risks and uncertainties that are common in the leather and retail apparel industry and the market environment generally. These risks and uncertainties may impact Danier s ability to successfully execute its key strategies and may affect future performance. The risks included here are not exhaustive. Danier operates in a very competitive and rapidly changing environment. New risk factors may emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on Danier s business. FASHION AND APPAREL AND LEATHER INDUSTRY RISKS The Company s success is based in part on its ability to identify and interpret fashion and product trends, as well as to anticipate, gauge and react to changing consumer demands in a timely manner. If the Company is unable to identify new fashion trends and adjust the product mix in a timely manner or if market preferences are misjudged, the Company could be faced with significant excess inventories for some products and missed DANIER ANNUAL REPORT

22 opportunities for other products. In response, additional markdowns or promotions may be required to reduce excess, slow-moving inventories, which may have a material adverse effect on the business, financial condition and results of operations. Historically, a large proportion of the Company s merchandise was black and shades of brown. Current fashion trends are emphasizing more colour and the ability of the Company to correctly identify and balance its inventories with these fashion colours increases fashion risk and can have a material adverse effect on the business, financial condition and results of operations. The apparel industry is cyclical and consumer purchases of the Company s products are discretionary. Purchases of apparel and related merchandise tend to decline during recessionary periods and may also decline at other times, particularly if the retail environment remains stagnant or declines. Further, a recession in the general economy, increased interest rates, a change in the availability of consumer credit, increased taxation levels, increased unemployment, or uncertainties regarding future economic prospects could affect consumers spending habits and have an adverse effect on the Company s results of operations. In addition, consumer sentiment towards and demand for leather may change. Bovine Spongiform Encephalopathy (BSE or "mad-cow" disease) and hoof-and-mouth disease may affect consumer demand for leather products. Although current scientific evidence suggests that such diseases cannot be transmitted to humans through contact with leather products, demand for leather products could be affected as a result of the publicity regarding these diseases. CONSUMER SHOPPING PATTERNS Changes in customer shopping patterns could affect sales. Most of the Company s stores are located in enclosed shopping malls and power centres. The ability to sustain or increase the level of sales depends in part on the continued popularity of malls and power centers as shopping destinations and the ability of malls and power centres, tenants and other attractions to generate a high volume of customer traffic. Many factors that are beyond the control of the Company may decrease mall and power centre traffic, including, economic downturns, closing of anchor department stores, weather, concerns of terrorist attacks, construction and accessibility, alternative shopping formats such as e-commerce, discount stores and lifestyle centres, among other factors. Any changes in consumer shopping patterns could adversely affect the Company s financial condition and operating results. WEATHER Extreme changes in weather can affect the timing of consumer spending and may have an adverse effect upon the Company s results of operations. In particular, unseasonably warm weather, especially during Danier s peak selling season, may have an adverse effect on the Company s sales. SEASONALITY The Company s business is seasonal, as are most retail businesses. Historically, approximately 45% or more of the Company s total annual sales have been generated during its second fiscal quarter, which includes the Christmas season. The Company s results of operations depend significantly upon the sales generated during this period. Any material decrease in sales for such period could have a material adverse effect upon the Company's profitability. The Company s quarterly results of operations may also fluctuate as a result of a variety of other factors, including the timing of new store openings and net sales contributed by new stores, the impact of new stores on existing stores within the same trade area, the timing of redemption of gift cards or gift certificates, the merchandise mix and the timing and level of markdowns, timing and level of markdowns and promotions by competitors and consumer shopping patterns and preferences. COMPETITION The retail industry is highly competitive with price, quality, service, selection, fashion, location and store environment being the principal competitive factors. The Company competes with numerous national and international mass merchandisers, discounters, department stores, specialty apparel stores that supplement their product line with leather merchandise and accessories, leather and suede specialty stores and with designers and manufacturers of apparel and accessory products, some of which are significantly larger and have substantially greater resources than the Company. Increased competition may reduce sales, increase operating expenses, decrease profit margins and negatively affect the Company s ability to obtain site locations, sales associates and other employees. FOREIGN CURRENCY A significant portion of Danier s raw material and imported finished goods purchases are denominated in U.S. dollars. Accordingly, the Company s foreign currency exposure is mainly related to fluctuations between the Canadian and U.S. dollar. From time to time, the Company may use forward contracts to fix the exchange rate on a portion of its expected requirements for U.S. dollars. Forward contracts expose the Company to credit risk 20 DANIER ANNUAL REPORT 2006

23 representing the maximum potential accounting loss due to non-performance by counterparties under terms of their contracts. The Company manages credit risk under its foreign exchange contracts by only dealing with major financial institutions. As at June 24, 2006, there were no forward foreign exchange contracts outstanding. A significant portion of Danier s imported finished goods purchases are sourced in China. The Chinese currency (the Renminbi or Yuan ( RMB ), was previously pegged to the U.S. dollar at US$1=8.28RMB but has recently been revalued and is being allowed to float against a basket of foreign currencies. Fluctuations of the Renminbi could result in higher costs to the Company which may not be able to be passed on to customers and could have a material adverse effect on cost of sales and decrease profitability. LEATHER AVAILABILITY AND PRICES Leather comprises approximately two-thirds of the garment cost of leather apparel and the availability and price of leather may fluctuate significantly. A number of factors affect the price of leather, including the demand for leather in other industries such as shoe, furniture, and automobile upholstery industries. Leather supply is influenced by a number of factors including wars, worldwide meat consumption and the availability of hides. Certain leather-supplying countries have experienced highly publicized outbreaks of mad-cow disease and hoof-and-mouth disease. The effect of these diseases cannot be determined but could affect leather supply and pricing. Fluctuations in leather supply and pricing, which can be significant, may have a material adverse effect on the business and profitability of the Company. FOREIGN SOURCING AND MANUFACTURING Danier sources a majority of its garments from independent foreign contract manufacturers located primarily in the Far East. Risks associated with foreign sourcing include economic and political instability, transportation delays and interruptions, restrictive actions by foreign governments, inability to meet the Company s quality standards, production delays, duties, trade and foreign tax laws, fluctuations in currency exchange rates and restrictions on the transfer of funds, tariffs and quotas and boycotts or other actions prompted by domestic concerns regarding foreign labour practices. Any event causing a sudden disruption of imports from the Far East, primarily China, including a disruption due to financial difficulties of a supplier, could have a material adverse effect on the Company. The Company regularly seeks out new sources of supply and sub-contractors to minimize the impact of potential disruptions. The Company has not historically experienced material adverse effects from foreign sourcing of finished goods. LEGAL PROCEEDINGS In fiscal 1999, the Company and certain of its directors and officers were served with a Statement of Claim under the Class Proceedings Act (Ontario) which made allegations about the accuracy and disclosure of certain information contained in a financial forecast issued by the Company and contained in the Prospectus it issued dated May 6, 1998 for its initial public offering ( IPO ) which closed on May 20, The suit sought damages to be paid equal to the alleged diminution in value of the Subordinate Voting Shares sold under the Prospectus. In October 2001, a motion to certify the action as a class proceeding was granted. The trial commenced in the Superior Court of Justice (Ontario) in May 2003 and was completed in January On May 7, 2004, the trial judge issued a judgment against the Company and two of its Senior Officers in favour of the Plaintiffs and awarded damages to Canadian shareholders who purchased Subordinate Voting Shares under the Prospectus. For those shareholders who sold their shares between June 4 and 9, 1998, the trial judge awarded the difference between the IPO price and the price at which they sold their shares. For those shareholders who sold or still held their shares after June 9, 1998, the trial judge awarded $2.35 per share. Although the trial judge concluded that at the date of the Prospectus the forecast was reasonable, and that at the time of closing of the IPO the Company's CEO and CFO had an honest belief that the forecast could still be achieved, and although he held that the forecast was, in fact, substantially achieved, the trial judge decided that management s judgment that the forecast was still achievable at the time of closing was not reasonable and that therefore the Prospectus contained a misrepresentation. Based solely on information available at the time, the Company estimated that the trial judge s award would have totaled approximately $15 million. As noted below, the Company and its Senior Officers have successfully appealed this decision. In May 2005, the trial judge awarded the plaintiffs a portion of the costs claimed for the action and referred for assessment the amount of costs to be paid. Based solely on the information available at the time, the Company estimated that these costs would have amounted to approximately $3 million to $4 million. A hearing to determine the awarding of costs related to the certification and summary judgment motion which was decided in 2000 and 2001 was held in December In June 2005, partial indemnity costs were awarded to the plaintiffs for these motions in an amount to be assessed. The Company has appealed this decision and the appeal is still waiting to be heard. DANIER ANNUAL REPORT

24 In June 2004, a Notice of Appeal was filed by the Company and two of its Senior Officers from the trial judge s decision. The appeal was heard by the Ontario Court of Appeal in June 2005 and in December 2005, the Court of Appeal unanimously allowed the appeal on three separate grounds, set aside the trial decision and dismissed the class proceeding. As a result, the Company and its Senior Officers are not required to pay any of the damages, interest or costs awarded by the trial judge. The Court of Appeal s decision stated that the Company had met its disclosure obligations in the Prospectus and during the IPO process and the trial judge erred in finding that any misrepresentation had occurred. The Court of Appeal will determine the Company s and its Senior Officers entitlement to costs for the trial and for the appeal at a later date. In February 2006, the plaintiffs filed an Application for Leave to Appeal to the Supreme Court of Canada. In June 2006, the Supreme Court of Canada granted the plaintiff s application. The Company expects the appeal to be heard by the Supreme Court of Canada during March Based solely on the information available at the time, if the damages, costs and interest awarded by the trial judge had been paid at the fiscal 2005 year-end, the Company estimated this amount to be approximately $18 million. During the fourth quarter of 2004, the Company recorded an expense and set up a provision of $15 million to reflect the trial judge s decision. This provision was subsequently increased by $3 million to $18 million during the fourth quarter of 2005 to take into account the trial judge s award of costs which was released in May The provision for recovery of income taxes related to the trial judge s award was based on the entire $18 million provision and the provision did not take into account the potential results of the appeal, any possible insurance recoveries or future tax adjustments. The provision for the damages award, costs and interest and the income tax recovery were based on management s best estimate and is subject to adjustment when all facts are known and all issues are resolved. The possible adjustment could be significant. Although the Court of Appeal has set aside the trial judge s decision, the provision will remain until the Supreme Court of Canada makes a final determination. If the Supreme Court of Canada overturns the Ontario Court of Appeal s decision and upholds the judgment awarded by the Superior Court of Justice (Ontario) and if directors and officers insurance does not cover the two Senior Officers portion of the total award, then the Company may be required to pay the total award and this could have a material adverse affect on the Company's financial condition and operations. Furthermore, the amount of interest and costs are estimated as of June 25, Additional interest and costs will likely be required to be paid by the Company should the trial judge s award be reinstated. RISKS OF BUSINESS STRATEGY There can be no assurance that the Company s business strategy will be successful or that the Company s overall net revenue will increase as a result of an increase in the number of retail stores or a change in the merchandising or marketing strategy. The Company's future growth and profitability may be restricted if it is unable to open new stores on a profitable basis, increase sales at existing stores, identify, consummate and integrate strategic acquisitions, identify, negotiate, lease and open stores in suitable locations on a profitable and timely basis, obtain necessary capital to operate the business and hire, train and retain qualified personnel including management, executives and sales associates. WAR AND ACTS OF TERRORISM War and acts of terrorism, or if either is threatened, may negatively impact Danier s ability to source leather and obtain and ship merchandise available for sale. The majority of Danier s stores are located in enclosed shopping malls and power centres. Any threat of terrorist attacks or actual terrorist events could lead to lower customer traffic in shopping malls and power centres and could negatively affect consumer behaviour, spending and shopping patterns which may result in an adverse effect upon the Company's results of operations. UTILITY AND FUEL PRICES The Company is a consumer of electricity, natural gas and fuel. Unanticipated cost increases in these items could increase the Company s operating costs and reduce profitability. SENIOR MANAGEMENT Danier s success depends largely on the efforts and abilities of the current senior management team. Mr. Jeffrey Wortsman in particular has been with the Company since 1986 and has been instrumental in defining and implementing the Company s business strategy and providing direction on merchandising and marketing strategy. The senior management team and Mr. Wortsman s experience and worldwide contacts in the leather industry significantly benefit the Company. If Danier were to lose the benefit of their experience and contacts, the Company could be adversely affected. 22 DANIER ANNUAL REPORT 2006

25 MANAGEMENT INFORMATION SYSTEMS Danier relies on vendors to support, maintain and periodically upgrade merchandise, distribution, design, accounting and financial reporting packages. The inability of these vendors to continue to maintain and upgrade these software programs could disrupt operations if Danier were unable to convert to alternate systems in an efficient and timely manner. CONCENTRATION OF HEAD OFFICE AND DISTRIBUTION CENTRE Danier s corporate office and main distribution centre are in one location. Operations could be materially and adversely affected if a catastrophic or other event impacts the use of this facility. INFLATION Inflation has not had a material impact on Danier s results of operations during the past several years, however, there can be no assurance that Danier's business will not be affected by inflation in the future. REAL ESTATE With the exception of the head office store, all of Danier s store locations are leased. Competition for prime locations within shopping malls, power centres and for street-front locations is intense and there can be no assurance that Danier will be able to obtain new locations or renew existing locations at existing or favourable terms. CRITICAL ACCOUNTING ESTIMATES The Company s significant accounting policies are described in Note 1 of the 2006 consolidated financial statements. The preparation of these consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Some of the Company s significant accounting policies involve a higher degree of judgment or complexity than its other accounting policies. The policies described below are considered to be critical accounting estimates, as they require significant estimation or judgment. LITIGATION PROVISION AND RELATED EXPENSES The amount of damages, costs and interest were estimated based on various judgments issued by the Superior Court of Justice (Ontario). The Court awarded a portion of the costs claimed by the plaintiffs but referred the matter for assessment to determine the amount of costs to be paid. The quantum of the costs award will not be known until the Supreme Court makes a final determination on the Court of Appeal s decision and a final assessment ordered by the Superior Court of Justice (Ontario) has been conducted. The amount of damages, interest and costs were estimated by management as of June 25, 2005 and do not include any potential interest and costs that could be awarded from June 25, 2005 to the date the decision is received from the Supreme Court of Canada. Any change in the amount of costs determined by an assessment officer appointed by the Court or any change in damages, costs and interest by the Supreme Court of Canada could have a significant impact on operating results and cash flows. In addition, the amount of the provision could change as a result of the amount of directors and officers insurance recovered, the amounts of which cannot be reasonably determined at this time. Proceeds from directors and officers insurance could have a significant impact on operating results and cash flows. INVENTORY VALUATION Inventory is valued at the lower of cost or market. For finished goods and work-in-process, market is defined as net realizable value and for raw materials, market is defined as replacement cost. Cost is determined using the weighted average cost method and includes standard costs, estimates and averages for domestic labour, exchange rates for U.S. dollar purchases of leather and finished goods purchased from foreign vendors, freight, duty, brokerage and overhead. In addition, a provision is recorded to reduce the cost of inventories for loss due to theft (shrinkage), obsolete, damaged and slow moving items to their estimated net realizable values. Any significant unanticipated changes in consumer demand, fashion trends, retail markdowns, or in any of the standard costs, estimates and averages could have a significant impact on the value of inventories and operating results including cost of sales and gross profit. PROPERTY AND EQUIPMENT AND AMORTIZATION Property and equipment consist of store leasehold improvements, furniture and fixtures, computer equipment and manufacturing equipment in addition to the Company's building. These assets are recorded at cost and are amortized over their estimated useful lives. Property and equipment are reviewed for impairment whenever events such as a decision to close a store or changes in circumstances indicate that the carrying value of an asset may not be recoverable in which case accelerated amortization over the revised useful life or a write-down is recorded in the financial statements. DANIER ANNUAL REPORT

26 INCOME TAXES Income taxes are provided for using the asset and liability method of accounting. This method recognizes future tax assets and liabilities that arise from differences between the accounting basis of the Company s assets and liabilities and their corresponding tax basis. Future taxes are measured using tax rates expected to apply when the asset is realized or the liability is settled. The calculation of current and future income taxes requires management to make estimates and assumptions and to exercise judgment regarding the financial statement carrying values of assets and liabilities which are subject to accounting estimates inherent in those balances, the interpretation of income tax legislation across various jurisdictions, expectations about future operating results and the timing of reversal of temporary differences and possible audits of tax filings by the regulatory authorities. The Company is audited regularly by federal and provincial authorities in the areas of income taxes and the remittance of sales taxes. These audits consider the timing and amount of deductions and compliance with federal and provincial tax laws. To the extent that the Company s filing positions are challenged, the Company s effective tax rate in a given financial statement period could be materially affected. The provision for recovery of income taxes related to the class action award is based on the entire $18 million provision and does not take account of the potential decision of the Supreme Court, any possible insurance recoveries or future tax adjustments. The income tax recovery related to the class action provision is subject to adjustment when all facts are known and all issues are resolved. The possible adjustment for any of the factors noted could be significant. FUTURE ACCOUNTING STANDARDS The Company monitors new accounting standards to assess the impact, if any, on its consolidated financial statements. The CICA has issued the following accounting standards that may be applicable to the Company: CICA Section 3855, Financial Instruments - Recognition and Measurement establishes standards for recognizing and measuring financial assets, financial liabilities and non-financial derivatives. All financial instruments must be classified into a defined category, namely, held-to-maturity investments, held for trading, loans and receivables, available-for-sale financial assets, and other liabilities. This classification will determine how each instrument is measured and how gains and losses are recognized. In addition, the recommendations define derivatives to include non financial derivatives and embedded derivatives which meet certain criteria. All such derivatives must be classified as held for trading and therefore recorded at fair values unless they are designated in a hedging relationship. This standard is effective for interim and annual financial statements for fiscal years beginning on or after October 1, The Company is currently assessing the impact of this standard and the impact on the Company s consolidated financial statements has not been determined. The Company will adopt this new section for its fiscal year beginning July 1, CICA Section 3865, Hedges replaces AcG 13 Hedging Relationships. This section establish standards for the accounting treatment of qualifying hedge relationships and the necessary disclosures. The recommendations of this section are optional and are only required if the entity is applying hedge accounting. CICA Section 1530, Comprehensive Income introduces a statement of comprehensive income which will be included in the full set of interim and annual financial statements. Comprehensive income will represent the change in equity during a period from transactions and other events and circumstances from non-owner sources and will include all changes in equity other than those resulting from investments by owners and distributions to owners. The Company is currently reviewing the above standards and the impact, if any, on its consolidated financial statements has not been determined. The Company will adopt these new sections for its fiscal year beginning July 1, The Accounting Standards Board finalized its strategic plan for financial reporting in Canada whereby Canadian GAAP will converge with International Financial Reporting Standards over a several year period. After this transitional period, Canadian GAAP will cease to exist as a separate, distinct basis of financial reporting. The Company will continue to monitor the changes resulting from this transition. OUTSTANDING SHARE DATA As of the date hereof, 5,328,925 Subordinate Voting Shares and 1,224,329 Multiple Voting Shares of the Company were issued and outstanding. Each Subordinate Voting Share entitles the holder to one vote and each Multiple Voting Share entitles the holder to 10 votes at meetings of shareholders of the Company. 24 DANIER ANNUAL REPORT 2006

27 OUTLOOK A more price promotional retail environment, increased customer preferences for lower price point merchandise and the continued fashion trend to shorter length jackets which have a lower average price point negatively impacted Danier s performance during We expect Danier s business environment during 2007, especially during the first quarter to remain challenging and competitive. To improve performance during 2007, Danier plans to focus on its core customer who wants quality outerwear with a sophisticated look and classic styling at remarkable value. Danier also plans to improve merchandise planning processes and has started to purchase fall merchandise earlier so that sufficient quantities and sizes of merchandise are in-stock when the customer comes to the store. In addition, advertising dollars will be focussed on more frequent and better quality newspaper inserts that emphasize great product at excellent value. Danier also plans to reduce its selling, general and administrative expenses through reduced advertising expense, head office staff reductions which have already been implemented, no longer processing transactions through Danier s website and selective closure of under performing stores and power centre locations. Capital investments of approximately $3.6 million are planned for fiscal Approximately $2.2 million is anticipated to be used for renovations at seven existing stores, visual display equipment and miscellaneous expenditures in the retail division; $1.1 million for information technology including enhancement to the point-of-sale system and customer relationship management system, upgrading of merchandising and merchandise planning systems, and upgrade of computer hardware and software at head office; and $0.3 million for manufacturing equipment and building improvements. NON-GAAP MEASURES The Company reports its financial results in accordance with Canadian GAAP. However, the Company has included certain non-gaap financial measures and ratios which it believes provides useful information to both management and readers of this Annual Report, including this MD&A, in measuring the financial performance of the Company for the reasons set out below. These measures do not have a standardized meaning prescribed by Canadian GAAP and, therefore, may not be comparable to similarly titled measures presented by other publicly traded companies, nor should they be construed as an alternative to other financial measures determined in accordance with Canadian GAAP. EBITDA from Continuing Operations and Adjusted EBITDA - The following table reconciles net earnings (loss) before interest, incomes taxes, amortization, loss from discontinued operations, restructuring costs and litigation provision and related expenses ( Adjusted EBITDA ) to Canadian GAAP measures reported in the consolidated statements of net earnings (loss) for the fiscal years 2002 to 2006 as well as the quarterly periods for 2005 and Adjusted EBITDA is useful to management in assessing the Company s performance of its ongoing operations and its ability to generate cash flows to fund its cash requirements, including the Company's capital expenditure program Net earnings (loss) ($5,503) ($185) ($7,097) $5,394 $10,725 Add (deduct) impact of the following: Provision for (recovery of) income taxes (2,839) 931 (806) 3,849 7,429 Interest expense (income) (445) (340) (18) Amortization 6,239 6,216 5,771 5,760 4,909 Loss from discontinued operations - 2,768 1, Restructuring costs 1, Litigation provision and related expenses - 3,098 15,450 2,773 - Adjusted EBITDA ($1,159) $12,488 $14,487 $18,730 $24,388 DANIER ANNUAL REPORT

28 Q1 Q Net earnings (loss) ($5,291) ($3,413) $4,595 $7,182 Add (deduct) impact of the following: Provision for (recovery of) income taxes (3,242) (2,323) 2,902 4,940 Interest income (81) (59) (23) (11) Amortization 1,540 1,630 1,540 1,631 Loss from discontinued operations Restructuring costs Litigation provision and related expenses Adjusted EBITDA ($7,074) ($3,704) $9,014 $13,924 Q3 Q Net earnings (loss) ($192) ($794) ($4,615) ($3,160) Add (deduct) impact of the following: Provision for (recovery of) income taxes (78) 790 (2,421) (2,476) Interest income (182) (139) (159) (131) Amortization 1,609 1,632 1,550 1,323 Loss from discontinued operations - 2,147 - (22) Restructuring costs - - 1,389 - Litigation provision and related expenses ,098 Adjusted EBITDA $1,157 $3,636 ($4,256) ($1,368) Adjusted Net Earnings (Loss) - The following table reconciles net earnings (loss) before loss from continuing operations, litigation provision and related expenses and restructuring costs ( Adjusted Net Earnings (Loss) ) to Canadian GAAP measures reported in the consolidated statements of earnings (loss) for the fiscal years 2002 to 2006 as well as the quarterly periods for 2005 and Items listed in the reconciliation below are excluded because the Company believes this allows for a more effective analysis of the operating performance of the Company. In addition, they affect the comparability of the financial results and could potentially distort the analysis of trends. The exclusion of these items does not imply they are non-recurring. Adjusted Net Earnings (Loss) is useful to management in assessing the Company's performance and in making decisions regarding the ongoing operations of its business Net earnings (loss) ($5,503) ($185) ($7,097) $5,394 $10,725 Add (deduct) impact of the following: Loss from discontinued operations - 2,768 1, Restructuring costs 1, Litigation provision and related expenses - 3,098 15,450 2,773 - Income tax recovery (472) (832) (4,074) (1,155) - Adjusted net earings (loss) ($4,586) $4,849 $5,466 $7,900 $11, DANIER ANNUAL REPORT 2006

29 Q1 Q Net earnings (loss) ($5,291) ($3,413) $4,595 $7,182 Add (deduct) impact of the following: Loss from discontinued operations Litigation provision and related expenses Restructuring costs Income tax recovery Adjusted net earnings (loss) ($5,291) ($2,952) $4,595 $7,364 Q3 Q Net earnings (loss) ($192) ($794) ($4,615) ($3,160) Add (deduct) impact of the following: Loss from discontinued operations - 2,147 - (22) Litigation provision and related expenses ,098 Restructuring costs - - 1,389 - Income tax recovery - - (472) (832) Adjusted net earnings (loss) ($192) $1,353 ($3,698) ($916) ADDITIONAL INFORMATION Additional information, including the Company s annual information form, quarterly and annual reports, and supplementary information is available on SEDAR at Press releases and other information are also available in the Investor Relations section of the Company s website at DANIER ANNUAL REPORT

30 MANAGEMENT S RESPONSIBILITY FOR FINANCIAL STATEMENTS The accompanying financial statements and other financial information contained in this annual report are the responsibility of management. The financial statements have been prepared in conformity with Canadian generally accepted accounting principles using management s best estimates and judgements based on currently available information, where appropriate. The financial information contained elsewhere in this annual report has been reviewed to ensure consistency with that in the financial statements. Management is also responsible for a system of internal controls which is designed to provide reasonable assurance that assets are safeguarded, liabilities are recognized and that financial records are properly maintained to provide timely and accurate financial reports. The Board of Directors is responsible for ensuring that management fulfills its responsibility in respect of financial reporting and internal control. The Audit Committee of the Board, which is comprised solely of unrelated and outside directors, meets regularly to review significant accounting and auditing matters with management and the independent auditors and to review the interim and annual financial statements. The financial statements have been audited by PricewaterhouseCoopers LLP, the independent auditors, in accordance with generally accepted auditing standards on behalf of the shareholders. The Auditors Report outlines the nature of their examination and their opinion on the financial statements. PricewaterhouseCoopers LLP have full and unrestricted access to the Audit Committee to discuss their audit and related findings as to the integrity of the financial reporting. Jeffrey Wortsman President and CEO Bryan Tatoff, C.A. Senior Vice-President, CFO and Secretary AUDITORS REPORT TO SHAREHOLDERS To the Shareholders of Danier Leather Inc. We have audited the consolidated balance sheets of Danier Leather Inc. as at June 24, 2006 and June 25, 2005 and the consolidated statements of loss, retained earnings and cash flow for the years then ended. These consolidated financial statements are the responsibility of the Company s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at June 24, 2006 and June 25, 2005 and the results of its operations and its cash flow for the years then ended in accordance with Canadian generally accepted accounting principles. Chartered Accountants Toronto, Ontario July 26, DANIER ANNUAL REPORT 2006