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  As Of                Filer                Filing    For/On/As Docs:Size              Issuer               Agent

 6/25/07  Heelys/Inc                        S-1/A                  2:135                                    Merrill Corp/New/- FA

Document/Exhibit                   Description                      Pages   Size 

 1: S-1/A       Pre-Effective Amendment to Registration Statement   HTML   1.00M 
                          (General Form)                                         
 2: EX-23.1     Consent of Experts or Counsel                       HTML      6K 

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TABLE OF CONTENTS
HEELYS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

As filed with the Securities and Exchange Commission on June 25, 2007.

Registration No. 333-142673

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Amendment No. 3
to
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

HEELYS, INC.
(Exact Name of Registrant as Specified in its Charter)

3200 Belmeade Drive, Suite 100
Carrollton, Texas 75006
(214) 390-1831
(Address, including zip code, and telephone number, including area code, of registrant's principal executive offices)

Michael G. Staffaroni
Chief Executive Officer and President
3200 Belmeade Drive, Suite 100
Carrollton, Texas 75006
(214) 390-1831
(Name, address, including zip code, and telephone number, including area code, of agent for service)

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

        If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box.    o

        If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    o

        If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    o

        If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    o

        The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment that specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission acting pursuant to such Section 8(a), may determine.

SUBJECT TO COMPLETION, DATED JUNE 18, 2007

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

PROSPECTUS

4,500,000 Shares

HEELYS, INC.

Common Stock

        The selling stockholders named in this prospectus are offering 4,500,000 shares of our common stock. We will not receive any proceeds from the sale of the shares by the selling stockholders.

        Our common stock is quoted on the Nasdaq Global Market under the symbol "HLYS." The closing price of our common stock on the Nasdaq Global Market on June 22, 2007 was $25.95 per share.

        Investing in our common stock involves risks. See "Risk Factors" beginning on page 6.

        Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

        The underwriters expect to deliver the shares against payment in New York, New York on or about                        , 2007.

        The underwriters have a 30-day option to purchase up to 675,000 additional shares of common stock from the selling stockholders to cover over-allotments, if any. We will not receive any proceeds from the exercise of the over-allotment option.

The date of this prospectus is                        , 2007.




TABLE OF CONTENTS



        You should rely only on information contained in this prospectus, any free writing prospectus prepared by us or information to which we have referred you. We have not, and the underwriters have not, authorized anyone to provide you with different information. This prospectus may only be used where it is legal to sell these securities and this prospectus is not an offer to sell or a solicitation of an offer to buy shares in any jurisdiction where an offer or sale of shares would be unlawful. The information in this prospectus and any free writing prospectus prepared by us may be accurate only as of their respective dates.

        We own trademarks and trade names that we use in conjunction with the operation of our business. Our trademarks include HEELYS®, which is registered in the United States and in many other countries for wheeled footwear and other goods. Each trademark, service mark or trade name of any other company appearing in this prospectus belongs to its owner. Use or display by us of trademarks, service marks or trade names owned by others is not intended to and does not imply a relationship between us and, or endorsement or sponsorship by, the owners of the trademarks, service marks or trade names.

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PROSPECTUS SUMMARY

        You should read the following summary together with the more detailed information regarding us and our common stock being sold in this offering in our consolidated financial statements and notes appearing elsewhere in this prospectus and the risk factors beginning on page 6. As used in this prospectus, the terms "we," "our," "us," or "our company" refer to Heelys, Inc. and its consolidated subsidiaries, taken as a whole, unless the context otherwise indicates.

 
Our Company

        We are a designer, marketer and distributor of innovative, action sports-inspired products under the HEELYS brand targeted to the youth market. Our primary product, HEELYS-wheeled footwear, is patented, dual-purpose footwear that incorporates a stealth, removable wheel in the heel. HEELYS-wheeled footwear allows the user to seamlessly transition from walking or running to skating by shifting weight to the heel. Users can transform HEELYS-wheeled footwear into street footwear by removing the wheel. Our distinctive product offering has driven our growth, and we believe that our HEELYS brand is becoming synonymous with an increasingly popular lifestyle activity. We believe that the growing exposure of our HEELYS brand will allow us to selectively introduce additional product categories in the future by taking advantage of our expertise in product development and sourcing, strong retail relationships and knowledge of our target consumer. In 2006, our net sales increased $144.3 million, or 328.2%, to $188.2 million from $44.0 million in 2005. For the three months ended March 31, 2007, our net sales increased $35.8 million, or 261.6%, to $49.4 million from $13.7 million for the three months ended March 31, 2006.

        We believe that HEELYS-wheeled footwear provides users with a unique combination of fun and style that differentiates it from other footwear and wheeled sports products. Our distinctive product offering has driven our growth, and we believe that our HEELYS brand is becoming synonymous with an increasingly popular lifestyle activity.

        We currently offer HEELYS-wheeled footwear in a wide variety of styles and colors at domestic retail price points ranging from $59.99 to $89.99 depending upon performance features, comfort and materials. HEELYS-wheeled footwear is protected by numerous patents and trademarks, enabling us to capture the emerging demand for our unique offering in the United States and other countries where we can enforce our patents. In 2006, and in the three-month period ended March 31, 2007, approximately 98% of our net sales was derived from the sale of our HEELYS-wheeled footwear. We also sell branded accessories, such as replacement wheels, helmets and other protective gear and a limited variety of apparel items.

        Our brand message emphasizes individuality and independence and is represented by our marketing slogan, "Freedom is a wheel in your sole." We believe that our brand has developed broad appeal among boys and girls between six and fourteen years of age, particularly those who associate themselves with the action sports youth lifestyle. We employ a grass-roots marketing program designed to promote our brand image, stimulate demand for our products, maintain a connection with our target consumer and capture consumer feedback on our products.

        We sell our products through distribution channels that merchandise our products in a manner that we believe enhances and protects our HEELYS brand image. Domestically, our products can be purchased from full-line sporting goods retailers such as The Sports Authority, Modell's and Dick's Sporting Goods; specialty apparel and footwear retailers such as Journeys and The Finish Line; and select department stores, such as Nordstrom and Mervyn's. In 2006, 85.7% of our net sales were derived from retailers in the United States. For the three months ended March 31, 2007, 80.8% of our net sales were derived from retailers in the United States. Internationally, our products are sold to independent distributors with exclusive rights to specified territories.

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        The growth and longstanding popularity of skateboarding, inline skating, roller skating and scooter riding in the United States reflect consumers' sustained interest in wheeled sports activities. We believe that our HEELYS-wheeled footwear, which has broad patent protection relative to other wheeled sports products, appeals to many of these same consumers. Although the market for HEELYS-wheeled footwear has grown significantly since our first product was introduced in 2000, we believe this market continues to have strong potential for growth.

 
Business Strengths

        We attribute our success to the following business strengths:

•

strong brand recognition;



•

appealing, high-quality products;



•

our focus on product innovation, supported by intellectual property protection;



•

an in-depth understanding of our target market;



•

the compelling value proposition we offer to our retail customers;



•

our flexible and efficient sourcing model; and



•

our senior management team with deep industry experience.

 
Growth Strategy

        We plan to continue growing our net sales and earnings through the following strategies:

•

increasing awareness and popularity of our HEELYS brand with consumers;



•

broadening our relationships with existing retail customers;



•

expanding our customer base; and



•

developing and selectively acquiring new products and brands.

 
Risks Affecting Us

        We face a number of risks and uncertainties that may affect our financial and operating performance and our ability to execute our business strategies, as discussed in "Risk Factors." In particular, substantially all of our net sales are generated by one product, and we may not be able to successfully introduce new product categories. Our intellectual property may not restrict competing products that infringe on our patents from being sold. We outsource all of our manufacturing and our results of operations may be adversely affected if our independent manufacturers do not provide us with quality goods on a timely basis. If we are not able to manage our growth effectively, or if the popularity of our products does not continue to grow as rapidly as it has in the past or declines, our results of operations could suffer. As we grow, we must also effectively assimilate new employees and implement additional processes and information technology systems in order to effectively manage our business and report our financial results on a timely basis.

 
Corporate Information

        We were incorporated in Nevada in May 2000, and since that time have operated through a wholly-owned limited partnership organized in the State of Texas. On August 25, 2006, we reincorporated as a Delaware corporation pursuant to a merger of Heeling, Inc., a Nevada corporation, into Heelys, Inc., a Delaware corporation. Our principal executive offices are located at 3200 Belmeade Drive, Suite 100, Carrollton, Texas, and our telephone number is (214) 390-1831. Our website address is www.heelys.com. The information on our website is not part of this prospectus.

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The Offering

        The number of shares of common stock outstanding is based on 27,058,409 shares of common stock outstanding as of May 31, 2007, and does not take into account 2,209,163 shares of common stock issuable upon the exercise of stock options outstanding as of May 31, 2007 and 34,028 additional shares available for issuance upon exercise of stock options not yet granted under our 2006 Stock Incentive Plan. Of the outstanding options, 437,423 are vested, 1,566,740 vest and become exercisable in 37 equal monthly installments beginning on June 30, 2007, 125,000 vest and become exercisable in four equal cumulative installments beginning December 7, 2007, 55,000 vest and become exercisable in four equal cumulative installments beginning December 12, 2007, and 25,000 vest and become exercisable in four equal cumulative installments beginning March 8, 2008.

        Unless otherwise indicated, all information in this prospectus:

•

assumes no underwriters' over-allotment option to purchase up to 675,000 additional shares of common stock from the selling stockholders; and



•

reflects the number of shares of our common stock outstanding on May 31, 2007.

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Summary Consolidated Financial Data

        The following summary consolidated financial data should be read in conjunction with, and are qualified by reference to, our consolidated financial statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this prospectus. The consolidated statements of operations data for the years ended December 31, 2004, 2005 and 2006, and the consolidated balance sheet data at December 31, 2005 and 2006, are derived from our consolidated financial statements which have been audited by Deloitte & Touche LLP, an independent registered public accounting firm, and are included elsewhere in this prospectus. The consolidated balance sheet data at December 31, 2004, are derived from our consolidated financial statements not included herein which have been audited by Deloitte & Touche LLP, an independent registered public accounting firm. The consolidated statements of operations data for the three months ended March 31, 2006 and 2007, and the consolidated balance sheet data at March 31, 2007, are derived from our unaudited consolidated financial statements included elsewhere in this prospectus and, in the opinion of our management, include all adjustments, consisting only of normal recurring adjustments, that are necessary for a fair presentation of our financial position and results of operations for these periods. The historical results are not necessarily indicative of future results.

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(1)

Includes $500,000 of Series A Redeemable Preferred Stock outstanding at December 31, 2004.

 
Note: The numbers in the tables above, except per share data, have been rounded to thousands. All calculations related to the period-to-period comparisons in "Management's Discussion and Analysis of Financial Condition and Results of Operations" are derived from the tables above, are rounded to millions and could differ immaterially if such calculations were computed without rounding.

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RISK FACTORS

        Investment in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all of the other information in this prospectus before making an investment decision. Our business, financial condition and results of operations could be seriously harmed if any of the following risks actually occur. In that case, the trading price of our common stock could decline and you could lose all or part of your investment.

Risks Related to Our Business

We depend primarily upon sales from a single product line and the absence of continued demand for our products would have a material adverse effect on our net sales and results of operations.

        In 2005, 2006 and in the three-month period ended March 31, 2007, we generated approximately 95%, 98% and 98% of our net sales, respectively, from our HEELYS-wheeled footwear and we expect to continue to depend upon HEELYS-wheeled footwear for substantially all of our net sales in the foreseeable future. Because we are dependent on a single line of products, factors such as changes in consumer preferences may have a disproportionately greater impact on us than if we offered multiple product categories. If consumer interest in HEELYS-wheeled footwear or wheeled sports activity products in general declines, we would likely experience a significant loss of sales and may be forced to liquidate excess inventories at a discount, which would have a material adverse impact on our business and operations.

If we are unable to enforce our patents, trademarks and other intellectual property rights, competitors may be able to sell products that are substantially similar to our products, which could adversely affect our sales and damage our brand image.

        We believe our trademarks, trade names, copyrights, trade secrets, issued and pending patents, trade dress and designs are valuable and integral to our success. The costs associated with obtaining and maintaining our intellectual property rights and protecting our HEELYS brand are significant. Further, we do not know whether our pending or future patent applications will result in the issuance of patents. Even if patents are issued in the future, we cannot predict how the patent claims will be construed and such patents may not provide us with the ability to prevent the development, manufacturing or marketing of infringing products. Enforcement of our patents and other intellectual property rights is often met with defenses, counterclaims and countersuits attacking the validity and enforceability of our patents and other intellectual property rights. The validity and enforceability of our patents may be challenged by third parties for many different reasons, including for example, prior art, prior disclosure, prior offers to sell, incorrect inventorship, prior invention by another, patent misuse, antitrust violations, laches and estoppel.

        In addition, we may not be able to detect infringement of our intellectual property rights quickly or at all, and at times in the past we have not been, and in the future we may not be, successful combating counterfeit, infringing or knockoff products, thereby damaging our competitive position. For example, on many occasions, we have identified knockoff products sold by others that we believe may infringe upon our intellectual property rights. Historically, knockoff products have been sold mainly in international markets, but recently we have identified an increasing number of knockoff products being sold domestically. Knockoff products are often sold under a brand name that is the same as or substantially similar to the HEELYS name. Knockoff and counterfeit products may continue to emerge, as others seek to trade on the goodwill of the HEELYS name and benefit from the consumer demand for our products. We may not be able to detect all knockoff and counterfeit products and may lose our competitive position in a given geographic market before we become aware of any such infringement. For example, our net sales in Asia decreased from $12.1 million in 2003 to $5.4 million in 2004, which we believe was primarily due to the presence of lower-priced counterfeit, knockoff and infringing products in certain Asian markets.

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        To protect our HEELYS brand, we have already spent significant resources and may be required to spend significantly greater resources in the future to monitor and police our intellectual property rights. If we are unsuccessful in enforcing our intellectual property rights, sales of counterfeit, knockoff or infringing products by others could harm our HEELYS brand and adversely affect our business, financial condition and results of operations. Even if we successfully enforce our intellectual property rights, the presence in the market of counterfeit, knockoff or infringing products of poor quality for even a short time period could have a detrimental impact on our HEELYS brand.

We may not be able to obtain and maintain patent, trademark or other intellectual property rights protection in some foreign countries, which could result in us being unable to prevent others from using our HEELYS mark, which could have a material adverse effect on our business.

        We depend upon the laws of the countries where our products are sold to protect our intellectual property. Intellectual property rights may be unavailable or limited in some countries because patent laws and standards of patentability vary internationally. Consequently, in certain foreign jurisdictions, we have elected not to apply for patents or trademark registrations. Further, patent and trademark protection may not be available in every country where our products are sold. While we generally apply for patents and trademarks in most countries where we intend to sell patented products, we may not accurately predict all of the countries where patent or trademark protection will ultimately be desirable. If we fail to timely file a patent or trademark application in any such country, we will likely be precluded from doing so at a later date. Failure to adequately pursue and enforce our patent and trademark rights could damage our HEELYS brand, enable others to compete with us and impair our ability to compete effectively.

        In some countries where we have sought patent protection, third parties have challenged the validity, enforceability and scope of our patent rights. For example, the validity of our Japanese patent was challenged in May 2004, resulting in the Japan Patent Office issuing an opinion in February 2006 that our Japanese patent is invalid. We filed a lawsuit with the Intellectual Property High Court in Japan in June 2006, and we filed a Request for Trial for Correction in the Japan Patent Office in September 2006 to attempt to overturn the prior opinion. These actions are still proceeding. In addition, a third party filed a cancellation application in July 2004 with the Taiwan Intellectual Property Office to cancel our issued patent in Taiwan, and this proceeding is still pending. There can be no assurance that we will prevail in these or similar proceedings. Our HEELYS brand, business, financial condition and results of operations could be adversely affected if we fail to obtain and maintain intellectual property right protection in foreign countries where we derive a large amount of our net sales.

Because we are a consumer products company, if we fail to accurately forecast consumer demand and trends in consumer preferences, our HEELYS brand, net sales, customer relationships and results of operations may be adversely affected.

        Demand for our products, and for consumer products in general, is subject to rapidly changing consumer demand and trends in consumer preferences. Therefore, our success depends upon our ability to:

•

identify, anticipate, understand and respond to these trends in a timely manner;



•

expand the number of styles of HEELYS-wheeled footwear we offer to broaden the appeal of our products to a wider range of consumers; and



•

introduce appealing new products and performance features on a timely basis.

        We generally must make decisions regarding product designs several months before our products are available for sale, and it can take us up to six months to achieve full production of certain models. Accordingly, at the time we have to make decisions that determine our inventory levels, we cannot be certain that our product offerings will be well received by consumers, in which case we may be forced

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to liquidate excess inventories at a discount. Conversely, if we underestimate consumer demand for our products, we could have inventory shortages, which would result in lost sales, delays in shipments to retail customers and independent distributors, strains on our relationships with retail customers and independent distributors and diminished brand loyalty. Even if we introduce appealing new styles and products on a timely basis, we may set prices for our products too high to be successful. A decline in demand for our products, or any failure on our part to satisfy increased demand for our products, could adversely affect our net sales and results of operations.

We have significantly increased our sales and the scope of our operations over the past two years. If we fail to manage our growth effectively, we may experience difficulty in filling purchase orders, declines in product quality, increased costs or other operating challenges.

        We have:

•

transitioned from purchasing almost all of our footwear products from one independent manufacturer at December 31, 2005 to purchasing from a number of additional manufacturers in the second quarter of 2006;



•

increased the pairs of HEELYS-wheeled footwear sold from 697,000 pairs in 2004, to 1.4 million pairs in 2005 and to 6.2 million pairs in 2006; and



•

increased the number of our full-time employees from 19 at June 30, 2004 to 51 at May 31, 2007.

        We anticipate that continued growth of our operations will be required to satisfy increasing consumer demand and to avail ourselves of new market opportunities. The expanding scope of our business and growth in the number of our employees, customers and independent manufacturers have placed and will continue to place a significant strain on our management, information technology systems and other resources. To properly manage our growth, we need to hire additional employees, upgrade our existing financial and reporting systems, improve our business processes and controls and identify and develop relationships with additional independent manufacturers. We may also be required to expand our distribution facilities or add new facilities. Failure to effectively manage our growth could result in difficulty in distributing our products and filling purchase orders, declines in product quality or increased costs, any of which would adversely impact our business and results of operations.

Because we outsource all of our manufacturing to a small number of independent manufacturers, we may face challenges in maintaining a sufficient supply of products to meet demand for our products or experience interruptions in our supply chain. Any shortfall in the supply of our products may decrease our net sales and have an adverse impact on our customer relationships and results of operations.

        All of our products are produced by independent manufacturers with which we do not have long-term contracts. As such, any of them could unilaterally terminate its relationship with us or increase the prices it charges us at any time. Until May 2006, one independent manufacturer produced almost all of our HEELYS-wheeled footwear. Commencing in May 2006, when demand for our HEELYS-wheeled footwear products outstripped the capacity of this independent manufacturer, we used additional independent manufacturers to produce HEELYS-wheeled footwear. Although these additional manufacturers have enabled us to increase our monthly production capacity, we may be unable to fill a substantial number of orders placed by our customers on a timely basis. To expedite the delivery of past-due customer orders, we typically ship via air freight for which we pay higher shipping rates. During the second and third quarters of 2006 our inability to deliver customer orders on a timely basis resulted in delayed sales and higher shipping costs which caused us to miss certain internal financial targets. If we cannot procure sufficient quantities of HEELYS-wheeled footwear to meet customer demand in a timely manner, or if the quality of our products declines, customers may cancel orders, refuse shipments, negotiate for reduced purchase prices or ask us to pay extraordinary shipping costs, any of which could have a material adverse effect on our customer relationships and operating

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results. Additionally, if any of our independent manufacturers fail or refuse to ship any orders for any reason, our business could be adversely affected.

Our operations are dependent upon the strength of our relationships with our retail customers and independent distributors and their success in selling our products, and a small number of retail customers and independent distributors are responsible for a significant percentage of our net sales.

        Our success is dependent upon the willingness and ability of our retail customers to market and sell our products to consumers, as well as the success of our independent distributors in developing foreign markets for our products. For the year ended December 31, 2005, Big 5 Sporting Goods, Journeys and The Sports Authority were responsible for approximately 12.3%, 11.3% and 10.6% of our net sales, respectively. For the year ended December 31, 2006, Journeys and The Sports Authority accounted for approximately 12.7% and 8.8% of our net sales, respectively. In the three months ended March 31, 2007, Shiner Ltd. (our distributor in the United Kingdom), The Sports Authority and Finish Line accounted for approximately 14.8%, 13.4% and 10.7% of our net sales, respectively. If any of these or our other significant retail customers or independent distributors were to experience financial difficulties, reduce the quantity of our products it sells or stop selling our products, our financial condition and results of operations could be adversely affected.

We do not have long-term contracts with any of our retail customers or independent distributors, and the loss or material reduction in their business with us could result in reduced sales of our products.

        Our retail customers and independent distributors generally purchase products from us on a purchase order basis and do not have long-term contracts with us. Consequently, with little or no notice and without penalty, our retail customers and independent distributors may terminate their relationship with us or materially reduce the level of their purchases of our products. If this were to occur with one or more retail customers or independent distributors who purchase significant quantities of our products, it may be difficult for us to establish substitute relationships in a timely manner, which could have a material adverse effect on our financial condition and results of operations.

We rely on our independent sales representatives for our domestic sales, and if our relationships with a material number of these representatives were terminated, it could result in reduced sales of our products.

        We sell substantially all of our products domestically through our network of 20 independent sales representatives. We rely on these independent sales representatives to provide new customer prospects and market our products to our retail customers. Our independent sales representatives do not sell our products exclusively and may terminate their relationships with us at any time with limited notice. Our ability to maintain and increase our domestic sales depends in large part on our success in maintaining relationships with our independent sales representatives on commercially reasonable terms. Any failure to maintain and develop new satisfactory relationships with independent sales representatives, or any failure of our independent sales representatives to effectively market our products, could adversely affect our domestic sales.

Our current information technology systems may be unable to support our growth, and planned improvements may be inadequate or may not be successfully implemented on a timely basis, which would adversely affect our ability to operate effectively.

        We are in the process of upgrading and implementing new information technology systems to facilitate our growth, streamline our financial reporting and improve our internal controls. We have identified a number of significant deficiencies related to the security of our information technology systems that may affect the timeliness and accuracy of recording transactions and which could become material weaknesses in future periods if not remedied. The deficiencies include our need to further enhance access privileges and password settings and provide for more frequent monitoring of production critical processes. In addition, we may experience difficulties in transitioning to new or

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upgraded systems, including the loss of data and diminished productivity as our personnel become familiar with our new systems. As we grow and our business needs change, we could experience difficulties associated with systems transitions. If we experience difficulties in implementing new or upgraded information technology systems or experience system failures, or if we are unable to successfully modify our information technology systems to respond to changes in our business, our ability to operate effectively could be adversely affected.

Our business could suffer if our independent manufacturers violate legal requirements or fail to conform to generally accepted ethical standards.

        We expect our independent manufacturers to comply with applicable legal requirements and generally accepted ethical standards for working conditions and other matters. However, we do not control our independent manufacturers or their business practices. If any of our manufacturers were to use forced or indentured labor or child labor, fail to pay compensation in accordance with local law, fail to operate in compliance with local safety regulations or diverge from other applicable legal requirements or business practices generally accepted as ethical, we would take appropriate action, which could result in an interruption in our product supply. In addition, we could suffer negative publicity and damage to our reputation and the value of our HEELYS brand, which would adversely affect our business and results of operations.

If our independent manufacturers are unable to obtain raw materials, our costs could increase or the delivery of our products could be delayed, which could adversely affect our net sales and results of operations.

        The production capacity of our independent manufacturers is dependent, in part, upon the availability of raw materials. Our manufacturers may experience shortages of raw materials, which could result in increased costs to us or delays in deliveries of our products from our manufacturers. As a result, we could experience cancellation of orders, refusal to accept deliveries or a reduction in our sales prices and profit margins, any of which could harm our net sales and results of operations.

Because our products are manufactured in Asia and a portion of our sales activities occur outside of the United States, we are subject to international business, political, operational, financial and economic risks that could adversely affect our net sales and results of operations.

        Conducting business internationally entails numerous risks which could interrupt or otherwise adversely affect our business, including:

•

increased transportation costs;



•

delays and other logistical problems relating to the transportation of goods shipped by ocean freight;



•

work stoppages, strikes, lockouts or increased security concerns at seaports;



•

tariffs, import and export controls and other barriers, such as quotas and local content rules;



•

restrictions on the transfer of funds;



•

changing economic conditions;



•

changes in governmental policies and regulations;



•

limitations on the level of intellectual property protections;



•

poor or unstable infrastructure of certain foreign countries;



•

trade sanctions, political unrest, terrorism, war, epidemics and pandemics;



•

expropriation and nationalization; and



•

difficulties in understanding and complying with local laws, regulations and customs in foreign jurisdictions.

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        These factors and the failure to effectively respond to them could result in, among other things, poor quality in our products, product shortages, delivery delays, decreased net sales and increased costs.

We are subject to foreign exchange risk, and if the U.S. dollar significantly weakens compared to the currency in the markets where our products are produced, our manufacturers could increase the prices they charge us for our products, which could reduce our profitability.

        We pay for our products and we pay commissions to our independent sourcing agent in U.S. dollars, and our independent distributors pay us in U.S. dollars. International sales accounted for approximately 35.1% of our net sales in 2004, 16.8% of our net sales in 2005, 14.3% of our net sales in 2006 and 19.2% of our net sales in the three months ended March 31, 2007. We do not engage in any foreign currency hedging transactions. If the U.S. dollar strengthens compared to the currency in the foreign markets where our products are sold, our products will be more expensive in those markets making them less attractive to consumers. If the U.S. dollar significantly weakens compared to the currency in the foreign markets where our products are produced, our manufacturers could increase the prices they charge us for our products, which could reduce our profitability. There can be no assurance that we can effectively mitigate our foreign exchange risk.

HEELYS-wheeled footwear could become subject to import duties in the United States, and if we cannot increase our prices to compensate for such duties, it could reduce our profitability.

        HEELYS-wheeled footwear is currently classified by U.S. Customs and Border Protection as a skate, and as such we do not pay import duties to the United States. This customs classification can be changed at any time and, although we would vigorously oppose any proposed change, there can be no assurance that we would prevail. If the classification for HEELYS-wheeled footwear changed and HEELYS-wheeled footwear became subject to an import duty, it might be difficult to increase our prices to compensate for any such duty, which could reduce our profitability.

Third parties may claim that we are infringing their intellectual property rights, and such claims may be costly to defend, may require us to pay licensing fees, damages or other amounts and may prevent or limit the manufacture, marketing or sale of our products.

        Third parties may successfully claim that we are infringing their intellectual property rights. While we do not believe that any of our products infringe the valid intellectual property rights of third parties, we may be unaware of the intellectual property rights of others that may cover some of our technology or products. For example, because many patent applications in the United States are not publicly disclosed immediately after they are filed, we could adopt technology without knowledge of a pending patent application, which technology would infringe a third-party patent once that patent is issued.

        Our competitors in both the United States and foreign countries may have applied for or obtained, or may in the future apply for or obtain, patents that will prevent, limit or otherwise interfere with our ability to make, market or sell our products. Although we may conduct our own independent review of patents issued to certain third parties, we cannot assure you that we will be aware of all pre-existing technology that may subject us to patent litigation. Further, we may adopt a trademark or trade dress that a third party claims infringes their rights in such trademark or trade dress. If we are forced to defend against infringement claims, whether or not such claims are resolved in our favor, we could encounter expensive and time-consuming litigation which could divert the attention of our management and other key personnel from our business operations. Furthermore, if we are found to be infringing intellectual property rights of others, we could be required to pay licensing fees or damages. In addition, if we are not able to obtain license agreements on terms acceptable to us, or at all, we may be prevented from manufacturing, marketing or selling our products. As a result, our net sales could be significantly reduced and our cost of sales could be significantly increased, either of which could have an adverse effect on our business.

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We are dependent on our management team and other personnel, and the failure to attract and retain such individuals could adversely affect our operations.

        Our future success will depend in large part on our ability to retain Michael G. Staffaroni, Michael W. Hessong, Charles D. Beery and Patrick F. Hamner and to attract and retain other qualified managerial personnel. Our management and other employees can terminate their employment with us at any time, and we do not maintain key person life insurance. Our inability to attract or retain qualified employees, or the loss of any key employee, could harm our business and results of operations. We recently hired a Vice President — Marketing, a Vice President — Design and Development and a Vice President — Sourcing. Our failure to successfully integrate any of these individuals into our management team could adversely affect our business and results of operations.

We are subject to product liability, warranty and recall claims and our insurance coverage may not cover such claims, which could cause us to incur substantial costs and adversely affect our business.

        Due to the inherent risk of injury related to the use of our products, our business exposes us to claims for product liability and warranty claims if our products actually or allegedly fail to perform as expected, or the use of our products results or is alleged to result in personal injury, disability or death. There can be no assurance that we will be able to successfully defend or settle the product liability claims and lawsuits to which we are and in the future may be subject.

        We attach warning labels to our products and packaging relating to safe usage and the risk of injury. However, if a product liability claim is brought against us, the content of the warnings, the placement of them or both may be considered inadequate by courts, exposing us to liability. We cannot be certain that our safety warning labels are adequate. Product liability claims could result in us having to expend significant time and expense to defend these claims and to pay, if necessary, settlement amounts or damages, which could adversely affect our financial condition. In addition, claims that use of our products resulted in an injury, disability or death could cause our HEELYS brand image and operating performance to suffer by damaging our reputation and prospects and by diverting the time and attention of our management, even if we are not at fault.

        There can be no assurance that our product liability insurance coverage will be adequate, that our insurers will be financially viable when payment of a claim is required or that we will be able to obtain such insurance in the future on acceptable terms, if at all.

        If any of our products are or are alleged to be defective, we may be required to recall that product. Any product recall could cause us to incur substantial cost, and irreparably harm our relationships with our customers, which could adversely affect our business.

Negative publicity relating to our products could cause our HEELYS brand to suffer and adversely affect our net sales and results of operations.

        Various media outlets have recently reported on injuries suffered by users of our products and have quoted from or referred to medical studies and U.S. Consumer Product Safety Commission data relating to injury rates of users of wheeled footwear. This negative publicity and any future negative publicity relating to the safety of our products or products similar to ours could cause our HEELYS brand image to suffer and adversely affect our net sales and operating performance.

Additional bans on the use of our HEELYS-wheeled footwear due to public safety and liability concerns could adversely affect our net sales and results of operations.

        Various places of business and other institutions, such as shopping malls and schools, have imposed bans on the use of our HEELYS-wheeled footwear due to public safety and liability concerns. If the number of businesses and other institutions instituting such bans increases in the future, consumers could find our HEELYS-wheeled footwear less appealing, which could adversely affect our net sales and results of operations.

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Expanding our distribution to mass merchants could have a material adverse effect on our gross margin, brand image and results of operations.

        We sell our products to sporting goods retailers, specialty apparel and footwear retailers and select department stores in an effort to maintain a high-quality image for our HEELYS brand and premium price points for our products. Although we do not currently anticipate distributing to mass merchants, if we choose to do so in the future it could have a material adverse effect on our gross margin and could negatively affect our HEELYS brand image and our reputation with consumers, which could adversely affect our results of operations and financial condition.

Our operating results are subject to seasonal and quarterly variations in our net sales and net income, which could adversely affect the price of our common stock.

        We have experienced, and expect to continue to experience, substantial seasonal and quarterly variations in our net sales and net income. These variations are primarily related to increased sales of our products during the holiday selling season. Our quarterly results of operations may also fluctuate significantly as a result of a variety of other factors, including, among other things, the timing of holidays and advertising initiatives and changes in our product mix. In addition, variations in weather conditions may significantly affect our results of operations.

        As a result of these seasonal and quarterly fluctuations, we believe that comparisons of our operating results between different quarters within a single year are not necessarily meaningful and that these comparisons cannot be relied upon as indicators of our future performance. Any seasonal or quarterly fluctuations that we report in the future may differ from the expectations of market analysts and investors. This could cause the price of our common stock to fluctuate significantly.

As a relatively young consumer products company, we may not be able to compete effectively, which could have a negative impact on our sales and our business.

        We compete with companies that sell to young consumers in several different product markets, including footwear, sporting goods and recreational products. These markets are intensely competitive and we expect competition to increase in the future. A number of our competitors have significantly greater financial, marketing, distribution and manufacturing resources than we do, as well as greater brand awareness in the markets in which they operate. We also compete with counterfeit, knockoff and infringing products, which are often sold at lower prices. If we fail to remain competitive with respect to the quality, design, price and timely delivery of products, our business, financial condition and results of operations could be materially adversely affected.

We may have difficulty identifying and successfully integrating acquisitions into our business and any acquisitions we make could result in adverse consequences.

        We may make acquisitions of complementary companies and products. The pursuit of acquisitions may divert the attention of management and cause us to incur significant expenses identifying, investigating and pursuing suitable acquisitions, whether or not they are consummated.

        We have limited experience acquiring other businesses and may not be able to successfully integrate any acquired operations with our business or effectively manage the combined business following an acquisition. We also may not achieve the anticipated benefits of an acquisition due to any of the following factors:

•

unanticipated costs associated with making the acquisition and operating the acquired business;



•

harm to our business relationships with independent manufacturers, retail customers and independent distributors;



•

loss of key employees of the acquired business; or

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•

difficulties associated with entering product categories or markets in which we have little or no prior experience.

        If we experience any of the difficulties noted above, our business and financial condition could be adversely affected.

Risks Related to this Offering

The trading price of our common stock has been and may continue to be volatile and you may lose all or a part of your investment.

        Since our initial public offering in December 2006, the price of our common stock as reported by the Nasdaq Global Market has ranged from a low of $24.84 on June 22, 2007 to a high of $40.09 on February 5, 2007. The trading price of our common stock could continue to fluctuate significantly for various reasons, including:

•

expiration of lock-up agreements;



•

our operating and financial performance and prospects;



•

our quarterly or annual earnings or those of other companies in our industry;



•

the public's reaction to our press releases, other public announcements and filings with the SEC;



•

changes in earnings estimates or recommendations by research analysts who track our common stock or the stock of other companies in our industry;



•

strategic actions by us or our competitors;



•

new laws or regulations or new interpretations of existing laws or regulations applicable to our business;



•

changes in accounting standards, policies, guidance, interpretations or principles;



•

changes in general economic conditions in the United States and global economies or financial markets, including such changes resulting from war or incidents of terrorism; and



•

sales of our common stock by us or members of our management team.

        In addition, in recent years, the stock market has experienced significant price and volume fluctuations. This volatility has had a significant impact on the trading price of securities issued by many companies, including companies in our industry. The changes frequently occur irrespective of the operating performance of the affected companies. Hence, the trading price of our common stock could fluctuate based upon factors that have little or nothing to do with our business.

Future sales of our common stock in the public market could lower the trading price of our common stock, and the exercise of outstanding stock options and any additional capital raised by us through the sale of our common stock may dilute your ownership in us.

        We may sell additional shares of common stock in the future. Our Certificate of Incorporation authorizes us to issue 75,000,000 shares of common stock. As of May 31, 2007, we had 27,058,409 shares of common stock outstanding. Of this amount, a total of 11,916,284 shares, including the 4,500,000 shares that the selling stockholders are selling in this offering and 7,386,750 of the shares sold in our initial public offering in December 2006 may be resold immediately in the public market unless held by "affiliates" of ours as that term is defined in Rule 144 of the Securities Act of 1933, or the Securities Act. Of the remaining 15,142,125 shares, 14,558,700 will be restricted from immediate resale under lock-up agreements to be entered into between certain of our current stockholders and the underwriters. These lock-up agreements are described in "Underwriting" and expire 90 days after the date of this prospectus, unless Bear, Stearns & Co. Inc., Wachovia Capital Markets, LLC and J.P. Morgan Securities Inc., on behalf of the underwriters, consent otherwise. Such period could be extended by the underwriters for up to an additional 34 days under certain circumstances. Immediately

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after the expiration of the lock-up period, these shares will be eligible for resale under Rule 144 or Rule 701 of the Securities Act, subject to volume limitations and applicable holding period requirements.

        In addition, as of May 31, 2007, options to purchase 2,209,163 shares of our common stock were outstanding and 34,028 additional shares of our common stock were available for future awards under our 2006 Stock Incentive Plan. Of this total, 437,423 are vested, 1,566,740 vest and become exercisable in 37 equal monthly installments beginning June 30, 2007, 125,000 vest and become exercisable in four equal cumulative installments beginning December 7, 2007, 55,000 vest and become exercisable in four equal cumulative installments beginning December 12, 2007 and 25,000 vest and become exercisable in four equal cumulative installments beginning March 8, 2008. We have filed a registration statement under the Securities Act covering all of the shares of common stock reserved for issuance under our 2006 Stock Incentive Plan, including the shares issuable upon exercise of the outstanding options. The registration statement has become effective and permits the resale of shares issued under this plan in the public markets without restriction under the Securities Act.

        After completion of this offering and the expiration of the lock-up agreements, holders of 12,139,610 shares of our outstanding common stock will have demand and other registration rights, as described in "Description of Capital Stock."

        We cannot predict the effect, if any, that future issuances and sales of our common stock will have on the trading price of our common stock. Sales of substantial amounts of our common stock (including shares issued in connection with an acquisition), or the perception that such sales could occur, may adversely affect prevailing trading prices for our common stock.

Existing stockholders significantly influence our corporate governance.

        Upon completion of this offering, our executive officers, key employees, directors and their affiliates will beneficially own, in the aggregate, approximately 54.6% of our outstanding common stock. In addition, Capital Southwest Venture Corporation, or "CSVC," which will own approximately 23.3% of our common stock after this offering, has the contractual right to designate (i) two nominees for director to be included in management's slate of director nominees, so long as it owns at least 15% of the outstanding shares of our common stock, and (ii) one such nominee so long as it owns at least 10%, but less than 15%, of the outstanding shares of our common stock. As a result, through its designees, CSVC may significantly influence our corporate governance.

Our Certificate of Incorporation and By-Laws and Delaware law contain provisions that could discourage a third party from acquiring us and consequently decrease the value of an investment in our common stock.

        Our Certificate of Incorporation and By-Laws and Delaware corporate law contain provisions that could delay or prevent a change in control of our company or changes in our management. Among other things, these provisions:

•

authorize our board of directors, without prior stockholder approval, to issue preferred stock with rights, privileges and preferences, including voting rights, senior to those of our common stock;



•

prohibit stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders;



•

establish advance notice requirements for submitting nominations for election to the board of directors and for proposing matters that can be acted upon by stockholders at a meeting; and



•

impose restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock.

        These provisions could discourage proxy contests, make it more difficult for our stockholders to elect directors and take other corporate actions and may discourage, delay or prevent a change in

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control or changes in our management that a stockholder might consider favorable. Any delay or prevention of a change in control or change in management that stockholders might otherwise consider to be favorable could deprive you of the opportunity to sell your common stock at a price in excess of the prevailing trading price and cause the trading price of our common stock to decline.

As a public company, we are required to meet periodic reporting requirements under SEC rules and regulations. Complying with federal securities laws as a public company is expensive and we will incur significant time and expense enhancing, documenting, testing and certifying our internal control over financial reporting. Any deficiencies in our financial reporting or internal controls could adversely affect our business and the trading price of our common stock.

        SEC rules require that, as a publicly traded company, we file periodic reports containing our financial statements within a specified time following the completion of quarterly and annual periods. Prior to the completion of our initial public offering in December 2006, we were not required to comply with SEC requirements to have our financial statements completed and reviewed or audited within a specified time. We may experience difficulty in meeting the SEC's reporting requirements. Any failure by us to file our periodic reports with the SEC in a timely manner could harm our reputation and reduce the trading price of our common stock.

        As a public company we will incur significant legal, accounting, insurance and other expenses. The Sarbanes-Oxley Act of 2002, as well as compliance with other SEC and Nasdaq rules, will increase our legal and financial compliance costs and make some activities more time-consuming and costly. Furthermore, SEC rules require that our chief executive officer and chief financial officer periodically certify the existence and effectiveness of our internal control over financial reporting. Our independent registered public accounting firm will be required, beginning with our Annual Report on Form 10-K for our fiscal year ending on December 31, 2007, to attest to our assessment of our internal control over financial reporting. This process generally requires significant documentation of policies, procedures and systems, review of that documentation by our internal accounting staff and our outside auditors and testing of our internal control over financial reporting by our internal accounting staff and our outside independent registered public accounting firm. Documentation and testing of our internal controls, which we have not undertaken in the past, will involve considerable time and expense, may strain our internal resources and have an adverse impact on our operating costs.

        During the course of our testing, we may identify deficiencies which would have to be remediated to satisfy the SEC rules for certification of our internal control over financial reporting. As a consequence, we may have to disclose in periodic reports we file with the SEC significant deficiencies or material weaknesses in our system of internal controls. The existence of a material weakness would preclude management from concluding that our internal control over financial reporting is effective, and would preclude our independent auditors from issuing an unqualified opinion that our internal control over financial reporting is effective. In addition, disclosures of this type in our SEC reports could cause investors to lose confidence in our financial reporting and may negatively affect the trading price of our common stock. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud. If we have deficiencies in our disclosure controls and procedures or internal control over financial reporting it may negatively impact our business, results of operations and reputation.

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

        This prospectus includes forward-looking statements with respect to our financial condition, results of operations and business that are not historical information. Forward-looking statements include statements that may relate to our plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs and other information that is not historical information. Many of these statements appear, in particular, under the headings "Prospectus Summary," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business." Forward-looking statements can be identified by the use of terminology such as "subject to," "believes," "anticipates," "plans," "expects," "intends," "estimates," "projects," "may," "will," "should," "can," the negatives thereof, variations thereon and similar expressions, or by discussions of strategy.

        All forward-looking statements are based upon our current expectations and various assumptions. We believe there is a reasonable basis for our expectations and assumptions, but they are inherently uncertain, we may not realize our expectations and our assumptions may not prove correct. Actual results could differ materially from those described or implied by such forward-looking statements. Factors that may materially affect such forward-looking statements include:

•

significant competition;



•

our ability to adequately enforce our intellectual property rights;



•

unfavorable publicity, consumer perception or material product liability claims concerning our products;



•

costs of compliance and our failure to comply with governmental regulations;



•

economic, political and other risks associated with our international manufacturing and sales;



•

our failure to satisfy consumer demand for our products;



•

changes in consumer preferences or demand for our products;



•

our inability to attract and retain key members of management;



•

the effects of seasonality on our sales; and



•

other factors described in this prospectus under "Risk Factors."

        Consequently, such forward-looking statements should be regarded solely as our current plans, estimates and beliefs. You should not place undue reliance on forward-looking statements. We cannot guarantee future results, events, performance or achievements. We do not have any obligation and do not intend to update, republish or revise forward-looking statements to reflect future events or circumstances or to reflect the occurrences of unanticipated events.

 
INDUSTRY AND MARKET DATA

        Industry and market data used in this prospectus were obtained through surveys and studies conducted by third parties, industry and general publications and our internal research. Industry data estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under "Risk Factors."

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USE OF PROCEEDS

        All of the shares of common stock being offered by this prospectus are being sold by the selling stockholders. We will not receive any proceeds from the sale of the shares.

 
PRICE RANGE OF COMMON STOCK

        Our common stock, par value $0.001, has been listed on the Nasdaq Global Market under the stock symbol "HLYS" since December 8, 2006. Prior to that time there was no public market for our stock. The initial public offering price of our common stock on December 8, 2006 was $21.00 per share. As of May 31, 2007, there were 28 holders of record of our common stock. The following table sets forth, for the periods indicated, the range of high and low sales prices for our common stock as reported on the Nasdaq Global Market.

        On June 22, 2007, the last reported sales price of our common stock on the Nasdaq Global Market was $25.95.

 
DIVIDEND POLICY

        In the past we have not paid any dividends, nor do we anticipate paying any dividends in the foreseeable future. Instead, we anticipate that all of our earnings, if any, in the foreseeable future will be used for working capital and to finance the growth and development of our business. Any future determination relating to dividend policy will be made at the discretion of our board of directors and will depend on a number of factors, including our outstanding indebtedness, earnings, capital requirements, financial condition and future prospects, applicable Delaware law, which provides that dividends are only payable out of surplus or net profit for the then current and immediately preceding fiscal years, and other factors that our board of directors may deem relevant. Our revolving credit facility prohibits us from paying dividends or making other distributions to our stockholders, and future agreements governing our borrowings, and the terms of any preferred stock we may issue in the future, will also likely contain restrictive covenants prohibiting us from paying dividends.

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CAPITALIZATION

        The following table provides our cash and cash equivalents and our capitalization as of March 31, 2007.

        You should read this table in connection with "Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as the consolidated financial statements and related notes included elsewhere in this prospectus.

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SELECTED CONSOLIDATED FINANCIAL DATA

        The following selected consolidated financial data should be read in conjunction with, and are qualified by reference to, our consolidated financial statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this prospectus. The consolidated statements of operations data for the years ended December 31, 2004, 2005 and 2006, and the consolidated balance sheet data at December 31, 2005 and 2006 are derived from our consolidated financial statements which have been audited by Deloitte & Touche LLP, an independent registered public accounting firm, and are included elsewhere in this prospectus. The consolidated statements of operations data for the years ended December 31, 2002 and 2003, and the consolidated balance sheet data at December 31, 2002, 2003 and 2004 are derived from our consolidated financial statements not included herein which have been audited by Deloitte & Touche LLP, an independent registered public accounting firm. The consolidated statements of operations data for the three months ended March 31, 2006 and 2007, and the consolidated balance sheet data at March 31, 2007, are derived from our unaudited consolidated financial statements included elsewhere in this prospectus and, in the opinion of our management, include all adjustments, consisting only of normal recurring adjustments, that are necessary for a fair presentation of our financial position and results of operations for these periods. The historical results are not necessarily indicative of future results.

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(1)

Includes $1.1 million of cash on deposit held under a previously outstanding revolving line of credit.

(2)

Includes current portion of long-term debt.

(3)

Includes $500,000 of Series A Redeemable Preferred Stock outstanding at December 31, 2002, 2003 and 2004.

 
Note: The numbers in the tables above, except per share data, have been rounded to thousands. All calculations related to the period-to-period comparisons in "Management's Discussion and Analysis of Financial Condition and Results of Operations" are derived from the tables above, are rounded to millions and could differ immaterially if such calculations were computed without rounding.

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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

        The following discussion should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. See "Risk Factors" included elsewhere in this prospectus for a discussion of important factors that could cause actual results to differ materially from those described or implied by the forward-looking statements contained in this discussion. Please refer to "Special Note Regarding Forward-Looking Statements" included elsewhere in this prospectus.

 
Overview

        We are a designer, marketer and distributor of innovative, action sports-inspired products under the HEELYS brand targeted to the youth market. Our primary product, HEELYS-wheeled footwear, is patented, dual-purpose footwear that incorporates a stealth, removable wheel in the heel. HEELYS-wheeled footwear allows the user to seamlessly transition from walking or running to skating by shifting weight to the heel. Users can transform HEELYS-wheeled footwear into street footwear by removing the wheel. In 2006, and in the three-month period ended March 31, 2007, approximately 98% of our net sales was derived from the sale of our HEELYS-wheeled footwear. We also sell branded accessories such as replacement wheels, helmets and other protective gear and a limited variety of apparel items.

        We introduced HEELYS-wheeled footwear in 2000, and for several years our domestic sales were concentrated with one large, national specialty retailer. Although we initially focused on driving our domestic sales growth, we also established relationships with an independent distributor in each of Japan, South Korea and Southeast Asia. As a result, the sources of our net sales were largely concentrated and we were susceptible to customer-specific and region-specific factors, including competition from counterfeit, knockoff and infringing products in international markets. This concentration caused variability in our results of operations. Since that time, we have diversified our retail customer base in the United States and expanded our international distribution channels to mitigate this concentration.

        Since 2003, our domestic net sales have increased rapidly. We believe that this increase has resulted primarily from the growing acceptance of HEELYS-wheeled footwear by consumers, increasing recognition of our HEELYS brand name and expanding distribution of HEELYS-wheeled footwear to existing and new retail customers. We believe that our grass-roots marketing programs, quality products and relationships with our retail customers have contributed to this growing demand. Continued growth of our net sales will depend on consumer demand for HEELYS-wheeled footwear and our ability to satisfy this demand. A number of factors may impact consumer demand for our products, including:

•

the effectiveness of our marketing strategies;



•

our ability to effectively distribute our products;



•

our ability to design products that appeal to our target consumers;



•

our ability to protect our intellectual property rights;



•

general economic conditions, particularly changes in consumer discretionary spending patterns; and



•

changes in the popularity of and participation rates in wheeled sports activities.

        We intend to continue to diversify our product offering with new HEELYS-wheeled footwear models, product categories and accessories in order to benefit from the increasing recognition of our HEELYS brand and the growing market for action sports-inspired products. Designing, marketing and distributing new products will require us to devote additional resources to product development,

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marketing and operations. These additional resources may include hiring new employees to support our growth in these areas and increasing amounts allocated to product advertising and promotion. Each of these additional resource commitments will increase our selling, general and administrative expenses. Because the selling price and unit cost of new products may differ from those of our existing products, sales of these new products may also impact our gross margin. In addition, we may seek to selectively acquire products and companies that offer products that are complementary to ours.

 
General

Net Sales

        Net sales represent primarily sales of HEELYS-wheeled footwear, less an estimated reserve for sales returns, allowances and discounts. A small portion of our net sales is derived from the sale of accessories such as replacement wheels, helmets and other protective gear and a limited variety of apparel items. Amounts billed to domestic customers for shipping and handling are included in net sales.

        We sell our products through distribution channels that merchandise our products in a manner that we believe enhances and protects our HEELYS brand image. Domestically, our products can be found in full-line sporting goods retailers, specialty apparel and footwear retailers and select department stores and online retailers. As of May 31, 2007, our customer base of retail customers in the United States included more than 850 accounts that operated more than 7,400 stores. Based on communications with these customers, we believe that as of May 31, 2007, our HEELYS-wheeled footwear was offered for sale in more than 5,700 of these stores. In 2006, 85.7% of our net sales were derived from domestic retail customers. For the three months ended March 31, 2007, 80.8% of our net sales were derived from domestic retail customers. Internationally, our products are sold to independent distributors with exclusive rights to specified territories. Sales to our independent distributors are denominated in U.S. dollars. As of May 31, 2007, we had 28 independent distributors. For the three months ended March 31, 2007, the United Kingdom accounted for 14.8% of our net sales. No country, other than the United States and the United Kingdom, accounted for 10% or more of our net sales for the three months ended March 31, 2007. In 2005 and 2006, no country, other than the United States, accounted for 10% or more of our net sales.

Cost of Sales and Gross Profit

        Cost of sales consists primarily of the cost to purchase finished products from our independent manufacturers. Cost of sales also includes commissions paid to our independent sourcing agent, inbound and outbound freight, warehousing expenses, tooling depreciation, royalty expenses related to licensed intellectual property and an inventory reserve for shrinkage and write-downs.

        We source all of our products and accessories from manufacturers located in China, Indonesia and South Korea. Our product costs are largely driven by the prices we negotiate with our independent manufacturers. Each season, we negotiate a unit price for each model of HEELYS-wheeled footwear. Factors that influence these prices include raw materials and labor costs and foreign exchange rates. We pay our independent sourcing agent a commission equal to a specified percentage of our per unit cost, with the percentage decreasing when our annual purchases exceed a predetermined unit volume threshold. We believe that our sourcing model allows us to minimize our capital investment, retain the production flexibility, cost-effectiveness and scalability inherent in the use of independent manufacturers and focus our resources on developing new products and enhancing our HEELYS brand image. In December 2006, we hired a Vice President — Sourcing to manage our relationship with our independent sourcing agent and manufacturers.

        We have generally avoided selling our products at close-out prices due to strong demand. Should demand for our products slow, we may discount our products to reduce our inventory, which may cause

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our gross profit as a percentage of net sales, or gross margin, to decline. Our gross margin is affected by our sourcing and distribution costs, our product mix and our ability to avoid excess inventory by accurately forecasting demand for our products. The unit prices that we charge our domestic retail customers are generally higher than what we charge our independent distributors for similar products, because our independent distributors are responsible for distribution and marketing costs relating to our products. The gross margin for products sold to our domestic retail customers and independent distributors are similar, however, due to higher shipping costs and standard customer discounts and allowances related to domestic sales.

Selling, General and Administrative Expenses

        Selling, general and administrative expenses consist of wages and related payroll and employee benefit costs, sales and marketing expenses, advertising costs, travel and insurance expenses, product development costs, costs to enforce our intellectual property rights, depreciation, amortization, professional fees, facility expenses and costs associated with operating as a public company. Our selling, general and administrative expenses have increased annually as we have increased our marketing expenses and expanded our infrastructure to support our sales growth. In addition, our product liability insurance premiums have increased as our net sales have increased.

        We adopted SFAS No. 123(R) effective January 1, 2006. SFAS No. 123(R) requires the measurement of compensation cost of stock-based compensation awards based on the estimated fair value of that award on the date of grant. We recognize this compensation cost using the straight-line method over the period during which the employee is required to provide service in exchange for the award — the requisite service period. No compensation cost is recognized for awards for which the employee does not render the required service. If the requisite service is not provided, all previously recognized compensation cost is reversed. For all awards granted to-date, the requisite service period is the same as the vesting period of the award. For the three months ended March 31, 2007, we recognized $456,000 of stock-based compensation cost, of which $139,000 is included in sales and marketing expense and $261,000 is included in general and administrative expense. The balance, $56,000, is included in cost of sales. We did not grant any stock-based compensation awards prior to June 2006.

        We expect that our selling, general and administrative expenses will continue to increase in future periods as we continue to hire additional personnel, develop our infrastructure, increase our brand recognition through marketing, increase our product development efforts, secure and enforce our intellectual property rights and incur additional expenses associated with operating as a public company, including compliance with the Sarbanes-Oxley Act of 2002.

Income Taxes

        We operate through Heeling Sports Limited, a Texas limited partnership, and, accordingly, have not incurred significant amounts of Texas franchise taxes. Texas recently passed legislation amending its franchise tax law. We do not expect this change in the Texas franchise tax law to have a material impact on our effective tax rate.

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Results of Operations

Comparison of the Three Months Ended March 31, 2007 and Three Months Ended March 31, 2006

        Net sales.    Net sales increased $35.8 million, or 261.6%, to $49.4 million for the three months ended March 31, 2007 from $13.7 million for the three months ended March 31, 2006. This increase was primarily the result of higher unit sales of our HEELYS-wheeled footwear, which increased by 1.3 million pairs, or 291.2%, to 1.7 million pairs for the three months ended March 31, 2007 from 434,000 pairs for the three months ended March 31, 2006, partially offset by a lower average selling price due to product mix. For the three months ended 2007, 80.8% of our net sales were derived from domestic retail customers, compared to 88.0% for the three months ended March 31, 2006. Domestically, our net sales increased $27.9 million, or 231.9%, to $39.9 million for the three months ended March 31, 2007 from $12.0 million for the three months ended March 31, 2006. This increase was primarily the result of higher unit sales of our HEELYS-wheeled footwear to existing and new retail customers, which increased by 954,000 pairs, or 254.4%, to 1.3 million pairs for the three months ended March 31, 2007 from 375,000 pairs for the three months ended March 31, 2006. Internationally, our net sales increased $7.8 million, or 480.2%, to $9.5 million for the three months ended March 31, 2007, compared to $1.6 million for the three months ended March 31, 2006.

        Gross profit.    Gross profit increased $12.6 million to $17.5 million for the three months ended March 31, 2007 from $4.9 million for the three months ended March 31, 2006. Our gross margin was 35.4% for the three months ended March 31, 2007 compared to 36.0% for the three months ended March 31, 2006. The decrease in gross margin was attributed to an increase in our estimated reserves for returns and co-op advertising and marketing discretionary fund allowances of 1.5% of our net sales. This increase was offset by reduced costs of 0.4% of net sales related to reduced freight costs and 0.3% of net sales related to efficiencies in operating our distribution center.

        Sales and marketing expense.    Sales and marketing expense increased $1.5 million to $2.8 million for the three months ended March 31, 2007 from $1.4 million for the three months ended March 31, 2006. This increase was primarily the result of a $510,000 increase in sales commissions related to our increased domestic net sales partially offset by a decrease in commission rates, a $284,000 increase in co-op advertising resulting from increased sales, a $198,000 increase in payroll and payroll related expenses resulting from an increase in the number of employees to support our growth, a $143,000

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increase in point-of-sale marketing efforts and $139,000 in stock-based compensation costs. Although the dollar amount of sales and marketing expense increased, sales and marketing expense as a percentage of net sales decreased to 5.8% for the three months ended March 31, 2007 from 10.1% for the three months ended March 31, 2006.

        General and administrative expense.    General and administrative expense increased $1.5 million to $2.4 million for the three months ended March 31, 2007 from $931,000 for the three months ended March 31, 2006. This increase was the result of $548,000 in costs directly attributable to our status as a public company after the completion of our initial public offering in December 2006, a $320,000 increase in payroll and related employee costs resulting from an increase in headcount, $261,000 in stock-based compensation costs, $220,000 in legal fees to enforce our intellectual property and a $162,000 increase in our product liability insurance premiums due to increased sales volume, partially offset by a $148,000 reduction in our provision for doubtful accounts from December 31, 2006 to March 31, 2007. Although the dollar amount of general and administrative expense increased, as a percentage of net sales, general and administrative expense decreased to 4.8% for the three months ended March 31, 2007 from 6.8% for the three months ended March 31, 2006.

        Operating income.    As a result of the above factors, operating income increased $9.6 million to $12.2 million for the three months ended March 31, 2007 from $2.6 million for the three months ended March 31, 2006. As a percentage of net sales, operating income increased to 24.8% for the three months ended March 31, 2007 from 19.1% for the three months ended March 31, 2006.

        Income taxes.    Income taxes were $4.6 million for the three months ended March 31, 2007, representing an effective income tax rate of 35.4%, compared to $912,000 for the three months ended March 31, 2006, representing an effective income tax rate of 35.0%. We currently expect our effective tax rate to be approximately 35.4% for the fiscal year ended December 31, 2007.

        Net income.    As a result of the above factors, net income was $8.5 million for the three months ended March 31, 2007 compared to $1.7 million for the three months ended March 31, 2006. As a percentage of net sales, net income increased to 17.1% for the three months ended March 31, 2007 from 12.4% for the three months ended March 31, 2006.

Comparison of the Years Ended December 31, 2006 and December 31, 2005

        Net sales.    Net sales increased $144.3 million, or 328.2%, to $188.2 million in 2006 from $44.0 million in 2005. This increase was primarily the result of higher unit sales of our HEELYS-wheeled footwear, which increased by 4.8 million pairs, or 338.1%, to 6.2 million pairs in 2006 from 1.4 million pairs in 2005. In 2006, 85.7% of our net sales were derived from domestic retail customers, compared to 83.2% in 2005. Domestically, our net sales increased $124.8 million, or 341.2%, to $161.3 million in 2006 from $36.6 million in 2005. This increase was primarily the result of higher unit sales of our HEELYS-wheeled footwear to existing and new retail customers, which increased by 4.1 million pairs, or 353.7%, to 5.2 million pairs in 2006 from 1.1 million pairs in 2005. Internationally, our net sales increased $19.5 million, or 264.1%, to $26.9 million in 2006, compared to $7.4 million in 2005. This increase was primarily the result of increased sales to distributors in the United Kingdom, Canada and Ireland, partially offset by decreased sales to distributors in Japan and Spain/Portugal.

        Gross profit.    Gross profit increased $50.6 million to $65.6 million in 2006 from $15.0 million in 2005. Our gross margin was 34.9% in 2006 compared to 34.1% in 2005. The increase in gross margin was attributed to a decrease in our product costs of 0.8% of net sales due to product mix and reduced sourcing commissions; reduced costs of 0.4% of net sales related to efficiencies in operating our distribution center and reduced royalty expense of 0.2% of net sales related to fewer royalty-based sales. These cost reductions were partially offset by increased freight costs of 0.7% of net sales,

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including extraordinary air freight costs incurred to offset startup production delays at several of our new independent manufacturers.

        Sales and marketing expense.    Sales and marketing expense increased $8.4 million to $13.7 million in 2006 from $5.2 million in 2005. This increase was primarily the result of a $6.4 million increase in sales commissions related to our increased domestic net sales, together with a $696,000 increase in television advertising, a $561,000 increase in co-op advertising, and $127,000 in stock-based compensation. Although the dollar amount of sales and marketing expense in 2006 increased from the prior period, as a percentage of net sales, sales and marketing expense decreased to 7.3% in 2006 from 11.9% in 2005.

        General and administrative expense.    General and administrative expense increased $3.4 million to $6.4 million in 2006 from $3.0 million in 2005. This increase was primarily the result of a $1.2 million increase in our product liability insurance premiums which are based on sales volumes, $602,000 in payroll and related costs due to an increase in the number of employees, $441,000 in stock-based compensation expense and a $328,000 increase in our provision for doubtful accounts due to increased sales volume. Although the dollar amount of general and administrative expense in 2006 increased from the prior period, as a percentage of net sales, general and administrative expense decreased to 3.4% in 2006 from 6.8% in 2005.

        Operating income.    As a result of the above factors, operating income increased $38.8 million to $45.6 million in 2006 from $6.8 in 2005. As a percentage of net sales, operating income increased to 24.2% in 2006 from 15.4% in 2005.

        Income taxes.    Income taxes were $15.8 million in 2006, representing an effective income tax rate of 35.1%, compared to $2.3 million in 2005, representing an effective income tax rate of 34.5%.

        Net income.    As a result of the above factors, net income was $29.2 million in 2006 compared to $4.3 million in 2005. As a percentage of net sales, net income increased to 15.5% in 2006 from 9.9% in 2005.

 
Comparison of the Years Ended December 31, 2005 and 2004

        Net sales.    Net sales increased $22.6 million, or 106.2%, to $44.0 million in 2005 from $21.3 million in 2004. This increase was primarily the result of higher unit sales of our HEELYS-wheeled footwear, which increased by 714,000 pairs, or 102.4%, to 1.4 million pairs in 2005 from 697,000 pairs in 2004. In 2005, 83.2% of our net sales were derived from domestic retail customers compared to 64.9% in 2004. Domestically, our net sales increased $22.7 million, or 164.4%, to $36.6 million in 2005 from $13.8 million in 2004. This increase was primarily the result of higher unit sales of our HEELYS-wheeled footwear to existing and new retail customers, which increased by 722,000 pairs, or 170.7%, to 1.1 million pairs in 2005 from 423,000 pairs in 2004. Internationally, our net sales decreased $98,000, or 1.3%, to $7.4 million in 2005 compared to $7.5 million in 2004. This decrease was primarily the result of lower sales in Japan that we believe occurred primarily due to competing counterfeit and knockoff products, partially offset by increased sales to independent distributors in Canada, the United Kingdom, Ireland and Spain/Portugal.

        Gross profit.    Gross profit increased $8.2 million to $15.0 million in 2005 from $6.8 million in 2004. Our gross margin improved to 34.1% in 2005 from 31.8% in 2004. The increase in gross margin was primarily due to decreases in our product costs of 1.0% of net sales due to product mix and cost reductions, reduced inventory reserve costs of 0.8% of net sales based on actual experience, reduced costs of 0.3% of net sales related to efficiencies in operating our distribution center and reduced royalty expense of 0.3% of net sales related to fewer royalty-based sales, all of which were partially offset by increased freight costs of 0.1% of net sales.

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        Sales and marketing expense.    Sales and marketing expense increased $2.1 million to $5.2 million in 2005 from $3.2 million in 2004. This increase was primarily the result of a $1.3 million increase in sales commissions related to our increased domestic net sales, together with a $415,000 increase in advertising expense. Although the dollar amount of sales and marketing expense in 2005 increased from the prior period, as a percentage of net sales, sales and marketing expense decreased to 11.9% in 2005 from 15.0% in 2004.

        General and administrative expense.    General and administrative expense increased $619,000 to $3.0 million in 2005 from $2.4 million in 2004. This increase was primarily the result of $304,000 in increased compensation expense due to an increase in the number of our employees and amount of bonus payments, and a $110,000 increase in our bad debt expense as we increased our provision for doubtful accounts due to increased sales volume. Although the dollar amount of general and administrative expense in 2005 increased from the prior period, as a percentage of net sales, general and administrative expense decreased to 6.8% in 2005 from 11.1% in 2004.

        Operating income.    As a result of the above factors, operating income increased $5.5 million to $6.8 million in 2005 from $1.2 million in 2004. As a percentage of net sales, operating income increased to 15.4% in 2005 from 5.7% in 2004.

        Income taxes.    Income taxes were $2.3 million in 2005, representing an effective income tax rate of 34.5%, compared to $418,000 in 2004, representing an effective income tax rate of 34.2%.

        Net income.    As a result of the above factors, net income was $4.3 million in 2005 compared to $803,000 in 2004. As a percentage of net sales, net income increased to 9.9% in 2005 from 3.8% in 2004.

 
Liquidity and Capital Resources

        Our primary cash need is for working capital, which we generally finance with cash flow from operating activities. In December 2006, we completed an initial public offering of our common stock. We received approximately $58.8 million in net proceeds, after deducting an aggregate of $4.6 million in underwriting discounts and commissions and $2.2 million in other expenses incurred in connection with the offering. As of March 31, 2007, we used $8.5 million of these proceeds to repay amounts outstanding under our revolving credit facility and $11.5 million for working capital purposes. We intend to use the remaining proceeds to fund infrastructure improvements, including expanding and upgrading our information technology systems; hiring new employees; marketing and advertising programs; product development; working capital needs; and other general corporate purposes. Our liquidity may be impacted by fluctuations in demand for our products, investments in our infrastructure and expenditures on marketing and advertising.

        The table below sets forth, for the periods indicated, our beginning balance of cash and cash equivalents, net cash flows from operating, investing and financing activities and our ending balance of cash and cash equivalents:

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        Cash flow from operating activities consists primarily of net income adjusted for certain non-cash items, including depreciation and amortization, deferred income taxes, stock-based compensation expense and gains or losses on sales of assets and the effect of changes in operating assets and liabilities, principally including accounts receivable, inventory, accounts payable and accrued expenses.

        For the three months ended March 31, 2007, cash provided by operating activities was $16.5 million compared to $2.9 million for the three months ended March 31, 2006. Cash provided by operating activities for the three months ended March 31, 2007 consisted primarily of net income, adjusted for non-cash items, and a decrease in net working capital of $7.7 million. The decrease in net working capital for the three months ended March 31, 2007 was primarily due to a decrease of $14.1 million in accounts receivable which was the result of seasonality fluctuations and an increase of $1.6 million in income taxes payable resulting from an increase in the liability for the current period provision offset by estimated tax payments, partially offset by an increase in inventory of $4.3 million primarily due to increased inventory in transit at March 31, 2007 and a $4.0 million decrease in accounts payable and accrued expenses which was primarily the result of a $2.9 million decrease in amounts received from customers or credits due to customers in excess of invoices they owe us, which are included in accrued expenses.

        In 2006, cash used in operating activities was $2.2 million and consisted primarily of an increase in net working capital of $31.7 million partially offset by net income of $29.2 million and non-cash items of $384,000. The increase in net working capital was primarily the result of an increase of $35.0 million in accounts receivable due to increased net sales, an increase of $4.6 million in inventory primarily due to the timing of receipt of our initial inventory for our spring product line and an increase in inventory in transit, an increase of $644,000 in prepaid expenses due to higher liability insurance premiums resulting from increased net sales, partially offset by an increase in accounts payable of $1.1 million, accrued expenses of $4.9 million and income taxes payable of $2.5 million, net of excess tax benefit on stock-based compensation awards, related to our increased income before income taxes.

        In 2005, cash provided by operating activities was $21,000 and consisted of net income of $4.3 million, increased by adjustments for non-cash items of $244,000, offset by an increase of $4.6 million in net working capital. The increase in net working capital consisted primarily of increases in accounts receivable of $5.8 million due to the increase in net sales for the period, and an increase in inventory of $542,000, partially offset by increases in accrued expenses of $1.2 million and income taxes payable of $209,000.

        In 2004, cash provided by operating activities was $711,000 and consisted of net income of $803,000, increased by adjustments for non-cash items of $399,000, partially offset by an increase of $491,000 in net working capital. The increase in net working capital consisted primarily of an increase in accounts receivable of $778,000 and a decrease in accounts payable of $130,000, partially offset by a decrease in inventory of $279,000 and an increase in income taxes payable of $115,000.

        Investing activities relate primarily to investments in intangible assets and capital expenditures. Investments in intangible assets are amounts we capitalize related to the acquisition and enforcement of our patents and trademarks. Our capital expenditures are primarily related to leasehold improvements, furniture and fixtures, computer equipment, warehouse equipment and product molds and designs.

        For the three months ended March 31, 2007, cash used in investing activities was $456,000 compared to $54,000 for the three months ended March 31, 2006. This $402,000 increase in cash used was mainly due to the leasehold improvements to our corporate headquarters to expand our office space and purchases of office equipment and furniture and fixtures to accommodate increased headcount. Additionally, during the three months ended March 31, 2007, we began to expand and upgrade our information technology systems to support recent growth.

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        In 2006, cash used in investing activities was $505,000 compared to $416,000 in 2005. The cash used in investing activities primarily related to purchases of equipment and legal and other costs capitalized related to securing intellectual property rights. In 2005, cash used in investing activities was $416,000, consisting primarily of $236,000 for capital expenditures and $180,000 for legal and other costs capitalized related to securing intellectual property rights. In 2004, cash provided by investing activities was $863,000, consisting primarily of $1.1 million from the withdrawal of cash on deposit with our commercial lender, partially offset by $209,000 for legal and other costs capitalized related to securing intellectual property rights and $84,000 in capital expenditures.

        Financing activities relate primarily to our initial public offering in December 2006, net borrowings and repayments under our revolving credit facility and promissory notes, redemptions of our preferred stock, the exercise of stock options and the excess tax benefit on stock-based compensation awards. We borrow funds under our revolving credit facility primarily to fund seasonal increases in our inventory and selling, general and administrative expenses. We repay amounts outstanding on our revolving credit facility with cash generated from the sale of our inventory and the collection of accounts receivable. We also borrow funds from commercial finance companies to finance the payment of insurance premiums.

        For the three months ended March 31, 2007, net cash used in financing activities was $1.2 million. This was primarily the result of the payment of $1.1 million of liabilities incurred in connection with our initial public offering, which we closed in December 2006, and principal payments on our promissory notes of $211,000 offset by $22,000 in cash provided by the exercise of stock options. For the three months ended March 31, 2006, net cash used in financing activities was $96,000 which was due to principal payments on the promissory notes we executed to finance certain of our insurance policies.

        In 2006, cash provided by financing activities was $56.1 million compared to $495,000 used in 2005. The cash provided by financing activities in 2006 is primarily the result of the completion of our initial public offering in December 2006. We sold 3,125,000 shares of common stock at a price of $21.00 per share for total gross proceeds of $65.6 million. The net proceeds were $61.0 million, after deducting $4.6 million in underwriting discounts and commissions. We incurred a total of $2.2 million in other direct expenses in connection with this offering of which $1.1 million was paid in 2006, bringing the net cash provided by the offering to $59.9 million. Cash provided by financing activities in 2006 also included $120,000 in net proceeds from short-term debt, $117,000 excess tax benefit on stock-based compensation awards and $35,000 proceeds from the exercise of stock options, offset by our repurchase of $4.0 million in shares of our common stock from certain of our stockholders. In 2005, cash used in financing activities was $500,000 related to our redemption of our Series A Preferred Stock. In 2004, cash used in financing activities was $7,000 related to the net repayment of our promissory notes.

        We believe that our cash flow from operating activities and borrowings available to us under our revolving credit facility, together with the net proceeds from the initial public offering for our common stock, will be sufficient to meet our liquidity needs and capital expenditure requirements for at least the next 12 months.

Revolving Credit Facility

        On August 20, 2004, we entered into a $3.0 million revolving credit facility with a predecessor of JPMorgan Chase Bank, N.A. On August 28, 2006, we amended this revolving credit facility, increasing our maximum amount available to $25.0 million. In December 2006, we repaid all amounts outstanding under this revolving credit facility with a portion of the proceeds from our initial public offering. The maximum amount available under our revolving credit facility was decreased to $10.0 million on January 1, 2007 and on February 7, 2007, we amended our revolving credit facility to (a) decrease the maximum amount available to $2.0 million, (b) eliminate the 0.25% non-usage fee and (c) eliminate certain other terms, including terms requiring us to provide monthly reports regarding our inventory

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and accounts receivable. This revolving credit facility expires on June 30, 2007. Borrowings are subject to certain limitations, primarily based upon 85% of eligible accounts receivable and 50% of eligible inventory. Accounts receivable, inventory and general intangibles other than our patents and trademarks are pledged as collateral for our revolving credit facility and we are subject to compliance with certain covenants, including maintaining a minimum level of net worth of at least $7.0 million as of the end of each fiscal quarter and a minimum interest coverage ratio of 2.5 to 1.0. Our revolving credit facility also prohibits us from, among other things, incurring indebtedness for borrowed money, guaranteeing the obligations of another person or entity, creating or permitting any liens on our assets, paying dividends or making other distributions to our stockholders. Currently, we are in compliance with these covenants. Indebtedness under our revolving credit facility bears interest at a floating rate of interest based on either the prime rate quoted by JPMorgan Chase Bank, N.A. or an adjusted LIBOR rate. At December 31, 2006, the applicable interest rate under our revolving credit facility was 8.0% per annum. There were no outstanding borrowings under our revolving credit facility at December 31, 2006. There were no borrowings under this revolving credit facility during the three months ended March 31, 2007. An irrevocable standby letter of credit in the amount of $50,000 is outstanding under our revolving credit facility in favor of the landlord for our corporate headquarters. The landlord may draw upon this letter of credit if we are in default under the lease. The letter of credit expires on March 1, 2008.

 
Contractual Obligations and Commercial Commitments

        The following table summarizes our significant contractual cash obligations as of December 31, 2006:

(1)

Our office lease provides that if we are in default of the lease, we must pay certain damages to the landlord, and the landlord may elect to require us to continue to pay rent through the end of the lease term or to pay the present value of the excess, if any, of the aggregate rent otherwise payable through the end of the lease over the aggregate fair market value of the premises for the lease period.

        We lease our corporate headquarters, an approximately 48,400 square-foot facility located in Carrollton, Texas, consisting of approximately 34,500 square feet of warehouse space and approximately 13,900 square feet of office space. Our lease expires in August 2015, but we have two five-year extension options. The information in the table above does not include these lease extensions.

        We pay monthly royalties related to a feature incorporated in our grind-and-roll HEELYS-wheeled footwear equal to a percentage of the purchase price we pay to our manufacturers, net of the costs of the wheels and any other skating apparatus. Because the royalty is calculated in this manner, we cannot quantify the future royalty payments. In 2004, 2005 and 2006 and the three months ended March 31, 2006 and 2007, we expensed $143,000, $179,000, $299,000, $28,000 and $47,000, respectively, in royalties. Our payment obligation for these royalties will terminate on December 31, 2008.

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Seasonality and Quarterly Results

        The following table sets forth certain financial information for the periods indicated. The data is prepared on the same basis as the audited consolidated financial statements. All recurring, necessary adjustments are reflected in the data below.