-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, F6Mw2foGgXrv2hgKtmwF0iVUYAQBepinZfAcXA9wt9ydg6tNSIspaN5CAq90vbl9 aRlJBgfPp6UpWiV/I9OX7A== 0000898430-98-000481.txt : 19980217 0000898430-98-000481.hdr.sgml : 19980217 ACCESSION NUMBER: 0000898430-98-000481 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980212 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: K SWISS INC CENTRAL INDEX KEY: 0000862480 STANDARD INDUSTRIAL CLASSIFICATION: FOOTWEAR, (NO RUBBER) [3140] IRS NUMBER: 954265988 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-18490 FILM NUMBER: 98535428 BUSINESS ADDRESS: STREET 1: 20664 BAHAMA ST CITY: CATSWORTH STATE: CA ZIP: 91311 BUSINESS PHONE: 8189983388 MAIL ADDRESS: STREET 1: 20664 BAHAMA ST CITY: CATSWORTH STATE: CA ZIP: 91311 10-K405 1 FOR FISCAL YEAR ENDED DECEMBER 31, 1997 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) [X] OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the transition period from _______ to _______ COMMISSION FILE NO. 0-18490 K-SWISS INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-4265988 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 20664 BAHAMA STREET, CHATSWORTH, 91311 CALIFORNIA (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 998-3388 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED ------------------- --------------------- None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Class A Common Stock, par value $.01 per share (Title of class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the Class A Common Stock of the Registrant held by non-affiliates of the Registrant on February 3, 1998 based on the closing price of the Class A Common Stock on the NASDAQ National Market System on such date was $52,879,274. The number of shares of the Registrant's Class A Common Stock outstanding at February 3, 1998 was 3,022,886 shares. The number of shares of the Registrant's Class B Common Stock outstanding at February 3, 1998 was 2,480,572 shares. DOCUMENTS INCORPORATED BY REFERENCE Portions of the proxy statement for the Registrant's 1998 Annual Stockholders Meeting are incorporated by reference into Part III. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- K-SWISS INC. INDEX TO ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
CAPTION PAGE ------- ---- PART I Item 1. Business..................................................... 3 Item 2. Properties................................................... 10 Item 3. Legal Proceedings............................................ 10 Item 4. Submission of Matters to a Vote of Security Holders.......... 10 Item 4(a). Executive Officers of the Registrant......................... 11 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...................................................... 13 Item 6. Selected Financial Data...................................... 14 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................... 15 Item 8. Financial Statements and Supplementary Data.................. 19 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..................................... 38 PART III Item 10. Directors and Executive Officers of the Registrant........... 38 Item 11. Executive Compensation....................................... 38 Security Ownership of Certain Beneficial Owners and Item 12. Management................................................... 38 Item 13. Certain Relationships and Related Transactions............... 38 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................................................... 38
2 PART I ITEM 1. BUSINESS COMPANY HISTORY AND GENERAL STRATEGY K-Swiss Inc. designs, develops and markets a growing array of athletic footwear for high performance sports use, fitness activities and casual wear. The Company was founded in 1966 by two Swiss brothers, who introduced one of the first leather tennis shoes in the United States. The shoe, the K-Swiss "Classic", has remained relatively unchanged from its original design, and accounts for a significant portion of the Company's sales. The Classic has evolved from a high-performance shoe into a casual, lifestyle shoe. Since its inception, the Company has emphasized in its marketing the Swiss heritage of the Company, including the commitment to produce products of high quality and enduring style. The Company plans to continue to emphasize the high quality and classic design of its products as it introduces new models of athletic footwear. On December 30, 1986, the Company was purchased by an investment group led by the Company's current President. The Company thereafter recruited experienced management and reduced manufacturing costs by increasing offshore production and entering into new, lower cost purchasing arrangements. The Company's products are manufactured to its specifications by overseas suppliers predominately in China and Indonesia. In June 1991 and September 1992, K-Swiss International Ltd. and K-Swiss B.V. (located in the Netherlands), respectively, commenced operations to broaden the Company's distribution on a global scale. In addition, in August 1992, K-Swiss Inc. completed the acquisition of K-Swiss Europe Limited (renamed to K-Swiss (UK) Ltd.) which handles distribution in the United Kingdom. The Company's product strategy is two pronged. The first combines classic styling with high quality components and technical features designed to meet performance requirements of specific sports. The Company endeavors to use classic styling to reduce the impact of changes in consumer preferences and believes that this strategy leads to longer product life cycles than are typical of the products of certain of its competitors. Management believes that long product life cycles reduce total markdowns over the life of the products, thereby enhancing their attractiveness to retailers. This strategy also enables the Company to maintain inventory with less risk of obsolescence than is typical of more fashion-oriented products. The second product strategy uses fashion oriented footwear sold principally on a futures only basis usually with little or no planned inventory position taken on these products. This strategy allows the Company to take advantage of trends in the marketplace that it identifies while attempting to minimize the risk generally associated with this type of product. The Company sells its products in the United States through independent sales representatives primarily to specialty athletic footwear stores, pro shops, sporting good stores and department stores. The Company also sells its products to a number of foreign distributors. The Company now has sales offices or distributors throughout the world. During 1992, the Company established sales offices and now has appointed exclusive distributors in much of Europe. The Company believes that its overseas sales offices and foreign distributors provide an opportunity for future growth. The Company was organized under the laws of the State of Delaware on April 16, 1990. The Company is successor in interest to K-Swiss Inc., a Massachusetts corporation, which in turn was successor in interest to K-Swiss Inc., a California corporation. The Company's principal executive offices are located at 20664 Bahama St., Chatsworth, California 91311, and its telephone number is (818) 998-3388. Unless the context otherwise requires, the term the "Company" as used herein refers to K-Swiss Inc. and its consolidated subsidiaries. 3 PRODUCTS The following table summarizes the K-Swiss product lines and sets forth the approximate contribution to revenues (in dollars and as a percentage of revenues) attributable to each footwear category for the periods indicated. All footwear categories come in both men's (approximately 42% of 1997 revenues) and women's (approximately 36% of 1997 revenues). Most styles within each footwear category are offered in men's, women's and children's.
REVENUES (1) ---------------------------------------- YEAR ENDED DECEMBER 31, ---------------------------------------- 1997 1996 1995 ------------ ------------ ------------ PRODUCT CATEGORY $ % $ % $ % - ---------------- -------- --- -------- --- -------- --- (DOLLAR AMOUNTS IN THOUSANDS) Classic............................... $ 67,163 58% $ 50,573 48% $ 65,745 56% Tennis/Court.......................... 20,505 18 25,511 24 21,624 18 Children's............................ 21,288 19 18,693 18 18,811 16 Other(2).............................. 6,169 5 10,733 10 12,112 10 -------- --- -------- --- -------- --- Total................................. $115,125 100% $105,510 100% $118,292 100% ======== === ======== === ======== === Domestic(3)........................... $ 91,040 79% $ 75,945 72% $ 88,929 75% ======== === ======== === ======== ===
- -------- (1) For purposes of this table, revenues do not include other domestic income and fees earned by the Company on sales by foreign licensees and distributors. (2) Other consists of outdoor shoes, apparel, accessories, sport sandals, blemished shoes and sales of shoe components. (3) Included in totals on previous line. Footwear The Company's product line through 1987 consisted primarily of the Classic. The Classic was originally developed in 1966 as a high-performance tennis shoe. Since that time, the Classic has become a popular casual shoe, while realizing strong sales as the Original Classic shoe. The upper of the Classic includes only three separate pieces of leather, which allows for a relatively simple manufacturing process and yields a product with few seams. This simple construction improves the shoe's comfort, fit and durability. The Company has from time to time incorporated certain technical advances in materials and construction, but the Classic has remained relatively unchanged in style since 1966. The Classic continues to be the Company's single most important product. Since 1988, the Company has developed new product categories whose initial styles were extensions of the Classic. Each product category has certain styles designated as core products. The Company's core products offer style continuity and often include on-going improvement. The Company believes its core product program is a critical factor in attempting to achieve the Company's goal of becoming the "retailers' most profitable vendor". The Classic was named one of the "1994 Shoes of the Year" by Footwear News, the industry's leading trade publication. The core program tends to minimize retailers' markdowns and maximizes the effectiveness of marketing expenditures because of longer product life cycles. The Company now competes in three principal product categories: Tennis, Casual (Classic) and Children's. Apparel and Accessories The Company markets a line of K-Swiss branded apparel and accessories. The products are designed with the same classic strategies used in the footwear line. Classic styling allows the Company to appeal to a variety of new markets from an urban distribution to an upscale suburban 4 consumer. The products represent high quality with an exceptional value. Products consist of tennis apparel (skirts, shorts, polo's, and warm-up suits) worn by the number one Men's Doubles Team in the World, to oversized mesh jersey's, fleece sweatshirts and pants, windwear, denim shorts, tee shirts, caps, and socks for the casual athletic consumer. The apparel line is distributed through the large chain sporting goods stores as well as independent shoe and sporting goods dealers nationwide. The apparel products offer the company the ability to dress the consumer from head to toe. It also offers the Company visible promotional opportunities. Sales Financial information relating to international and domestic operations is presented as part of Item 8 of this report. See Note M to the Company's Consolidated Financial Statements. MARKETING Advertising and Promotion Management believes that its strategy of designing products with longer life cycles and introducing fewer new models relative to its competition enhances the effectiveness of its advertising and promotions. In 1997, K-Swiss launched its largest ever television campaign marking the first time since 1992 that the Company's products have been advertised on television. The campaign was run primarily on cable television, and was supported by several general interest/fashion magazines, as well as select tennis magazines. As the Company's heritage has been rooted in performance tennis, the launch in 1997 of a new high-end performance tennis line, the 7.0 System (after the NTRP rating system), was well received by retailers and consumers. This launch was supported by an extensive print campaign in tennis enthusiast magazines. Along with this, the Company signed the # 1 Doubles Team in the World, "The Woodies", as endorsers of the new line. These marketing efforts were in addition to the existing Grassroot's efforts already in place, which include: club teaching professionals, local tennis tournaments, and sponsorship of individual junior players. Advertising and promotion efforts in foreign markets are directed by local distributors. The Company's agreements with foreign distributors generally require such distributors to spend a certain percentage of their sales of the Company's products on advertising and promotion. The Company controls the nature and content of these promotions. Domestic Marketing The Company's current marketing strategy emphasizes distribution to retailers whose marketing strategies are consistent with the Company's reputation for quality and service. The Company's footwear products are sold domestically through approximately 45 independent regional sales representatives and three Company-employed senior sales managers. The independent sales representatives are paid on a commission basis, and are prohibited by contract from representing other brands of athletic footwear and related products. These representatives sold to approximately 3,100, 3,300 and 3,700 separate accounts as of December 31, 1997, 1996 and 1995, respectively. The Company's strategy is to increase its account base of upscale retail outlets in a controlled manner. 5 During 1997, the Foot Locker group of stores and affiliates accounted for approximately 17% of total revenues. See Note L to the Company's Consolidated Financial Statements. No other domestic customer accounted for more than 10% of total revenues during this period. The Company offers a "futures" program, under which retailers are offered discounts on orders scheduled for delivery more than five months after the order is made. There is no guarantee that such orders will not be canceled prior to acceptance by the customer. This program is similar to programs offered by other athletic shoe companies. Because of the positive effect of the futures program on inventory costs, planning and production scheduling, the Company has expanded the program. See "Distribution". In addition, the Company engages in certain marketing programs from time to time that provide for extended terms on initial domestic orders of new styles. The Company maintains a customer service department consisting of 12 persons at its Chatsworth, California facility. The customer service department accepts telephone orders for the Company's products, handles inquiries and notifies retailers of the status of their orders. The Company has made a substantial investment in leased computer facilities for general customer support and service, as well as for distribution. See "Distribution". International Marketing In 1991, the Company established a sales management team in Asia. The Company has exclusive distributors in certain Pacific Rim countries. Exclusive distributors of the Company's products are generally contractually obligated to spend specific amounts on advertising and promotion of the Company's products. The Company has also established exclusive distributors in other international markets. In 1991, the Company entered into a joint venture with C & J Clark International Ltd., to expand the marketing of its products into Europe. The joint venture formed K-Swiss Europe Ltd. and launched the K-Swiss brand in the United Kingdom. During 1992, the Company purchased C & J Clark's 50% share of K-Swiss Europe Ltd. (renamed K-Swiss (UK) Ltd.) and the joint venture was terminated. In 1992, the Company opened its own office in Amsterdam, the Netherlands. By the end of 1997, K-Swiss was working through 4 international subsidiaries and 28 distributors to market K-Swiss in potentially 56 countries. DISTRIBUTION During December 1997, the Company relocated its distribution facility. The Company now maintains 309,000 square feet of warehouse space at a leased facility in Mira Loma, California. The Company owned a 56,000 square foot warehouse in Pacoima, California which was leased to a tenant. This warehouse was sold in January 1998. See "Item 2. Properties". The Company purchases footwear from independent manufacturers located predominantly in China and Indonesia. The time required to fill new orders placed by the Company with its producers is approximately five months. Such footwear is generally shipped in ocean containers and delivered to the Company's facility in California. In some cases, large customers of the Company may receive containers of footwear directly from the manufacturer. Distribution to European and certain other distributors is based out of the Netherlands office public distribution facility. The Company generally arranges shipment of international orders directly from its independent manufacturers. The Company maintains an open-stock inventory which permits it to ship to retailers on an "at once" basis in response to orders placed by mail or toll- free telephone call. The Company has made a significant investment in leased computer facilities that provide on-line capability to determine open- 6 stock availability for shipment. Additionally, products can be ordered under the Company's "futures" program. See "Marketing--Domestic Marketing". The Company ships by package express or truck from California, depending upon size of order, customer location and availability of inventory. PRODUCT DESIGN AND DEVELOPMENT The Company maintains offices in Chatsworth, California and Taiwan that include a staff of individuals responsible for the design and development of new styles for all global regions. This staff receives guidance from the Company's management team in California, who meet regularly to review sales, consumer and market trends. MANUFACTURING In 1997, approximately 87% of the Company's footwear products were manufactured in China, 10% in Indonesia, and 3% in Taiwan. In excess of 97% of the Company's production capacity is located in China and Indonesia. This shift from prior years in the geographic sourcing of production capacity occurred primarily because of lower prevailing labor wage rates in China and Indonesia and certain other factors. Although the Company has no long-term manufacturing agreements and competes with other athletic shoe companies for production facilities (including companies that are much larger than the Company), management believes that the Company's relationships with its footwear producers are satisfactory and that it has the ability to develop, over time, alternative sources for its footwear. The Company's operations, however, could be materially and adversely affected if a substantial delay occurred in locating and obtaining alternative producers. During 1992, the Company experienced production sourcing problems in certain countries which caused delays in the shipment of certain footwear. Since then, the Company has and continues to implement a strategy to better manage its product sourcing which includes reducing the number of factories manufacturing its footwear in order to become a more substantial customer of such factories and employing more experienced personnel to manage and oversee the manufacturers. The Company has established its own offices in Taiwan, China, and Indonesia to perform services which include securing manufacturing capacity, testing raw materials, handling orders, inspecting production and performing other procurement functions. However, in 1993, the Company experienced difficulty in securing sufficient vulcanized construction production capacity. The canvas product is made primarily by vulcanized construction. This situation led to delivery delays and cancellations of some future orders and a diminished ability to fill at once orders for vulcanized product in 1994. Although the Company has taken steps to solve this problem and currently believes it has sufficient vulcanized construction capacity, no assurances can be given that the Company will not again experience similar difficulties. All manufacturing of footwear is performed in accordance with detailed specifications furnished by the Company and is subject to quality control standards, with the Company retaining the right to reject products that do not meet specifications. The bulk of all raw materials used in such production is purchased by manufacturers at the Company's direction. The Company's inspectors at the manufacturing facilities conduct testing and inspection of footwear products prior to shipment from those facilities. During 1997, the Company's apparel and accessory products were manufactured in Taiwan, Hong Kong, China, Macau, Bangladesh, Thailand and the United States by certain manufacturers selected by the Company. The Company's operations are subject to compliance with relevant laws and regulations enforced by the United States Customs Service and to the customary risks of doing business abroad, including fluctuations in the value of currencies, increases in customs duties and related fees resulting from position changes by the United States Customs Service, import controls and trade barriers (including 7 the unilateral imposition of import quotas), restrictions on the transfer of funds, work stoppages and, in certain parts of the world, political instability causing disruption of trade. These factors have not had a material adverse impact upon the Company's operations to date. Imports into the United States are also affected by the cost of transportation, the imposition of import duties, and increased competition from greater production demands abroad. The United States or the countries in which the Company's products are manufactured may, from time to time, impose new quotas, duties, tariffs or other restrictions, or adjust presently prevailing quotas, duty or tariff levels, which could affect the Company's operations and its ability to import products at current or increased levels. The Company cannot predict the likelihood or frequency of any such events occurring. A change in any such duties, quotas or restrictions could result in increases in the costs of such products generally and might adversely affect the sales or profitability of the Company and the athletic footwear industry as a whole. The Company's use of common elements in raw materials, lasts and dies gives the Company flexibility to duplicate sourcing in various countries in order to reduce the risk that the Company may not be able to obtain products from a particular country. The Company's footwear products are subject to the United States customs duties which range from 8.5% to 10.5% on footwear made principally of leather to duties on moderately priced canvas shoes of 15.6% to 37.5% plus $.90 per pair. Currently, approximately 81% of the Company's revenues are derived from sales of leather footwear and approximately 9% of the Company's revenues are derived from sales of canvas footwear. A large portion of the Company's imported products are manufactured in the People's Republic of China ("China"). As discussed below, the continued importation of these products could be affected by any one of several significant trade issues that presently impact U.S.-China relations. After a serious dispute with the United States Trade Representative ("USTR") over the protection of intellectual property rights in China, including the threat by USTR to impose trade sanctions, the Chinese government agreed to meet its enforcement obligations. That agreement is now being monitored by USTR, and the failure of China to comply with its obligations could result in trade sanctions in the future, including the imposition of retaliatory tariffs that might affect the Company's imports of footwear from China. From time to time there have been other trade disputes with China, involving such things as market access, textile quotas, automotive industry policies, and agricultural products. These and other such matters could also present problems in the future that might lead to trade sanctions affecting the Company's imports of footwear. Imports from China continue to enter the United States on a conditional most-favored nation ("MFN") basis. Pursuant to MFN, products imported by the Company from China currently receive the lower tariff rates made available to most of the United States' major trading partners. In the case of China, however, this MFN treatment is made possible under the Trade Act of 1974 by virtue of certain Presidential findings that waive restrictions that would otherwise render China ineligible for MFN treatment. The President has waived these restrictions each year since 1979. There can be no assurance that China will continue to enjoy MFN status in the future. If goods manufactured in China enter the United States without benefit of MFN treatment, such goods will be subject to significantly higher duty rates, ranging between 20% and 66% of customs value. Any such increased duties or tariffs could significantly increase the cost or reduce supply of goods from China. BACKLOG At December 31, 1997 and 1996, domestic footwear futures orders with start ship dates from January through June 1998 and 1997 were approximately $56,189,000 and $29,762,000, respectively. At December 31, 1997 and 1996, international footwear futures orders with start ship dates from January through June 1998 and 1997 were approximately $8,473,000 and $11,028,000, respectively. 8 "Backlog", as of any date, represents orders scheduled to be shipped within the next six months. Backlog does not include orders scheduled to be shipped on or prior to the date of determination of backlog. The mix of "futures" and "at once" orders can vary significantly from quarter to quarter and year to year and therefore "futures" are not necessarily indicative of revenues for subsequent periods. Orders generally may be canceled by customers without financial penalty. The Company believes its rate of net customer cancellations of domestic orders approximates industry averages for similar companies. Customers may also reject nonconforming goods. To date, the Company believes it has not experienced returns of its products or bad debts of customers materially in excess of industry averages for similar companies. COMPETITION The athletic footwear industry is highly competitive, and recent sales growth of athletic and athletic-style leisure footwear has spurred the entry of many new competitors and an increase in competition from established companies. The largest domestic marketers of such footwear are Nike and Reebok, while the international market is dominated by Adidas, Nike and Reebok. Each of these companies has substantially greater financial, distribution and marketing resources as well as greater brand awareness than the Company. The Company has recently increased its emphasis on product lines beyond the Company's Classic tennis model. In the past, the Company has introduced products in such highly competitive categories such as court, boating, outdoor and children's shoes. See "Products". There can be no assurance that the Company will penetrate these or other new markets or increase the market share it has established to date. The principal elements of competition in the athletic footwear market include brand awareness, product quality, design, pricing, fashion appeal, marketing, distribution, performance and brand positioning. The Company's products compete primarily on the basis of technological innovations, quality, style, and brand awareness among consumers. While the Company believes that its competitive strategy has resulted in increased brand awareness and market share, there can be no assurance that the Company will be able to retain or increase its market share or respond to changing consumer preferences. TRADEMARKS AND PATENTS The Company utilizes trademarks on all of its products and believes that its products are more marketable on a long-term basis when identified with distinctive markings. K-Swiss(R) is a registered trademark in the United States and certain other countries. The Company's name is not registered as a trademark in certain countries because of restrictions on registering names having geographic connotations. However, since K-Swiss is not a geographic name, the Company has often secured registrations despite such objections. The Company's shield emblem and the five-stripe design are also registered in the United States and certain foreign countries. The five-stripe design is not presently registered in some countries because it has been deemed ornamental by regulatory authorities. The five-stripe design has not been registered in Germany because of a possible conflict with Adidas' three stripe design mark. The Company selectively seeks to register the names of its shoes, its logos and the names given to certain of its technical and performance innovations, including Aosta(R) rubber and Silicone Formula 18(R). The Company has obtained patents in the United States regarding the D.R. Cinch System(R), the stability design incorporated into the Si-18(R) tennis shoe, and other features. The Company vigorously defends its trademarks and patent rights against infringement worldwide and employs independent security 9 consultants to assist in such protection. To date, the Company is not aware of any significant counterfeiting problems regarding its products. EMPLOYEES At December 31, 1997, the Company employed 144 persons in the United States, 66 persons in Taiwan, Indonesia and China, and 25 persons in England and the Netherlands. ITEM 2. PROPERTIES The Company leases a 27,000 square foot facility in Chatsworth, California which is used as the Company's principal executive offices. This lease expires in April 1998, subject to two options, each of which would extend the term of the lease by one month and one option which would extend the term of the lease by three and one-half months. The Company and the landlord of the Chatsworth facility have agreed to extend the lease until September 15, 1998 on or before such time the Company expects to move into its new headquarters facility in Westlake Village, California. The effective monthly commitment for the Chatsworth facility, calculated in accordance with generally accepted accounting principles, is approximately $18,000. In December 1996, the Company purchased 3.6 acres of land in Westlake Village, California for a cash purchase price of $691,000. The Company intends to develop this site for a new headquarters facility of approximately 50,000 square feet. The Company expects to complete construction of this facility during the third quarter of 1998 with an estimated building cost of approximately $4,900,000. The Company owned a 56,000 square foot facility in Pacoima, California, which was used as the Company's principal executive offices through December 1992. This facility was sold in January 1998. The Company leases a 309,000 square foot distribution facility in Mira Loma, California. This lease expires in January 2003, subject to two options, each of which would extend the term of the lease for three years. The Company uses the Mira Loma facility as its main distribution center. The effective monthly commitment for the Mira Loma facility, calculated in accordance with generally accepted accounting principles, is approximately $79,000. ITEM 3. LEGAL PROCEEDINGS The Company is, from time to time, a party to litigation which arises in the normal course of its business operations. The Company does not believe it is presently a party to litigation which will have a material adverse effect on its business or operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 10 ITEM 4(a). EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company are as follows:
AGE AT DECEMBER 31, NAME 1997 POSITION - ---- ------------ -------- Steven Nichols 55 Chairman of the Board and President Preston Davis 53 Vice President--Sales Edward Flora 46 Vice President--Operations Lee Green 44 Corporate Counsel Thomas Harrison 55 Senior Vice President Donna Lucas 35 Vice President--Apparel Deborah Mitchell 36 Vice President--Marketing George Powlick 53 Vice President--Finance, Chief Financial Officer, Secretary and Director Janice Smith 36 Corporate Controller Brian Sullivan 44 Vice President--National Accounts Peter Worley 37 Vice President--Product Development
Officers are appointed by and serve at the discretion of the Board of Directors. Steven Nichols has been President and Chairman of the Board of the Company since 1987. From 1980 to 1986, Mr. Nichols was a director and Vice President-- Merchandise of Stride Rite Corp., a footwear manufacturer and holding company. In addition, Mr. Nichols was President of Stride Rite Footwear from 1982 to 1986. From 1979 to 1982, Mr. Nichols served as an officer and President of Stride Rite Retail Corp., the largest retailer of branded children's shoes in the United States. From 1962 through 1979, he was an officer of Nichols Foot Form Corp., which operated a chain of New York retail footwear stores. Preston Davis, Vice President--Sales, joined the Company in March 1987 as a consultant and served as Vice President--Sales from June 1987 to January 1989 and Vice President--Marketing from February 1989 to February 1991. Prior to joining the Company, Mr. Davis owned and managed Preston Davis Associates, a marketing and sales consulting firm, specializing in sporting goods. From June 1982 through December 1985, Mr. Davis was Vice President--Sales for Kaepa, Inc., another athletic shoe manufacturer. Edward Flora, Vice President--Operations, joined the Company as a consultant in June 1990 and served as Director--Administration from October 1990 to February 1994. Prior to joining the Company, Mr. Flora was Vice President-- Distribution for Bugle Boy Industries, a manufacturer and distributor of Men's, Women's, and Children's apparel, from 1987 through May 1990. Lee Green, Corporate Counsel, joined the Company in December 1992. Mr. Green was formerly a partner in the international law firm of Baker & McKenzie. He worked in the firm's Taipei office from 1985 to 1988 and its Palo Alto office from 1988 to 1992. Thomas Harrison, Senior Vice President, joined the Company in January 1989. From 1987 through 1988, Mr. Harrison was President of Osh Kosh Footwear, a manufacturer and wholesaler of casual footwear. From 1985 to 1987, Mr. Harrison was President of Keds Corp., a division of Stride Rite Corp. From 1984 to 1985, Mr. Harrison was national account representative for Osh Kosh Footwear. From 1977 through 1984, Mr. Harrison was manager of the consumer products division of Uniroyal, Inc., which included the footwear lines of Keds, Pro-Keds and Sperry Topsider. Mr. Harrison joined Uniroyal in 1967 as a sales representative for its Keds Division. 11 Donna Lucas, Vice President--Apparel, joined the Company in December 1996. Ms. Lucas was the Director of Design and Merchandising for Benetton Sportsystem USA from 1990 to 1996. Previous to that she was with adidas USA in several different capacities from 1986 to 1990. Her responsibilities ranged from design to merchandising of all the product categories from tennis to special markets ending in Senior Merchandising for the entire product range. Deborah Mitchell, Vice President--Marketing, joined the Company in October 1994. Ms. Mitchell served as Director of Marketing for Fruit of the Loom, the largest manufacturer of men's underwear, from December 1993 through October 1994. Ms. Mitchell worked at Procter and Gamble in various positions ending in brand management from 1984 through 1993 except while she was earning her degree from Harvard Business School. George Powlick, Director, Vice President--Finance, Chief Financial Officer and Secretary, joined the Company in January 1988. Mr. Powlick is a certified public accountant and was an audit partner in the independent public accounting firm of Grant Thornton from 1975 to 1987. Janice Smith, Corporate Controller, joined the Company in August 1987. Ms. Smith is a certified public accountant. From 1984 to July 1987, Ms. Smith was an auditor with the independent public accounting firm of Grant Thornton. Brian Sullivan, Vice President--National Accounts, joined the Company in December 1989. From 1986 to 1989, he was Vice--President and General Manager of Tretorn, Inc., a manufacturer and distributor of tennis shoes. From 1984 through 1985, Mr. Sullivan was Vice--President of Sales of Bancroft/Tretorn, a tennis shoe manufacturer and distributor and predecessor to Tretorn. From 1978 to 1984, Mr. Sullivan held various positions at Bancroft/Tretorn, including Field Salesperson, Marketing and Sales Planning Manager and National Sales Manager. Peter Worley, Vice President--Product Development, joined the Company in May 1996. Mr. Worley worked for Reebok International, Ltd. from May 1986 through October 1989, and again from July 1991 through April 1996 in various merchandising and product line management positions, including Director of Classic, Director of Cross Training and Director of Tennis. From October 1989 through July 1991, Mr. Worley was Sport Product Manager of Bausch & Lomb's Ray-ban Sunglass Division. 12 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Class A Common Stock began trading June 4, 1990 on the National Market System maintained by the National Association of Securities Dealers upon completion of the Company's initial public offering. Per share high and low sales prices (in dollars) for the quarterly periods during 1997 and 1996 as reported by NASDAQ were as follows:
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, --------- -------- ------------- ------------ 1997 Low....................... 9 7/8 10 7/8 14 1/2 15 3/4 High...................... 12 3/4 15 3/4 19 7/8 18 1996 Low....................... 7 3/4 7 7/8 9 5/8 9 5/8 High...................... 11 3/4 11 3/4 11 1/4 12 7/8
The Class A Common Stock is listed on the automatic quotation system of the National Association of Securities Dealers under the symbol KSWS. The number of stockholders of record of the Class A Common Stock on December 31, 1997 was 123. However, based on available information, the Company believes that the total number of Class A Common stockholders, including beneficial stockholders, is approximately 1,410. There is currently no established public trading market for the Company's Class B Common Stock. The number of stockholders of record of the Class B Common Stock on December 31, 1997 was 12. DIVIDEND POLICY The Company announced on February 16, 1994 that the Company's Board of Directors was initiating a cash dividend program payable at an annual rate of 8 cents per common share. The Board declared quarterly dividends of 2 cents per share, to stockholders of record as of the close of business on the last day of each quarter in 1997 and 1996. The payment of any future dividends will be at the discretion of the Company's Board of Directors and will depend upon, among other things, future earnings, operations, capital requirements, the general financial condition of the Company and general business conditions. The Company is currently limited in the extent to which it is able to pay dividends under the Company's revolving credit agreement. See Note E to the Company's Consolidated Financial Statements. 13 ITEM 6. SELECTED FINANCIAL DATA The selected consolidated financial data presented below for each of the five years in the period ended December 31, 1997 have been derived from audited financial statements which for the most recent three years appear elsewhere herein. The data presented below should be read in conjunction with such financial statements, including the related notes thereto and the other information included herein.
YEAR ENDED DECEMBER 31, ------------------------------------------------ 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) INCOME STATEMENT DATA Revenues...................... $116,213 $106,833 $120,252 $154,935 $149,562 Cost of goods sold............ 70,769 72,320 77,726 91,934 90,836 -------- -------- -------- -------- -------- Gross Profit................ 45,444 34,513 42,526 63,001 58,726 Selling, general and administrative expenses...... 40,074 33,440 36,131 38,458 38,925 -------- -------- -------- -------- -------- Operating profit............ 5,370 1,073 6,395 24,543 19,801 Interest (income) expense, net.......................... (1,823) (1,527) (789) (254) 376 -------- -------- -------- -------- -------- Earnings before income taxes...................... 7,193 2,600 7,184 24,797 19,425 Income tax expense............ 3,020 1,869 5,331 9,921 6,904 -------- -------- -------- -------- -------- Net earnings................ $ 4,173 $ 731 $ 1,853 $ 14,876 $ 12,521 ======== ======== ======== ======== ======== EARNINGS PER SHARE Basic......................... $ .71 $ .11 $ .28 $ 2.27 $ 1.92 ======== ======== ======== ======== ======== Diluted....................... $ .70 $ .11 $ .28 $ 2.21 $ 1.87 ======== ======== ======== ======== ======== WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING Basic......................... 5,844 6,455 6,578 6,563 6,507 Diluted(1).................... 5,964 6,493 6,630 6,737 6,699 BALANCE SHEET DATA (AT PERIOD END) Current assets................ $ 91,544 $ 90,537 $ 92,786 $ 90,132 $ 75,684 Current liabilities........... 15,951 11,240 9,603 12,891 15,098 Total assets.................. 101,686 100,275 102,378 100,324 86,925 Total debt(2)................. 1,142 1,711 920 3,402 5,426 Stockholders' equity.......... 75,865 79,569 84,069 82,817 68,019
- -------- (1) Includes common stock and dilutive potential common stock (options). (2) Includes all interest-bearing debt and capital lease obligations, but excludes outstanding letters of credit ($12,156,000, $8,000,000, $7,741,000, $15,632,000 and $20,018,000 as of December 31, 1997, 1996, 1995, 1994 and 1993). 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage of certain items in the consolidated statements of earnings relative to revenues.
YEAR ENDED DECEMBER 31, ------------------- 1997 1996 1995 ----- ----- ----- Revenues.............................................. 100.0% 100.0% 100.0% Cost of goods sold.................................... 60.9 67.7 64.6 Gross profit.......................................... 39.1 32.3 35.4 Selling, general and administrative expenses.......... 34.5 31.3 30.1 Interest income, net.................................. 1.6 1.4 0.6 Earnings before income taxes.......................... 6.2 2.4 5.9 Income tax expense.................................... 2.6 1.7 4.4 Net Earnings.......................................... 3.6 0.7 1.5
1997 COMPARED TO 1996 Total revenues increased 8.8% to $116,213,000 in 1997 from $106,833,000 in 1996. This increase was attributable to increases in the average underlying wholesale price per pair, in addition to an increase in the volume of footwear sold. The volume of footwear sold increased 3.7% to 4,870,000 pair in 1997 from 4,697,000 pair in 1996. The average wholesale price per pair increased by 8.5% to $22.74 in 1997 from $20.95 for 1996. This increase in the average wholesale price per pair is primarily attributable to an increase in the Classic category, in both units and average price per pair. Also, there was a decrease in close-out sales during 1997 which carry a lower average wholesale price per pair. The major changes in volume for footwear categories are as follows: Classics and children's categories increased 12% and 11%, respectively, and the tennis/court category decreased 20%. Revenue increased despite a poor retail environment due principally to the popularity of several new Classic products and the cumulative results of additional spending on marketing and advertising. Domestic revenues increased 20.2% to $91,568,000 in 1997 from $76,168,000 in 1996. International product revenues decreased 18.5% in 1997 to $24,085,000 from $29,565,000 in 1996. International product revenues, as a percentage of total revenues, decreased to 20.7% in 1997 from 27.7% in 1996. Fees earned by the Company on sales by foreign licensees and distributors decreased to $560,000 for 1997 from $1,100,000 for 1996. The Company believes that the athletic and casual footwear industry experiences seasonal fluctuations, due to increased domestic sales during certain selling seasons, including Easter, back-to-school and the year-end holiday seasons. The Company presents full-line offerings for the Easter and back-to-school seasons, for delivery during the first and third quarters, respectively, but not for the year-end holiday season; consequently, fourth quarter sales are generally the Company's lowest. At December 31, 1997 domestic and international footwear futures orders with start ship dates from January through June 1998 were approximately $56,189,000 and $8,473,000, respectively, 89% higher and 23% lower, respectively, than such orders were at December 31, 1996 for start ship dates of the comparable period of the prior year. These orders are not necessarily indicative of revenues for subsequent periods because: (1) the mix of "future" and "at-once" orders can vary significantly from quarter to quarter and year to year and (2) the rate of customer order cancellations can also vary from quarter to quarter and year to year. Gross profit margins increased as a percentage of revenues to 39.1% in 1997 from 32.3% in 1996. Gross profit margins increased due to a decrease in close- out sales which carry lower margins and to changes in the domestic/international and product mix of sales. 15 Selling, general and administrative expenses increased 19.8% to $40,074,000 (34.5% of revenues) in 1997 from $33,440,000 (31.3% of revenues) in 1996. The increase in the amounts, as well as the percentage of sales, for the year ended December 31, 1997 compared to the year ended December 31, 1996 was primarily the result of an increase in direct advertisement and promotion activities, as well as an increase in the bonus accrual for an employee incentive program. Net interest income was $1,823,000 (1.6% of revenues) in 1997 compared to $1,527,000 (1.4% of revenues) in 1996, an increase of $296,000 or 19.4%. This increase in net interest income was the result of higher average balances and rates earned on commercial paper investments partially offset by higher outstanding balances owed under the Company's revolving credit facilities. The Company's effective tax rate decreased to 42.0% in 1997 from 71.9% in 1996. In 1996, the rate was higher than the federal and state statutory rates due primarily to recording of income taxes relating to a state income tax audit. Net earnings increased 470.9% to $4,173,000 or $.71 per common share (basic earnings per share) in 1997 from $731,000 or $.11 per common share (basic earnings per share) in 1996. Included in the international results of operations presented in Note M to the Company's Consolidated Financial Statements were net losses of $1,602,000 incurred by the Company's European operations. The European operations are wholly-owned subsidiaries of the Company rather than independent unaffiliated distributors as are utilized throughout most of the balance of the Company's international operations. The Company's European operations do not generate sufficient margins to exceed the necessary fixed costs involved in creating a presence in this foreign market. The Company is attempting to increase revenues in this market as well as exploring ways to reduce costs. See Note A12 to the Company's Consolidated Financial Statements for the Company's policies relating to risk management of foreign currency. 1996 COMPARED TO 1995 Total revenues decreased 11.2% to $106,833,000 in 1996 from $120,252,000 in 1995. This decrease was attributable to decreases in the volume of footwear sold, in addition to a decrease in the average underlying wholesale price per pair. The volume of footwear sold decreased 12.1% to 4,697,000 pair in 1996 from 5,341,000 pair in 1995. The average wholesale price per pair decreased by 2.5% to $20.95 in 1996 from $21.49 for 1995. This decrease in the average wholesale price per pair is primarily attributable to an increase in closeout sales during 1996 which carry a lower average wholesale price per pair partially offset by an increase in the tennis/court category which carries a higher average wholesale price per pair. The major changes in volume for footwear categories are as follows: Classics and children's categories decreased 18% and 4%, respectively, and the tennis/court category increased 14%. The overall decline in revenues was due to a difficult retail environment during 1996 and new products that were less successful than the industry leaders' products. The Company was the official footwear sponsor of the 1996 U.S. Open Tennis Tournament in an effort to increase tennis sales. Domestic revenues decreased 14.6% to $76,168,000 in 1996 from $89,192,000 in 1995. International product revenues increased 0.7% in 1996 to $29,565,000 from $29,363,000 in 1995. International product revenues, as a percentage of total revenues, increased to 27.7% in 1996 from 24.4% in 1995. Fees earned by the Company on sales by foreign licensees and distributors decreased to $1,100,000 for 1996 from $1,697,000 for 1995. Gross profit margins decreased as a percentage of revenues to 32.3% in 1996 from 35.4% in 1995. Gross profit margins decreased partially due to an increase in close-out sales which carry lower margins. In addition, gross profit margins decreased due to changes in the domestic/international and product mix of sales. 16 Selling, general and administrative expenses decreased 7.4% to $33,440,000 (31.3% of revenues) in 1996 from $36,131,000 (30.1% of revenues) in 1995. This decrease in the amounts was primarily the result of increased bad debt expense recorded during 1995 (due to the unexpected bankruptcies of two of the Company's larger customers) and expenses recorded relating to the dissolution of the Company's Canadian subsidiary. In addition, reductions were made for potential contributions to the employee's profit sharing plan in 1996. These decreases were partially offset by an increase in the bonus accrual due to the implementation of an incentive program. The increase in selling, general and administrative expenses, as a percentage of sales, was due to an increase in direct advertisement, promotion activities and product development and bonuses, partially offset by a decrease in bad debts. Net interest income was $1,527,000 (1.4% of revenues) in 1996 compared to $789,000 (0.6% of revenues) in 1995, an increase of $738,000 or 93.5%. This increase in net interest income was the result of higher average balances and rates earned on commercial paper investments partially offset by higher outstanding balances owed under the Company's revolving credit facilities. The Company's effective tax rate decreased to 71.9% in 1996 from 74.2% in 1995. In 1996, the rate was higher than the federal and state statutory rates due primarily to recording of income taxes relating to a state income tax audit. In 1995, the Company recorded deferred income taxes for the previously untaxed portion of unremitted earnings of a foreign subsidiary. Net earnings decreased 60.6% to $731,000 or $.11 per common share (basic earnings per share) in 1996 from $1,853,000 or $.28 per common share (basic earnings per share) in 1995. Included in the international results of operations presented in Note M to the Company's Consolidated Financial Statements were net losses of $1,335,000 incurred by the Company's European operations. The European operations are wholly-owned subsidiaries of the Company rather than independent unaffiliated distributors as are utilized throughout the balance of the Company's international operations. As these operations are in a start-up mode, their revenues do not generate sufficient margins to exceed the necessary fixed costs involved in creating a presence in this foreign market. The Company is attempting to increase revenues in this market as well as exploring ways to reduce costs. See Note A12 to the Company's Consolidated Financial Statements for the Company's policies relating to risk management of foreign currency. LIQUIDITY AND CAPITAL RESOURCES The Company experienced a net cash inflow of approximately $17,871,000, $9,183,000, and $18,995,000 from its operating activities during 1997, 1996 and 1995, respectively. Cash provided by operations in 1997 increased from 1996, due to an increase in net earnings, and accounts payable and accrued liabilities and a decrease in prepaid expenses and other assets, partially offset by an increase in inventories. Cash provided by operations in 1996 decreased from 1995, primarily due to an increase in prepaid expenses and other assets (principally a prepayment to secure inventory purchases) and a decrease in net earnings, partially offset by a decrease in inventories. The Company had a net outflow of cash from its investing activities during 1997 principally from the purchase of investment securities partially offset by the maturity of investment securities. The Company had a net outflow of cash from its investing activities during 1996 principally for the purchase of property, plant and equipment and the purchase of certain assets and rights of a small apparel brand where products are primarily sold in the Netherlands. In 1997 and 1996, the net cash provided by operating activities was used for the purchase of treasury stock and to pay cash dividends. The Company anticipates future cash needs for principal repayments required pursuant to the Company's lines of credit facilities. In addition, depending on the Company's future growth rate, 17 additional funds may be required by operating activities. Finally, at December 31, 1997, approximately $24,282,000 of foreign subsidiary earnings which are not considered indefinitely invested will eventually be remitted to the parent company as circumstances warrant. Upon receipt of these funds, the Company will use approximately $9,303,000 in cash to pay income taxes previously accrued on these foreign subsidiary earnings. The Company's intention is to repatriate earnings of foreign operations as cash needs and other circumstances require. During 1998, the Company will need approximately $3,740,000 for the construction of its new headquarters facility. See "Item 2. Properties". No other material capital commitments exist at December 31, 1997. With continued use of its revolving credit facility (as discussed below), the Company believes its present and currently anticipated sources of capital are sufficient to sustain its anticipated capital needs for the remainder of 1998. The Company is heavily dependent upon complex computer systems for all phases of its operations, which include production, sales and distribution. The Company's computer software programs recognize only the last two digits of the year in any date (e.g., "97" for "1997"), and therefore some software may inaccurately process data in 1999 or 2000 if the software is not reprogrammed, upgraded or replaced (the "Year 2000 Issue"). The Company has initiated a program intended to timely mitigate and/or prevent the adverse effects of the Year 2000 Issue, and to pursue compliance by suppliers. The Company believes that many of its suppliers and customers may also have Year 2000 Issues which could affect the Company. At this time, while the Company cannot state with certainty the precise amount of expenditures necessary to resolve the Year 2000 Issue, it appears such expenditures could amount to $200,000 to $300,000 for the Company. However, in any event the Company presently believes that the cost of fixing the Year 2000 Issue will not have a material adverse impact on the Company's financial position and results of operations. In January 1998, the Company announced that under its share repurchase program, the Board of Directors had authorized the Company to purchase up to $2,832,000 of its Class A Common Stock on the open market through December 1998. The amount of the authorization represents the remaining amount of the previous $10,000,000 buy back authorization which expired December 31, 1997. Such open market purchases, if any, will occur from time to time as market conditions warrant. The Company adopted this program because it believes repurchasing its shares can be a good use of excess cash depending on the Company's array of alternatives. Currently, the Company has made purchases under this program from August 14, 1996 through February 12, 1998 (the date of filing of this Form 10-K) of 1,097,700 shares at an aggregate cost totaling approximately $14,064,000. In August 1997 the Company amended an agreement with a bank whereby the Company may borrow, in the form of a secured revolving credit facility, up to $30,000,000. The unused portion of this credit facility, which includes letters of credit and bankers acceptances, was $18,756,000 at December 31, 1997. This facility currently expires in July 1999. Substantially all of the Company's assets (other than real estate) are pledged as security for this facility. The credit facility provides for interest to be paid at the prime rate or, at the Company's discretion and with certain restrictions, other market based rates. The Company pays a commitment fee of 1/8% of the unused line for availability of the credit facility. The Company's European offices have agreements with a bank whereby they can borrow up to $5,000,000 in the form of secured revolving credit facilities. The unused portion of these credit facilities was $3,446,000 at December 31, 1997. These facilities are made available until terminated by either party. Total debt decreased 33.3% to $1,142,000 at December 31, 1997 from $1,711,000 at December 31, 1996 (excluding outstanding letters of credit of $12,156,000 and $8,000,000 at December 31, 1997 and 1996, respectively). The increase was primarily due to borrowings under bank lines of credit under the Company's credit facility. 18 The Company's working capital decreased $3,704,000 to $75,593,000 at December 31, 1997 from $79,297,000 at December 31, 1996. The Company has historically maintained higher levels of inventory relative to sales compared to its competitors because (1) it does not ship directly to its major domestic customers from its foreign contract manufacturers, to the same extent as its larger competitors, which would reduce inventory levels and increase inventory turns, and (2) unlike many of its competitors, the Company designates certain shoes as core products whereby the Company commits to its retail customers that it will carry core products from season to season and, therefore, the Company attempts to maintain open stock positions on its core products in the Company's Mira Loma, California distribution center to meet at-once orders. At the end of 1995, the Company recorded deferred income taxes of $4,433,000 on the previously untaxed portion of unremitted earnings of a foreign subsidiary. This change in estimate was precipitated by the Company changing its intention regarding unremitted earnings of the foreign subsidiary. The Company decided to no longer indefinitely invest unremitted earnings of this foreign subsidiary and therefore deferred taxes were recorded. The Company changed its intention because of changes in the tax law and the lack of foreign opportunities to invest the unremitted earnings of the foreign subsidiary. The federal income tax returns of the Company for the years ended December 31, 1990, 1991 and 1992 are under examination by the Internal Revenue Service ("IRS"). See Note H to the Company's Consolidated Financial Statements. In December 1995, the IRS issued its report proposing additional taxes of approximately $3,850,000 plus penalties and interest. The Company protested the IRS proposed assessment. Also, the federal income tax returns of the Company for the years ended 1993 and 1994 are currently under examination by the IRS. In addition, the IRS Appeals Division returned the earlier cycle to the Examination Division to reopen its examination of the 1991 and 1992 fiscal years. The IRS has issued a preliminary revised examination report covering the 1991 through 1994 fiscal years proposing additional taxes of approximately $4,760,000 plus penalties and interest for these years combined. Although no assurance can be given regarding the outcome of such examinations, the Company believes that any taxes which might become payable as a result of these examinations would not result in additional expense recognized in the financial statements other than interest and penalties, if any, as the Company has recorded deferred income taxes on the untaxed portion of unremitted earnings of a foreign subsidiary. Therefore, management believes that resolution of the IRS examinations should not have a material adverse impact on the Company's financial position and results of operations. INFLATION The Company believes that distributors of footwear in the higher priced end of the footwear market, including the Company, are able to adjust their prices in response to an increase in direct and general and administrative expenses, without a significant loss in sales. Accordingly, to date, inflation and changing prices have not had a material adverse effect on the Company's revenues or earnings. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Consolidated Financial Statements required in response to this section are submitted as part of Item 14(a) of this Report. 19 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Board of Directors and Stockholders K-Swiss Inc. We have audited the consolidated balance sheets of K-Swiss Inc. as of December 31, 1997 and 1996, and the related consolidated statements of earnings, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of K-Swiss Inc. as of December 31, 1997 and 1996, and the consolidated results of its operations and its consolidated cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. We have also audited Schedule II of K-Swiss Inc. for each of the three years in the period ended December 31, 1997. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein. /s/ GRANT THORNTON LLP Los Angeles, California January 30, 1998 20 K-SWISS INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, (DOLLAR AMOUNTS IN THOUSANDS)
1997 1996 -------- -------- ASSETS ------ Current Assets Cash and cash equivalents (Note A4)...................... $ 36,123 $ 34,314 Investment securities (Note A5).......................... 5,995 -- Accounts receivable, less allowance for doubtful accounts of $477 and $630 for 1997 and 1996, respectively (Notes E and L)................................................ 15,657 14,702 Inventories (Notes A6 and E)............................. 27,214 23,789 Prepaid expenses and other (Note B)...................... 4,299 15,674 Deferred taxes (Notes A9 and H).......................... 2,256 2,058 -------- -------- Total current assets................................... 91,544 90,537 Property, Plant and Equipment, net (Notes A7, C and E)..... 4,885 3,910 Other Assets Intangible assets (Notes A8, D and E).................... 4,712 5,005 Other.................................................... 545 823 -------- -------- 5,257 5,828 -------- -------- $101,686 $100,275 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Bank lines of credit (Note E)............................ $ 642 $ 1,209 Current maturities of capital lease obligations and subordinated debentures (Note G)........................ 400 302 Trade accounts payable................................... 4,379 3,239 Accrued liabilities (Note F)............................. 10,530 6,490 -------- -------- Total current liabilities.............................. 15,951 11,240 Subordinated Debentures (Note G)........................... 100 200 Deferred Taxes (Notes A9 and H)............................ 9,770 9,266 Commitments and Contingencies (Notes H and I).............. -- -- Stockholders' Equity (Note K) Preferred Stock--authorized 2,000,000 shares of $.01 par value; none issued and outstanding...................... -- -- Common Stock: Class A--authorized 18,000,000 shares of $.01 par value; 4,110,586 shares issued, 3,107,886 shares outstanding and 1,002,700 shares held in treasury at December 31, 1997 and 4,087,018 shares issued, 3,585,018 shares outstanding and 502,000 shares held in treasury at December 31, 1996....................................... 41 41 Class B--authorized 10,000,000 shares of $.01 par value; issued and outstanding 2,485,572 shares at December 31, 1997 and 2,495,572 shares at December 31, 1996.......... 25 25 Additional paid-in capital............................... 25,271 25,100 Treasury Stock........................................... (12,389) (5,221) Retained earnings (Note E)............................... 63,387 59,675 Foreign currency translation (Note A10).................. (470) (51) -------- -------- 75,865 79,569 -------- -------- $101,686 $100,275 ======== ========
The accompanying notes are an integral part of these statements. 21 K-SWISS INC. CONSOLIDATED STATEMENTS OF EARNINGS YEAR ENDED DECEMBER 31, (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1997 1996 1995 -------- -------- -------- Revenues (Notes A13, L and M)....................... $116,213 $106,833 $120,252 Cost of goods sold.................................. 70,769 72,320 77,726 -------- -------- -------- Gross profit...................................... 45,444 34,513 42,526 Selling, general and administrative expenses (Note A14)............................................... 40,074 33,440 36,131 -------- -------- -------- Operating profit.................................. 5,370 1,073 6,395 Interest income, net................................ 1,823 1,527 789 -------- -------- -------- Earnings before income taxes...................... 7,193 2,600 7,184 Income tax expense (Notes A9 and H)................. 3,020 1,869 5,331 -------- -------- -------- NET EARNINGS...................................... $ 4,173 $ 731 $ 1,853 ======== ======== ======== Earnings per common share (Note A15) Basic............................................. $ .71 $ .11 $ .28 ======== ======== ======== Diluted........................................... $ .70 $ .11 $ .28 ======== ======== ========
The accompanying notes are an integral part of these statements. 22 K-SWISS INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY THREE YEARS ENDED DECEMBER 31, 1997 (DOLLAR AMOUNTS IN THOUSANDS)
COMMON STOCK TREASURY STOCK ---------------------------------- ------------------ CLASS A CLASS B ADDITIONAL CLASS A FOREIGN ---------------- ----------------- PAID-IN ------------------ RETAINED CURRENCY SHARES AMOUNT SHARES AMOUNT CAPITAL SHARES AMOUNT EARNINGS TRANSLATION TOTAL --------- ------ --------- ------ ---------- --------- -------- -------- ----------- ------- Balance at January 1, 1995................... 4,057,779 $41 2,515,572 $25 $24,985 -- $ -- $58,133 $(367) $82,817 Conversion of shares (Note K)............... 20,000 -- (20,000) -- -- -- -- -- -- -- Proceeds from exercise of options (Note K).... 8,072 -- -- -- 90 -- -- -- -- 90 Income tax benefit of options exercised (Note K)..................... -- -- -- -- 13 -- -- -- -- 13 Dividends paid ($.08 per share) (Note E)........ -- -- -- -- -- -- -- (526) -- (526) Net earnings for the year................... -- -- -- -- -- -- -- 1,853 -- 1,853 Foreign currency translation (Note A10)............. -- -- -- -- -- -- -- -- (178) (178) --------- --- --------- --- ------- --------- -------- ------- ----- ------- Balance at December 31, 1995................... 4,085,851 41 2,495,572 25 25,088 -- -- 59,460 (545) 84,069 Proceeds from exercise of options (Note K).... 1,167 -- -- -- 12 -- -- -- -- 12 Purchase of treasury stock.................. -- -- -- -- -- 502,000 (5,221) -- -- (5,221) Dividends paid ($.08 per share) (Note E)........ -- -- -- -- -- -- -- (516) -- (516) Net earnings for the year................... -- -- -- -- -- -- -- 731 -- 731 Foreign currency translation (Note A10)............. -- -- -- -- -- -- -- -- 494 494 --------- --- --------- --- ------- --------- -------- ------- ----- ------- Balance at December 31, 1996................... 4,087,018 41 2,495,572 25 25,100 502,000 (5,221) 59,675 (51) 79,569 Conversion of shares (Note K)............... 10,000 -- (10,000) -- -- -- -- -- -- -- Proceeds from exercise of options (Note K).... 13,568 -- -- -- 144 -- -- -- -- 144 Income tax benefit of options exercised...... -- -- -- -- 27 -- -- -- -- 27 Purchase of treasury stock.................. -- -- -- -- -- 500,700 (7,168) -- -- (7,168) Dividends paid ($.08 per share) (Note E)........ -- -- -- -- -- -- -- (461) -- (461) Net earnings for the year................... -- -- -- -- -- -- -- 4,173 -- 4,173 Foreign currency translation (Note A10)............. -- -- -- -- -- -- -- -- (419) (419) --------- --- --------- --- ------- --------- -------- ------- ----- ------- Balance at December 31, 1997................... 4,110,586 $41 2,485,572 $25 $25,271 1,002,700 $(12,389) $63,387 $(470) $75,865 ========= === ========= === ======= ========= ======== ======= ===== =======
The accompanying notes are an integral part of this statement. 23 K-SWISS INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEAR ENDED DECEMBER 31, (DOLLAR AMOUNTS IN THOUSANDS)
1997 1996 1995 ------- -------- ------- Cash flows from operating activities: Net earnings..................................... $ 4,173 $ 731 $ 1,853 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization.................. 918 1,197 1,181 Loss on disposal of equipment and goodwill..... 2 -- 152 Deferred income taxes.......................... 306 3,199 960 (Increase) decrease in accounts receivable..... (954) 64 9,628 (Increase) decrease in inventories............. (3,428) 17,399 4,823 Decrease (increase) in prepaid expenses and other assets.................................. 11,647 (14,373) 1,354 Increase (decrease) in accounts payable and accrued liabilities........................... 5,207 556 (956) Foreign currency translation write off for K-Swiss Canada................................ -- 410 -- ------- -------- ------- Net cash provided by operating activities...... 17,871 9,183 18,995 Cash flows from investing activities: Cash paid for acquisition of certain assets and rights of Robey Sportswear...................... -- (435) -- Purchase of investment securities................ (9,619) -- -- Proceeds from maturity of investment securities.. 3,624 -- 5,102 Purchase of property, plant and equipment........ (1,641) (1,034) (397) Proceeds from disposal of property, plant and equipment....................................... 9 15 18 ------- -------- ------- Net cash (used in) provided by investing activities.................................... (7,627) (1,454) 4,723 Cash flows from financing activities: Net (repayments) borrowings under bank lines of credit and capital leases....................... (564) 790 (2,479) Purchase of treasury stock....................... (7,168) (5,221) -- Payment of dividends............................. (461) (516) (526) Proceeds from stock options exercised............ 144 12 90 Income tax benefit of options exercised.......... 27 -- 13 ------- -------- ------- Net cash used in financing activities.......... (8,022) (4,935) (2,902) Effect of exchange rate changes on cash ........... (413) 89 (102) ------- -------- ------- Net increase in cash and cash equivalents.... 1,809 2,883 20,714 Cash and cash equivalents at beginning of period... 34,314 31,431 10,717 ------- -------- ------- Cash and cash equivalents at end of period......... $36,123 $ 34,314 $31,431 ======= ======== ======= Supplemental disclosure of cash flow information: Cash paid during the year for: Interest....................................... $ 156 $ 213 $ 239 Income taxes................................... $ 3,280 $ 1,171 $ 3,341
The accompanying notes are an integral part of these statements. 24 K-SWISS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997, 1996 AND 1995 NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES 1. Nature of Operations The Company designs, develops and markets footwear for high performance use, fitness and casual activities. The Company operates in an industry dominated by a small number of very large competitors. The size of these competitors enables them to lead the product direction of the industry, and therefore, potentially diminish the value of the Company's products. In addition to generally greater resources, these competitors spend substantially more money on advertising and promotion than the Company and therefore dominate market share. The Company's market share is estimated at approximately one percent. Lastly, the retail environment forecasted for the near term is difficult, which could put additional pressure on the Company's ability to maintain margins. The Company purchases its products from a small number of contract manufacturers in China and Indonesia. This concentration of suppliers in these locations subjects the Company to the risk of interruptions of product flow for various reasons and possible loss of sales, which would affect operating results adversely. Recently, the United States Trade Representative ("USTR") has expressed concern about the protection of intellectual property rights within China. The failure of the Chinese government to make substantial progress with respect to these concerns could result in the imposition of retaliatory duties on imports from China, including footwear, which could affect the cost of products purchased and sold by the Company. 2. Estimates in Financial Statements In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities; the disclosure of contingent assets and liabilities at the date of the financial statements; and revenues and expenses during the reporting period. Actual results could differ from those estimates. 3. Basis of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated. Certain reclassifications have been made in the 1996 presentation to conform with the 1997 presentation. 4. Cash Equivalents For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. 5. Investment Securities The Company's investment securities, which consist of U.S. Government obligations, are classified as held-to-maturity, carried at amortized cost and mature within one year. Fair market value of these investments approximates cost at December 31, 1997. 25 K-SWISS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) 6. Inventories Inventories, consisting of merchandise held for resale, are stated at the lower of cost (first-in, first-out method) or market. Management continually evaluates its inventory position and implements promotional or other plans to reduce inventories to appropriate levels relative to its sales estimates for particular product styles or lines. Estimated losses are recorded when such plans are implemented. It is at least reasonably possible that management's plans to reduce inventory levels will be less than fully successful, and that such an outcome would result in a change in the inventory reserve in the near- term. 7. Property, Plant and Equipment Property, plant and equipment are carried at cost. For financial reporting and tax purposes, depreciation and amortization are calculated using straight- line and accelerated methods over the estimated service lives of the depreciable assets. The service lives of the Company's buildings and related improvements are 25 and 5 years, respectively. Equipment is depreciated from 5 to 10 years and leasehold improvements are amortized over the lives of the respective leases. 8. Intangible Assets Intangible assets are being amortized using the straight-line method over their estimated economic useful lives at the time of acquisition. The intangible assets principally include trademarks and contingent purchase payments and are amortized over 30 to 35 years. Other intangible assets consist of organization costs and trademark defense costs and are amortized over 5 to 7 years. 9. Income Taxes The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Provision is made for appropriate United States income taxes on earnings of subsidiary companies which are intended to be remitted to the parent company. 10. Foreign Currency Translation Assets and liabilities of certain foreign operations are translated into U.S. dollars at current exchange rates. Income and expenses are translated into U.S. dollars at average rates of exchange prevailing during the period. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are taken directly to a separate component of stockholders' equity. Foreign currency transaction gains and losses are included in income. 11. Fair Value of Financial Instruments For certain of the Company's financial instruments, including cash and cash equivalents, accounts receivable, outstanding borrowings under the line of credit, accounts payable and other accrued liabilities, the carrying amounts approximate fair value due to their short maturities. Long-term 26 K-SWISS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) subordinated debentures are carried at amounts that approximate fair value. The estimated fair value of the subordinated debentures is based on borrowing rates currently available to the Company for bank loans with similar terms and maturities. 12. Financial Risk Management and Derivatives The Company enters into foreign exchange contracts in order to reduce the impact of foreign currency fluctuations (principally German marks and pounds sterling) and not to engage in currency speculation. The use of derivative financial instruments allows the Company to reduce its exposure to the risk that the eventual dollar net cash inflow or outflows resulting from the sale of products to foreign customers and purchases from foreign suppliers will be adversely affected by changes in exchange rates. Fluctuations in the value of hedging instruments are offset by fluctuations in the value of the underlying exposures being hedged. The Company does not hold or issue financial instruments for trading purposes. The foreign exchange contracts are designated for firmly committed or forecasted purchases and sales. These transactions are generally expected to occur in less than one year. Gains and losses related to hedges of firmly committed transactions are deferred and are recognized in income or as adjustments of carrying amounts when the hedged transaction occurs. Gains and losses of foreign exchange contracts that are designated for forecasted transactions are recognized as the exchange rates change. At December 31, 1997 and 1996, deferred gains and losses are not material to the consolidated financial statements. The forward exchange contracts generally require the Company to exchange U.S. dollars for foreign currencies (principally German marks and pounds sterling) at maturity, at rates agreed to at the inception of the contracts. The counter party to derivative transactions is a major financial institution with investment grade or better credit rating; however, the Company is exposed to credit risk with these institutions. The credit risk is limited to the unrealized gains in such contracts should this counter party fail to perform as contracted. The aggregate notional principal amounts and fair values of the Company's derivative financial instruments were $3,680,000 and $176,000 at December 31, 1997, respectively and $3,918,000 and $150,000 at December 31, 1996, respectively. The estimated fair value of derivatives used to hedge the Company's risks will fluctuate over time. The fair value of the forward exchange contracts is estimated by obtaining quoted market prices. 13. Recognition of Revenues Revenues include sales and fees earned on sales by licensees and are recognized upon shipment of goods. 14. Advertising Costs Advertising costs are expensed as incurred and are included in selling, general and administrative expenses. Advertising expenses amounted to $6,553,000, $3,073,000, and $1,941,000 for 1997, 1996, and 1995, respectively. 27 K-SWISS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) 15. Earnings per Share In 1997, the Company adopted the provisions of Statement of Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"), which superseded APB Opinion No. 15. Earnings per share for all periods presented has been restated to reflect the adoption of SFAS 128. SFAS 128 requires companies to present basic earnings per share, and, if applicable, diluted earnings per share, instead of primary and fully diluted earnings per share. Basic earnings per share excludes dilution and is computed by dividing net earnings available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if options to issue common stock were exercised into common stock. The following is a reconciliation of the number of shares (denominator) used in the basic and diluted earnings per share computations (shares in thousands):
1997 1996 1995 ---------------- ---------------- ---------------- PER SHARE PER SHARE PER SHARE SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT ------ --------- ------ --------- ------ --------- Basic EPS................... 5,844 $ .71 6,455 $.11 6,578 $.28 Effect of Dilutive Stock Options.................... 120 (.01) 38 -- 52 -- ----- ----- ----- ---- ----- ---- Diluted EPS................. 5,964 $ .70 6,493 $.11 6,630 $.28 ===== ===== ===== ==== ===== ====
The following options were not included in the computation of diluted EPS because the options' exercise price was greater than the average market price of the common shares:
1997 1996 1995 ------------- ------------- ------------- Options to purchase shares of common stock (in thousands)................ 358 463 429 Exercise prices...................... $15.25-$23.00 $10.31-$23.00 $13.75-$23.00 Expiration dates..................... January 2000- January 2000- January 2000- August 2007 August 2006 February 2005
16. New Accounting Pronouncements In 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130 ("SFAS 130"), Reporting Comprehensive Income, which prescribes standards for reporting comprehensive income and its components. Comprehensive income consists of net income or loss for the current period and other comprehensive income (income, expenses, gains and losses that currently bypass the income statement and are reported directly in a separate component of equity). SFAS 130 requires that components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS 130 is effective for financial statements issued for periods beginning after December 15, 1997. In 1997, the FASB issued Statement of Financial Accounting Standards No. 131 ("SFAS 131"), Disclosures about Segments of an Enterprise and Related Information, which applies only to publicly held business entities. A reportable segment, referred to as an operating segment, is a component of an entity about which separate financial information is produced internally, that is evaluated by the 28 K-SWISS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE A--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) chief operating decision-maker to assess performance and allocate resources. SFAS 131 is effective for financial statements issued for periods beginning after December 15, 1997. NOTE B--PREPAID EXPENSES AND OTHER Prepaid expenses and other as of December 31 consist of the following (in thousands):
1997 1996 ------ ------- Prepayment to secure inventory purchases................... $2,153 $11,327 Income taxes receivable.................................... 1,457 3,682 Other prepaid expenses..................................... 689 665 ------ ------- $4,299 $15,674 ====== =======
NOTE C--PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment as of December 31 consists of the following (in thousands):
1997 1996 ------- ------- Building and improvements................................ $ 3,240 $ 2,071 Furniture, machinery and equipment....................... 4,433 4,085 Leased property under capital leases..................... 766 766 ------- ------- 8,439 6,922 Less accumulated depreciation and amortization........... (5,380) (4,835) ------- ------- 3,059 2,087 Land..................................................... 1,826 1,823 ------- ------- $ 4,885 $ 3,910 ======= =======
Accumulated amortization of leased property is approximately $764,000 and $760,000 at December 31, 1997 and 1996 respectively. NOTE D--INTANGIBLE ASSETS Intangible assets as of December 31 consist of the following (in thousands):
1997 1996 ------- ------- Contingent purchase payments............................. $ 4,579 $ 4,579 Trademarks............................................... 2,269 2,269 Other.................................................... 198 387 Less accumulated amortization............................ (2,334) (2,230) ------- ------- $ 4,712 $ 5,005 ======= =======
29 K-SWISS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE E--BANK LINES OF CREDIT The Company maintains revolving credit facilities whereby it may borrow up to an aggregate of $35,000,000 including outstanding letters of credit and bankers' acceptances. The weighted average interest rate provided under these credit facilities was 8.25% and 4.53% at December 31, 1997 and 1996, respectively. Until August of 1996, a fee of up to 1/4% of the average unused line was paid for availability of the primary credit facility. Currently, a fee of up to 1/8% of the average unused line is paid for availability of the primary credit facility. The credit agreement contains certain covenants and financial ratio requirements, including restrictions on dividend payments. At December 31, 1997, $5,628,000 was unrestricted as to the payment of dividends. The amounts borrowed under the facilities are collateralized by substantially all of the assets of the Company. Under the most restrictive covenant, the Company must maintain stockholders' equity, including subordinated debt, less intangible assets and exclusive of treasury stock of at least $65,912,000 at December 31, 1997. NOTE F--ACCRUED LIABILITIES Accrued liabilities as of December 31 consist of the following (in thousands):
1997 1996 ------- ------ Income taxes................................................ $ 1,362 $1,315 Bonuses..................................................... 2,790 680 Advertising................................................. 866 42 Other....................................................... 5,512 4,453 ------- ------ $10,530 $6,490 ======= ======
NOTE G--SUBORDINATED DEBENTURES The subordinated debentures are payable to an officer and a director of the Company. The debentures bear interest at 10%. Interest is due on the unpaid balance quarterly. The debentures are due in full in 2001, however, beginning June 30, 1996 the debenture holders could require the Company to redeem a portion of principal semi-annually. NOTE H--INCOME TAXES The provision for income taxes includes the following for the years ended December 31 (in thousands):
1997 1996 1995 ------ ------- ------ Current United States Federal........................................... $2,366 $(1,961) $3,570 State............................................. 243 514 677 Foreign............................................ 105 117 124 Deferred United States Federal........................................... 273 2,864 859 State............................................. 33 335 101 ------ ------- ------ $3,020 $ 1,869 $5,331 ====== ======= ======
30 K-SWISS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE H--INCOME TAXES--(CONTINUED) A reconciliation from the U.S. federal statutory income tax rate to the effective tax rate follows for the years ended December 31:
1997 1996 1995 ---- ---- ----- U.S. Federal statutory rate................... 34.0% 34.0% 34.0% State income taxes...... 4.1 4.1 4.1 State income tax audit.. -- 18.3 -- California net operating loss carry forward limitation............. -- 4.4 -- Subsidiary liquidation.. -- -- (36.0) Unremitted prior years earnings of foreign subsidiary............. -- -- 61.7 Net results of other foreign subsidiaries... 1.8 7.4 7.0 Amortization of intangibles............ 0.9 2.5 0.9 Other................... 1.2 1.2 2.5 ---- ---- ----- 42.0% 71.9% 74.2% ==== ==== =====
Deferred taxes are determined based on the estimated future tax effects of differences between the financial statement and the tax basis of assets and liabilities given the provisions of the enacted tax laws. The net current and non-current components of deferred income taxes recognized in the balance sheets are as follows as of December 31 (in thousands):
1997 1996 ------ ------ Net current assets.......................................... $2,256 $2,058 Net non-current liabilities................................. 9,770 9,266 ------ ------ Net liability.............................................. $7,514 $7,208 ====== ======
Significant components of the Company's deferred tax assets and liabilities are as follows as of December 31 (in thousands):
1997 1996 ------ ------ Assets State taxes............................................... $ 322 $ 261 State tax net operating loss carry forwards............... 5 137 Bad debts................................................. 130 121 Inventory reserve and capitalized costs................... 1,251 1,487 Bonuses................................................... 491 -- Other..................................................... 96 88 ------ ------ Gross deferred tax assets............................... 2,295 2,094 Liabilities Unremitted earnings of a foreign subsidiary............... 9,303 9,061 Contingent purchase payments.............................. 183 196 Other..................................................... 323 45 ------ ------ Gross deferred tax liabilities.......................... 9,809 9,302 ------ ------ Net deferred tax liability................................ $7,514 $7,208 ====== ======
31 K-SWISS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE H--INCOME TAXES--(CONTINUED) The Company did not record any valuation allowances against deferred tax assets at December 31, 1997. Management has determined, based on the Company's history of prior operating earnings and its expectations for the future, that operating income of the Company will more likely than not be sufficient to recognize fully these deferred tax assets. At the end of 1995, the Company recorded deferred income taxes of $4,433,000 ($.67 per share) on the previously untaxed portion of unremitted earnings of a foreign subsidiary. This change in estimate was precipitated by the Company changing its intention regarding unremitted earnings of the foreign subsidiary. The Company decided to no longer indefinitely invest unremitted earnings of this foreign subsidiary and therefore deferred taxes were recorded. The Company changed its intention because of changes in the tax law and the lack of foreign opportunities to invest the unremitted earnings of the foreign subsidiary. The federal income tax returns of the Company for the years ended 1990, 1991 and 1992 are under examination by the Internal Revenue Service ("IRS"). In December 1995, the IRS issued its report proposing additional taxes of approximately $3,850,000 plus penalties and interest. The Company protested the IRS proposed assessment. Also, the federal income tax returns of the Company for the years ended 1993 and 1994 are currently under examination by the IRS. In addition, the IRS Appeals Division returned the earlier cycle to the Examination Division to reopen its examination of the 1991 and 1992 fiscal years. The IRS has issued a preliminary revised examination report covering the 1991 through 1994 fiscal years proposing additional taxes of approximately $4,760,000 plus penalties and interest for these years combined. Although no assurance can be given regarding the outcome of such examinations, the Company believes that any taxes which might become payable as a result of these examinations would not result in additional expense recognized in the financial statements other than interest and penalties, if any, as the Company has recorded deferred income taxes on the untaxed portion of unremitted earnings of a foreign subsidiary. Therefore, management believes that resolution of the IRS examinations should not have a material adverse impact on the Company's financial position and results of operations. NOTE I--COMMITMENTS AND CONTINGENCIES The Company leases its principal warehouse facility through January 2003, under an agreement which provides for two options, each of which would extend the lease for three years. The Company also leases its principal executive offices under an agreement expiring in April 1998. This lease provides for two options, each of which would extend the lease for one month and one option which would extend the lease for three and one-half months. In addition, certain property and equipment is leased primarily on a month to month basis. Future minimum rental payments under these leases as of December 31, 1997 are as follows (in thousands):
YEAR ENDING DECEMBER 31, ------------ 1998............................................................... $1,362 1999............................................................... 1,060 2000............................................................... 1,026 2001............................................................... 986 2002............................................................... 955 Thereafter......................................................... 78 ------ $5,467 ======
32 K-SWISS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE H--INCOME TAXES--(CONTINUED) Rent expense for operating leases was approximately $1,451,000, $1,615,000, and $1,676,000 for the years ended December 31, 1997, 1996, and 1995, respectively. The Company has outstanding letters of credit totaling approximately $12,156,000 and $8,000,000 at December 31, 1997 and 1996 respectively. These letters of credit, which have original terms from one to four months, collateralize the Company's obligation to third parties for the purchase of inventory. The fair value of these letters of credit is based on fees currently charged for similar agreements and is not significant at December 31, 1997 and 1996. NOTE I--COMMITMENTS AND CONTINGENCIES--(CONTINUED) The Company is, from time to time, a party to litigation which arises in the normal course of its business operations. The Company does not believe it is presently a party to litigation which will have a material adverse effect on its business or operations. During 1998, the Company will need approximately $3,740,000 for the construction of its new headquarters facility. NOTE J--EMPLOYEE BENEFIT PLANS In 1988, the Company adopted a discretionary contribution profit sharing plan covering all employees meeting certain eligibility requirements. In 1993, the plan was amended to include a 401(k) plan. The expense for this plan was approximately $472,000, $17,000, and $218,000 for 1997, 1996 and 1995, respectively. NOTE K--STOCKHOLDERS' EQUITY Each share of Class B Common Stock is freely convertible into one share of Class A Common Stock at the option of the Class B stockholder. Holders of Class A Common Stock are entitled to one vote per share and holders of Class B Common Stock are entitled to ten votes per share for all matters submitted to a vote of the stockholders of the Company, other than the election of directors. Holders of Class A Common Stock are initially entitled to elect two directors and holders of Class B Common Stock are entitled to elect all directors other than directors that the holders of Class A Common Stock are entitled to elect. If the number of members of the Company's Board of Directors is increased to not less than eleven and not greater than fifteen (excluding directors representing holders of Preferred Stock, if any), holders of Class A Common Stock will be entitled to elect three directors. If the number of members of the Company's Board of Directors is increased to a number greater than fifteen (excluding directors representing holders of Preferred Stock, if any), holders of Class A Common Stock will be entitled to elect four directors. During 1988, the Company adopted the 1988 Stock Option Plan under which it was authorized to issue non-qualified stock options, incentive stock options, and warrants to key employees to purchase up to an aggregate of 157,500 shares of Class A Common Stock. In 1990, the unused portion of the 1988 Plan was terminated and the Company adopted the 1990 Stock Option Plan. As amended, the number of options available for issuance under the 1990 Stock Option Plan is 825,000 shares of Class A Common Stock. The options have a term of ten years and generally become fully vested by the end of the fifth year. 33 K-SWISS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE K--STOCKHOLDERS' EQUITY--(CONTINUED) Combined plan transactions for 1997, 1996 and 1995 are as follows:
1997 1996 1995 ----------------- ----------------- ----------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ------- -------- ------- -------- ------- -------- Options outstanding January 1,.............. 685,262 $13.51 587,662 $15.47 628,326 $15.53 Granted.................. 96,150 10.56 178,800 8.80 8,700 8.50 Exercised................ (13,568) 10.65 (1,167) 10.00 (8,072) 11.24 Canceled................. (63,950) 13.50 (80,033) 17.39 (41,292) 15.79 ------- ------- ------- Options outstanding December 31,............ 703,894 13.16 685,262 13.51 587,662 15.47 ======= ======= ======= Options available for grant at December 31,... 88,955 121,155 219,922
Weighted average fair value of options granted during the year are as follows:
1997 1996 1995 ------ ----- ------ Exercise price is below market price at date of grant............................................... $12.44 $8.75 $12.29 Exercise price equals market price at date of grant.. 4.86 3.14 4.96
The following information applies to options outstanding at December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------- -------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE ------------------------ ----------- ----------- -------- ----------- -------- $ 1.00--$ 2.51.......... 44,157 7 $ 1.30 9,740 $ 2.34 $ 8.75--$13.00.......... 292,702 7 9.96 157,535 9.90 $13.75--$19.25.......... 306,735 5 16.31 257,335 16.24 $21.25--$23.00.......... 60,300 7 21.41 43,031 21.33 ------- ------- 703,894 6 13.16 467,641 14.29 ======= =======
The fair value of options at date of grant was estimated using the Black- Scholes model with the following weighted average assumptions:
1997 1996 1995 ---- ---- ---- Expected life (years).................................... 7 7 7 Risk-free interest rate.................................. 6.25% 5.50% 5.50% Volatility............................................... 22% 20% 20% Dividend yield........................................... .7% .7% .7%
34 K-SWISS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE K--STOCKHOLDERS' EQUITY--(CONTINUED) Statement of Financial Accounting Standards No. 123, "Accounting for Stock- Based Compensation", encourages, but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock. During 1997, 1996 and 1995, 21,000, 14,000,and 4,000 options, respectively, were granted at exercise prices below fair market value. This resulted in net compensation expense of $32,000, $28,000, and $55,000 for 1997, 1996 and 1995, respectively. All other options were granted at an exercise price equal to the fair market value of the Company's common stock at the date of grant. Accordingly, no compensation cost has been recognized for such options granted. In connection with the exercise of options, the Company realized income tax benefits in 1997, 1996 and 1995 which have been credited to additional paid-in capital. Had compensation cost for the plan been determined based on the fair value of the options at the grant dates consistent with the method of SFAS No. 123, the Company's net earnings and earnings per share would have been:
1997 1996 1995 ------ ---- ------ Net earnings (in thousands) As reported........................................... $4,173 $731 $1,853 Pro forma............................................. 4,163 742 1,906 Basic earnings per share As reported........................................... $ .71 $.11 $ .28 Pro forma............................................. .71 .11 .29 Diluted earnings per share As reported........................................... $ .70 $.11 $ .28 Pro forma............................................. .70 .11 .29
The effects of applying SFAS 123 in this proforma disclosure are not indicative of future amounts. SFAS 123 does not apply to awards prior to 1995, and additional awards in future years are anticipated. NOTE L--CONCENTRATIONS OF CREDIT RISK Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents, trade accounts receivable and financial instruments used in hedging activities. The Company maintains cash and cash equivalents with high quality institutions and limits the amount of credit exposure to any one institution. As part of its cash and risk management processes, the Company performs periodic evaluations of the relative credit standing of the financial institutions. 35 K-SWISS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE L--CONCENTRATIONS OF CREDIT RISK--(CONTINUED) During the years ended December 31, 1997, 1996 and 1995, approximately 17%, 11%, and 12%, respectively, of revenues were made to one domestic customer. At December 31, 1997 and 1996 approximately 18% and 14%, respectively, of accounts receivable were from this major customer. Credit risk with respect to other trade accounts receivable is generally diversified due to the large number of entities comprising the Company's customer base and their dispersion across many geographies. The Company controls credit risk through credit approvals, credit limits and monitoring procedures and for international receivables, the use of letters of credit and letters of guarantee. NOTE M--OPERATIONS BY GEOGRAPHIC AREA The Company's predominant business is the design, development and distribution of athletic footwear. Information about the Company's domestic and international revenues, operating income and other financial information is presented below (in thousands):
YEAR ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 -------- -------- -------- Revenues from unrelated entities: United States.............................. $ 91,568 $ 76,170 $ 89,220 International.............................. 24,645 30,663 31,032 -------- -------- -------- $116,213 $106,833 $120,252 ======== ======== ======== Inter-geographic revenues: United States.............................. $ 2,721 $ 2,102 $ 4,337 International.............................. 2,937 4,573 6,240 -------- -------- -------- $ 5,658 $ 6,675 $ 10,577 ======== ======== ======== Total Revenues: United States.............................. $ 94,289 $ 78,272 $ 93,557 International.............................. 27,582 35,236 37,272 Less Inter-geographic revenues............. (5,658) (6,675) (10,577) -------- -------- -------- $116,213 $106,833 $120,252 ======== ======== ======== Operating profit: United States.............................. $ 10,669 $ 3,720 $ 9,116 International.............................. 1,493 2,271 2,608 Less corporate expenses and eliminations... (6,792) (4,918) (5,329) -------- -------- -------- $ 5,370 $ 1,073 $ 6,395 ======== ======== ======== Identifiable assets: United States.............................. $ 47,070 $ 42,068 $ 56,896 International.............................. 19,620 30,531 17,664 Corporate assets and eliminations ......... 34,996 27,676 27,818 -------- -------- -------- $101,686 $100,275 $102,378 ======== ======== ========
36 K-SWISS INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DECEMBER 31, 1997, 1996 AND 1995 NOTE N--QUARTERLY FINANCIAL DATA (UNAUDITED) Summarized quarterly financial data for 1997 and 1996 follows (in thousands except for per share amounts):
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER YEAR ------- ------- ------- ------- -------- 1997 Revenues.......................... $31,199 $28,415 $32,835 $23,764 $116,213 Gross profit...................... 11,722 9,610 13,418 10,694 45,444 Net earnings (loss)............... 1,539 (379) 1,714 1,299 4,173 Basic earnings (loss) per share... $ .25 $ (.06) $ .30 $ .23 $ .71 Diluted earnings (loss) per share. $ .25 $ (.06) $ .29 $ .22 $ .70 1996 Revenues.......................... $34,365 $26,019 $28,781 $17,668 $106,833 Gross profit...................... 12,445 7,740 9,063 5,265 34,513 Net earnings (loss)............... 2,127 (731) 281 (946) 731 Basic earnings (loss) per share... $ .32 $ (.11) $ .04 $ (.16) $ .11 Diluted earnings (loss) per share. $ .32 $ (.11) $ .04 $ (.16) $ .11
37 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Except for the information disclosed in Item 4(a) of this Annual Report on Form 10-K, the information required by this item will be contained in the Company's Proxy Statement for its Annual Stockholders Meeting to be held May 20, 1998 to be filed with the Securities and Exchange Commission within 120 days after December 31, 1997 and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by this item will be contained in the Company's Proxy Statement for its Annual Stockholders Meeting to be held May 20, 1998 to be filed with the Securities and Exchange Commission within 120 days after December 31, 1997 and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item will be contained in the Company's Proxy Statement for its Annual Stockholders Meeting to be held May 20, 1998 to be filed with the Securities and Exchange Commission within 120 days after December 31, 1997 and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item will be contained in the Company's Proxy Statement for its Annual Stockholders Meeting to be held May 20, 1998 to be filed with the Securities and Exchange Commission within 120 days after December 31, 1997 and is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (A) FINANCIAL STATEMENTS:
PAGE REFERENCE FORM 10-K -------------- Report of Independent Certified Public Accountants.............. 20 Consolidated Balance Sheets as of December 31, 1997 and 1996.... 21 Consolidated Statements of Earnings for the three years ended December 31, 1997.............................................. 22 Consolidated Statement of Stockholders' Equity for the three years ended December 31, 1997.................................. 23 Consolidated Statements of Cash Flows for the three years ended December 31, 1997.............................................. 24 Notes to Consolidated Financial Statements...................... 25--37
(B) REPORTS ON FORM 8-K A Form 8-K, dated October 15, 1997, was filed with the Securities and Exchange Commission during the fourth quarter of 1997. The Form 8-K reported the issuance of a press release on October 15, 1997, regarding the filing by the Company of a Form S-3 Registration Statement covering shares of the Company's Class A Common Stock held by one of its principal stockholders. 38 In addition, another Form 8-K was filed on January 15, 1998. The Company issued a press release relating to the purchase of up to $2,832,000 of its Class A Common Stock on the open market through December 1998. (C) EXHIBITS 3.1 Amended and Restated Certificate of Incorporation of K-Swiss Inc. (incorporated by reference to exhibit 3.4 to the Registrant's Form S-1 Registration Statement No. 33-34369). 3.2 Certificate of Designations of Class A Common Stock of K-Swiss Inc. (incorporated by reference to exhibit 3.2 to the Registrant's Form S-1 Registration Statement No. 33-34369). 3.3 Certificate of Designations of Class B Common Stock of K-Swiss Inc. (incorporated by reference to exhibit 3.3 to the Registrant's Form S-1 Registration Statement No. 33-34369). 3.4 Amended and Restated Bylaws of K-Swiss Inc. (incorporated by reference to exhibit 3.4 to the Registrant's Form 10-K for the fiscal year ended December 31, 1991). 4.1 Specimen K-Swiss Inc. Class A Common Stock Certificate (incorporated by reference to exhibit 4.1 to the Registrant's Form S-1 Registration Statement No. 33-34369). 4.2 Specimen K-Swiss Inc. Class B Common Stock Certificate (incorporated by reference to exhibit 4.2 to the Registrant's Form S-1 Registration Statement No. 33-34369). 4.3 $400,000 324 Corp. 10% Junior Subordinated Debenture due December 31, 2001 originally issued to The Rug Warehouse, Inc. Pension Plan and Trust (incorporated by reference to exhibit 4.7 to the Registrant's Form S-1 Registration Statement No. 33-34369). 4.4 $100,000 324 Corp. 10% Junior Subordinated Debenture due December 31, 2001 issued to George E. Powlick (incorporated by reference to exhibit 4.8 to the Registrant's Form S-1 Registration Statement No. 33-34369). 9.1 Voting Agreement by and between Steven B. Nichols and each of Lawrence Feldman and George Powlick dated as of June 11, 1990, as amended (incorporated by reference to exhibit 9.1 to the Registrant's Form 10-K for the year ended December 31, 1990). 9.2 Stockholders Agreement dated as of December 30, 1986 by and among 324 Corp., Steven B. Nichols, Kenneth J. Zises and The Biltrite Corporation (incorporated by reference to exhibit 9.2 to the Registrant's Form S-1 Registration Statement No. 33-34369). 9.3 Letter Agreement dated May 3, 1990 by and among the Company, Steven B. Nichols, Kenneth J. Zises, The Biltrite Corporation and certain affiliates (incorporated by reference to exhibit 9.3 to the Registrant's Form S-1 Registration Statement No. 33-34369). 9.4 Voting Agreement dated May 3, 1990 by and between The Biltrite Corporation and the Nichols Family Trust (incorporated by reference to exhibit 9.4 to the Registrant's Form S-1 Registration Statement No. 33-34369). 10.1 K-Swiss Inc. 1990 Stock Incentive Plan (incorporated by reference to exhibit 10.1 to the Registrant's Form S-1 Registration Statement No. 33-34369).
39 10.2 Amendment to K-Swiss Inc. 1990 Stock Incentive Plan (incorporated by reference to exhibit 10.36 to the Registrant's Form 10-K for the fiscal year ended December 31, 1993). 10.3 Amendment to K-Swiss Inc. 1990 Stock Incentive Plan (incorporated by reference to exhibit 10.32 to the Registrant's Form 10-K for the fiscal year ended December 31, 1995). 10.4 324 Corp. 1988 Stock Option Plan (incorporated by reference to exhibit 10.2 to the Registrant's Form S-1 Registration Statement No. 33-34369). 10.5 K-Swiss Inc. Profit Sharing Plan, as amended (incorporated by reference to exhibit 10.3 to the Registrant's Form S-1 Registration Statement No. 33-34369). 10.6 Amendment to K-Swiss Inc. 401(k) and Profit Sharing Plan (incorporated by reference to exhibit 10.35 to the Registrant's Form 10-K for the fiscal year ended December 31, 1993). 10.7 Amendment to K-Swiss Inc. 401(k) and Profit Sharing Plan dated May 26, 1994 (incorporated by reference to exhibit 10.32 to the Registrant's Form 10-K for the fiscal year ended December 31, 1994). 10.8 Form of Indemnity Agreement entered into by and between K-Swiss Inc. and directors (incorporated by reference to exhibit 10.4 to the Registrant's Form S-1 Registration Statement No. 33-34369). 10.9 Distributor agreement dated June 10, 1991 by and between K-Swiss International Ltd. and Five Lines Corporation (incorporated by reference to exhibit 10.5 to the Registrant's Form 10-K Annual Report for the fiscal year ended December 31, 1991). 10.10 Employment Agreement dated as of June 11, 1990 with Steven B. Nichols (incorporated by reference to exhibit 10.11 to the Registrant's Form S-1 Registration Statement No. 33-34369). 10.11 First Amendment to Employment Agreement with Steven B. Nichols dated November 13, 1991 (incorporated by reference to exhibit 10.32 to the Registrant's Form 10-K for the fiscal year ended December 31, 1991). 10.12 Employment Agreement between the Registrant and Steven B. Nichols dated as of April 30, 1993 (incorporated by reference to exhibit 10.30 to the Registrant's Form S-1 Registration Statement No. 33- 62254). 10.13 Employment Agreement between the Registrant and Steven B. Nichols dated as of March 1, 1995 (incorporated by reference to exhibit 10.2 to the Registrant's Form 10-Q for the quarter ended June 30, 1995). 10.14 Note and Warrant Agreement dated as of December 29, 1986 by and among K-Swiss, 324 Corp. and John Hancock Mutual Life Insurance Company (incorporated by reference to exhibit 10.18 to the Registrant's Form S-1 Registration Statement No. 33-34369). 10.15 Amendment to Note and Warrant Agreement dated as of August 1, 1988 by and among K-Swiss, 324 Corp. and John Hancock Mutual Life Insurance Company (incorporated by reference to exhibit 10.19 to the Registrant's Form S-1 Registration Statement No. 33-34369).
40 10.16 Note Agreement dated August 25, 1989 and Amendment to Note and Warrant Agreement dated as of December 29, 1986, as amended, by and between K-Swiss Inc. and John Hancock Mutual Life Insurance Company (incorporated by reference to exhibit 10.20 to the Registrant's Form S-1 Registration Statement No. 33-34369). 10.17 Amendment to Note and Warrant Agreement, as amended, dated as of April 26, 1990 by and among K-Swiss Inc., the Registrant and John Hancock Mutual Life Insurance Company (incorporated by reference to exhibit 10.21 to the Registrant's Form S-1 Registration Statement No. 33-34369). 10.18 Amendment to Note and Warrant Agreement as amended, and Note Agreement, dated as of January 15, 1991, between the Registrant and John Hancock Mutual Life Insurance Company (incorporated by reference to exhibit 10.17 to the Registrant's Form 10-K for the year ended December 31, 1990). 10.19 Stock Pledge Agreement, Secured Promissory Note and Letter Agreement dated as of December 26, 1990 by and between the Registrant and George Powlick (incorporated by reference to exhibit 10.18 to the Registrant's Form 10-K for the year ended December 31, 1990). 10.20 Stock Pledge Agreement, Secured Promissory Note and Letter Agreement dated as of April 10, 1991 by and between Registrant and George Powlick (incorporated by reference to exhibit 10.33 to the Registrant's Form 10-K for the fiscal year ended December 31, 1991). 10.21 Stock Pledge Agreement and Secured Promissory Note dated as of April 10, 1991 by and between the Registrant and Lawrence D. Feldman (incorporated by reference to exhibit 10.34 to the Registrant's Form 10-K for the fiscal year ended December 31, 1991). 10.22 Purchase Agreement dated as of December 29, 1986 by and between 324 Corp. and The Biltrite Corporation (incorporated by reference to exhibit 10.37 to the Registrant's Form S-1 Registration Statement No. 33-34369). 10.23 Amendment to Purchase Agreement dated December 29, 1986 by and between 324 Corp. and The Biltrite Corporation (incorporated by reference to exhibit 10.34 to the Registrant's Form S-1 Registration Statement No. 33-34369). 10.24 Amendment to Purchase Agreement dated December 29, 1986 by and between 324 Corp. (the Registrant's predecessor in interest) and The Biltrite Corporation (incorporated by reference to exhibit 10.33 to the Registrant's Form S-1 Registration Statement No. 33-62254). 10.25 Registration Rights Agreement between the Registrant and Steven B. Nichols dated as of April 30, 1993 (incorporated by reference to exhibit 10.31 to the Registrant's Form S-1 Registration Statement No. 33-62254). 10.26 Amended and Restated Registration Rights Agreement between the Registrant and Steven B. Nichols dated as of April 30, 1993 (incorporated by reference to exhibit 10.32 to the Registrant's Form S-1 Registration Statement No. 33-62254). 10.27 Lease dated April 25, 1990 by and between the Registrant and Premier Business Properties, Ltd. No. 1 (incorporated by reference to exhibit 10.35 to the Registrant's Form S-1 Registration Statement No. 33-34369). 10.28 Amendment to Lease Agreement dated April 25, 1990 by and between the Registrant and Premier Business Properties, Ltd. No. 1 (incorporated by reference to exhibit 10 to the Registrant's Form 10-Q for the quarter ended September 30, 1994).
41 10.29 Lease Agreement dated November 30, 1992 by and between K-Swiss Inc. and S. Daryl Parker, d.b.a. Parker Industrial Properties (incorporated by reference to exhibit 10.28 to the Registrant's Form 10-K for the fiscal year ended December 31, 1992). 10.30 Lease Agreement dated March 25, 1993 between the Registrant and Woodpecker Manufacturing Company, Inc. (incorporated by reference to exhibit 10.34 to the Registrant's Form S-1 Registration Statement No. 33-62254). 10.31 Lease Agreement dated March 11, 1997 by and between K-Swiss Inc. and Space Center Mira Loma, Inc. (incorporated by reference to exhibit 10 to the Registrant's Form 10-Q for the quarter ended March 31, 1997). 10.32 Credit Agreement dated March 25, 1994 by and among the Registrant and Bank of America National Trust and Savings Association, with schedules (incorporated by reference to exhibit 10.33 to the Registrant's Form 10-K for the fiscal year ended December 31, 1994). 10.33 Amendment to Credit Agreement dated March 25, 1994 by and among the Registrant and Bank of America National Trust and Savings Association (incorporated by reference to exhibit 10.1 to the Registrant's Form 10-Q for the quarter ended June 30, 1995). 10.34 Second Amendment to Credit Agreement (incorporated by reference to exhibit 10 to the Registrant's Form 10-Q for the quarter ended September 30, 1996). 10.35 Third Amendment to Credit Agreement (incorporated by reference to exhibit 10 to the Registrant's Form 10-Q for the quarter ended September 30, 1997). 10.36 Agreement for the Purchase of Assets and Rights of Robey between N. Chr. M. Wilke and NMB-Heller N.V. and K-Swiss International Ltd., dated January 4, 1996 (incorporated by reference to exhibit 10 to the Registrant's Form 10-Q for the quarter ended March 31, 1996). 10.37 Standard Offer, Agreement and Escrow Instructions for Purchase of Real Estate dated September 29, 1997 by and between K-Swiss Inc. (the seller) and Hager Investments, Inc., or Nominee (the buyer). 21 Subsidiaries of K-Swiss Inc. 23 Consent of Grant Thornton LLP. 27 Financial Data Schedule
(D) SCHEDULES
PAGE ---- Financial Statement Schedules: Schedule II--Valuation and Qualifying Accounts...................... 44 All supplemental schedules other than as set forth above are omitted as inapplicable or because the required information is included in the Consolidated Financial Statements or the Notes to Consolidated Financial Statements.
42 SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS FORM 10-K TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED. K-Swiss Inc. /s/ George Powlick By __________________________________ George Powlick, Vice-President and Chief Financial Officer February 11, 1998 PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE --------- ----- ---- /s/ Steven Nichols Chairman of the Board, February 11, 1998 - --------------------------- President and Chief Steven Nichols Executive Officer /s/ George Powlick Vice President Finance, February 11, 1998 - ---------------------------- Chief Financial Officer, George Powlick Principal Accounting Officer, Secretary and Director /s/ Stanley Bernstein Director February 11, 1998 - ---------------------------- Stanley Bernstein /s/ Lawrence Feldman Director February 11, 1998 - ---------------------------- Lawrence Feldman /s/ Stephen Fine Director February 11, 1998 - ---------------------------- Stephen Fine /s/ Jonathan Layne Director February 11, 1998 - ---------------------------- Jonathan Layne /s/ Martyn Wilford Director February 11, 1998 - ---------------------------- Martyn Wilford
43 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (AMOUNTS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E -------- ------------- --------------------- -------------- ---------- ADDITIONS --------------------- BALANCE AT CHARGED TO CHARGED TO WRITE-OFFS AND BALANCE AT BEGINNING OF COSTS AND OTHER DEDUCTIONS, END DESCRIPTION PERIOD EXPENSES ACCOUNTS NET OF PERIOD ----------- ------------- ---------- ---------- -------------- ---------- Allowance for bad debts. (1995) $ 712 $1,504 $ -- $(1,343) $ 873 (1996) 873 247 -- (490) 630 (1997) 630 420 -- (573) 477 Allowance for inventories............ (1995) $ 145 $3,389 $ -- $(1,735) $1,799 (1996) 1,799 2,977 -- (1,896) 2,880 (1997) 2,880 1,769 -- (2,022) 2,627
44 EXHIBIT INDEX
NUMBER ------ 10.37 Standard Offer, Agreement and Escrow Instructions for Purchase of Real Estate...................................................... 21 Subsidiaries of K-Swiss Inc....................................... 23 Consent of Grant Thornton LLP..................................... 27 Financial Data Schedule...........................................
EX-10.37 2 STANDARD OFFER, AGRMNT & ESCROW INSTRUCTIONS EXHIBIT 10.37 STANDARD OFFER, AGREEMENT AND ESCROW INSTRUCTIONS FOR PURCHASE OF REAL ESTATE (Non-Residential) American Industrial Real Estate Association September 29, 1997 ------------------------------- (Date for Reference Purposes) 1. BUYER. 1.1 Hager Investments, Inc., or Nominee, (the "Buyer") hereby offers to purchase the real property, hereinafter described, from the owner thereof (the "Seller") (collectively, the "Parties" or individually, a "Party"), through an escrow (the "Escrow") to close on 68 days after opening of escrow (the "Expected Closing Date") to be held by First American Title Company (Corporate Account) (the "Escrow Holder") whose address is 114 E. 5th Street, Santa Ana, CA 92701, Phone No. __________________, Facsimile No. _______________ upon the terms and conditions set forth in this agreement (the "Agreement"). Buyer shall have the right to assign Buyer's rights hereunder, but any such assignment shall not relieve Buyer of Buyer's obligations herein unless the Seller expressly releases Buyer. 1.2 The term "Date of Agreement as used herein shall be the date when by execution and delivery (as defined in paragraph 20.2) of this document or a subsequent counter-offer thereto, Buyer and Seller have reached agreement in writing whereby Seller agrees to sell, and Buyer agrees to purchase, the Property upon terms accepted by both Parties. 2. PROPERTY. 2.1 The real property (the "Property") that is the subject of this offer consists of (insert a brief physical description) that approximate 56,056 square foot industrial building situated on approximately 115,434 square feet of M2 zoned land is located in the City of Pacoima, County of Los Angeles, State of California, is commonly known by the street address of 12300 Montague Street and is legally described as: to be provided in escrow. 2.2 If the legal description of the Property is not complete or is inaccurate, this Agreement shall not be invalid and the legal description shall be completed or corrected to meet the requirements of First American Title Company (the "Title Company"), which Title Company shall issue the title policy hereinafter described. 2.3 The Property includes, at no additional cost to Buyer, the permanent improvements thereon, including those items which the law of the state in which the Property is located provides is part of the Property, as well as the following items, if any, owned by Seller and presently located in the Property: electrical distribution systems (power panels, buss ducting, conduits, disconnects, lighting fixtures), telephone distribution systems (lines, jacks and connections), space heaters, air conditioning equipment, air lines, fire sprinkler systems, security systems, carpets, window coverings, wall coverings, and ____________________________________________________________________________ (collectively, the "Improvements"). 2.4 If the Property is located in the State of California, the Broker(s) is/are required under the Alquist-Priolo Special Studies Zones Act, to disclose to a prospective purchaser of real property whether the property being purchased is located within a delineated special studies zone (a zone that encompasses a potentially or recently active trace of an earthquake fault that is deemed by the State Geologist to be sufficiently active and well defined enough to constitute a potential hazard to structures from surface faulting or fault (creep). If the Property is located within such a special studies zone, its development may require a geologic report from a state registered geologist. In accordance with such law, the Broker(s) hereby inform(s) Buyer that the Property: [X] (a) Is not within such a special studies zone. [_] (b) Is within such a special studies zone. 2.5 If (1) the Property is located in the State of California, (2) the Improvements were constructed prior to 1975, and (3) the Improvements include structures with (i) pre-cast (e.g., tilt-up) concrete or reinforced masonry walls together with wood frame floors or roofs or (ii) unreinforced masonry walls, California law requires that Seller or Seller's Broker provide Buyer with a copy of The Commercial Property Owner's Guide to Earthquake Safety (the "Booklet") published by the California Seismic Safety Commission. Seller and Seller's Broker hereby inform Buyer that the Property: [_] (a) meets the foregoing requirements, and Seller and Seller's Broker are required to provide Buyer with a copy of the Booklet. Seller or Seller's Broker shall, within five (5) business days of the Date of Agreement, deliver to Buyer a copy of the Booklet and a completed "Commercial Property Earthquake Weakness Disclosure Report" contained in the Booklet duly executed by Seller. Within five (5) business days of Buyer's receipt of said Disclosure Report, Buyer shall deliver a duly countersigned copy of the same to Escrow Holder, with a copy to Seller and Seller's Broker. Escrow Holder is hereby instructed that the Escrow shall not close unless and until Escrow Holder has received the Disclosure Report duly signed by both Seller and Buyer. [X] (b) does not meet the foregoing requirements requiring the delivery of the Booklet. 3. PURCHASE PRICE. 3.1 The purchase price (the "Purchase Price") to be paid by Buyer to Seller for the Property shall be $2,250,000.00, payable as follows: (a) Cash down payment, including the Deposit as defined in paragraph 4.3 (or if an all cash transaction, the Purchase Price): $2,250,000.00 ------------- (Strike if not applicable) (Strike if not applicable) (Strike if not applicable) ------------- Total Purchase Price: $2,250,000.00 ============= 3.2 If an Existing Deed of Trust permits the beneficiary thereof to require payment of a transfer fee as a condition to the transfer of the Property subject to such Existing Deed of Trust, Buyer agrees to pay transfer fees and costs of up to one and one-half percent (1 1/2%) of the unpaid principal balance of the applicable Existing Note. 4. DEPOSITS. 4.1 Buyer hereby delivers a check in the sum of $50,000, payable to First American Title Company, to be (check applicable box) [_] forthwith deposited in the payee's trust account [X] hold uncashed until the Date of Agreement. When cashed, the check shall be deposited into the payee's trust account to be applied toward the Purchase Price of the Property at the Closing, as defined in paragraph 8.3. Should Buyer and Seller not enter into an agreement for purchase and sale, Buyer's check or funds shall, upon request by Buyer, be promptly returned to Buyer. DH GP - --------- --------- - --------- --------- _________ _________ Initials Initials Page 1 4.3 The funds deposited with Escrow Holder by or on behalf of Buyer under paragraphs 4.1 and 4.2, above (collectively the "Deposit"), shall be deposited by Escrow Holder in such State or Federally chartered bank as Buyer may select and in such interest-bearing account or accounts as Escrow Holder or Broker(s) deem appropriate and consistent with the timing requirements of this transaction. The interest therefrom shall accrue to the benefit of Buyer, who hereby acknowledges that there may be penalties or interest forfeitures if the applicable instrument is redeemed prior to its specified maturity. Buyer's Federal Tax Identification Number is to be provided in escrow. ------------------------- 5. FINANCING CONTINGENCY. (strike if not applicable) 6. PURCHASE MONEY NOTE. (strike if not applicable) 7. REAL ESTATE BROKERS. 7.1 The following real estate broker(s) (collectively, the "Brokers") and brokerage relationships exist in this transaction and are consented to by the parties (check applicable boxes): [_] ________________________ represents Seller exclusively ("Seller's Broker") [_] ________________________ represents Buyer exclusively ("Buyer's Broker"); or [X] The Seeley Company represents Seller and Buyer ("Dual Agency"). (Also ________________________ see Paragraph 26.) (the "Broker(s)"), all such named Broker(s) being the procuring cause(s) of this Agreement. See paragraph 26 for Disclosures Regarding the Nature of a Real Estate Agency Relationship. Buyer shall use the services of Buyer's Broker exclusively in connection with any and all negotiations and offers with respect to the property described in paragraph 2.1 for a period of one year from the date above. 7.2 Buyer and Seller each represent and warrant to the other that he/she/it has had no dealings with any person, firm, broker or finder in connection with the negotiation of this Agreement and/or the consummation of the purchase and sale contemplated herein, other than the Broker(s) named in paragraph 7.1 and no broker or other person, firm or entity, other than said Broker(s) is/are entitled to any commission or finder's fee in connection with this transaction as the result of any dealings or acts of such Party. Buyer and Seller do each hereby agree to indemnify, defend, protect and hold the other harmless from and against any costs, expenses or liability for compensation, commission or charges which may be claimed by any broker, finder or other similar party, other than said named Broker(s) by reason of any dealings or act of the indemnifying Party. 8. ESCROW AND CLOSING. 8.1 Upon acceptance hereof by Seller, this Agreement, including any counter-offers incorporated herein by the Parties, shall constitute not only the agreement of purchase and sale between Buyer and Seller, but also instructions to Escrow Holder for the consummation of the Agreement through the Escrow. Escrow Holder shall not prepare any further escrow instructions restating or amending this Agreement unless specifically so instructed by the Parties of a Broker herein. 8.2 Escrow Holder is hereby authorized and instructed to conduct the Escrow in accordance with this Agreement, applicable law, custom and practice of the community in which Escrow Holder is located, including any reporting requirements of the Internal Revenue Code. In the event of a conflict between the law of the state where the Property is located and the law of the state where the Escrow Holder is located, the law of the state where the Property is located shall prevail. 8.3 Subject to satisfaction of the contingencies herein described, Escrow Holder shall close this escrow (the "Closing") by recording the grant deed and other documents required to be recorded and by disbursing the funds and documents in accordance with this Agreement. 8.4 If this transaction is terminated for non-satisfaction and non-waiver of a Buyer's Contingency, as defined in paragraph 9.4, then neither of the Parties shall thereafter have any liability to the other under this Agreement, except to the extent of the breach of any affirmative covenant or warranty in this Agreement that may have been involved. In the event of such termination, Buyer shall be promptly refunded all funds deposited by or on behalf of Buyer with a Broker, Escrow Holder or Seller, less only Title Company and Escrow Holder cancellation fees and costs, all of which shall be Buyer's obligation. 8.5 The Closing shall occur on the Expected Closing Date, or as soon thereafter as the Escrow is in condition for Closing; provided, however, that if the Closing does not occur by the Expected Closing Date and the Expected Closing Date is not extended by mutual instructions of the Parties, a Party hereto not then in default under this Agreement may notify the other Party, Escrow Holder, and Broker(s), in writing that, unless the Closing occurs within five (5) business days following said notice, the Escrow and this Agreement shall be deemed terminated without further notice or instructions. 8.6 Should the Closing not occur during said five (5) day period, this Agreement and Escrow shall be deemed terminated and Escrow Holder shall forthwith return all monies and documents, less only Escrow Holder's reasonable fees and expenses, to the Party who deposited them. Such Party shall indemnify and hold Escrow Holder harmless in connection with such return. However, no refunds or documents shall be returned to a party claimed by written notice to Escrow Holder to be in default under this Agreement. 8.7 Except as otherwise provided herein, the termination of Escrow and this Agreement and/or the return of deposited funds or documents shall not relieve or release either Buyer or Seller from any obligation to pay Escrow Holder's fees and costs or constitute a waiver, release or discharge of any breach or default that has occurred in the performance of the obligations, agreements, covenants or warranties contained herein. 8.8 If this Agreement terminates for any reason other than Seller's breach or default, then at Seller's request, and as a condition to the return of Buyer's deposit, Buyer shall within five (5) days after written request deliver to Seller, at no charge, copies of all surveys, engineering studies, soil reports, maps, master plans, feasibility studies and other similar items prepared by or for Buyer that pertain to the Property. 9. CONTINGENCIES TO CLOSING. 9.1 Notwithstanding anything to the contrary contained in Paragraphs 9.1(a) through 9.1(p), the Closing of this transaction is contingent upon the satisfaction or waiver of the following contingencies: no later than thirty- eight (38) days following open of escrow. (a) Disclosure. Buyer's receipt and written approval, within ten (10) days after delivery to Buyer, of a completed Property Information Sheet (the "Property Information Sheet"), concerning the Property, duly executed by or on behalf of Seller in the current form or equivalent to that published by the American Industrial Real Estate Association (the "A.I.R."). Seller shall provide Buyer with the Property Information Sheet within ten (10) days following the Date of Agreement. See also paragraph 2.5 for possible additional disclosure and contingency regarding a "Commercial Property Earthquake Weakness Disclosure Report." (b) Physical Inspection. Buyer's written approval, within ten (10) days following the later of the Date of Agreement or receipt by Buyer of the Property Information Sheet, of an inspection by Buyer, at Buyer's expense, of the physical aspects of the Property. DH GP ___________ ___________ ___________ ___________ Initials Initials PAGE 2 (c) Hazardous Substance Conditions Report. Buyer's written approval, within thirty (30) days following the later of the Date of Agreement or receipt by Buyer of the Property Information Sheet, of a Hazardous Substance Conditions Report concerning the Property and relevant adjoining properties. Such report will be obtained at Buyer's direction and expense. A "Hazardous Substance" for purposes of this Agreement is defined as any substance whose nature and/or quantity of existence, use, manufacture, disposal or effect, render it subject to Federal, state or local regulation, investigation, remediation or removal as potentially injurious to public health or welfare. A "Hazardous Substance Condition "for purposes of this Agreement is defined as the existence on, under or relevantly adjacent to the Property of a Hazardous Substance that would require remediation and/or removal under applicable Federal, state or local law. (d) Soil Inspection. Buyer's written approval, within thirty (30) days after the later of the Date of Agreement or receipt by Buyer of the Property Information Sheet, of a soil test report concerning the Property, Said report shall be obtained at Buyer's direction and, expense. Seller shall promptly provide to Buyer copies of any existing soils reports that Seller may have. (e) Governmental Approvals. Buyer's receipt, within fifteen (15) days of the Date of Agreement, of all approvals and permits from governmental agencies or departments which have or may have jurisdiction over the Property which Buyer deems necessary or desirable in connection with its intended use of the Property, including, but not limited to, permits and approvals required with respect to zoning, planning, building and safety, fire, police, handicapped access, transportation and environmental matters. Buyer's failure to deliver to Escrow Holder and Seller written notice terminating this Agreement prior to the expiration of said fifteen (15) day period as a result of Buyer's failure to obtain such approvals and permits shall be conclusively deemed to be Buyer's waiver of this condition to Buyer's obligations under this Agreement. (f) Condition of Title. Buyer's written approval of a current preliminary title report concerning the Property (the "PTR") issued by the Title Company, as well as all documents (the "Underlying Documents") referred to in the PTR, and the issuance by the Title Company of the title policy described in 10.1. Seller shall cause the PTR and all Underlying Documents to be delivered to Buyer promptly after the Date of Agreement. Buyer's approval is to be given within ten (10) days after receipt of said PTR and legible copies of all Underlying Documents. The disapproval by Buyer of any monetary encumbrance, which by the terms of this Agreement is not to remain against the Property after the Closing, shall not be considered a failure of this condition, as Seller shall have the obligation, at Seller's expense, to satisfy and remove such disapproved monetary encumbrance at or before the Closing. (g) Survey. Buyer's written approval, within thirty (30) days after receipt of the PTR and Underlying Documents, of an ALTA title supplement based upon a survey prepared to American Land Title Association (the "ALTA") standards for an owner's policy by a licensed surveyor, showing the legal description and boundary lines of the Property, any easements of record, and any improvements, poles, structures and things located within ten (10) feet either side of the Property boundary lines. The survey shall be prepared at Buyer's direction and expense. If Buyer has obtained a survey and approved the ALTA title supplement, Buyer may elect within the period allowed for Buyer's approval of a survey to have an ALTA extended coverage owner's form of title policy, in which event Buyer shall pay any additional premium attributable thereto. (h) Existing Leases and Tenancy Statements. Buyer's written approval, within ten (10) days after receipt of legible copies of all leases, subleases or rental arrangements (collectively the "Existing Leases") affecting the Property, and a statement (the "Tenancy Statement") in the latest form or equivalent to that published by the A.I.R., executed by Seller and each tenant and subtenant of the Property. Seller shall use its best efforts to provide Buyer with said Existing Leases and Tenancy Statements promptly after the Date of Agreement. (i) Other Agreements. Buyer's written approval, within ten (10) days after receipt, of a copy of any other agreements ("Other Agreements") known to Seller that will affect the Property beyond the Closing. Seller shall cause said copies to be delivered to Buyer promptly after the Date of Agreement. (j) Financing. If paragraph 5 hereof dealing with a financing contingency has not been stricken, the satisfaction or waiver of such New Loan contingency. (k) Existing Notes. If paragraph 3.1(c) has not been stricken. Buyer's written approval, within ten (10) days after receipt, of conformed and legible copies of the Existing Notes, Existing Deeds of Trust and related agreements (collectively the "Loan Documents") to which the Property will remain subject after the Closing, including a beneficiary statement (the "Beneficiary Statement") executed by the holders of the Existing Notes confirming: (1) the amount of the unpaid principal balance, the current interest rate, and the date to which interest is paid, and (2) the nature and amount of any impounds held by the beneficiary in connection with said loan. Seller shall use its best efforts to provide Buyer with said Loan Documents and Beneficiary Statement promptly after the Date of Agreement, Buyer's obligation to close is further conditioned upon Buyer's being able to purchase the Property without acceleration or change in the terms of any Existing Notes or charges to Buyer except as otherwise provided in this Agreement or approved by Buyer, provided, however, Buyer shall pay the transfer fee referred to in paragraph 3.2 hereof. (l) Destruction, Damage or Loss. There shall not have occurred prior to the Closing, a destruction of, or damage or loss to, the Property or any portion thereof, from any cause whatsoever, which would cost more than $10,000.00 to repair or cure. If the cost of repair or cure is $10,000.00 or less, Seller shall repair or cure the loss prior to the Closing. Buyer shall have the option, within ten (10) day after receipt of written notice of a loss costing more than $10,000.00 to repair or cure , to either terminate this transaction or to purchase the Property notwithstanding such loss, but without deduction or offset against the Purchase Price. If the cost to repair or cure is more than $10,000.00, and Buyer does not elect to terminate this transaction, Buyer shall be entitled to any insurance proceeds applicable to such loss. Unless otherwise notified in writing by either Party or Broker, Escrow Holder shall assume no destruction, damage or loss costing more than $10,000.00 to repair or cure has occurred prior to Closing. (m) Material Change. No Material Change, as hereinafter defined, shall have occurred with respect to the Property that has not been approved in writing by Buyer. For purposes of this Agreement, a "Material Change" shall be a change in the status of the use, occupancy, tenants, or condition of the Property as reasonably expected by the Buyer, that occurs after the date of this offer and prior to the Closing. Buyer shall have ten (10) days following receipt of written notice from any source of any such Material Change within which to approve or disapprove same. Unless otherwise notified in writing by either Party or Broker, Escrow Holder shall assume that no Material Change has occurred prior to the Closing. (n) Seller Performance. The delivery of all documents and the due performance by Seller of each and every undertaking and agreement to be performed by Seller under this Agreement. (o) Breach of Warranty. That each representation and warranty of Seller herein be true and correct as of the Closing. Escrow Holder shall assume that this condition has been satisfied unless notified to the contrary in writing by Buyer or Broker(s) prior to the Closing. (p) Broker's Fee. Payment at the closing of such Broker's Fee as is specified in this Agreement or later written instructions to Escrow Holder executed by Seller and Broker(s). It is agreed by Buyer, Seller and Escrow Holder that Broker(s) is/are a third party beneficiary of this Agreement insofar as the Broker's fee is concerned, and that no change shall be made in Buyer, Seller or Escrow Holder with respect to the time of payment, amount of payment, or the conditions to payment of the Broker's fee specified in this Agreement, without the written consent of Broker(s). (q) Notwithstanding anything to the contrary contained herein, Buyer shall have thirty-eight (38) days to satisfy itself of all contingencies. 9.2 All of the contingencies specified in sub-paragraphs (a) through (o) of paragraph 9.1 are for the benefit of, and may be waived by, Buyer, and may be elsewhere herein referred to as "Buyer Contingencies." 9.3 If Buyer shall fail, within the applicable time specified, to approve or disapprove in writing to Escrow Holder, Seller and the other Party's Broker, any item, matter or document subject to Buyer's approval under the terms of this Agreement, it shall be conclusively presumed that Buyer has approved such item, matter or document. Buyer's conditional approval shall constitute a disapproval, unless provision is made by the Seller within the time specified therefor by the Buyer in the conditional approval or by this Agreement, whichever is later, for the satisfaction of the condition imposed by the Buyer. 9.4 If any Buyer's Contingency is not satisfied or if Buyer disapproves any matter subject to its approval within the time period applicable thereto ("Disapproved Item"), Seller shall have the right within ten (10) days following the expiration of the time period applicable to such Buyer Contingency or receipt of notice of Buyer's disapproval, as the case may be, to elect to cure such Disapproved Item prior to the Expected Closing Date ("Seller's Election"). Seller's failure to give to Buyer within said ten (10) day period, written notice of Seller's commitment to cure such Disapproved Item on or before the Expected Closing Date shall be conclusively presumed to be Seller's Election not to cure such Disapproved Item. If Seller elects, either by written notice or failure to give written notice, not to cure a Disapproved Item, Buyer shall have the election, within ten (10) days after Seller's Election to either accept title to the Property subject to that Disapproved Item, or to terminate this transaction. Buyer's failure to elect termination by written notice to Seller within said ten (10) day period shall constitute Buyer's election to accept title to the Property subject to that Disapproved Item without deduction or offset. Unless expressly provided otherwise herein, Seller's right to cure shall not apply to Hazardous Substance Conditions referenced in paragraph 9.1(c) or the Financing Contingency set forth in paragraph 5. Unless the parties mutually instruct otherwise, if the time periods for the satisfaction of contingencies or for Seller's and Buyer's said Elections would expire on a date after the Expected Closing Date, the Expected Closing Date shall be deemed extended to coincide with the expiration of three (3) business days following the expiration of: (a) the applicable contingency period(s), (b) the period within which the Seller may elect to cure the Disapproved Item, or (c) if Seller elects not to cure, the period within which Buyer may elect to terminate this transaction, whichever is later. 9.5 9.6 As defined in subparagraph 9.1(c), Buyer and Seller acknowledge that extensive local, state and Federal legislation establish broad liability upon owners and/or users of real property for the investigation and remediation of a Hazardous Substance Condition. The determination of the existence of a Hazardous Substance Condition and the evaluation of the impact of such a condition are highly technical and beyond the expertise of Broker(s). Buyer and Seller acknowledge that they have been advised by Broker(s) to consult their own technical and legal experts with respect to the possible Hazardous Substance Condition aspects of this Property or adjoining properties, and Buyer and Seller are not relying upon any investigation by or statement of Broker(s) with respect thereto. Buyer and Seller hereby assume all responsibility for the impact of such Hazardous Substance Conditions upon their respective interests herein. 10. DOCUMENTS REQUIRED AT CLOSING: 10.1 Escrow Holder shall cause to be issued to Buyer a standard coverage (or ATLA extended, if so elected under paragraph 9.1(f)) owner's form policy of title insurance effective as the Closing, issued by the Title Company in the full amount of the Purchase Price, insuring title of the Property vested in Buyer, subject only to the exceptions approved by Buyer. In the event there is a Purchase Money Deed of Trust in this transaction, the policy of title insurance shall be a joint protection policy insuring both Buyer and Seller. "IMPORTANT: IN A PURCHASE OR EXCHANGE OR REAL PROPERTY, IT MAY BE ADVISABLE TO OBTAIN TITLE INSURANCE IN CONNECTION WITH THE CLOSE OF ESCROW SINCE THERE MAY BE PRIOR RECORDED LIENS AND ENCUMBRANCES WHICH AFFECT YOUR INTEREST IN THE PROPERTY BEING ACQUIRED. A NEW POLICY OF TITLE INSURANCE SHOULD BE OBTAINED IN ORDER TO ENSURE YOUR INTEREST IN THE PROPERTY THAT YOU ARE ACQUIRING." 10.2 Seller shall deliver or cause to be delivered to Escrow Holder in time for delivery to Buyer at the Closing, an original ink signed; (a) Grant deed (or equivalent), duly executed and in recordable form conveying fee title to the Property to Buyer. (b) If paragraph 3.1(c) has not been stricken, the Beneficiary Statements concerning Existing Note(s). DH GP ________ ________ ________ ________ Initials Initials PAGE 3 (c) If applicable, the Existing Leases and Other Agreements together with duly executed assignments thereof by Seller and Buyer. The assignment of Existing Leases shall be on the most recent Assignment and Assumption of Lessor's Interest in Lease form published by the A.I.R. or its equivalent. (d) If applicable, the Tenancy Statements executed by Seller and the Tenant(s) of the Property. (e) An affidavit executed by Seller to the effect that Seller is not a "foreign person" within the meaning of Internal Revenue Code Section 1445 or successor statutes. If seller does not provide such affidavit in form reasonably satisfactory to Buyer at least three (3) business days prior to the Closing, Escrow Holder shall at the Closing deduct from Seller's proceeds and remit to Internal Revenue Service such sum as is required by applicable Federal law with respect to purchases from foreign sellers. 10.3. Buyer shall deliver or cause to be delivered to Seller through escrow: (a) The cash portion of the Purchase Price and such additional sums as are required of Buyer under this Agreement for prorations, expenses and adjustments. The balance of the cash portion of the Purchase Price, including Buyer's escrow charges and other cash charges, if any, shall be deposited by Buyer with Escrow Holder, by cashier's check drown upon a local major banking institution, federal funds wire transfer, or any other method acceptable to Escrow Holder as immediately collectable funds, no later than 11:00 o'clock A.M. on the business day prior to the Expected Closing Date. (b) If a Purchase Money Note and Purchase Money Deed of Trust are called for by this Agreement, the duly executed originals of those documents, the Purchase Money Deed of Trust being in recordable form, together with evidence of fire insurance on the improvements in the amount of the full replacement cost naming Seller as a mortgage loss payee, and a real estate tax service contract (at Buyer's expense), assuring Seller of notice of the status of payment of real property taxes during the life of the Purchase Money Note. (c) The assumption portion of the Assignment and Assumption of Lessor's Interest in Lease form specified in paragraph 10.2(c), above, duly executed by Buyer with respect to the obligations of the Lessor accruing after the Closing as to each Existing Lease. (d) Assumptions duly executed by Buyer of the obligations of Seller that accrue after Closing under any Other Agreements. (e) If applicable, a written assumption duly executed by Buyer of the loan documents with respect to Existing Notes. 11. PRORATIONS, EXPENSES AND ADJUSTMENTS. 11.1 Taxes. Real property taxes payable by the owner of the Property shall be prorated through Escrow as of the date of the Closing, based upon the latest tax bill available. The Parties agree to prorate as of the Closing any taxes assessed against the Property by supplemental bill levied by reason of events occurring prior to the Closing. Payment shall be made promptly in cash upon receipt of a copy of any such supplemental bill of the amount necessary to accomplish such proration. Seller shall pay and discharge in full at or before the Closing the unpaid balance of any special assessment bonds. 11.2 Insurance. If Buyer elects to take an assignment of the existing casualty and/or liability insurance that is maintained by Seller, the current premium therefor shall be prorated through Escrow as of the date of Closing. 11.3 Rental, Interest and Expenses. Collected rentals, interest on Existing Notes, utilities, and operating expenses shall be prorated as of the date of Closing. The Parties agree to promptly adjust between themselves outside of Escrow any rents received after the Closing. 11.4 Security Deposit. Security Deposits held by Seller shall be given to Buyer by a credit to the cash required of Buyer at the Closing. 11.5 Post Closing Matters. Any item to be prorated that is not determined or determinable at the Closing shall be promptly adjusted by the Parties by appropriate cash payment outside of the Escrow when the amount due is determined. 11.6 Variations In Existing Note Balances. In the event that Buyer is taking title to the Property subject to an Existing Deed of Trust(s), and in the event that a Beneficiary Statement as to the applicable Existing Note(s) discloses that the unpaid principal balance of such Existing Note(s) at the Closing will be more or less than the amount set forth in paragraph 3.1(c) hereof (the "Existing Note Variation"), then the Purchase Money Note(s) shall be reduced or increased by an amount equal to such Existing Note Variation. If there is to be no Purchase Money Note, the cash required at the Closing per Paragraph 3.1(a) shall be reduced or increased by the amount of such Existing Note Variation. 11.7 Variations In New Loan Balance. In the event Buyer is obtaining a New Loan and in the event that the amount of the New Loan actually obtained is greater than the amount set forth in Paragraph 5.1 hereof, the Purchase Money Note, if one is called for in this transaction, shall be reduced by the excess of the actual face amount of the New Loan over such amount as designated in Paragraph 5.1 hereof. 11.8 Escrow Costs and Fees. Buyer and Seller shall each pay one-half of the Escrow Holder's charges and Seller shall pay the usual recording fees and any required documentary transfer taxes. Seller shall pay the premium for a standard coverage owner's or joint protection policy of title insurance. 12. REPRESENTATION AND WARRANTIES OF SELLER AND DISCLAIMER. 12.1 Seller's warranties and representations shall survive the Closing and delivery of the deed, and, unless otherwise noted herein, are true, material and relied upon by Buyer and Broker(s) in all respects, both as of the Date of Agreement, and as of the date of Closing. Seller hereby makes the following warranties and representations to Buyer and Broker(s): (a) Authority of Seller. Seller is the owner of the Property and/or has the full right, power and authority to sell, convey and transfer the Property to Buyer as provided herein, and to perform Seller's obligations hereunder. (b) Maintenance During Escrow and Equipment Condition At Closing. Except as otherwise provided in paragraph 9.1(l) hereof dealing with destruction, damage or loss, Seller shall maintain the Property until the Closing in its present condition, ordinary wear and tear excepted. The heating, ventilating, air conditioning, plumbing, elevators, loading doors and electrical systems shall be in good operating order and condition at the time of Closing. (c) Hazardous Substances/Storage Tanks. Seller has no knowledge, except as otherwise disclosed to Buyer in writing, of the existence or prior existence on the Property of any Hazardous Substance (as defined in paragraph 9.1(c)), nor of the existence or prior existence of any above or below ground storage tank or tanks. (d) Compliance. Seller has no knowledge of any aspect or condition of the Property which violates applicable laws, rules, regulations, codes, or covenants, conditions or restrictions, or of improvements or alterations made to the Property without a permit where one was required, or of any unfulled order or directive of any applicable governmental agency or casualty insurance company that any work of investigation, remediation, repair, maintenance or improvement is to be performed on the Property. (e) Changes in Agreements. Prior to the Closing, Seller will not violate or modify, orally or in writing, any Existing Lease or Other Agreement, or create any new leases or other agreements affecting the Property, without Buyer's written approval, which approval will not be unreasonably withheld. (f) Possessory Rights. Seller has no knowledge that anyone will, at the Closing, have any right to possession of the Property, except as disclosed by this Agreement or otherwise in writing to Buyer. (g) Mechanics' Liens. There are no unsatisfied mechanic's or materialman's lien rights concerning the Property. (h) Actions, Suits or Proceedings. Seller has no knowledge of any actions, suits or proceedings pending or threatened before any commission, board, bureau, agency, instrumentality, arbitrator(s) court or tribunal that would affect the Property or the right to occupy or utilize same. (i) Notice of Changes. Seller will promptly notify Buyer and Broker(s) in writing of any Material Change (as defined in paragraph 9.1(m)) affecting the Property that becomes known to Seller prior to the Closing. (j) No Tenant Bankruptcy Proceedings. Seller has no notice or knowledge that any tenant of the Property is the subject of a bankruptcy or insolvency proceeding. (k) No Seller Bankruptcy Proceedings. Seller is not the subject of a bankruptcy, insolvency or probate proceeding. 12.2 Buyer hereby acknowledges that, except as otherwise stated in this Agreement, Buyer is purchasing the Property in its existing condition and will, by the time called for herein, make or have waived all inspections of the Property Buyer believes are necessary to protect its own interest in, and its contemplated use of, the Property. The Parties acknowledge that, except as otherwise stated in this Agreement, no representations, inducements, promises, agreements, assurances, oral or written, concerning the Property, or any aspect of the Occupational Safety and Health Act, hazardous substance laws, or any other act, ordinance or law, have been made by either Party or Broker, or relied upon by either Party hereto. 13. POSSESSION. 13.1 Possession of the Property shall be given to Buyer at the Closing subject to the rights of tenants under Existing Leases. 14. BUYER'S ENTRY. 14.1 At any time during the Escrow period, Buyer, and its agents and representatives, shall have the right at reasonable times and subject to rights of tenants under Existing Leases, to enter upon the Property for the purpose of making inspections and tests specified in this Agreement. Following any such entry or work, unless otherwise directed in writing by Seller, Buyer shall return the Property to the condition it was in prior to such entry or work, including the recompaction or removal of any disrupted soil or material as Seller may reasonably direct. All such inspections and tests and any other work conducted or materials furnished with respect to the Property by or for Buyer shall be paid for by Buyer as and when due and Buyer shall indemnify, defend, protect and hold harmless Seller and the Property of and from any and all claims, liabilities, demands, losses, costs, expenses (including reasonable attorney's fees), damages or recoveries, including those for injury to person or property, arising out of or relating to such work or materials or the acts or omissions of Buyer, its agents or employees in connection therewith. 15. FURTHER DOCUMENTS AND ASSURANCES. 15.1 Buyer and Seller shall each, diligently and in good faith, undertake all actions and procedures reasonably required to place the Escrow in condition for Closing as and when required by this Agreement. Buyer and Seller agree to provide all further information, and to execute and deliver all further documents and instruments, reasonably required by Escrow Holder or the Title Company. 16. ATTORNEYS' FEES. 16.1 In the event of any litigation or arbitration between the Buyer, Seller, and Broker(s), or any of them, concerning this transaction, the prevailing party shall be entitled to reasonable attorney's fees and costs. The attorneys' fee award shall not be computed in accordance with any court fee schedule, but shall be such as to fully reimburse all attorneys' fees reasonably incurred in good faith. 17. PRIOR AGREEMENTS/AMENDMENTS. 17.1 The contract in effect as of the Date of Agreement supersedes any and all prior agreements between Seller and Buyer regarding the Property. 17.2 Amendments to this Agreement are effective only if made in writing and executed by Buyer and Seller. DH GP ________ ________ ________ ________ Initials Initials PAGE 4 18. BROKER'S RIGHTS. 18.1 If this sale shall not be consummated due to the default of either the Buyer or Seller, the defaulting party shall be liable to and shall pay to Broker(s) the commission that Broker(s) would have received had the sale been consummated. This obligation of Buyer, if Buyer is the defaulting party, is in addition to any obligation with respect to liquidated damages. 18.2 Upon the Closing, Broker(s) is/are authorized to publicize the facts of this transaction. 19. NOTICES. 19.1 Whenever any Party hereto, Escrow Holder or Broker(s) herein shall desire to give or serve any notice, demand, request, approval or other communication, each such communication shall be in writing and shall be delivered personally, by messenger or by mail, postage prepaid, addressed as set forth adjacent to that party's or Broker's signature on this Agreement or by telecopy with receipt confirmed by telephone. Service of any such communication shall be deemed made on the date of actual receipt at such address. 19.2 Any Party or Broker hereto may from time to time, by notice in writing served upon the other Party as aforesaid, designate a different address to which, or a different person or additional persons to whom, all communications are thereafter to be made. 20. DURATION OF OFFER. 20.1 If this offer shall not be accepted by Seller on or before 5:00 P.M. according to the time standard applicable to the city of Los Angeles on the date ----------- of October 16, 1997, it shall be deemed automatically revoked. ---------------- 20.2 The acceptance of this offer, or of any subsequent counter-offer hereto, that creates an agreement between the Parties as described in paragraph 1.2, shall be deemed made upon delivery to the other Party or either Broker herein of a duly executed writing unconditionally accepting the last outstanding offer or counter-offer. 21. LIQUIDATED DAMAGES. (This Liquidated Damages paragraph is applicable only if initialled by both parties.) 21.1 THE PARTIES AGREE THAT IT WOULD BE IMPRACTICABLE OR EXTREMELY DIFFICULT TO FIX, PRIOR TO SIGNING THIS AGREEMENT, THE ACTUAL DAMAGES WHICH WOULD BE SUFFERED BY SELLER IF BUYER FAILS TO PERFORM ITS OBLIGATIONS UNDER THIS AGREEMENT. THEREFORE, IF, AFTER THE SATISFACTION OR WAIVER OF ALL CONTINGENCIES PROVIDED FOR THE BUYER'S BENEFIT, BUYER BREACHES THIS AGREEMENT, SELLER SHALL BE ENTITLED TO LIQUIDATED DAMAGES IN THE AMOUNT OF $50,000 PLUS INTEREST, IF ANY, ACCRUED THEREON. UPON PAYMENT OF SAID SUM TO SELLER, BUYER SHALL BE RELEASED FROM ANY FURTHER LIABILITY TO SELLER, AND ANY ESCROW CANCELLATION FEES AND TITLE COMPANY CHARGES SHALL BE PAID BY SELLER. DH GP ------------------ ----------------- BUYER INITIALS SELLER INITIALS 22. ARBITRATION OF DISPUTES. (This Arbitration of Disputes paragraph is applicable only if initialled by both parties and is subject to paragraph 23, below.) 22.1 ANY CONTROVERSY AS TO WHETHER SELLER IS ENTITLED TO THE LIQUIDATED DAMAGES AND/OR BUYER IS ENTITLED TO THE RETURN OF DEPOSIT MONEY, SHALL BE DETERMINED BY BINDING ARBITRATION BY, AND UNDER THE COMMERCIAL RULES (the "COMMERCIAL RULES") OF, THE AMERICAN ARBITRATION ASSOCIATION. HEARINGS ON SUCH ARBITRATION SHALL BE HELD IN THE COUNTY WHERE THE PROPERTY IS LOCATED. ANY SUCH CONTROVERSY SHALL BE ARBITRATED BY THREE (3) ARBITRATORS WHO SHALL BE IMPARTIAL REAL ESTATE BROKERS WITH AT LEAST FIVE (5) FULL TIME YEARS OF EXPERIENCE IN THE AREA WHERE THE PROPERTY IS LOCATED, IN THE TYPE OF REAL ESTATE THAT IS THE SUBJECT OF THIS AGREEMENT AND SHALL BE APPOINTED UNDER THE COMMERCIAL RULES. THE ARBITRATORS SHALL HEAR AND DETERMINE SAID CONTROVERSY IN ACCORDANCE WITH APPLICABLE LAW AND THE INTENTION OF THE PARTIES AS EXPRESSED IN THIS AGREEMENT, AS THE SAME MAY HAVE BEEN DULY MODIFIED IN WRITING BY THE PARTIES PRIOR TO THE ARBITRATION, UPON THE EVIDENCE PRODUCED AT AN ARBITRATION HEARING SCHEDULED AT THE REQUEST OF EITHER PARTY. SUCH PREARBITRATION DISCOVERY SHALL BE PERMITTED AS IS AUTHORIZED UNDER THE COMMERICAL RULES OR STATE LAW APPLICABLE TO ARBITRATION PROCEEDINGS. THE AWARD SHALL BE EXECUTED BY AT LEAST TWO (2) OF THE THREE (3) ARBITRATORS, BE RENDERED WITHIN THIRTY (30) DAYS AFTER THE CONCLUSION OF THE HEARING, AND MAY INCLUDE ATTORNEYS' FEES AND COSTS TO THE PREVAILING PARTY PER PARAGRAPH 16 HEREOF. JUDGMENT MAY BE ENTERED ON THE AWARD IN ANY COURT OF COMPETENT JURISDICTION NOTWITHSTANDING THE FAILURE OF A PARTY DULY NOTIFIED OF THE ARBITRATION HEARING TO APPEAR THEREAT. 22.2 BUYER'S RESORT TO OR PARTICIPATION IN SUCH ARBITRATION PROCEEDINGS SHALL NOT BAR SUIT IN A COURT OF COMPETENT JURISDICTION BY THE BUYER FOR DAMAGES AND/OR SPECIFIC PERFORMANCE UNLESS AND UNTIL THE ARBITRATION RESULTS IN AN AWARD TO THE SELLER OR LIQUIDATION DAMAGES, IN WHICH EVENT SUCH AWARD SHALL ACT AS A BAR AGAINST ANY ACTION BY BUYER FOR DAMAGES AND/OR SPECIFIC PERFORMANCE. 22.3 NOTICE: BY INITIALLING IN THE SPACE BELOW YOU ARE AGREEING TO HAVE ANY DISPUTE ARISING OUT OF THE MATTERS INCLUDED IN THE "ARBITRATION OF DISPUTES" PROVISION DECIDED BY NEUTRAL ARBITRATION AS PROVIDED BY CALIFORNIA LAW AND YOU ARE GIVING UP ANY RIGHTS YOU MIGHT POSSESS TO HAVE THE DISPUTE LITIGATED IN A COURT OR JURY TRIAL. IF YOU REFUSE TO SUBMIT TO ARBITRATION AFTER AGREEING TO THIS PROVISION, YOU MAY BE COMPELLED TO ARBITRATE UNDER THE AUTHORITY OF THE CALIFORNIA CODE OF CIVIL PROCEDURE. YOUR AGREEMENT TO THIS ARBITRATION PROVISION IS VOLUNTARY. WE HAVE READ AND UNDERSTAND THE FOREGOING AND AGREE TO SUBMIT DISPUTES ARISING OUT OF THE MATTERS INCLUDED IN THE "ARBITRATION OF DISPUTES" PROVISION TO NEUTRAL ARBITRATION. DH GP ------------------ ----------------- BUYER INITIALS SELLER INITIALS 23. APPLICABLE LAW 23.1 This Agreement shall be governed by, and paragraph 22.3 amended to refer to, the laws of the sate in which the Property is located. 24. TIME OF ESSENCE. 24.1 Time is of the essence of this Agreement. 25. COUNTERPARTS. 25.1 This Agreement may be executed by Buyer and Seller in counterparts, each of which shall be deemed an original, and all of which together shall constitute one and the same instrument. Escrow Holder, after verifying that the counterparts are identical except for the signatures, is authorized and instructed to combine the signed signature pages on one of the counterparts, which shall then constitute the Agreement. 26. DISCLOSURES REGARDING THE NATURE OF A REAL ESTATE AGENCY RELATIONSHIP. 26.1 The Parties and Broker(s) agree that their relationship(s) shall be governed by the principles set forth in California Civil Code, Section 2375, as summarized in the following paragraph 26.2. 26.2 When entering into a discussion with a real estate agent regarding a real estate transaction, a Buyer or Seller should from the outset understand what type of agency relationship or representation it has with the agent or agents in the transaction. Buyer and Seller acknowledge being advised by the Broker(s) in this transaction, as follows: (a) Seller's Agent. A Seller's agent under a listing agreement with the Seller acts as the agent for the Seller only. A Seller's agent or subagent has the following affirmative obligations: (1) To the Seller: A fiduciary duty of utmost care, integrity, honesty, and loyalty in dealings with the Seller, (2) To the Buyer and the Seller: a. Diligent exercise of reasonable skill and care in performance of the agent's duties. b. A duty of honest and fair dealing and good faith. c. A duty to disclose all facts known to the agent materially affecting the value or desirability of the property that are not known to, or within the diligent attention and observation of, the Parties. An agent is not obligated to reveal to either Party any confidential information obtained from the other Party which does not involve the affirmative duties set forth above. (b) Buyer's Agent. A selling agent can, with a Buyer's consent, agree to act as agent for the Buyer only. In these situations, the agent is not the Seller's agent, even if by agreement the agent may receive compensation for services rendered, either in full or in part from the Seller. An agent acting only for a Buyer has the following affirmative obligations. (1) To the Buyer: A fiduciary duty of utmost care, integrity, honesty, and loyalty in dealings with the Buyer, (2) To the Buyer and the Seller: a Diligent exercise of reasonable skill and care in performance of the agent's duties. b. A duty of honest and fair dealing and good faith c. A duty to disclose all facts known to the agent materially affecting the value or desirability of the property that are not known to, or within the diligent attention and observation of, the Parties. An agent is not obligated to reveal to either Party any confidential information obtained from the other Party which does not involve the affirmative duties set forth above. DH GP ------------ ------------ ------------ ------------ INITIALS INITIALS (c) Agent Representing Both Seller and Buyer. A real estate agent, either acting directly or through one or more associate licenses, can legally be the agent of both the Seller and the Buyer in a transaction, but only with the knowledge and consent of both the Seller and the Buyer. (1) In a dual agency situation, the agent has the following affirmative obligations to both the Seller and the Buyer: a. A fiduciary duty of utmost care, integrity, honesty and loyalty in the dealings with either Seller or the Buyer. b. Other duties to the Seller and the Buyer as stated above in their respective sections (a) or (b) of this paragraph 26.2. (2) In representing both Seller and Buyer, the agent may not without the express permission of the respective Party, disclose to the other Party that the Seller will accept a price less than the listing price or that the Buyer will pay a price greater than the price offered. (3) The above duties of the agent in a real estate transaction do not relieve a Seller or Buyer from the responsibility to protect their own interests. Buyer and Seller should carefully read all agreements to assure that they adequately express their understanding of the transaction. A real estate agent is a person qualified to advise about real estate. If legal or tax advise is desired, consult a competent professional. (d) Further Disclosures. Throughout this transaction Buyer and Seller may receive more than one disclosure, depending upon the number of agents assisting in the transaction. Buyer and Seller should each read its contents each time it is presented considering the relationship between them and the real estate agent in this transaction and that disclosure. 26.3 Confidential Information: Buyer and Seller agree to identify to Broker(s) as "Confidential" any communication or information given Broker(s) that is considered by such Party to be confidential. 27. ADDITIONAL PROVISIONS: Additional provisions of this offer, if any, are as follows or are attached hereto by an addendum consisting of paragraphs 29 through 32. (It will be -- -- presumed no other provisions are included unless specified here.) ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ ________________________________________________________________________________ BUYER AND SELLER HEREBY ACKNOWLEDGE THAT THEY HAVE BEEN AND ARE NOW ADVISED BY THE BROKER(S) TO CONSULT AND RETAIN THEIR OWN EXPERTS TO ADVISE AND REPRESENT THEM CONCERNING THE LEGAL AND INCOME TAX EFFECTS OF THIS AGREEMENT, AS WELL AS THE CONDITION AND/OR LEGALITY OF THE PROPERTY. THE IMPROVEMENTS AND EQUIPMENT THEREIN, THE SOIL THEREOF, THE CONDITION OF TITLE THERETO, THE SURVEY THEREOF, THE ENVIRONMENT ASPECTS THEREOF, THE INTENDED AND/OR PERMITTED USAGE THEREOF, THE EXISTENCE AND NATURE OF TENANCIES THEREIN, THE OUTSTANDING OTHER AGREEMENTS, IF ANY, WITH RESPECT THERETO, AND THE EXISTING OR CONTEMPLATED FINANCING THEREOF, AND THAT THE BROKER(S) IS/ARE NOT TO BE RESPONSIBLE FOR PURSUING THE INVESTIGATION OF ANY SUCH MATTERS UNLESS EXPRESSLY OTHERWISE AGREED TO IN WRITING BY BROKER(S) AND BUYER OR SELLER. THIS FORM IS NOT FOR USE IN CONNECTION WITH THE SALE OF RESIDENTIAL PROPERTY. IF THIS AGREEMENT HAS BEEN FILLED IN, IT HAS BEEN PREPARED FOR SUBMISSION TO YOUR ATTORNEY FOR HIS APPROVAL. NO REPRESENTATION OR RECOMMENDATION IS MADE BY THE REAL ESTATE BROKER(S) OR THEIR AGENTS OR EMPLOYEES AS TO THE LEGAL SUFFICIENCY, LEGAL EFFECT, OR TAX CONSEQUENCES OF THIS AGREEMENT OR THE TRANSACTION INVOLVED HEREIN. THE UNDERSIGNED BUYER OFFERS AND AGREES TO BUY THE PROPERTY ON THE TERMS AND CONDITIONS STATED AND ACKNOWLEDGES RECEIPT OF A COPY HEREOF.
BROKER: BUYER: The Seeley Company Hager Investments, Inc., or Nominee - ---------------------------------------- ------------------------------------------- By /Date By /s/ David Hager /Date 10/7/97 ----------------------- --------- ----------------------- ------------ Name Printed: Brad Koehler Name Printed: David Hager -------------------------- ----------------------------- Title: Sr. Marketing Executive Title: President --------------------------------- ------------------------------------ 16830 Ventura Blvd., Suite S 16027 Ventura Blvd., #601 - ---------------------------------------- ------------------------------------------- Address Address Encino, CA 91436 Encino, CA 91436 - ---------------------------------------- ------------------------------------------- (818) 905-5800 (818) 905-6130 (818) 905-5071 (818) 990-0875 - ------------------ -------------------- -------------------- ------------------ Telephone Facsimile No. Telephone Facsimile No.
28. ACCEPTANCE. 28.1 Seller accepts the foregoing offer to purchase the Property and hereby agrees to sell the Property to Buyer on the terms and conditions therein specified. 28.2 Seller acknowledges that Broker(s) has/have been retained to locate a Buyer and is/are the procuring cause of the purchase and sale of the Property set forth in this Agreement. In consideration of real estate brokerage service rendered by Broker(s), Seller agrees to pay Broker(s) a real estate brokerage fee described per separate agreement (the "Broker(s) Fee") divided equally in such shares as said Broker(s) shall direct in writing. As is provided in paragraph 9.1(p), this Agreement shall serve as an irrevocable instruction to Escrow Holder to pay such brokerage fee to Broker(s) out of the proceeds accruing to the account of Seller at the Closing. 28.3 Seller acknowledges receipt of a copy hereof and authorizes the Broker(s) to deliver a signed copy to Buyer. NOTE: A PROPERTY INFORMATION SHEET IS REQUIRED TO BE DELIVERED TO BUYER BY SELLER UNDER THIS AGREEMENT.
BROKER: BUYER: K-Swiss Inc. - ---------------------------------------- --------------------------------------------- By /Date By /s/ George Powlick V.P. /Date 10/7/97 ----------------------- --------- ----------------------- -------------- Name Printed: Name Printed: George Powlick -------------------------- -------------------------------- Title: Title: Vice President, Chief Financial Officer --------------------------------- --------------------------------------- 20664 Bahama Street - ---------------------------------------- ---------------------------------------------- Address Address Chatsworth, CA 91311 - ---------------------------------------- -------------------------------------------- (818) 998-3388 (818) 998-6240 - ------------------ -------------------- -------------------- ------------------- Telephone Facsimile No. Telephone Facsimile No.
PAGE 6 THESE FORMS ARE OFTEN MODIFIED TO MEET CHANGING REQUIREMENTS OF LAW AND NEEDS OF THE INDUSTRY. ALWAYS WRITE OR CALL TO MAKE SURE YOU ARE UTILIZING THE MOST CURRENT FORM: AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION, 700 SOUTH FLOWER STREET, SUITE 600 LOS ANGELES, CA 90017. (213) 687-8777. (c)Copyright 1989-By American Industrial Real Estate Association. All rights reserved. No part of these works may be reproduced in any town without permission in writing. ADDENDUM TO STANDARD OFFER, AGREEMENT AND ESCROW INSTRUCTIONS FOR PURCHASE OF REAL ESTATE BY AND BETWEEN HAGER INVESTMENTS, INC., OR NOMINEE, AS BUYER, AND K-SWISS INC., AS SELLER FOR THE PROPERTY COMMONLY KNOWN AS 12300 MONTAGUE STREET, PACOIMA, CALIFORNIA, DATED SEPTEMBER 29, 1997. 29. CONTINGENCIES. Paragraph 9.1(c & d) - All hazardous substance -------------------- reports and soil inspections reports shall be at the sole cost and expense of Buyer. Seller will provide to Buyer, without warranty, any existing environmental reports in Seller's possession. No invasive environmental testing (including, without limitation, soil boring) shall be permitted without prior consent of Seller, which consent Seller may give or withhold at it's sole discretion. Paragraph 9.1(g) - Seller has prepared and will supply to ---------------- Buyer an ALTA survey. Cost of the ALTA Title Insurance and any endorsements to the title policy shall be borne by Buyer. 30. TRADEMARK FILING. Notwithstanding sale of the Premises to Buyer, Seller shall be permitted to use the address of the Premises as a business/mailing address for purposes of trademark filings. If Buyer shall ever receive any mail or other deliveries at the Premises but addressed to Seller, Buyer will promptly forward the same to Seller or will notify Seller promptly in writing of receipt of the items and will hold the items for prompt pick-up by Seller. Seller will promptly reimburse Buyer for all reasonable costs incurred in forwarding to Seller any mail or other items delivered to Buyer and addressed to Seller. 31. SURVIVAL OF REPRESENTATION AND WARRANTIES. Seller's representations and warranties set forth in Section 12.1 of the Standard Offer, Agreement and Escrow Instructions for Purchase of Real Estate shall survive for a period of one (1) year from the Closing Date. 32. BUYER'S ENTRY. Before any entry on the Property by Buyer and/or its agents and representatives, Buyer shall provide Seller with not less than two (2) days' prior verbal notice of Buyer's intention to enter the Property. BUYER SELLER /s/ David Hager /s/ George Powlick - ---------------- ------------------ V. P. - ---------------- ------------------ 10/7/97 10-7-97 - ---------------- ------------------ Date Date EX-21 3 SUBSIDIARIES OF K.SWISS INC. EXHIBIT 21 LIST OF SUBSIDIARIES (EACH 100% OWNED BY K-SWISS INC.) 1. K-Swiss Pacific Inc., a Massachusetts corporation. 2. K-Swiss International Ltd., a corporation organized under the laws of Bermuda. 3. K-Swiss (UK) Ltd., a United Kingdom corporation. 4. K-Swiss Amsterdam B.V., a Dutch corporation. 5. K-Swiss S.A. de C.V., a Mexico corporation. 6. K-Swiss Retail Services Inc., a California corporation. 7. K-Swiss Australia Pty. Ltd., an Australia corporation. 8. K-Swiss International Services (BAARN) B.V., a Dutch corporation. EX-23 4 CONSENT OF GRANT THORNTON LLP EXHIBIT 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We have issued our report dated January 30, 1998, accompanying the consolidated financial statements and schedule included in the Annual Report of K-Swiss Inc. on Form 10-K for the year ended December 31, 1997. We hereby consent to the incorporation by reference of said report in the Registration Statements of K-Swiss Inc. on Form S-8 (File No. 33-36505, effective August 23, 1990, File No. 33-77258, effective April 4, 1994 and File No. 33-95650, effective August 10, 1995) and on Form S-3 (File No. 333-37895, effective October 17, 1997). /s/ Grant Thornton LLP Los Angeles, California January 30, 1998 EX-27 5 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF EARNINGS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 36,123 5,995 16,134 (477) 27,214 91,544 4,885 0 101,686 15,951 0 0 0 66 75,799 101,686 116,213 116,213 70,769 40,074 0 0 1,823 7,193 3,020 4,173 0 0 0 4,173 0.710 0.700 INTEREST INCOME NET OF INTEREST EXPENSE BASIC EARNINGS PER COMMON SHARE
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