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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998 Commission File No. 1-13082
KENNETH COLE PRODUCTIONS, INC.
(Exact name of Registrant as specified in its charter)
New York 13-3131650
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
152 West 57th Street, New York, NY 10019
(Address of Principal Executive Offices)
(212) 265-1500
Registrant's telephone number
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on Which Registered
------------------- -------------------
Class A common stock, par value $.01 per share New York Stock Exchange
Securities registered pursuant to Section 12 (g) of the Act:
None
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 the 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. |_|
Aggregate market value of the voting stock held by nonaffiliates of the
registrant as of the close of business on March 26, 1999: $163,750,882.
Number of shares of Class A Common Stock, $.01 par value, outstanding as
of the close of business on March 26, 1999: 7,287,568.
Number of shares of Class B Common Stock, $.01 par value, outstanding as
of the close of business on March 26, 1999: 5,785,398.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of Form 10-K is incorporated herein by
reference to the Registrant's definitive proxy statement to be mailed to the
shareholders of the Registrant by April 30, 1999.
Kenneth Cole Productions, Inc.
TABLE OF CONTENTS
PART I
Page
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Item 1 Business 3
Item 2 Properties 13
Item 3 Legal Proceedings 13
Item 4 Submission of Matters to a Vote of Security Holders 13
PART II
Item 5 Market for Registrant's Common Equity and Related Shareholder
Matters 14
Item 6 Selected Financial Data 15
Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations 17
Item 7A Quantitative and Qualitative Disclosures about Market Risk 22
Item 8 Financial Statements and Supplementary Data 22
Item 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 22
PART III
Item 10 Directors and Executive Officers of the Registrant 23
Item 11 Executive Compensation 23
Item 12 Security Ownership of Certain Beneficial Owners and Management 23
Item 13 Certain Relationships and Related Transactions 23
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 24
2
Item 1. Business
General
Kenneth Cole Productions, Inc. (the "Company"), incorporated in September
1982, designs, sources and markets a broad range of fashion footwear and
handbags, and through license agreements, designs and markets apparel and
accessories under its Kenneth Cole New York, Kenneth Cole Reaction and Unlisted
brand names. The Company's products are targeted to appeal to fashion conscious
consumers, reflecting a casual urban perspective and a lifestyle uniquely
associated with Kenneth Cole. These products include core basics, which
generally remain in demand from season to season, and fashion products that are
designed to establish or capitalize on market trends. The combination of basics
and fashion styles provides freshness in assortments and maintains a
fashion-forward image, while a multiple brand strategy insulates the Company
from a temporary downturn in business at any particular time. In addition to
footwear, the Company, through licensing agreements, offers a lifestyle
collection of men's product categories including tailored clothing, dress
shirts, sportswear, neckwear, briefcases, portfolios, jewelry, belts, scarves,
leather and fabric outerwear, sunglasses, eyewear, watches, luggage, hosiery,
underwear, robes, loungewear and small leather goods. Aside from footwear and
handbags, women's product categories sold pursuant to license agreements include
hosiery, small leather goods, belts, hats, gloves, scarves and wraps, leather
and fabric outerwear, sunglasses, eyewear, watches, jewelry and luggage.
The Company's strategy is to continue to build upon the strength of its
lifestyle brand franchise, which is comprised of three well-differentiated and
distinct brands: the premier Kenneth Cole New York lifestyle brand, Kenneth Cole
Reaction and Unlisted. This promotes the broadening of product offerings, which
attracts new customers and further enables the Company to address a wider
variety of customers' needs domestically and abroad. The Company markets its
products to more than 3,500 department and specialty store locations, as well as
through its consumer direct business, which includes an expanding base of retail
and outlet stores, consumer catalogs and an interactive website, including an
on-line store. The Company believes the diversity of its product offerings
distinguishes the Company from its competitors in terms of product categories
(men's, women's and children's footwear, handbags, apparel and accessories),
prices (from "better" to "moderate") and styling. The diversity of the Company's
product mix provides balance to its overall product sales and business planning
and increases sales opportunities to wholesale customers who do not carry the
Company's full range of products.
The Company continues to pursue opportunities to expand its retail
operations. As of December 31, 1998, the Company operated 54 specialty retail
and outlet stores as compared with 46 stores as of December 31, 1997, and plans
to open or expand approximately 8 to 10 stores in 1999. The Company believes
that the sales of footwear, handbags and licensed products through its specialty
retail stores increase consumer awareness of the Company's brands and reinforce
the Company's image. Additionally, outlet stores provide opportunities for the
Company to sell excess and out-of-season merchandise, thereby reducing the need
to sell such merchandise through its regular off-price channels of distribution
or to discounters at excessively low prices.
The Company continues to invest in the enhancement and visual presentation
of its existing website. The Company has existing capabilities in customer
service, including multiple toll-free telemarketing lines, merchandising,
catalog, fulfillment and an on-line store. Therefore, the Company believes it
has a strategic advantage over those just beginning with on-line commerce. The
Company believes that e-commerce will be an integral contributor in the
Company's future both as a source of consumer information and as a generator of
revenue.
The growing strength of the Company's three brands Kenneth Cole New York,
Kenneth Cole Reaction and Unlisted, provides opportunities, through licensing
agreements, to extend into new product categories and broader distribution
channels. The brands are currently licensed for a range of products consistent
with the Company's image (see "Licensing" in Item 1).
Products
The Company markets its products principally under its Kenneth Cole New
York, Kenneth Cole Reaction and Unlisted brand names; each are targeted to
appeal to different consumers. The Company believes that the Kenneth Cole brand
name has developed into a true aspirational lifestyle brand; while having
similar designer cache as other international designer brands, it has value
credibility most do not.
3
Kenneth Cole New York
Kenneth Cole New York products are generally designed for the fashion
conscious consumer and reflect the relaxed urban sophistication that is
identified with the Kenneth Cole New York image. The distinctive hip styling of
this line has established Kenneth Cole as a fashion authority for sophisticated
urban men and women who are seeking a value alternative to other designer shoes,
handbags and accessories. As a result of strong brand name recognition and
reputation for style, quality and value, the Company believes that Kenneth Cole
New York has become a core resource for better department and specialty stores,
continuing to provide significant growth opportunities. The product offering has
evolved from a very trendy line to one with broad appeal, including both fashion
forward styling and core basics. The Company continues to leverage the strength
of the name through brand extensions (e.g., Kenneth Cole Collection), in-store
shops and the licensing of many new product categories.
Kenneth Cole New York men's footwear, primarily manufactured in Italy, is
designed as contemporary, comfortable fashion footwear and is sold to the
bridge-designer market at retail price points ranging from $130 to $175. As
versatile as it is sophisticated, Kenneth Cole New York men's footwear may be
worn to work, for a special occasion or on weekends with casual clothes.
Kenneth Cole New York women's footwear, primarily manufactured in Italy
and Spain, includes sophisticated and elegant dress, casual and special occasion
(e.g., bridal) and is sold to the bridge-designer market at retail price points
ranging from $100 to $140. Women's footwear is generally constructed with
leather soles and linings, and fabric uppers.
Kenneth Cole New York handbags are sleek designer bags offered at
affordable prices, generally made of quality leathers and are sold to the
bridge-designer market at retail price points ranging from $100 to $200. Certain
updated styles offer the customer high fashion day bags, while evening bags make
strong sophisticated statements in satins and updated silhouettes.
Kenneth Cole Reaction
Kenneth Cole Reaction consists of a variety of product classifications,
which address the growing trend toward flexible lifestyle dressing. Originally
introduced as a comfort-oriented casual line, Kenneth Cole Reaction now includes
more dressy styles as well. Kenneth Cole Reaction women's footwear is designed
for the workplace as well as outside the office, with an emphasis on comfort,
contemporary styling and perceived value and is targeted to compete in the
largest single category of footwear sold in department stores, women's "better"
casual. The majority of the line retails in the $60 to $80 price range. Kenneth
Cole Reaction men's footwear combines fashionable and versatile styling with
affordable pricing and represents the fastest growing classification in the
men's market as consumer preferences lean away from athletic constructed
footwear toward regular constructed footwear. This line retails in the $80 to
$120 price range.
Kenneth Cole Reaction handbags are designed to be multifunctional with a
contemporary look and are primarily made of non-leather technical fabrications,
such as nylon, microfiber and canvas. Kenneth Cole Reaction handbags, including
Essentials, Itemize and the Reactive collections, are one of the fastest growing
product classifications and have been created to meet the varying needs of the
Company's customers. This line generally retails at price points ranging from
$35 to $90.
Kenneth Cole Reaction children's footwear, primarily manufactured in
Brazil, includes dress and casual footwear sold at price points ranging from $40
to $75 and is targeted to boys and girls ages 5 to 16 who are making more of
their own fashion choices than ever before. The Company believes that the
expansion into children's footwear is a natural extension of its footwear
business and, by utilizing takedowns of successful performers of existing men's
and women's styles, greatly enhances the likelihood of product performance.
4
Unlisted
Unlisted products are designed and targeted to the younger trendier
consumer market, the country's largest consumer base of fashion merchandise. The
Unlisted brand was developed to expand the Company's sales into a younger more
moderately priced business and includes approximately 30 styles of women's
casual and dress shoes and approximately 60 styles of handbags per season.
Unlisted footwear provides the junior consumer with a wide selection of
footwear with contemporary styling and quality at affordable prices. Unlisted
women's footwear includes not only fashion styles, but also evening styles,
basic pumps and loafers that generally retail at price points ranging from $30
to $50. In the first quarter of 1999, the Company launched Unlisted men's
footwear and is exploring distribution channels and licensing agreements to
further expand this brand.
Unlisted handbags are designed for the younger price-conscious
trend-driven consumer and consist of strong, trendy bags in vinyl, straw and
other exciting fabrications. Unlisted handbags generally retail at price points
ranging from $25 to $50.
Business Segments
The Company primarily distributes its products through Wholesale and its
own Consumer Direct distribution channels. During the periods presented below,
the percentage of net revenues contributed by the Company's business segments
were as follows:
Year Ended
December 31
-----------------------
1998 1997 1996
---- ---- ----
Wholesale 66% 71% 75%
Consumer Direct 30 26 23
Licensing 4 3 2
-----------------------
Total 100% 100% 100%
=======================
Wholesale Operations
The Company strives to provide affordable fashion footwear, handbags and
accessories with consistent marketing and management support to its wholesale
customers. The Company provides this support by producing strong image driven
advertising, offering creative quality products and maintaining adequate
inventory levels of new products as well as products included in the Company's
open stock program. The Company employs independent wholesale agents as well as
salaried corporate account specialists to sell its products and to manage its
relationships with its wholesale customers, including analyzing and monitoring
their selling information.
The Company's products are distributed in more than 1,100 wholesale
accounts for sale in more than 3,500 store locations in the United States. The
Company markets its branded products to major department stores and chains, such
as the department store divisions of Dayton Hudson Corporation, Dillard
Department Stores, Inc., Federated Department Stores (including Macy's,
Bloomingdales, and Burdines), and Nordstrom, Inc., and upscale specialty
retailers, including Neiman Marcus and Saks Fifth Avenue. In addition, the
Company sells out-of-season branded products and overruns to off-price retailers
and through the Company's outlet stores. In addition, the Company sells its
products, directly or through distributors, to wholesale customers in Australia,
Canada, Hong Kong, Japan, Taiwan, the Philippines and Singapore.
The Company markets its product lines and introduces new styles at
separate industry-wide footwear and handbag tradeshows which occur several
times throughout the year in New York, Las Vegas and at various regional shows.
These shows also afford the Company the opportunity to assess preliminary demand
for its products. After each show, the Company's wholesale agents and corporate
account specialists visit customers to review the Company's product lines and to
secure purchase commitments. The Company's products are also displayed at
separate handbag and footwear showrooms in New York.
5
Private Label
The Company also designs, develops and sources private label footwear and
handbags for selected retailers. These private label customers include major
retailers that do not purchase the Company's brands. The Company's private label
business requires minimal overhead and capital because the Company does not
incur any costs related to importing, shipping or warehousing of inventory, all
of which are borne by the retailer.
Consumer Direct Operations
Retail Operations
The Company continues to pursue several opportunities to enhance and
expand its retail operations. At December 31, 1998, the Company operated 38
specialty retail stores and 16 outlet stores under the Kenneth Cole New York
name.
The Company's retail stores are primarily operated to develop consumer
recognition of its brand names, to provide a showcase for Kenneth Cole branded
products marketed by the Company and its licensees and to enhance the Company's
overall profitability. The Company believes that these stores complement its
wholesale business by building brand awareness. In addition, Kenneth Cole retail
stores enable the Company to reach consumers who prefer the environment of a
specialty store. Approximately 20% to 25% of the Company's retail store products
are sourced exclusively for such stores which differentiate the product mix of
its stores from that of its wholesale customers. The Company opened six retail
stores in 1998, including two larger format showcase stores, and plans to open
or expand six or seven new full price stores in 1999. The two new larger format
stores were more than double in size than the Company's existing stores and
serve as showcases for a significant cross-section of the Company's offerings,
including apparel.
At December 31, 1998, the Company also operated 16 outlet stores. The
Company establishes its outlet stores to enable it to sell a portion of its
excess wholesale, retail and catalog inventory in a manner which it believes
does not have an adverse impact on its wholesale customers and the Company's
retail operations. The Company generally does not make a style available in its
outlet stores or to off-price retailers until wholesale customers have taken
their first markdown on that style. The Company anticipates that it will require
additional outlet stores as higher levels of sales are achieved and additional
retail stores are opened. The Company opened three outlet stores and closed one
in 1998 and plans to open two or three new stores in 1999.
The success of the Company's new and existing stores will depend on
various factors, including general economic and business conditions affecting
consumer spending, the acceptance by consumers of the Company's retail concept,
the ability of the Company to successfully manage such expansion and hire and
train personnel, the availability of desirable locations, the negotiation of
acceptable lease terms for new locations and the expansion of the Company's
management information systems to support the growth of its retail operations.
The Company believes that its retail stores, which further enhance its image,
also represent an opportunity for revenue and earnings growth.
Catalog, Website and Customer Service
The Company produces consumer catalogs that feature a variety of Kenneth
Cole New York and Kenneth Cole Reaction branded products. Catalog order-taking
and fulfillment have been performed by a third party service located in
Virginia. In 1999, the Company began performing fulfillment of footwear and
handbags from its distribution center in New Jersey.
The Company maintains a website to provide information regarding the
Company and its products, as well as to present a commercially viable
opportunity as visitors to the website may order selected products from the
Company's on-line store. During 1998, the Company enhanced its original website
Kennethcole.com, launched kc-reaction.com and kennethcolebridal.com and
partnered with Yahoo! for several cross promotions. The Company believes that
based on its existing merchandising, fulfillment and marketing capabilities, it
is well positioned to deliver an on-line commerce solution with nonpareil
customer service. The Company also
6
maintains two toll-free telephone numbers (1-800-KEN-COLE and 1-800-UNLISTED)
which provide customer service and answer product-related questions.
Licensing
The Company views its licensing agreements as a vehicle to better service
its customers by extending its product offerings to meet more of their fashion
accessory needs without compromising on price, value or style. The Company
considers entering into licensing, joint venture and distribution agreements
with respect to certain products if such agreements provide more effective
sourcing, marketing and distribution of such products than could be achieved
internally. The Company continues to pursue opportunities in new product
categories which are believed to be complementary to its existing product lines.
Licensees range from small to medium size manufacturers to companies that
are among the industry leaders in their respective product categories. The
Company selects licensees that it believes can produce and service quality
fashion products consistent with the Kenneth Cole New York, Kenneth Cole
Reaction and Unlisted brand images. The Company's licensing department
communicates its design ideas and coordinates all marketing efforts
with its licensees. The Company generally grants licenses for three to five
years with renewal options, limits licensees to certain territorial rights, and
retains the right to terminate the license if certain specified sales levels are
not attained. Each license provides that the Company has the right to review,
inspect and/or approve all product designs and quality as well as any use of its
trademarks in packaging, advertising and marketing.
In 1998, for the first time, Kenneth Cole was seen on the runway during
the Menswear New York Collections. This was an important step in further
defining Kenneth Cole as a premier lifestyle brand as its distinctive image is
consistently developed across an expanding number of products, brands and
markets.
The following table summarizes the Company's licensed product categories:
Kenneth Cole Kenneth Cole
Product Category New York Reaction Unlisted
Kid's Leather Outerwear X X
Kid's Belts X X
Kid's Legwear X X
Kid's Sunglasses X X
Men's Tailored Clothing X
Men's Sportswear X X
Men's Neckwear X X
Men's Underwear, Robes, Loungewear X X
Men's Dress Shirts X X
Men's Hosiery X X
Men's Leather & Fabric Outerwear X X
Men's Small Leather Goods X X X
Women's Legwear X X X
Women's Small Leather Goods X X X
Women's Leather & Fabric Outerwear X X
Men's/Women's Scarves & Wraps X X
Men's/Women's Hats & Gloves X X
Men's/Women's Belts X X X
Men's/Women's Jewelry X
Men's/Women's Watches X X
Men's/Women's Optical Frames X X
Men's/Women's Luggage/Briefcases X X X
Men's/Women's Sunglasses X X X
All of the Company's licensees are required to contribute to the Company a
percentage of their net sales of licensed product, subject to minimum amounts,
for the ongoing marketing of the Kenneth Cole brands.
7
International
The Company sells its products, directly or through distributors, to
wholesale customers in Australia, Canada, Hong Kong, Japan, Taiwan, the
Philippines and Singapore. The Company plans to continue to expand its
international licensing and wholesale distribution programs as a means of
developing global brand recognition and creating additional wholesale markets
for its products. The Company also operates one retail store in the Netherlands.
The Company has a licensing agreement with Dickson Concepts, Ltd.
("Dickson") to retail Kenneth Cole New York and Kenneth Cole Reaction branded
products throughout Hong Kong, Taiwan and Singapore through free standing
Kenneth Cole retail stores, leased departments and shop-in-shops. In spite of
the challenging economic climate in Asia, ten shops have been opened pursuant to
this agreement. During 1998, the Company also entered into an agreement to
retail the Company's branded products throughout the Philippines. The
international stores' format and product mix are consistent with that of the
Company's Kenneth Cole New York domestic retail stores. In connection with the
Company's business strategy of enhancing and expanding its international
operations, the Company is considering other licensing and distribution
opportunities.
In 1998, the Company expanded its presence in Canada by choosing different
partners with individual competencies, while consolidating marketing,
advertising and distribution with one brand manager. The Company, through
license agreements, now sells most product classifications in Canada.
Design
Kenneth D. Cole, Chief Executive Officer and President, founded the
Company and its success to date is largely attributable to his design talent,
creativity and marketing abilities. Mr. Cole selects designers to join a design
team to work with him in the creation and development of new product styles.
Members of each design team work together with Mr. Cole to create a design that
they believe fits the Company's image, reflects current or approaching trends
and can be manufactured cost-effectively.
The Company's design teams constantly monitor fashion trends and search
for new inspirations. Members of the various teams travel extensively to assess
fashion trends in Europe, the United States and Asia and work closely with
retailers to monitor consumer preferences. The process of designing and
introducing a new product takes approximately three to four months. Once the
initial design is complete, a prototype is developed, reviewed and refined prior
to commencement of production.
In order to reduce the impact of changes in fashion trends on the
Company's product sales and to increase the profitability of the Company's
products, the Company continuously seeks to develop new core basic product
styles that remain fashionable from season to season without significant changes
in design or styling. Since these core basic products are seasonless, retailers'
inventories of core basic products tend to be maintained throughout the year and
reordered as necessary, primarily through electronic data interchange.
Sourcing
The Company does not own or operate any manufacturing facilities and
sources its branded and private label products directly or indirectly through
independently owned manufacturers in Italy, Spain, Brazil, India, China and
Korea. The Company maintains offices in Florence, Italy and Hong Kong and
generally has long-standing relationships with several independent buying agents
to monitor the production, quality and timely distribution of the Company's
products from its manufacturers. The Company sources each of its product lines
separately based on the individual design, styling and quality specifications of
such products.
The Company attempts to limit the concentration of manufacturing with any
one manufacturer. However, approximately 58% and 36% of men's footwear was
produced by one manufacturer in Italy in 1998 and 1997, respectively, and
approximately 46% of the dollar value of total handbags purchased by the Company
in 1998 were produced by one manufacturer in China. These manufacturers,
however, subcontract a significant portion of such purchases to ensure the
8
consistent and timely delivery of quality products. The Company is the largest
customer of these manufacturers and has established long-standing relationships
with them. While the Company believes it has alternative manufacturing sources
available to meet its current and future production requirements, there can be
no assurance that in the event the Company is required to change from current
manufacturers, alternative suppliers will be available on terms comparable to
the Company's existing arrangements.
In advance of the Fall and Spring selling seasons, the Company works with
its manufacturers to develop product prototypes for industry trade shows. During
this process, the Company works with the manufacturers to determine production
costs, materials, break-even quantities and component requirements for new
styles. Based on indications from the trade shows and initial purchasing
commitments from wholesalers, the Company places production orders with the
manufacturers. As a result of the need to maintain in-stock inventory positions,
the Company places manufacturing orders for open stock and certain fashion
products prior to receiving firm commitments. Once an order has been placed, the
manufacturing and delivery time ranges from three weeks to four months depending
on whether it is currently in production or a new product. Throughout the
production process, the Company monitors product quality through inspections at
both the factories and upon receipt at its warehouses. To reduce the risk of
overstocking, the Company monitors sell-through data on a weekly basis and seeks
input on product demand from wholesale customers to adjust production when
needed.
Advertising and Marketing
The Company believes that advertising to promote and enhance the Kenneth
Cole New York and Kenneth Cole Reaction brands is an intricate part of its
long-term growth strategy. The Company believes that its advertising campaigns,
which have brought it national recognition for their timely focus on current
events and social issues, have resulted in increased sales and consumer
awareness of its branded products. The Company's advertisements appear in
magazines such as Vogue, Vanity Fair, Details, GQ, Glamour and Marie Claire,
newspapers and outdoor advertising media. All of the Company's licensees are
required to contribute to the Company a percentage of their net sales of
licensed product, subject to minimums, for the advertising and promotion of the
Kenneth Cole trademark. In addition, selected personal appearances by Kenneth D.
Cole have been utilized to further enhance the Company's image. The Company
utilizes in-house advertising and public relations staff to implement these
efforts.
In order to continue to strengthen brand awareness of its products and
increase sales, the Company is actively involved in the development, marketing
and merchandising programs for its customers. As part of this effort, the
Company utilizes cooperative advertising programs, sales promotions and produces
consumer catalogs which feature a variety of Kenneth Cole New York and Kenneth
Cole Reaction branded products marketed by the Company and its licensees. In
addition, the Company has, on a limited basis, worked with customers to develop
distinctive catalogs that market the Company's products and to develop point of
sale displays. Because all this work is done internally, there is a singular
focus, a strong synergy and a consistency to all communications.
An important developing aspect of the Company's marketing efforts is the
creation of shop-in-shops, where an entire collection of the Company's branded
products is featured, along with focus areas, where specific product categories
are highlighted. These shop-in-shops and focus areas create an environment that
is consistent with the Company's image and enables the retailer to display and
stock a greater volume of the Company's products per square foot of retail
space. In addition, these shop-in-shops and focus areas encourage longer-term
commitment by retailers to the Company's products and enhance consumer brand
awareness.
Distribution
To facilitate distribution, the Company's products are inspected, bar
coded, packed and shipped from manufacturers by ocean or air to either the
Company's distribution facility located in Secaucus, New Jersey or a public
warehouse located in California. The Company utilizes fully integrated
information systems and bar code technology to facilitate the receipt,
processing and distribution of product through both distribution facilities. The
products are then shipped to the Company's wholesale customers either in bulk or
under its open stock program. The Company's open stock program allows its
wholesale customers to reorder, typically via electronic data interchange
("EDI"), core basic styles in a range of colors and sizes for immediate
shipment. While the open stock program requires an increased investment in
inventories, the Company believes this program is an important service for its
wholesale customers by allowing them to manage inventory levels more
effectively. The Company believes that
9
affording customers improved flexibility in ordering specific SKUs in smaller
quantities will ultimately reduce the incidence of markdowns and allowances.
Management Information Systems
The Company believes that sophisticated information systems are essential
to the Company's ability to maintain its competitive position and to support
continued growth. The Company's management information systems were designed to
provide, among other things, comprehensive order processing, production,
accounting and management information for the sourcing, importing, distribution
and marketing aspects of the Company's business. The Company is currently in
process of replacing its wholesale distribution and financial systems with newer
technologically advanced systems that offer greater functionality and enhanced
reporting. These new systems are Year 2000 compliant and are expected to be
implemented prior to any anticipated impact on the current operating system. The
Company also utilizes an EDI system which provides a computer link between the
Company and many of its wholesale customers that enables the Company to receive
on-line orders and to accumulate sales information on its products. The
Company's EDI system also improves the efficiency of responding to customer
needs and allows both the customer and the Company to monitor purchases,
shipments and invoicing. In its retail stores, the Company uses point-of-sale
registers to capture sales data and track inventories.
The Company regularly evaluates the adequacy of its management information
systems and upgrades such systems to support its growth. However, the Company's
failure to continue to upgrade its management information systems necessary to
support growth or expansion, or to continue to timely address the Year 2000
Issue, could have a material adverse effect on the Company's financial condition
and its results of operations (see Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Operations").
Trademarks
The Company, through its wholly-owned subsidiary, K.C.P.L., Inc., owns
federal registrations for its principal trademarks Kenneth Cole, Kenneth Cole
New York, Kenneth Cole Reaction, and Unlisted as well as several other ancillary
and derivative trademarks. Each of the federal registrations are currently in
full force and effect and are not the subject of any legal proceedings. In
addition, the Company has several pending federal applications in the United
States Patent and Trademark office for trademarks and service marks including
Kenneth Cole Collection, Reaction and several ancillary trademarks. Moreover,
the Company continues to expand its current international registrations in
numerous countries in Asia, South America, Europe and elsewhere. The Company
regards its trademarks and other proprietary rights as valuable assets in the
marketing and distribution of its products, and fully intends to maintain and
renew the registrations as well as vigorously defend against infringements.
Competition
Competition in the footwear and handbags industries is intense. The
Company competes with numerous designers, brands and manufacturers of footwear,
handbags, apparel and accessories, some of which may be larger, have achieved
greater recognition for their brand names, have captured greater market share
and/or have substantially greater financial, distribution, marketing and other
resources than the Company. The Company also competes for the limited
shelf-space available for the display of its products to the consumer. Moreover,
the general availability of contract manufacturing capacity allows access by new
market entrants. The Company's business depends on its ability to stimulate and
respond to changing consumer preferences by producing innovative and attractive
products, brands and marketing, while remaining competitive in quality and
price.
Foreign Operations
The Company's business is subject to risks of doing business abroad, such
as fluctuations in currency exchange rates, local market conditions, labor
unrest, political instability and the imposition of additional regulations
relating to imports, including quotas, duties or taxes and other charges on
imports. While these factors have not had a material adverse impact on the
Company's operations to date, there can be no assurance that they will not have
a material adverse affect on the Company's operations in the future.
10
In order to reduce the risk of exchange rate fluctuations, the Company
routinely enters into forward exchange contracts to protect the future purchase
price of inventory denominated in foreign currencies. These forward exchange
contracts are used to reduce the Company's exposure to changes in foreign
exchange rates and are not held for the purpose of trading or speculation (see
Item 7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations").
Import Restrictions
Although the majority of the goods sourced by the Company are not
currently subject to quotas, countries in which the Company's products are
manufactured may, from time to time, impose new or adjust prevailing quotas or
other restrictions on exported products. In addition, the United States may
impose new duties, tariffs and other restrictions on imported products, any of
which could have a material adverse affect on the Company's operations and its
ability to import its products at the Company's current or increased quantity
levels. In accordance with the Harmonized Tariff Schedule, a fixed duty
structure in effect for the United States, the Company pays import duties on its
products ranging from approximately 6% to 37.5%, depending on the principal
component of the product. Other restrictions on the importation of footwear and
other products are periodically considered by the United States government and
no assurance can be given that tariffs or duties on the Company's goods may not
be raised, resulting in higher costs to the Company, or that import quotas
restricting such goods may not be imposed or made more restrictive.
A significant portion of the Company's products is manufactured in and
imported from China. The Company's operations and its ability to import products
from China at current tariff levels could be materially and adversely affected
if the "most favored nation" status granted to China by the United States
government for trade and tariff purposes is terminated. As a result of such
status, products imported by the Company from China currently receive the lower
tariff rates made available to most of the United States' major trading
partners. While China has been granted "most favored nation" status in every
year since 1979, there can be no assurance that the United States will continue
to grant China "most favored nation" status in the future. In the event that
such status is not renewed in future years, tariff levels on imports from China
could rise significantly and could have a material adverse effect on the
Company's results of operations. However, the Company believes that it would be
able to shift production of certain goods to other countries on a cost effective
basis and to continue to produce in China those goods subject to lower tariff
rates.
Seasonality
The Company's products are marketed primarily for Fall and Spring seasons,
with slightly higher volume of wholesale products sold during the first and
third quarters. The Company's retail business follows the general seasonal
trends that are characteristic within the retail industry: sales and earnings
are highest in the fourth quarter and weakest in the first quarter. Because the
timing of wholesale shipments of products for any season may vary from year to
year, the results for any one quarter may not be indicative of the results for
the full year.
Customers Under Common Control
The Company's department store customers include major United States
retailers, certain of which are under common ownership. In 1998, the Company had
no customer or group under common ownership account for more than 10% of sales.
In 1997, when considered together as a group under common ownership, sales to
the department store customers which were owned by Federated Department Stores
and sales to The Marmaxx Group represented 10.0% and 12.4% of the net sales of
the Company, respectively. The Company's ten largest customers represented 44.5%
and 51.3% of the Company's net sales for the years ended December 31, 1998 and
1997, respectively. While the Company believes that purchasing decisions have
generally been made independently by each division within a department store
group, there is a trend among department store groups toward centralized
purchasing decisions of their divisions.
11
Backlog
At December 31, 1998 and 1997, the Company had unfilled wholesale customer
orders of $32.1 million and $32.3 million, respectively. The Company's backlog
at a particular time is affected by a number of factors, including seasonality,
timing of market weeks, and wholesale customer purchases of its core basic
products through the Company's open stock program. Accordingly, a comparison of
backlog from period to period may not be indicative of eventual shipments.
Employees
At December 31, 1998, the Company had approximately 1000 employees, 135 of
whom are covered under a collective bargaining agreement with a local affiliate
of the International Leather Goods, Plastics, Handbags and Novelty Workers'
Union, Local 1, Division of Local 342-50 United Food and Commercial Workers
Union. The Company considers its relationships with its employees to be
satisfactory.
Directors and Executive Officers
Name Age Present Position
- ---- --- ----------------
Kenneth D. Cole.... 45 President and Chief Executive Officer
Paul Blum.......... 39 Executive Vice President and Chief Operating Officer
Stanley A. Mayer... 51 Executive Vice President and Chief Financial Officer
Harry Kubetz....... 45 Senior Vice President
Susan Hudson....... 39 Senior Vice President
Robert Grayson..... 54 Director
Denis F. Kelly..... 49 Director
Jeffrey G. Lynn.... 49 Director
Kenneth D. Cole has served as the Company's President and Chief Executive
Officer since its inception in 1982. Mr. Cole was a founder, and from 1976
through 1982, a senior executive of El Greco, Inc., a shoe manufacturing and
design company which manufactured Candie's women's shoes. Mr. Cole is on the
Boards of Directors of the American Foundation for AIDS Research ("AmFAR") and
H.E.L.P., a New York agency that provides temporary housing for the homeless. In
addition, Mr. Cole is a Director and President of each of the wholly-owned
subsidiaries of the Company.
Paul Blum was promoted to Chief Operating Officer in February 1998. Prior
he served as Executive Vice President of the Company since May 1996 and as
Senior Vice President from August 1992 until May 1996. Mr. Blum joined the
Company in 1990. From 1982 until 1990, Mr. Blum served as Vice President and was
a principal shareholder of The Blum Co., a fashion accessory firm, the assets of
which were purchased in 1990 by the Company.
Stanley A. Mayer has served as Executive Vice President, Chief Financial
Officer, Treasurer and Secretary of the Company since March 1988. From 1986
until joining the Company, Mr. Mayer held the position of Vice President-Finance
and Administration of Swatch Watch USA, Inc. Mr. Mayer was the Controller of the
Ralph Lauren and Karl Lagerfeld womenswear divisions of Bidermann Industries,
USA, Inc. from 1979 until 1986. In addition, Mr. Mayer is the Vice President and
Secretary of each of the wholly-owned subsidiaries of the Company.
Harry Kubetz has served as Senior Vice President of Operations since
joining the Company in April 1996. Mr. Kubetz was President of "No Fear"
Footwear, Inc. from 1994 until 1996. From 1992 until 1994 Mr. Kubetz was
Executive Vice President of Asco General Supplies, a wholly owned subsidiary of
Pentland, PLC.
Susan Q. Hudson was promoted to Senior Vice President - wholesale footwear
in February 1998. Prior, Ms. Hudson served as Divisional President - Men's
Footwear since 1996 and as Vice President in charge of men's footwear since
1990. Prior to joining the Company, Ms. Hudson was at LA Gear, where she served
as Regional Sales Manager.
12
Robert C. Grayson is President of Robert C. Grayson & Associates, Inc. and
Vice Chairman of Berglass-Grayson, consulting firms. From 1992 to 1996, Mr.
Grayson served initially as an outside consultant to Tommy Hilfiger Corp., a
wholesaler and retailer of men's sportswear and boyswear, and later accepted
titles of Chairman of Tommy Hilfiger Retail, Inc. and Vice Chairman of Tommy
Hilfiger Corp. From 1970 to 1992, Mr. Grayson served in various capacities for
Limited Inc., including President and CEO of Lerner New York from 1985 to 1992,
and President and CEO of Limited Stores from 1983 to 1985.
Denis F. Kelly is a Managing Director and the head of the Mergers and
Acquisitions Department at Prudential Securities Incorporated since July 1993.
From 1991 until 1993, Mr. Kelly was President of Denbrook Capital Corp., a
merchant banking firm. Mr. Kelly was at Merrill Lynch from 1980 to 1991, where
he served as Managing Director, Mergers & Acquisitions from 1984 to 1986, and
then as a Managing Director, Merchant Banking, from 1986 to 1991. Mr. Kelly is a
director of MSC Industrial Direct, Inc.
Jeffrey G. Lynn has been the Chairman, President and Chief Executive
Officer of Dunham's Athleisure Corp., a specialty retailer of sportswear, since
1987. Mr. Lynn joined Dunham's Athleisure Corp. in 1985 and served as president
until 1987. Prior to 1985, he served as Executive Vice President of the
Musicland Group, a specialty retailer of audio/video entertainment software. Mr.
Lynn is a director of English Gardens and Fairlane Florists, Inc. and SOL
Capital Management Company.
Item 2. Properties
The Company's showrooms, sales and design staffs as well as its executive
offices are located at 152 West 57th Street, New York, N.Y., where the Company
leases approximately 30,000 square feet under a lease that expires December 31,
2006.
The Company's administrative offices and distribution facility are located
in Secaucus, New Jersey under a lease that expires June 29, 2002. The facility
comprises 244,000 square feet, of which, approximately 30,000 square feet is
used for administrative offices. The Company also leases a 23,500 square foot
facility in Secaucus used for outlet store space and as a warehousing facility.
The Company has technical and administrative offices in Florence, Italy and Hong
Kong. The Company does not own or operate any manufacturing facilities.
The Company leases space for all of its 38 full price retail stores
(aggregating approximately 93,000 square feet) and 16 outlet stores (aggregating
approximately 46,000 square feet). Generally, the leases provide for an initial
term of five to ten years, with renewal options permitting the Company to extend
the term thereafter.
In December 1998, the Company entered into a 15-year lease, which over a
period of two to five years, will provide the Company with approximately 120,000
square feet of office space, enabling it to relocate its corporate headquarters
to a larger location in New York City and consolidate various satellite office
space.
Item 3. Legal Proceedings
The Company is, from time to time, a party to litigation that arises in
the normal course of its business operations. The Company is not presently a
party to any such litigation that would have a material adverse effect on its
business or operations.
Item 4. Submission of Matters to a Vote of Security Holders
None.
13
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters
The Company's Class A Common Stock is listed and traded (trading symbol
KCP) on the New York Stock Exchange ("NYSE"). On March 26, 1999 the closing sale
price for the Class A Common Stock was $23.69. The following table sets forth
the high and low sale prices for the Class A Common Stock for each quarterly
period for 1997 and 1998, as reported on the NYSE Composite Tape:
1997: High Low
First Quarter 22 3/4 15 1/8
Second Quarter 21 1/8 14 1/4
Third Quarter 17 13/16 11 1/2
Fourth Quarter 16 15/16 13 1/8
1998: High Low
First Quarter 22 3/8 15 7/16
Second Quarter 26 3/4 19 3/16
Third Quarter 26 7/16 12 15/16
Fourth Quarter 21 3/8 13 7/8
The number of shareholders of record of the Class A Common Stock on March
26, 1999 was 35.
There is one holder of record of Class B Common Stock and 5,785,398 shares
of Class B Common Stock are issued and outstanding. There is no established
public trading market for the Company's Class B Common Stock.
Dividend Policy
The Company intends to retain its earnings to finance the development,
expansion and growth of its existing business. Accordingly, the Company does not
anticipate paying cash dividends on its Class A Common Stock in the foreseeable
future. 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 financial condition of the
Company and general business conditions.
14
Item 6. Selected Financial Data
The following selected financial data has been derived from the
consolidated financial statements of the Company and should be read in
conjunction with the consolidated financial statements and notes thereto that
appear elsewhere in this Annual Report and in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" set forth in Item 7.
Year Ended December 31,
-----------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- -------
(dollars in thousands, except share data)
Income Statement Data:
Net sales .................................. $219,781 $185,278 $148,258 $113,828 $84,893
Licensing revenue .......................... 8,357 6,028 3,575 1,855 795
Net revenue ................................ 228,138 191,306 151,833 115,683 85,688
Cost of goods sold ......................... 129,403 112,183 86,919 67,382 50,166
Gross profit ............................... 98,735 79,123 64,914 48,301 35,522
Selling and general administrative
expenses (1) ........................... 72,145 58,330 44,248 31,957 22,776
Loss on abandonment of leasehold
improvements and equipment .............. 106
Operating income ........................... 26,590 20,793 20,560 16,344 12,746
Interest income (expense), net ............. 404 (202) (22) 30 (25)
Income before provision for income taxes ... 26,994 20,591 20,538 16,374 12,721
Provision for income taxes ................. 10,663 8,189 8,251 6,550 2,894
Net income ................................. 16,331 12,402 12,287 9,824 9,827
Earnings per share:
Basic ................................... $1.24 $.94 $.94 $.75
Diluted ................................. $1.20 $.91 $.90 $.73
Weighted average shares outstanding:
Basic ................................... 13,222,000 13,162,000 13,109,000 13,021,000
Diluted ................................. 13,637,000 13,605,000 13,578,000 13,516,000
Pro Forma Income Statement Data:(2)
Net sales ........................................................................................... $84,893
Licensing revenue ................................................................................... 795
Net revenue ......................................................................................... 85,688
Cost of goods sold .................................................................................. 50,166
Gross profit ........................................................................................ 35,522
Selling, general and administrative expenses ........................................................ 22,776
Operating income .................................................................................... 12,746
Interest, net ....................................................................................... (25)
Income before provision for income taxes ............................................................ 12,721
Provision for income taxes .......................................................................... 5,088
Net income .......................................................................................... 7,633
Supplementary pro forma basic net income per share .................................................. $.61
Supplementary pro forma diluted net income per share ................................................ $.60
Supplementary pro forma basic shares outstanding (3) ................................................ 12,464,000
Supplementary pro forma diluted shares outstanding (3) .............................................. 12,690,000
15
At December 31,
---------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
Balance Sheet Data:
Working capital................ $56,644 $46,949 $37,023 $27,309 $18,701
Total assets................... 96,680 77,528 65,255 43,307 31,886
Total debt, including current
Maturities.................. 927 0 489 102 166
Total shareholders' equity..... 73,689 59,740 46,599 33,489 22,356
- ----------
(1) Includes shipping and warehousing expenses.
(2) Reflects the effect on the historical income statement data for the year
ended December 31, 1994 as if the Company's initial public offering, which
was consummated in June 1994, had been completed as of January 1, 1994 and
the Company was treated as a C Corporation filing on a consolidated return
basis for income tax purposes, with an assumed effective income tax rate
of 40%.
(3) For 1994, supplementary pro forma shares includes the weighted average
shares outstanding (12,464,000) during the period, increased by 226,280
shares from applying the treasury stock method to the exercise of options
to purchase 222,950 and 373,900 shares of Class A Common Stock at $2.1875
and $6.00 per share, respectively.
16
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis should be read in conjunction with
the consolidated financial statements and the notes thereto that appear
elsewhere in this Annual Report.
Results of Operations
The following table sets forth certain operating data of the Company as a
percentage of net revenues for the periods indicated below:
Year Ended December 31,
-----------------------
1998 1997 1996
--------------------------
Net sales ........................................ 96.3% 96.8% 97.6%
Licensing revenue ................................ 3.7 3.2 2.4
--------------------------
Net revenues ..................................... 100.0 100.0 100.0
Cost of goods sold ............................... 56.7 58.6 57.2
--------------------------
Gross profit ..................................... 43.3 41.4 42.8
Selling, general and administrative expenses ..... 31.6 30.5 29.2
Operating income ................................. 11.7 10.9 13.6
Income before provision for income taxes ......... 11.9 10.8 13.5
Provision for income taxes ....................... 4.7 4.3 5.4
--------------------------
Net income ....................................... 7.2% 6.5% 8.1%
==========================
Year Ended December 31,1998 Compared to Year Ended December 31,1997
Consolidated net revenues were $228.1 million in 1998 compared to $191.3
million in 1997, an increase of 19.3%. This improvement is principally due to
volume increases in each of the Company's business segments: wholesale, consumer
direct and licensing.
Wholesale net sales (including sales to its consumer direct business
segment) increased $20.1 million or 13.4% to $170.1 million in 1998 from $150.0
million in 1997. This increase is primarily attributable to an increase in sales
of men's footwear of approximately 60%, an increase in handbag sales of
approximately 15%, an increase in sales of private label products of
approximately 30%, and sales of children's footwear, which was a new product
classification introduced at the end of 1997, partially offset by a reduction in
sales of women's footwear due to an extremely challenging women's footwear
retail environment. The overall increase is due to increased sales to new and
existing customers due to increased brand awareness and continued growing
consumer acceptance of Kenneth Cole New York as a premier lifestyle brand. The
Company believes its advertising campaigns, marketing efforts, website, catalogs
and growing retail presence, combined with the marketing efforts of its
licensees, continue to be significant factors in increasing consumer demand and
the strengthening of its three distinct brands, Kenneth Cole New York, Kenneth
Cole Reaction and Unlisted across all product classifications.
Net sales in the Company's Consumer Direct segment increased $18.4 million
or 36.8% to $68.4 million in 1998 from $50.0 million in 1997. The increase in
the number of stores, as well as a comparable stores sales increase of 13.5%
contributed to the increase in net sales. Of the total increase, $6.7 million
was attributable to the comparable store sales increase, and $11.7 million was
attributable to stores opened since December 31, 1997. The Company believes that
the retail stores convey the image of the Company and seamlessly showcase both
Company and licensee products, and that this comprehensive presentation
reinforces the lifestyle brand, thus increasing consumer demand, not only in the
retail stores but also across all channels of distribution.
Licensing revenue increased 38.6% to $8.4 million in 1998 from $6.0
million in 1997, and sales of licensee product now represent approximately half
of the total brand sales at retail. The increase primarily reflects incremental
revenues from sales from existing licensees. The Company believes its recent
entry into men's apparel comes at an opportune time as consumers look toward
brands they know and feel comfortable with. During 1998, the Company continued
its roll out of men's tailored clothing, launched Kenneth Cole men's sportswear
and dress
17
shirts, and prepared for its early 1999 launch of loungewear. The Company
believes the synergies from its efforts to reinforce its brand identities
through greater marketing efforts, by itself and its licensees across all
product categories, will continue to propel licensee sales.
Consolidated gross profit as a percentage of net revenues increased to
43.3% in 1998 from 41.4% in 1997. The Company's wholesale gross profit,
excluding gross profit on sales to the Consumer Direct segment, increased 18.9%
to $51.6 million (34.1% of net Wholesale sales) in 1998 from $43.4 million
(32.1% of net Wholesale sales) in 1997. Wholesale gross profit as a percentage
of net wholesale revenues increased substantially as a result of increased sales
of men's footwear, which have the highest gross profit percentages within
Wholesale product categories, and better margins on sales of women's footwear,
compared to 1997 when the Company disposed of, at significant discounts, excess
Spring 1997 merchandise. The increase in sales of men's footwear was partially
attributable to improved fulfillment of customer orders due to the enhancement
of the Company's open stock inventory program combined with EDI replenishment.
Consumer Direct's gross profit percentage was 49.7% in 1998 compared with
52.1% in 1997. The decrease in Consumer Direct gross profit percentage was
attributable to a change in product mix, with a greater amount of merchandise
sourced from the Company's licensees, which carry lower initial markups than
footwear and handbags and the closing out of excess inventories relating to
catalog operations. However, the Consumer Direct gross profit percentage is
significantly higher than the Company's Wholesale gross profit percentage.
Accordingly, as sales of the Consumer Direct segment represent a larger
percentage of consolidated net sales, it increases the consolidated gross
profit percentage. Sales from the Consumer Direct segment were 30.0% of
consolidated net revenue in 1998 compared with 26.1% in 1997. Licensing revenue,
which has no associated cost of goods sold, increased as a percentage of net
revenues to 3.7% in 1998 from 3.2% in 1997.
Selling, general and administrative expenses, including shipping and
warehousing, increased 23.7% to $72.1 million (or 31.6% of net revenues) in 1998
from $58.3 million (or 30.5% of net revenues) in 1997. The increase was
primarily attributable to investment in organizational infrastructure to support
growth, marketing and public relations expenditures to build the Company's
brands, hiring of personnel and the expansion of the Company's consumer direct
operations. The increase as a percentage of net revenue is due to the expansion
of the Company's retail and outlet stores, which operate at a higher cost
structure than its Wholesale operations.
As a result of the foregoing, operating income increased 27.9% in 1998 to
$26.6 million (11.7% of net revenue) from $20.8 million (10.9% of net revenue)
in 1997.
Year Ended December 31,1997 Compared to Year Ended December 31,1996
Consolidated net revenues were $191.3 in 1997 compared to $151.8 million
in 1996, an increase of 26.0%. This improvement is principally due to increases
in each of the Company's business segments: wholesale, consumer direct and
licensing.
Wholesale net sales increased $25.7 million or 20.7% to $150.0 million in
1997 from $124.2 million in 1996. This increase reflects improved sales of men's
footwear and Unlisted women's footwear, partially offset by a reduction in
Kenneth Cole New York women's footwear, which experienced poor sell throughs of
its Spring 1997 merchandise. The Company believes that its advertising campaigns
and marketing efforts have been a significant factor leading to increased brand
awareness, continued growing consumer acceptance and the strengthening of the
Company's three distinct brands, Kenneth Cole New York, Kenneth Cole Reaction
and Unlisted, across all product classifications.
Net sales in the Company's Consumer Direct segment increased $14.7 million
or 41.6% to $50.0 million from $35.3 million in 1996. The increase was primarily
due to additional stores opened as well as increased sales at existing stores.
Of the total increase, $3.0 million was attributable to comparable store sales
increases and $11.7 million to new stores. The Company believes its retail
stores enable it to present a true cross section of the lifestyle offering that
consumers require.
Licensing revenue increased 68.6% to $6.0 million in 1997 from $3.6
million in 1996. This increase reflects the incremental revenues from the
introduction of new product licenses and an increase in sales from existing
licenses. Of this increase, approximately 29% or $0.7 million was due to
products introduced under new
18
licenses during 1997. The Company believes its efforts to reinforce its brand
identities through greater marketing efforts across all product categories and
through its various business segments, have contributed to the increase in
licensee sales.
Gross profit as a percentage of net revenues decreased to 41.4% in 1997
from 42.8% in 1996. The Company's wholesale gross profit, excluding gross profit
on sales to the Consumer Direct segment, increased 7.7% to $43.4 million (32.1%
of net Wholesale sales) in 1997 from $40.3 million (35.7% of net Wholesale
sales) in 1996. Wholesale gross profit as a percentage of net wholesale revenue
decreased primarily due to lower than expected sell-throughs of Spring 1997
women's footwear, which resulted in excess inventories that were disposed of at
significant discounts during the second quarter of 1997. The decrease in
Wholesale gross profit was partially offset by an increase in Consumer Direct
sales, as gross profit percentages on Consumer Direct sales are higher than
gross profit percentages on Wholesale sales and Consumer Direct sales
represented a larger percentage of total revenue in 1997. Net sales from
consumer direct operations were 26.1% as a percentage of net revenue in 1997 as
compared to 23.3% in 1996. Licensing revenue, which has no associated cost of
goods sold, increased as a percentage of net revenues to 3.2% in 1997 compared
to 2.4% in 1996.
Selling, general and administrative expenses, including shipping and
warehousing, increased 31.5% to $58.3 million (or 30.5% of net revenues) in 1997
from $44.4 million (or 29.2% of net revenues) in 1996. The increase as a
percentage of net revenues was a result of continued expansion of the Company's
consumer direct operations, which operate at a higher cost structure than
wholesale. The overall increase was due to volume related expenses, including
hiring of new personnel, necessary to support the increase in revenue from all
business segments and incremental marketing and advertising expenses.
As a result of the foregoing, operating income increased to $20.8 million
in 1997 from $20.6 million in 1996.
Liquidity and Capital Resources
The Company's capital requirements are generated primarily from working
capital needs and the continued growth of the business. These include the
purchase of wholesale and retail inventories in anticipation of increased
wholesale sales and new store openings and capital expenditures related to the
expansion, renovation and construction of retail and outlet stores. The Company
relies upon internally generated cash flows from operations and borrowings under
its line of credit facility to finance its operations and growth. Cash flows may
vary from time to time as a result of seasonal requirements of inventory, the
timing of the receipt of merchandise from suppliers, the Company's open stock
inventory program which requires increased inventory levels and the level of
accounts receivable balances. At December 31, 1998, working capital was $56.6
million compared to $46.9 million at December 31, 1997.
Net cash provided by operating activities increased to $14.3 million in
1998 from $12.0 million in 1997. This increase was primarily attributable to
increased licensing revenues and higher earnings offset by increased inventory
levels required to support significant sales growth in men's footwear and for
the initial inventory requirements of the new retail and outlet stores.
Net cash used in investing activities was $5.8 million in 1998 compared to
$4.8 million in 1997. This increase reflects an increase in capital
expenditures.
Net cash used in financing activities was $3.5 million in 1998 compared to
$0.1 million in 1997. The changes in net cash used in financing activities
principally reflect the amounts expended in the Company's stock repurchase
program, partially offset by the proceeds from the exercise of stock options. As
of March 26, 1999, the Company had purchased 350,000 shares of the 500,000
shares authorized under its stock repurchase program.
The Company currently sells substantially all of its account receivables
to one factor without recourse. In circumstances where a customer's account
cannot be factored without recourse, the Company may take other measures to
reduce its credit exposure which could include requiring the customer to pay in
advance or to provide a letter of credit covering the sales price of the
merchandise ordered.
19
The Company currently has a line of credit, as amended, under which up to
$25.0 million is available to finance working capital requirements and letters
of credit to finance the Company's inventory purchases. Borrowings available
under the line of credit are determined by a specified percentage of eligible
accounts receivable and inventories and bear interest at (i) the higher of The
Bank of New York's prime lending rate or the Federal Funds rate plus 0.5% at the
date of borrowing or (ii) a negotiated rate. In connection with the line of
credit, the Company has agreed to eliminate all the outstanding borrowings under
the facility for at least 30 consecutive days during each calendar year. In
addition, borrowings under the line of credit are secured by certain receivables
of the Company. Amounts available under the line of credit at December 31, 1998
were reduced by $1.6 million to $23.4 million for open letters of credit.
Capital expenditures were approximately $5.8 million, $4.8 million and
$4.9 million for 1998, 1997 and 1996, respectively. Expenditures on furniture,
fixtures and leasehold improvements for new retail store openings and expansions
were $4.9 million, $3.3 million and $3.0 million in 1998, 1997 and 1996,
respectively. The remaining expenditures were primarily for leasehold
improvements, information systems and equipment for the company's offices and
warehouse. During 1999, the Company anticipates opening or expanding
approximately 8 to 10 retail and outlet stores that will require aggregate
capital expenditures of approximately $4.0 million. The Company also expects to
spend approximately $2.5 million for the initial inventory requirements of these
new stores.
The Company also anticipates that it will require increased capital
expenditures to support its continued growth including an increase in its office
space and enhancements to its management information systems.
In December 1998, the Company entered into a 15-year lease which, over a
period of three to five years, will provide the Company with approximately
120,000 square feet of office space, enabling it to relocate its corporate
headquarters to a larger location in New York City and consolidate various
satellite office space. Currently, the timing of the turnover of space is
indeterminable and the Company does not expect to begin its phased relocation
until early in 2000. However, the Company expects to incur capital expenditures
of approximately $8 to $12 million over the next three to five years.
Year 2000
The Year 2000 problem is the result of computer programs being written
using two digits rather than four to define the applicable year. Certain
information technology systems and their associated software may recognize a
date using "00" as the year 1900 rather than the year 2000, which could result
in miscalculations, system failures or other computer errors. In addition, like
every other business, the Company is at risk from Year 2000 failures on the part
of its major business suppliers, distributors, licensees as well as potential
failures from public and private infrastructure service providers. System
failures resulting from the Year 2000 problem could adversely effect operations
and financial results in all of the Company's business segments. Failures may
cause loss of electric power or certain communication links, disruptions to
business operations including delayed deliveries from suppliers, disruptions to
the channels of distribution as well as disruptions to the Company's own
distribution center and retailing operations.
The Company believes that by replacing, rather than reprogramming, its
wholesale distribution and financial systems with newer technologically advanced
systems that offer greater functionality and enhanced reporting, the Year 2000
problem will be mitigated. However, if such replacements are not made, or are
not completed timely, the Year 2000 problem could have a material impact on the
operations of the Company.
The Company has adopted a five-phase Year 2000 program consisting of the
following: Phase I - identification of the components of the Company's systems,
equipment and suppliers that may be vulnerable to Year 2000 problems; Phase II -
assessment of items identified in Phase I; Phase III - remediation or
replacement of non-compliant systems; Phase IV - testing of systems and
components following replacement; and Phase V - developing contingency plans.
The Company has completed Phase I and Phase II.
Phase III - Remediation or replacement of non-compliant systems. This
phase involves creating plans, providing necessary resources and executing
remedial strategies. The Company's critical systems are being replaced with
newer advanced systems that are already Year 2000 compliant. The Company's
financial systems have been implemented, tested and "turned on" effective
January 1, 1999. The wholesale selling and distribution
20
system is warranteed as Year 2000 compliant and is scheduled to be implemented
during the second quarter of 1999. All systems are expected to be reliably
functioning by July 1, 1999.
Phase IV - Testing of systems and components following replacement. This
phase includes testing functionality and system compliance. Of the Company's
information systems, the financial, warehousing and EDI systems currently
in-place have been tested and are Year 2000 compliant. The Company's retail
systems, which are run by a third party provider, have been warranteed as Year
2000 compliant and the Company's point-of-sale and credit card processing have
been successfully tested. The Company is working with its wholesale and
distribution systems software provider to program enhanced functionality
designed specifically for fashion footwear businesses. However, the existing
standard base system is Year 2000 compliant and is capable of running the
Company's business. The updated system is planned to be implemented during the
second quarter of 1999.
Phase V - Contingency planning. This phase addresses any remaining open
issues expected in 1999 and thereafter. Based upon its efforts to date, the
Company believes that all of its critical information technology and
non-information technology will remain up and running beyond January 1, 2000.
Accordingly, the Company does not currently anticipate that internal systems
failures will result in any material adverse effect to its operations or
financial condition. As a contingency plan for its wholesale and distribution
systems that are not yet implemented, the Company plans on implementing the
existing standard base system, which is certified Year 2000 compliant and has
already been installed and tested by the Company.
Third-Party Relationships. In addition to addressing the Company's
internal systems and equipment, the Company is communicating with significant
suppliers, vendors and other third parties with whom the Company has a
significant business relationship with, to determine their state of readiness
with respect to Year 2000. To date, the Company is not aware of any third-party
with a Year 2000 issue that would materially impact the Company's results of
operations. However, failure of significant suppliers, vendors or other third
parties to timely address and remedy Year 2000 problems or to develop and effect
appropriate contingency plans could have a material adverse effect on the
Company's operations. Various fallback plans are being considered, including the
use of electronic spreadsheets and manual work-arounds (e.g., written purchase
orders and bulk distributions). In addition, the Company believes that the
geographically disbursed nature of its business and its large supplier and
vendor base mitigates such potential adverse effects.
The Company does not expect the costs associated with its Year 2000
efforts to be material to the Company's financial condition or results of
operations. The total cost of purchasing and implementing the new information
systems, including addressing the Year 2000 problem is estimated at $2.0
million, of which approximately $600,000 has been expensed to date and $1.0
million spent on new software and hardware. The Company's cost estimates do not
include costs associated with addressing and resolving issues as a result of the
failure of third parties to become Year 2000 compliant. The costs of the Year
2000 project are being funded through both leasing arrangements and operating
cash flows.
The Company believes that it will be able to satisfy its cash requirements
for 1999, including requirements for its retail expansion, new corporate office
space and information systems improvements, primarily with cash flow from
operations, supplemented by borrowings under its line of credit.
Exchange Rates
The Company routinely enters into forward exchange contracts in anticipation of
future purchases of inventory denominated in foreign currencies, primarily the
Italian Lira and Spanish Peseta. At December 31, 1998, forward exchange
contracts totaling $6.6 million were outstanding with settlement dates ranging
from January 1999 through May 1999. Gains and losses on forward exchange
contracts are deferred and accounted for as part of the purchase price of
imported merchandise. At December 31, 1998, the unrealized loss on these forward
contracts is
21
approximately $46,000. The Company expects to continue to routinely enter into
additional foreign exchange contracts throughout the year. While the Company
believes that its current procedures with respect to the reduction of risk
associated with currency exchange rate fluctuations is adequate, there can be no
assurance that such fluctuations will not have a material adverse effect on the
results of operations of the Company in the future.
On January 1, 1999, the Euro became the official single currency of the
European Economic and Monetary Union. As of this date, the conversion rates of
the national currencies of the union members were fixed irrevocably. During the
transition period between January 1999 and January 2002, parties may pay for
goods using either the Euro or the national currency. The Company believes
conversion to the Euro will not have a material effect on the Company's
financial condition or results of operation.
Inventory purchases from contract manufacturers in the Far East and Brazil
are denominated in United States dollars and the recent devaluation of many of
these currencies against the United States dollar has not had any material
adverse impact on the Company. However, future purchase prices for the Company's
products may be impacted by fluctuations in the exchange rate between the United
States dollar and the local currencies of the contract manufacturer, which may
effect the Company's cost of goods in the future. The Company does not believe
the potential effects of such fluctuations would have a material adverse affect
on the Company.
Effects of Inflation
The Company does not believe that the relatively moderate rates of
inflation experienced over the last few years in the United States, where it
primarily competes, have had a significant effect on revenues or profitability.
Important Factors Relating to Forward Looking Statements
The Private Securities Litigation Reform Act of 1995 (the "Act") provides
a safe harbor for forward-looking statements made by or on behalf of the
Company. The Company and its representatives may from time to time make written
or oral statements that are "forward-looking," including statements contained in
this report and other filings with the Securities and Exchange Commission and in
reports to the Company's shareholders. All statements that express expectations
and projections with respect to future matters, including the launching or
prospective development of new business initiatives, "Year 2000" remediation
efforts, future licensee sales growth, and the introduction of the Euro are
forward-looking statements within the meaning of the Act. These statements are
made on the basis of management's views and assumptions, as of the time the
statements are made, regarding future events and business performance. There can
be no assurance, however, that management's expectations will necessarily come
to pass. A number of factors affecting the Company's business and operations
could cause actual results to differ materially from those contemplated by the
forward-looking statements. Those factors include, but are not limited to,
demand and competition for the Company's products, changes in consumer
preferences on fashion trends, delays in anticipated store openings, and changes
in the Company's relationship with its suppliers and other resources. This list
of factors that may affect future performance and the accuracy of
forward-looking statements is illustrative, but by no means exhaustive.
Accordingly, readers of this Annual Report should consider these facts in
evaluating the information and are cautioned not to place undue reliance on the
forward-looking statements contained herein.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The Company does not believe it has a material exposure to market risk.
The Company is primarily exposed to currency exchange-rate risks with respect to
its inventory transactions denominated in Italian Lira and Spanish Pesetas, both
of which have been converted to the Euro effective January 1, 1999. Business
activities in various currencies expose the company to the risk that the
eventual net dollar cash flows from transactions with foreign suppliers
denominated in foreign currencies may be adversely affected by changes in
currency rates. The Company manages these risks by utilizing foreign exchange
contracts. The Company does not enter into foreign currency transactions for
speculative purposes. The Company's earnings may be affected by changes in
short-term interest rates as a result of borrowings under its line of credit
facility. A two percent increase in interest rates affecting the company's
credit facility would not have had a material effect on the Company's 1998
and 1997 net income.
Item 8. Financial Statements and Supplementary Data
22
See page F-1 for a listing of the consolidated financial statements
submitted as part of this report.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
23
PART III
Item 10. Directors and Executive Officers of the Registrant
Except for the information regarding directors and executive officers of
the registrant, which is included in Part I, the information required by this
item will be contained in the Company's Proxy Statement for its Annual
Shareholders Meeting to be held May 27, 1999 to be filed with the Securities and
Exchange Commission within 120 days after December 31, 1998 and is incorporated
herein by reference in response to this item.
Item 11. Executive Compensation
The information required by this item will be contained in the Company's
Proxy Statement for its Annual Shareholders Meeting to be held May 27, 1999 to
be filed with the Securities and Exchange Commission within 120 days after
December 31, 1998 and is incorporated herein by reference in response to this
item.
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 Shareholders Meeting to be held May 27, 1999 to
be filed with the Securities and Exchange Commission within 120 days after
December 31, 1998 and is incorporated herein by reference in response to this
item.
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 Shareholders Meeting to be held May 27, 1999 to
be filed with the Securities and Exchange Commission within 120 days after
December 31, 1998 and is incorporated herein by reference in response to this
item.
24
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) See page F-1 for a listing of consolidated financial statements
submitted as part of this report.
(a)(2) Schedule II - Valuation and Qualifying Accounts
All other schedules, for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions, are shown in the financial
statements or are inapplicable and therefore have been omitted.
(a)(3) The following exhibits are included in this report.
Exhibit
No. Description
- ------- -----------
3.01 --Restated Certificate of Incorporation of Kenneth Cole Productions,
Inc.; Certificate of Merger of Cole Fifth Avenue, Inc. into Kenneth
Cole Productions, Inc.; Certificate of Merger of Cole Productions,
Inc. into Kenneth Cole Productions, Inc.; Certificate of Merger of
Cole Sunset, Inc. into Kenneth Cole Productions, Inc.; Certificate of
Merger of Cole Union Street, Inc. into Kenneth Cole Productions,
Inc.; Certificate of Merger of Cole West, Inc. into Kenneth Cole
Productions, Inc.; Certificate of Merger of Kenneth Cole Woodbury,
Inc. into Kenneth Cole Productions, Inc.; Certificate of Merger of
Kenneth Cole Leather Goods, Inc. into Kenneth Cole Productions, Inc.;
Certificate of Merger of Unlisted into Kenneth Cole Productions, Inc.
(Incorporated by reference to Exhibit 3.01 to the Company's
Registration Statement on Form S-1, Registration No. 33-77636).
3.02 --By-laws. (Incorporated by reference to Exhibit 3.02 to the
Company's Registration Statement on Form S-1, Registration No.
33-77636).
4.01 --Specimen of Class A Common Stock Certificate. (Incorporated by
reference to Exhibit 4.01 to the Company's Registration Statement on
Form S-1, Registration No. 33-77636).
10.01 --Tax Matters Agreement, dated as of June 1, 1994, among Kenneth Cole
Productions, Inc., Kenneth D. Cole, Paul Blum and Stanley A. Mayer.
(Incorporated by reference to Exhibit 10.01 to the Company's
Registration Statement on Form S-1, Registration No. 33-77636).
10.02 --Term Loan Agreement, dated as of May 26, 1994, by and among Kenneth
Cole Productions, Inc., Kenneth Cole Leather Goods, Inc., Unlisted,
Inc., Cole West, Inc., Kenneth Cole Financial Services, Inc., Kenneth
Cole Woodbury, Inc., Cole Fifth Avenue, Inc., Cole Union Street, Inc.
and The Bank of New York; Promissory Notes, dated May 26, 1994,
issued by each of Kenneth Cole Leather Goods, Inc., Unlisted, Inc.,
Cole West, Inc., Kenneth Cole Financial Services, Inc., Kenneth Cole
Woodbury, Inc., Cole Fifth Avenue, Inc., Cole Union Street, Inc. to
The Bank of New York; Shareholder Guaranty by and between Kenneth D.
Cole and The Bank of New York, dated as of May 26, 1994;
Subordination Agreement by and among Kenneth D. Cole, Kenneth Cole
Productions, Inc., Kenneth Cole Leather Goods, Inc., Unlisted, Inc.,
Cole West, Inc., Kenneth Cole Financial Services, Inc., Kenneth Cole
Woodbury, Inc., Cole Fifth Avenue, Inc., Cole Union Street, Inc. and
The Bank of New York, dated as of April 13, 1994; Reinvestment
Agreement by and among Kenneth D. Cole, Kenneth Cole Productions,
Inc., Unlisted, Inc., Cole West, Inc., Kenneth Cole Financial
Services, Inc., Kenneth Cole Woodbury, Inc., Cole Fifth Avenue, Inc.,
Cole Union Street, Inc. and The Bank of New York, dated as of May 26,
1994; Amendment No. 1 to the Term Loan Agreement and the Reinvestment
Agreement by and among Kenneth D. Cole, Kenneth Cole Productions,
Inc., Cole West, Inc., Kenneth Cole Woodbury, Inc., Cole Fifth
Avenue, Inc., Cole Union Street, Inc., Kenneth Cole Financial
Services, Inc. and The Bank of New York, dated as of May 31, 1994.
(Incorporated by reference to Exhibit 10.02 to the Company's
Registration Statement on Form S-1, Registration No. 33-77636).
10.03 --Line of Credit Letter, dated January 13, 1994, from The Bank of New
York to Kenneth Cole Productions, Inc., Kenneth Cole Leather Goods,
Inc. and Unlisted, Inc.; $7,500,000 Promissory Note, dated February
25
1, 1994 by Kenneth Cole Productions, Inc., Kenneth Cole Leather
Goods, Inc. and Unlisted, Inc. issued to The Bank of New York; Letter
Agreement, dated December 16, 1993, between The Bank of New York and
Kenneth Cole Productions, Inc., Unlisted, Inc., Kenneth Cole Leather
Goods, Inc., Cole Productions, Inc., Cole West, Inc., Kenneth Cole
Financial Services, Inc., Cole Woodbury, Inc., Cole Sunset, Inc. and
Cole Fifth Avenue, Inc.; General Guarantees, dated December 16, 1993,
in favor of The Bank of New York by Kenneth Cole Leather Goods, Inc.
for Unlisted, Inc., by Kenneth Cole Leather Goods, Inc. for Kenneth
Cole Productions, Inc., by Unlisted, Inc. for Kenneth Cole
Productions, Inc., by Unlisted, Inc. for Kenneth Cole Leather Goods,
Inc., by Kenneth Cole Productions, Inc. for Kenneth Cole Leather
Goods, Inc., and by Kenneth Cole Productions, Inc. for Unlisted,
Inc.; General Loan and Security Agreements, dated December 16, 1993,
between The Bank of New York and each of Kenneth Cole Productions,
Inc., Kenneth Cole Leather Goods, Inc. and Unlisted, Inc.; and
Personal Guarantees of Mr. Kenneth D. Cole, dated December 16, 1993,
in favor of The Bank of New York for Kenneth Cole Productions, Inc.,
Unlisted, Inc. and Kenneth Cole Leather Goods, Inc. (Incorporated by
reference to Exhibit 10.03 to the Company's Registration Statement on
Form S-1, Registration No. 33-77636).
Line of Credit Letter, dated December 9, 1994 from The Bank of New
York to Kenneth Cole Productions, Inc.; $7,500 Promissory Note, dated
December 15, 1994 by Kenneth Cole Productions, Inc. issued to The
Bank of New York; Letter of Termination of Personal Guarantees of Mr.
Kenneth D. Cole, dated December 8, 1994, in favor of The Bank of New
York for Kenneth Cole Productions, Inc., Unlisted, Inc. and Kenneth
Cole Leather Goods, Inc. (Incorporated by reference to Exhibit 10.03
to the Company's 1994 Form 10-K).
10.03A $10,000 Promissory Note, dated July 31, 1995 by Kenneth Cole
Productions, Inc. issued to The Bank of New York. (Previously filed
as Exhibit 10.03A to the Registrant's Annual Report on Form 10-K for
the year ended December 31, 1996 and incorporated herein by
reference).
*10.04 --Kenneth Cole Productions, Inc. 1994 Stock Option Plan.
(Incorporated by reference to Exhibit 10.04 to the Company's
Registration Statement on Form S-1, Registration No. 33-77636).
*10.05 --Employment Agreement, dated as of April 30, 1994, between Kenneth
Cole Productions, Inc. and Kenneth D. Cole. (Incorporated by
reference to Exhibit 10.05 to the Company's Registration Statement on
Form S-1, Registration No. 33-77636).
*10.06 --Employment Agreement, dated as of April 30, 1994, between Kenneth
Cole Productions, Inc. and Paul Blum. (Incorporated by reference to
Exhibit 10.06 to the Company's Registration Statement on Form S-1,
Registration No. 33-77636).
*10.07 --Employment Agreement, dated as of April 30, 1994, between Kenneth
Cole Productions, Inc. and Stanley A. Mayer; Stock Option Agreement
dated as of March 31, 1994 between Kenneth Cole Productions, Inc. and
Stanley A. Mayer. (Incorporated by reference to Exhibit 10.07 to the
Company's Registration Statement on Form S-1, Registration No.
33-77636).
Stock Option Agreement dated as of June 1, 1994, between Kenneth Cole
Productions, Inc. and Stanley A. Mayer; Stock Option Agreement dated
as of July 7, 1994, between Kenneth Cole Productions, Inc. and
Stanley A. Mayer (Incorporated by reference to Exhibit 10.07 to the
Company's 1994 Form 10-K).
10.08 --Collective Bargaining Agreement by and between the New York
Industrial Council of the National Fashion Accessories Association,
Inc. and Leather Goods, Plastics, Handbags and Novelty Workers'
Union, Local 1, dated as of April 25, 1987; Memorandum of Agreement
by and between the New York Industrial Council of the National
Fashion Accessories Association, Inc. and Leather Goods, Plastics,
Handbags and Novelty Workers' Union, Local 1, Division of Local
342-50 United Food and Commercial Workers Union, dated as of June 16,
1993. (Incorporated by reference to Exhibit 10.08 to the Company's
Registration Statement on Form S-1, Registration No. 33-77636).
10.09 Memorandum of Agreement between the New York Industrial Council of
the National Fashion Accessories Association Inc. and Local 1 Leather
Goods, Plastics, Handbags, and Novelty Workers Union, Division of
Local 342-50 United Food and Commercial Workers Union (Previously
filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 1996 and incorporated
herein by reference).
26
*10.10 Employment Agreement between Kenneth Cole Productions, Inc., and Paul
Blum. (Previously filed as Exhibit 10.2 to the Registrant's Quarterly
Report on Form 10-Q for the quarterly period ended June 30, 1996 and
incorporated herein by reference).
10.11 Sublease Agreement, dated June 17, 1996, between Kenneth Cole
Productions, Inc. and Liz Claiborne Accessories, Inc. (Incorporated
by reference to Exhibit 10.11 to the Company's 1996 Form 10-K).
*10.12 Amended and Restated Kenneth Cole Productions, Inc. 1994 Stock Option
Plan (Previously filed as an Exhibit to the Registrant's Proxy
Statement filed on April 22, 1997 and incorporated herein by
reference).
*10.13 Employment Agreement between Kenneth Cole Productions, Inc. and Susan
Hudson (Previously filed as an Exhibit to the Company's 1997 Form
10-K).
+10.14 Lease Agreement, dated December 17, 1998, between Kenneth Cole
Productions, Inc. and SAAR Company, LLC.
+21.01 --List of Subsidiaries
+23.01 Consent of Ernst & Young LLP
+27.01 Financial Data Schedules
- ----------------------------
* Management contract or compensatory plan or arrangement required to be
identified pursuant to Item 14(a) of this report.
+ Filed herewith.
(b) Reports on Form 8-K
None.
(b) See (a)(3) above for a listing of the exhibits included as a part of this
report.
27
Kenneth Cole Productions, Inc. and Subsidiaries
Index to Consolidated Financial Statements
Page
----
Report of Independent Auditors............................................. F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997............... F-3
Consolidated Statements of Income for the years ended
December 31, 1998, 1997 and 1996........................................ F-5
Consolidated Statements of Changes in Shareholders' Equity
for the years ended December 31, 1998, 1997 and 1996.................... F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996........................................ F-7
Notes to Consolidated Financial Statements................................. F-8
F-1
Report of Independent Auditors
Board of Directors and Shareholders
Kenneth Cole Productions, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Kenneth
Cole Productions, Inc. and subsidiaries as of December 31, 1998 and 1997, and
the related consolidated statements of income, changes in shareholders' equity,
and cash flows for each of the three years in the period ended December 31,
1998. Our audits also included the financial statement schedule listed at Item
14(a). These financial statements are the responsibility of the Company's
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 Kenneth Cole
Productions, Inc. and subsidiaries at December 31, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.
New York, New York ERNST & YOUNG LLP
February 25, 1999
F-2
Kenneth Cole Productions, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31,
1998 1997
-------------------------
Assets
Current assets:
Cash $13,824,000 $ 8,803,000
Due from factors 19,552,000 23,292,000
Accounts receivable, less allowance for doubtful accounts
of $125,000 in 1998, and $80,000 in 1997 4,874,000 3,864,000
Inventories 32,957,000 23,365,000
Prepaid expenses and other current assets 1,735,000 1,420,000
Deferred taxes 718,000 1,135,000
-------------------------
Total current assets 73,660,000 61,879,000
-------------------------
Property and equipment--at cost, less accumulated
depreciation and amortization 16,171,000 12,211,000
Other assets:
Deposits and deferred taxes 3,106,000 1,489,000
Deferred compensation plan assets 3,743,000 1,949,000
-------------------------
Total other assets 6,849,000 3,438,000
-------------------------
Total assets $96,680,000 $77,528,000
=========================
See accompanying notes to consolidated financial statements.
F-3
Kenneth Cole Productions, Inc. and Subsidiaries
Consolidated Balance Sheets (continued)
December 31,
1998 1997
----------------------------
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 10,644,000 $ 9,837,000
Accrued expenses and other current liabilities 4,467,000 3,399,000
Current obligations under capital lease 167,000
Income taxes payable 1,738,000 1,694,000
----------------------------
Total current liabilities 17,016,000 14,930,000
Accrued rent 1,472,000 909,000
Deferred compensation 3,743,000 1,949,000
Obligations under capital lease 760,000
Commitments and contingencies
Shareholders' equity:
Preferred stock, par value $1.00, 1,000,000
shares authorized, none outstanding
Class A Common Stock, par value $.01, 20,000,000 shares
authorized, 7,609,697 and 7,410,160 issued in 1998 and 1997 76,000 74,000
Class B Convertible Common Stock, par value $.01,
6,000,000 shares authorized, 5,785,398
outstanding in 1998 and 1997 58,000 58,000
Additional paid-in capital 22,284,000 19,684,000
Cumulative other comprehensive income 74,000 90,000
Retained earnings 56,165,000 39,834,000
----------------------------
78,657,000 59,740,000
Class A Common Stock in treasury, at cost,
350,000 shares (4,968,000)
----------------------------
Total shareholders' equity 73,689,000 59,740,000
----------------------------
Total liabilities and shareholders' equity $ 96,680,000 $ 77,528,000
============================
See accompanying notes to consolidated financial statements.
F-4
Kenneth Cole Productions, Inc. and Subsidiaries
Consolidated Statements of Income
Year ended December 31,
1998 1997 1996
-----------------------------------------------------------
Net sales $ 219,781,000 $ 185,278,000 $ 148,258,000
Licensing revenue 8,357,000 6,028,000 3,575,000
-----------------------------------------------------------
Net revenue 228,138,000 191,306,000 151,833,000
Cost of goods sold 129,403,000 112,183,000 86,919,000
-----------------------------------------------------------
Gross profit 98,735,000 79,123,000 64,914,000
Selling, general and administrative expenses 72,145,000 58,330,000 44,354,000
-----------------------------------------------------------
Operating income 26,590,000 20,793,000 20,560,000
Interest income (expense), net 404,000 (202,000) (22,000)
-----------------------------------------------------------
Income before provision for income taxes 26,994,000 20,591,000 20,538,000
Provision for income taxes 10,663,000 8,189,000 8,251,000
===========================================================
Net income $ 16,331,000 $ 12,402,000 $ 12,287,000
===========================================================
Earnings per share:
Basic $1.24 $.94 $.94
Diluted $1.20 $.91 $.90
Shares used to compute earnings per share:
Basic 13,222,000 13,162,000 13,109,000
Diluted 13,637,000 13,605,000 13,578,000
See accompanying notes to consolidated financial statements.
F-5
Kenneth Cole Productions, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity
Class A Common Stock Class B Common Stock
-------------------- -------------------- Accumulated
Additional Other
Number Number Paid-In Comprehensive Retained
of Shares Amount of Shares Amount Capital Income Earnings
----------------------------------------------------------------------------------------------
Balance at December 31, 1995 7,299,382 $73,000 5,785,398 $ 58,000 $ 18,510,000 $ 15,145,000
Exercise of stock
options and related
tax benefits 53,797 1,000 594,000
Net income 12,287,000
Amortization of deferred
compensation
----------------------------------------------------------------------------------------------
Balance at December 31, 1996 7,353,179 74,000 5,785,398 58,000 19,104,000 27,432,000
Net income 12,402,000
Foreign Currency
Translation adjustment $90,000
Comprehensive income
Exercise of stock
options and related
tax benefits 56,981 580,000
Amortization of deferred
compensation
----------------------------------------------------------------------------------------------
Balance at December 31, 1997 7,410,160 74,000 5,785,398 58,000 19,684,000 90,000 39,834,000
Net Income 16,331,000
Foreign Currency
Translation adjustment (16,000)
Comprehensive income
Exercise of stock
options and related
tax benefits 199,537 2,000 2,600,000
Purchase of 350,000
shares of Class A
common stock
----------------------------------------------------------------------------------------------
Balance at December 31, 1998 7,609,697 $76,000 5,785,398 $58,000 $22,284,000 $74,000 $56,165,000
==============================================================================================
Treasury Stock
--------------------
Number Deferred
of Shares Amount Compensation Total
--------------------------------------------------
Balance at December 31, 1995 $ (297,000) $ 33,489,000
Exercise of stock
options and related
tax benefits 595,000
Net income 12,287,000
Amortization of deferred
compensation 228,000 228,000
--------------------------------------------------
Balance at December 31, 1996 (69,000) 46,599,000
Net income 12,402,000
Foreign Currency
Translation adjustment 90,000
--------------
Comprehensive income 12,492,000
Exercise of stock
options and related
tax benefits 580,000
Amortization of deferred
compensation 69,000 69,000
--------------------------------------------------
Balance at December 31, 1997 - 59,740,000
Net Income 16,331,000
Foreign Currency
Translation adjustment (16,000)
--------------
Comprehensive income 16,315,000
Exercise of stock
options and related
tax benefits 2,602,000
Purchase of 350,000
shares of Class A
common stock (350,000) $(4,968,000) (4,968,000)
--------------------------------------------------
Balance at December 31, 1998 (350,000) $(4,968,000) - $73,689,000
==================================================
See accompanying notes to consolidated financial statements.
F-6
Kenneth Cole Productions, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
1998 1997 1996
----------------------------------------------
Cash flows from operating activities
Net income $ 16,331,000 $ 12,402,000 $ 12,287,000
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 2,791,000 1,953,000 1,109,000
Unrealized gain on deferred compensation plan (502,000) (153,000)
Provision for doubtful accounts 197,000 157,000 35,000
Amortization of deferred compensation 69,000 228,000
Abandonment of leasehold improvements and equipment 106,000
(Benefit) provision for deferred taxes (373,000) 152,000 36,000
Changes in operating assets and liabilities:
Decrease (increase) in due from factors 3,740,000 (5,316,000) (4,078,000)
Increase in accounts receivable (1,207,000) (682,000) (1,058,000)
(Increase) decrease in inventories (9,592,000) 5,900,000 (12,904,000)
Increase in prepaid expenses and
other current assets (315,000) (419,000) (92,000)
Increase in deposits and deferred compensation
assets (2,119,000) (1,856,000) (786,000)
Increase in income taxes payable 1,140,000 632,000 1,497,000
Increase (decrease) in accounts payable 807,000 (2,901,000) 5,973,000
Increase in accrued expenses and
other current liabilities 1,068,000 934,000 485,000
Increase in other non-current liabilities 2,357,000 1,141,000 747,000
----------------------------------------------
Net cash provided by operating activities 14,323,000 12,013,000 3,585,000
Cash flows from investing activities
Acquisition of property and equipment, net (5,784,000) (4,832,000) (4,894,000)
----------------------------------------------
Net cash used in investing activities (5,784,000) (4,832,000) (4,894,000)
Cash flows from financing activities
(Repayment) proceeds of revolving line of credit, net (440,000) 440,000
Proceeds from exercise of stock options 1,506,000 395,000 345,000
Repayment of long-term debt (49,000) (54,000)
Principle payments of capital lease obligations (40,000)
Purchase of treasury stock (4,968,000)
----------------------------------------------
Net cash (used in) provided by financing activities (3,502,000) (94,000) 731,000
Effect of exchange rate changes on cash (16,000) 90,000
----------------------------------------------
Net increase (decrease) in cash 5,021,000 7,177,000 (578,000)
Cash, beginning of year 8,803,000 1,626,000 2,204,000
----------------------------------------------
Cash, end of year $ 13,824,000 $ 8,803,000 $ 1,626,000
==============================================
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest $ 29,000 $ 323,000 $ 119,000
Income taxes $ 9,901,000 $ 7,396,000 $ 5,804,000
See accompanying notes to consolidated financial statements.
F-7
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements
December 31, 1998
Note A - Summary of Significant Accounting Policies
1. Description of business
Kenneth Cole Productions, Inc. and its subsidiaries (the "Company")
designs, sources and markets a broad range of quality footwear and handbags, and
through license agreements, designs and markets men's and women's apparel and
accessories under its Kenneth Cole New York, Kenneth Cole Reaction and Unlisted
brands for the fashion conscious consumer. The Company was incorporated in
September 1982 and completed an initial public offering on June 9, 1994. The
Company markets its products for sale to more than 3,500 department stores and
specialty store locations in the United States and in several foreign countries,
through its retail and outlet store base, and its interactive website. The
Company also distributes consumer catalogs that feature a variety of Kenneth
Cole New York and Kenneth Cole Reaction branded products.
2. Principles of consolidation
The consolidated financial statements include the accounts of Kenneth Cole
Productions, Inc. and its wholly owned subsidiaries. All material intercompany
transactions and balances have been eliminated in consolidation.
3. Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
4. Cash and cash equivalents
The Company considers all highly liquid investments with a maturity of
three months or less at the time of purchase to be cash equivalents.
5. Inventories
Inventories, which consist of finished goods, are stated at the lower of
cost or market. Cost is determined by the first-in, first-out method.
F-8
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Note A - Summary of Significant Accounting Policies (continued)
6. Property and equipment
Property and equipment are stated at cost less accumulated depreciation
and amortization. Depreciation and amortization, which includes the amortization
of assets recorded under capital leases, are computed using the straight-line
method over estimated useful lives ranging from three to seven years. Leasehold
improvements are amortized by the straight-line method over the term of the
related lease or the estimated useful life, whichever is less.
The Company reviews long-lived assets for possible impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. The Company has determined that no provision is
necessary for the impairment of long-lived assets at December 31, 1998.
7. Income taxes
The Company accounts for income taxes using the liability method. Under
this method, deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
8. Revenue recognition
Wholesale revenues are recognized at the time merchandise is shipped to
customers. Retail store revenues are recognized at the time of sale.
9. Licensing revenue
The Company has entered into various trade name license agreements that
provide revenues based on minimum royalties and additional revenues based on
percentage of defined sales. Minimum royalty revenue is recognized on a
straight-line basis over each period, as defined, in each license agreement.
Royalties exceeding the defined minimum amounts are recognized as income during
the period corresponding to the licensee's sales.
10. Advertising costs
The Company incurred advertising costs, including certain in-house
marketing expenses, of $7.8 million, $6.8 million and $5.0 million for 1998,
1997 and 1996, respectively. The Company records advertising expense concurrent
with the first time the advertising takes place.
F-9
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Note A - Summary of Significant Accounting Policies (continued)
11. Stock-based compensation
The Company measures compensation expense for its stock-based compensation
plans using the intrinsic value method prescribed in Accounting Principles Board
Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB No. 25") and
related Interpretations. Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation" ("SFAS 123") requires companies
electing to continue using the intrinsic value method, under APB No. 25 to
disclose the pro forma effects or net income and earnings per share had the fair
value of options been expensed (see Note H).
12. Recent accounting pronouncements
Effective January 1, 1998, the Company adopted the Financial Accounting
Standards Board's Statement of Financial Accounting Standards No. 131,
Disclosures about Segments of an Enterprise and Related Information ("SFAS
131"). Statement 131 establishes standards for the way that public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim financial reports. SFAS 131 also establishes
standards for related disclosures about products and services, geographic areas,
and major customers. The adoption of SFAS 131 did not affect results of
operations or financial position, but did affect the disclosure of segment
information (see Note E).
In June 1988, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and for Hedging Activities" ("SFAS 133") which the Company expects to adopt
January 1, 2000. The new Statement requires all derivatives to be recorded in
the balance sheet at fair value and establishes special accounting for three
different types of hedges. The Company, based on its current hedging activities,
does not expect the adoption of SFAS 133 to have a material effect in the
earnings and financial position of the Company.
13. Reclassifications
Certain amounts included in the 1997 and 1996 financial statements have
been reclassified to conform with the year-end 1998 presentation.
F-10
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Note B - Due from Factors and Line of Credit Facility
The Company sells substantially all of its accounts receivable to a
factor, without recourse, subject to credit limitations established by the
factor for each individual account. Certain accounts receivable in excess of
established limits are factored with recourse. Included in amounts due from
factors at December 31, 1998 and 1997 are accounts receivable, subject to
recourse, totaling approximately $526,000 and $674,000, respectively. The
agreements with the factors provide for payment of a service fee on receivables
sold.
At December 31, 1998 and 1997, the balance due from factors, which
includes chargebacks due from customers, is net of a reserve for sales
allowances, returns, discounts, and other deductions of approximately $3,300,000
and $2,900,000, respectively.
The Company has entered into a Line of Credit Facility (the "Facility")
that, as amended, allows for uncommitted borrowings, letter of credits and
banker's acceptances subject to individual maximums and in the aggregate, an
amount not to exceed the lesser of $25,000,000 or a "Borrowing Base." The
Borrowing Base is calculated on a specified percentage of eligible amounts due
under factoring arrangements, eligible non-factored accounts receivable, and
eligible inventory. Borrowings under the revolving loan portion of the Facility
("Advances") are due on demand. The Company may pay down and re-borrow at will
under the Facility. Advances bear interest at the Alternate Base Rate (defined
as the higher of the Prime Rate or the Federal Funds in effect at borrowing date
plus 1/2 of 1%) or the Note Rate (which will be agreed upon between the lender
and the Company). There were no outstanding advances under this agreement at
December 31, 1998 or 1997. Amounts available under the Facility at December 31,
1998 were reduced by $1,569,000 to $23,431,000 for open letters of credit.
In connection with the line of credit, the Company has agreed to eliminate
all the outstanding advances under the Facility for at least 30 consecutive days
during each calendar year. In addition, borrowings under the line of credit are
secured by certain assets of the Company.
F-11
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Note C - Property and Equipment
Property and equipment consist of the following:
December 31,
1998 1997
-------------------------
Property and equipment--at cost:
Furniture and fixtures $ 7,817,000 $ 5,513,000
Machinery and equipment 4,731,000 3,862,000
Leasehold improvements 10,828,000 8,217,000
Leased equipment under capital lease 967,000
-------------------------
24,343,000 17,592,000
Less accumulated depreciation and amortization 8,172,000 5,381,000
-------------------------
Net property and equipment $16,171,000 $12,211,000
=========================
Note D - Accrued Expenses and Other Liabilities
Accrued expenses and other current liabilities consist of the following:
December 31,
1998 1997
-------------------------------
Rent $ 315,000 $ 438,000
Compensation 2,792,000 1,822,000
Customer credits 414,000 244,000
Other 946,000 895,000
-------------------------------
$4,467,000 $3,399,000
===============================
F-12
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Note E - Segment Reporting
Kenneth Cole Productions, Inc. has three reportable segments: Wholesale,
Consumer Direct, and Licensing. The Wholesale segment designs and sources a
broad range of fashion footwear, handbags and accessories and markets its
products for sale to more than 3,500 department and specialty store locations
and to the Company's Consumer Direct segment. The Consumer Direct segment
markets the broad selection of the Company's branded products, including
licensee products, for sale directly to the consumer through its own channels of
distribution, which include full price retail stores, outlet stores, e-commerce
(at website address www.kennethcole.com) and catalogs. The Licensing segment,
through third party licensee agreements, has evolved the Company from a footwear
resource to a diverse lifestyle brand competing effectively in about 30
categories of apparel and accessories for both men and women. The Company
maintains control over quality and image and allows licensees to sell to the
same channels of distribution as those of the Company's Wholesale segment. The
Company earns royalties on the licensee's sales of branded product.
The Company evaluates performance and allocates resources based on profit
or loss from each segment. The Wholesale segment is evaluated on income from
operations before income taxes. The Consumer Direct segment is evaluated on
profit or loss from operations before unallocated corporate overhead and income
taxes. The Licensing segment is evaluated based on royalties earned and pretax
segment profit. The accounting policies of the reportable segments are the same
as those described in the summary of significant accounting policies.
Intersegment sales between the Wholesale and Consumer Direct segments include a
markup which is eliminated in consolidation.
The Company's reportable segments are business units that offer products
to overlapping consumers through different channels of distribution. Each
segment is managed separately and planning, implementation and results are
reviewed internally by the executive management committee.
F-13
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Financial information of the Company's reportable segments is as follows:
(in thousands)
Consumer
Wholesale Direct Licensing Totals
---------------------------------------------------------------
Year Ended December 31, 1998
Revenues from external customers $151,402 $68,379 $8,357 $228,138
Intersegment revenues 18,679 18,679
Interest income, net 404 404
Depreciation expense 1,072 1,715 4 2,791
Segment income before provision
for income taxes 21,815 7,326 6,002 35,143
Segment assets 78,200 26,798 1,690 106,688
Expenditures for long-lived assets 836 4,923 25 5,784
Year Ended December 31, 1997
Revenues from external customers $135,296 $49,982 $6,028 $191,306
Intersegment revenues 14,682 14,682
Interest expense, net (202) (202)
Depreciation expense 791 1,161 1 1,953
Segment income before provision
for income taxes 15,682 6,929 4,278 26,889
Segment assets 65,324 19,309 1,253 85,886
Expenditures for long-lived assets 1,479 3,346 7 4,832
Year Ended December 31, 1996
Revenues from external customers $112,942 $35,316 $3,575 $151,833
Intersegment revenues 11,291 11,291
Interest expense, net (22) (22)
Depreciation expense 363 746 1,109
Segment income before provision
for income taxes 18,205 5,017 2,108 25,330
Segment assets 56,425 15,282 803 72,510
Expenditures for long-lived assets 1,874 3,020 4,894
F-14
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
The reconciliation of the Company's reportable segment revenues, profit
and loss, and assets are as follows:
(in thousands)
1998 1997 1996
-----------------------------------
Revenues
Revenues for reportable segments $ 228,138 $ 191,306 $ 151,833
Intersegment revenues for reportable segments 18,679 14,682 11,291
Elimination of intersegment revenues (18,679) (14,682) (11,291)
--------- --------- ---------
Total consolidated revenues $ 228,138 $ 191,306 $ 151,833
========= ========= =========
Income
Total profit for reportable segments $ 35,143 $ 26,889 $ 25,330
Elimination of intersegment profit (4,914) (3,956) (3,013)
Unallocated corporate overhead (3,235) (2,342) (1,779)
--------- --------- ---------
Total income before income taxes $ 26,994 $ 20,591 $ 20,538
========= ========= =========
Assets
Total assets for reportable segments $ 106,688 $ 85,886 $ 72,510
Elimination of intercompany receivables (8,687) (7,105) (6,166)
Elimination of inventory profit in consolidation (1,321) (1,253) (1,089)
--------- --------- ---------
Total consolidated assets $ 96,680 $ 77,528 $ 65,255
========= ========= =========
Revenues from international customers are less than two percent of the
Company's consolidated revenues.
F-15
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Note F - Foreign Currency Transactions
The Company routinely enters into forward exchange contracts in
anticipation of future purchases of inventory denominated in foreign currencies.
These forward exchange contracts are used to reduce the Company's exposure to
changes in foreign exchange rates and are not held for the purpose of trading or
speculation. The Company had forward exchange contracts of $6,600,000 and
$18,175,000 at December 31, 1998 and 1997, respectively to protect the purchase
price of merchandise under such commitments. Gains and losses on forward
exchange contracts are deferred and accounted for as part of the purchase price
of imported merchandise. At December 31, 1998, forward exchange contracts have
maturity dates through May 1999. The unrealized loss on these forward exchange
contracts is approximately $46,000.
Note G - Income Taxes
Significant items comprising the Company's deferred tax assets and
liabilities are as follows:
December 31,
1998 1997
----------------------------
Deferred tax assets:
Inventory allowances and capitalization $ 562,000 $ 590,000
Allowance for doubtful accounts and
sales allowances 75,000 457,000
Deferred rent 304,000 88,000
Deferred compensation 1,441,000 965,000
Other 40,000 40,000
----------------------------
2,422,000 2,140,000
----------------------------
Deferred tax liabilities:
Depreciation (778,000) (633,000)
Undistributed foreign earnings (523,000) (759,000)
----------------------------
(1,301,000) (1,392,000)
----------------------------
Net deferred tax assets $ 1,121,000 $ 748,000
============================
F-16
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Note G - Income Taxes (continued)
The provision (benefits) for income taxes consists of the following:
December 31,
1998 1997 1996
-----------------------------------------------
Current:
Federal $ 9,249,000 $ 6,385,000 $ 6,543,000
State and local 1,750,000 1,628,000 1,650,000
Foreign 37,000 24,000 22,000
-----------------------------------------------
11,036,000 8,037,000 8,215,000
Deferred:
Federal (330,000) 133,000 32,000
State and local (43,000) 19,000 4,000
-----------------------------------------------
(373,000) 152,000 36,000
-----------------------------------------------
$ 10,663,000 $ 8,189,000 $ 8,251,000
===============================================
The reconciliation of income tax computed at the U.S. federal statutory
tax rate to the effective income tax rate for 1998, 1997 and 1996 is as follows:
1998 1997 1996
------------------------
Federal income tax at statutory rate 35.0% 35.0% 35.0%
State and local taxes, net of federal tax benefit 4.5 5.0 5.0
------------------------
39.5% 40.0% 40.0%
========================
Note H - Stock Options Plans and Grants
1. 1994 stock option plan
The Company's 1994 Incentive Stock Option Plan, as amended on May 29,
1997, authorizes the grant of options to employees for up to 1,500,000 shares of
the Company's common stock. Certain options granted under the Plan vest in
one-third increments in each of the first, second and third years following the
date of grant, while certain other options vest over five years. Options granted
have 10-year terms. Non-employee Director options granted have 10 year terms and
vest 50% on the first anniversary of the date of grant and become fully
exercisable at the end of two years.
The Company has elected to continue to follow Accounting Principles Board
Opinion No. 25, in accounting for its employee stock options. Under APB 25, when
the exercise price of the Company's employee stock options equals the market
price of the underlying stock on the date of grant, no compensation expense is
recognized. Had compensation cost for the stock options been determined based on
the fair value at the grant dates for awards under the plan, consistent with the
alternative method set forth under SFAS 123, net income and earnings per share
would have been reduced by approximately $643,000 and $.04, $441,000 and $.03,
and $371,000 and $.02, in 1998, 1997 and 1996, respectively.
F-17
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Note H - Stock Options Plans and Grants (continued)
The effects of applying SFAS 123 on this pro forma disclosure may not be
indicative of future results. SFAS 123 does not apply to grants prior to 1995,
and additional awards in future years may be granted.
Pro forma information regarding net income and earnings per share is
required by Statement 123 and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for 1998, 1997 and 1996, respectively: risk-free interest rate of
5.25%, 5.50% and 6.25%; 0% dividend yields; expected volatility factors of
54.2%, 34.6% and 35.9% and expected lives of 5.6, 5.8 and 6.3 years. The
weighted-average fair value of options granted during 1998, 1997 and 1996 were
$9.55, $6.63 and $7.21, respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
The following table summarizes all stock option transactions from December
31, 1995 through December 31, 1998.
Weighted-Average
Shares Exercise Price
----------------------------------------------
Outstanding at December 31, 1995 702,458
Granted 156,583 $15.89
Exercised (53,797) $ 6.35
Forfeited (43,919) $ 9.04
-----------------------
Outstanding at December 31, 1996 761,325
Granted 325,725 $15.60
Exercised (56,981) $ 6.94
Forfeited (74,856) $14.04
-----------------------
Outstanding at December 31, 1997 955,213
Granted 335,700 $17.40
Exercised (166,587) $ 8.55
Forfeited (98,888) $12.74
-----------------------
Outstanding at December 31, 1998 1,025,438
=======================
F-18
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Note H - Stock Options Plans and Grants (continued)
The following table summarizes information concerning currently
outstanding and exercisable stock options at December 31, 1998:
Outstanding Stock Options Exercisable Stock Options
-------------------------- -------------------------
Weighted Average Weighted
Range of Outstanding Remaining Weighted Average Exercisable Average
Exercise Prices Shares Contractual Life Exercise Price Shares Exercise Price
- ------------------------------------------------------------------------------------------------------------------------
$ 6.00 to $10.00 248,268 5.82 years $ 8.24 106,868 $ 6.57
$ 10.01 to $16.00 299,130 7.71 years $13.49 60,578 $13.71
$ 16.01 to $22.94 478,040 8.55 years $17.90 46,207 $18.15
2. Stock option grants
In 1994, the Board of Directors granted non-transferable stock options to
an officer of the Company for the purchase of 222,950 shares of Class A Common
Stock at an exercise price of $2.1875 per share. In 1998, 32,950 options were
exercised and at December 31, 1998, 120,000 options were outstanding and
exercisable.
Note I - Benefit Plans
1. 401(k) Plan
The Company's 401(k) profit-sharing plan covers all non-union employees,
subject to certain minimum age and length of service requirements who are
permitted to contribute specified percentages of their salary up to the maximum
permitted by the Internal Revenue Service. The Company is obligated to make a
matching contribution and may make an additional discretionary contribution, as
defined. Contributions to the plan for the years ended December 31, 1998, 1997
and 1996 were approximately $89,000, $71,000 and $54,000, respectively.
F-19
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Note I - Benefit Plans (continued)
2. Deferred compensation plan
The Kenneth Cole Productions, Inc. Deferred Compensation Plan is an
unfunded non-qualified plan maintained primarily to provide deferred
compensation benefits for a select group of "highly compensated employees."
The Company accounts for the investments in the deferred compensation plan
in accordance with SFAS 115, "Accounting for Certain Investments in Debt and
Equity Securities," and such investments have been classified as trading.
Note J - Commitments and Contingencies
1. Capital lease
Included in property and equipment are assets held under capital lease of
$967,000, less accumulated amortization of $48,000. At December 31, 1998, future
minimum lease payments consist of the following:
1999 $235,000
2000 235,000
2001 235,000
2002 235,000
2003 177,000
--------------
Total minimum lease payments $1,117,000
Less amounts representing interest (190,000)
--------------
Present value of minimum lease payments 927,000
Less current maturities (167,000)
--------------
Capital lease obligation, less current maturities $760,000
==============
2. Operating leases
The Company leases office, retail, and warehouse facilities under
non-cancelable operating leases between 5 and 20 years with options to renew at
varying terms. Future minimum lease payments for non-cancelable leases with
initial terms of one year or more consisted of the following at December 31,
1998:
1999 $ 8,193,000
2000 9,116,000
2001 9,040,000
2002 8,651,000
2003 7,974,000
Thereafter 31,390,000
--------------
Total minimum cash payments $74,364,000
==============
F-20
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Note J - Commitments and Contingencies (continued)
In addition, certain of these leases contain rent escalation and
additional percentage rent payments to be made. Rent expense for the years ended
December 31, 1998, 1997 and 1996 was $9,313,000, $6,903,000 and $4,646,000,
respectively. In December 1998, the Company entered into a lease agreement for
new office space for its executive offices and showroom. The turnover of space
and date of occupancy has not yet been determined. Accordingly, the minimum
lease payments relating to this lease have not been included in the future
minimum lease payment schedule above. However, there will be no payments made
during 1999, and the Company's best estimate of future minimum lease payments
are approximately $3.3 million for the next five years and $14.0 million
thereafter.
2. Letters of credit
At December 31, 1998 and 1997, the Company was contingently liable for
approximately $1,169,000 and $1,957,000 of open letters of credit, respectively.
In addition, at December 31, 1998 and 1997, the Company was contingently liable
for approximately $400,000 of standby letters of credit.
3. Concentrations
In the normal course of business, the Company sells to major department
stores and specialty retailers and believes that its broad customer base will
mitigate the impact that financial difficulties of any such retailers might have
on the Company's operations. In 1998, the Company had no customer account for
more than 10% of net sales. The Company had sales to two customers that
accounted for 12.4% and 10.0% of net sales in 1997 and sales to one customer in
1996 that accounted for 14.2% of net sales.
The Company sources each of its product lines separately, based on the
individual design, styling and quality specifications of such products. The
Company primarily sources its products directly or indirectly through
manufacturers in Italy, Spain, Brazil, India, China and Korea. The Company
attempts to limit the concentration with any one manufacturer. However,
approximately 46% of the dollar value of total handbag purchases by the Company
were produced by one manufacturer in China in 1998 and 20% by two manufacturers
in India in 1997, respectively. In addition 58% and 36% of Kenneth Cole men's
footwear purchases were from one manufacturer in Italy during 1998 and 1997,
respectively. The Company believes it has alternative manufacturing sources
available to meet its current and future production requirements in the event
the Company is required to change current manufacturers or current manufacturers
are unavailable to fulfill the Company's production needs.
4. Other
The Company, from time to time, is a party to litigation that arises in
the normal course of its business operations. The Company presently is not a
party to any such litigation that would have a material adverse effect on its
business or operations.
F-21
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Note K - Comprehensive Income
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 130 "Reporting Comprehensive Income ("SFAS 130"). Statement 130 establishes
new rules for the reporting and display of comprehensive income and its
components. Comprehensive income is generally defined as all changes in
shareholder's equity exclusive of transactions with owners. SFAS 130 requires
the disclosure of comprehensive income and its components. Prior to adoption
these components were reported separately in shareholders' equity and are
currently included in comprehensive income and disclosed in the Statement of
Changes in Shareholders' Equity. Income taxes were not required to be provided
on these items and there were no reclassification adjustments made during 1998
or 1997.
Note L - Shareholders' Equity
1. Common stock
Class A Common Shareholders are entitled to one vote for each share held
of record, and Class B Common Shareholders are entitled to ten votes for each
share held of record. Each share of Class B Common Stock is convertible into one
share of Class A Common Stock at the option of the Class B Shareholder. The
Class A Common Shareholders vote together with Class B Common Shareholders on
all matters subject to shareholder approval, except Class A Common Shareholders
vote separately as a class to elect 25% of the Board of Directors of the
Company. Shares of neither class of common stock have preemptive or cumulative
voting rights.
2. Preferred stock
The Company's Certificate of Incorporation authorizes the issuance of
1,000,000 shares of preferred stock. The preferred stock may be issued from time
to time as determined by the Board of Directors of the Company, without
shareholder approval. Such preferred stock may be issued in such series and with
such preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends, qualifications or other provisions, as may be fixed
by the Board of Directors. There are no shares of preferred stock currently
outstanding.
3. Common stock repurchase
On August 13, 1998, the Board of Directors of the Company authorized
management to repurchase up to 500,000 shares of the Company's Class A Common
Stock. As of December 31, 1998, 350,000 shares were repurchased, in the open
market, at an aggregate price of $4,968,000 and have been recorded as treasury
stock.
F-22
Kenneth Cole Productions, Inc.
Notes to Consolidated Financial Statements (continued)
Note M - Quarterly Financial Data (Unaudited)
Summarized quarterly financial data for 1998 and 1997 appear below (in
thousands, except per share data):
First Second Third Fourth
Quarter Quarter Quarter Quarter
-------------------------------------------------
1998
Net sales $52,029 $48,331 $62,010 $57,411
Licensing revenue 1,656 1,791 2,294 2,616
Net revenues 53,685 50,122 64,304 60,027
Gross profit 23,585 21,165 27,792 26,193
Operating income 6,659 4,008 9,377 6,546
Net income 4,093 2,501 5,731 4,006
Earnings per share basic $ .31 $ .19 $ .43 $ .31
Earnings per share diluted $ .30 $ .18 $ .42 $ .30
1997
Net sales $44,910 $40,352 $50,287 $49,729
Licensing revenue 1,056 1,212 1,726 2,035
Net revenues 45,966 41,564 52,013 51,764
Gross profit 18,672 15,189 23,144 22,428
Operating income 5,532 1,410 8,158 5,693
Net income 3,252 794 4,871 3,485
Earnings per share basic $ .25 $ .06 $ .37 $ .26
Earnings per share diluted $ .24 $ .06 $ .36 $ .26
Certain amounts reported during the first three quarters of 1998 have been
reclassified to conform with the year-end 1998 presentation.
F-23
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
KENNETH COLE PRODUCTIONS, INC.
By /s/ KENNETH D. COLE
-------------------
Kenneth D. Cole
President and Chief Executive Officer
Date: March 30, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
Signature Title Date
- --------------------------------------------------------------------------------
/S/ KENNETH D. COLE President, Chief Executive Officer March 30, 1999
- -------------------------- and Director
Kenneth D. Cole
/S/ PAUL BLUM Executive Vice President, March 30, 1999
- -------------------------- Chief Operating Officer
Paul Blum and Director
/S/ STANLEY A. MAYER Executive Vice President, March 30, 1999
- -------------------------- Chief Financial Officer,
Stanley A. Mayer Treasurer and Director
/S/ DAVID P. EDELMAN Vice President Finance March 30, 1999
- -------------------------- (Principal Accounting Officer)
David P. Edelman
/S/ ROBERT C. GRAYSON Director March 30, 1999
- --------------------------
Robert C. Grayson
/S/ DENIS F. KELLY Director March 30, 1999
- --------------------------
Denis F. Kelly
/S/ JEFFREY G. LYNN Director March 30, 1999
- --------------------------
Jeffrey G. Lynn
F-24
Kenneth Productions, Inc.
Schedule II
Valuation and Qualifying Accounts
For the years ended December 31, 1998, 1997, and 1996
(in thousands)
Balance at Charged to Balance
Beginning Costs and at End
Description Of Period Expenses Deductions of Period
- ----------- --------- -------- ---------- ---------
Year ended December 31, 1998
Allowance for doubtful accounts $ (80,000) $ (197,000) $ 152,000 $ (125,000)
Reserve for returns and sales allowances (2,900,000) (400,000) (3,300,000)
----------- ----------- ----------- -----------
$(2,980,000) $ (597,000) $ 152,000 $(3,425,000)
=========== =========== =========== ===========
Year ended December 31, 1997
Allowance for doubtful accounts $ (65,000) $ (157,000) $ 142,000 $ (80,000)
Reserve for returns and sales allowances (2,200,000) (700,000) (2,900,000)
----------- ----------- ----------- -----------
$(2,265,000) $ (857,000) $ 142,000 $(2,980,000)
=========== =========== =========== ===========
Year ended December 31, 1996
Allowance for doubtful accounts $ (30,000) $ (70,000) $ 35,000 $ (65,000)
Reserve for returns and sales allowances (1,800,000) (400,000) (2,200,000)
----------- ----------- ----------- -----------
$(1,830,000) $ (470,000) $ 35,000 $(2,265,000)
=========== =========== =========== ===========