-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IN0pTfuCohrCDu4+sX33rgB7EPRpzgzJI7N+K7o44bME0yxq6gDotK30UJD0j7Ma EIdkXbwzEsr0jQj3kCFggw== 0000921691-06-000018.txt : 20060314 0000921691-06-000018.hdr.sgml : 20060314 20060314151852 ACCESSION NUMBER: 0000921691-06-000018 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20051231 FILED AS OF DATE: 20060314 DATE AS OF CHANGE: 20060314 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COLE KENNETH PRODUCTIONS INC CENTRAL INDEX KEY: 0000921691 STANDARD INDUSTRIAL CLASSIFICATION: FOOTWEAR, (NO RUBBER) [3140] IRS NUMBER: 133131650 STATE OF INCORPORATION: NY FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-13082 FILM NUMBER: 06684821 BUSINESS ADDRESS: STREET 1: 603 WEST 50 STREET CITY: NEW YORK STATE: NY ZIP: 10019 BUSINESS PHONE: 2015838508 MAIL ADDRESS: STREET 1: 603 WEST 50 STREET CITY: NEW YORK STATE: NY ZIP: 10019 10-K 1 k10123105e.txt FORM 10-K 12.31.05 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2005 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from___________to___________ 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) 603 West 50th 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: Class A common stock, par value $.01 per share Securities registered pursuant to Section 12 (g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. Yes ( ) No (X) Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ( ) No (X) 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. () Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. Large accelerated filer ( ) Accelerated filer (X) Non-accelerated filer ( ) Indicated by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ( ) No (X) The aggregate market value of voting stock held by nonaffiliates of the registrant as of the close of business on June 30, 2005: $350,421,158 Number of shares of Class A Common Stock, $.01 par value, outstanding as of the close of business on March 1, 2006: 12,119,108 Number of shares of Class B Common Stock, $.01 par value, outstanding as of the close of business on March 1, 2006: 8,010,497 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 May 1, 2006. Kenneth Cole Productions, Inc. TABLE OF CONTENTS Page PART I Item 1 Business 2 Item 1A Risk Factors 17 Item 1B Unresolved Staff Comments 21 Item 2 Properties 21 Item 3 Legal Proceedings 22 Item 4 Submission of Matters to a Vote of Security Holders 22 PART II Item 5 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer of Purchases of Equity Security 23 Item 6 Selected Financial Data 25 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 26 Item 7A Quantitative and Qualitative Disclosures About 34 Market Risk Item 8 Financial Statements and Supplementary Data 34 Item 9 Changes in and Disagreements With Accountants on 34 Accounting and Financial Disclosure Item 9A Controls and Procedures 35 Item 9B Other Information 35 PART III Item 10 Directors and Executive Officers of the Registrant 35 Item 11 Executive Compensation 35 Item 12 Security Ownership of Certain Beneficial Owners and 36 Management and Related Shareholder Matters Item 13 Certain Relationships and Related Transactions 36 Item 14 Principal Accountant Fees and Services 36 PART IV Item 15 Exhibits and Financial Statement Schedules 36 Item 1. Business Important Factors Relating to Forward- Looking Statements The Private Securities Litigation Reform Act of 1995 (the "Reform Act") and Section 21E of the Securities Exchange Act of 1934 provides a safe harbor for forward-looking statements made by or on behalf of Kenneth Cole Productions, Inc. (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. Forward-looking statements generally refer to future plans and performance and are identified by the words "believe," "expect," "anticipate," "plan," "intend," "will," "estimate," "project" or similar expressions. All statements that express expectations and projections with respect to future matters, including, but not limited to, the launching or prospective development of new business initiatives, future licensee sales growth, gross margins, store expansion and openings, changes in distribution centers, implementation of management information systems, are forward- looking statements within the meaning of the Reform 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 and are subject to certain risks and uncertainties. Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. While the Company does communicate from time to time with securities analysts, it is against company policy to disclose to them any material non-public information. Shareholders should not assume that the Company agrees with any statement or report issued by an analyst, regardless of the content of such statement or report. To the extent that reports issued by securities analysts contain any projections, forecasts or opinions, they are not the responsibility of the Company. There can be no assurance 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, changes in domestic economic conditions or in political, economic or other conditions affecting foreign operations and sourcing, demand and competition for the Company's products, risks associated with uncertainty relating to the Company's ability to implement its growth strategies or its ability to successfully integrate acquired business, risks arising out of litigation or trademark conflicts, changes in customer or 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 are 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. The Company undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. General Kenneth Cole Productions, Inc., 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, Unlisted, and Tribeca brand names. In addition, the Company, through a license agreement, has the rights to use the Bongo trademark for footwear. 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 that generally remain in demand from season to season and fashion products that are designed to establish or capitalize on market trends. The combination of basic products and fashion styles provides freshness in assortments and maintains a fashion-forward image, while a multiple brand strategy helps diversify business risk. The Company markets its products to more than 6,000 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 websites, including online e-commerce. The Company believes the diversity of its product offerings distinguishes the Company from its competitors in terms of product classifications (men's, women's and children's footwear, handbags, apparel and accessories), prices (from ''better'' to ''moderate'') and styling. The Company believes the diversity of its 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 popularity of the Kenneth Cole brand names among consumers has enabled the Company to expand its product offerings and channels of distribution through licensing agreements. The Company offers through these agreements a lifestyle collection of men's product categories, including tailored clothing, dress shirts, dress pants, sportswear, neckwear, briefcases, portfolios, jewelry, fragrance, belts, leather and fabric outerwear, sunglasses, prescription eyewear, watches, fragrance, swimwear, luggage, hosiery and small leather goods. Women's product categories currently being sold pursuant to license agreements include sportswear, small leather goods, belts, scarves and wraps, hosiery, leather and fabric outerwear, sunglasses, prescription eyewear, watches, jewelry, fragrance, swimwear, and luggage. In addition, the Company licenses its home collection and boys' and girls' apparel under the Kenneth Cole Reaction brand, which further broadens the Kenneth Cole lifestyle collection. Business Growth Strategies The Company's strategy is to continue to build upon the strength of its lifestyle brand franchise, which is comprised of well- differentiated and distinct brands: Kenneth Cole New York, Kenneth Cole Reaction, Unlisted, and Tribeca. During 2005, the Company discussed its brand elevation strategy to further enhance the strength of its lifestyle brand franchise. The Company began elevating Kenneth Cole New York in quality, price and value, and repositioning Kenneth Cole Reaction to introduce higher quality levels through its product categories and deliver it as a full contemporary lifestyle brand to the department store consumer. The Company views its lifestyle brands as a vital and significant strategic asset and the foundation for a sustainable competitive advantage. The Company believes that further segmentation and development of the brands afford growth potential within each of the Company's business segments. Wholesale. By strengthening and streamlining its distribution channels, the Company continues to reinforce the segmentation of its brands at wholesale, promoting even greater growth capability for each of its brands in the future. This approach will facilitate the broadening of product offerings, attract new customers and further enable the Company to address a wider variety of customers' needs, both domestically and internationally. Building on its distribution channels, the repositioning of its brands through elevation of its products, and the addition of the Bongo brand to its footwear business has given the Company the ability to reach other distribution tiers and new customers. By combining retail and wholesale merchandising functions, the Company is in a better position to respond quickly to market changes, thereby enabling each wholesale division to deliver appropriate fashions in a more timely and effective manner. This approach has been effective in maintaining the strength of the Kenneth Cole lifestyle brand franchise. The Company believes its strategic initiative to reposition the Kenneth Cole New York brand as an accessible luxury brand, and the repositioning of Kenneth Cole Reaction, will take the Company to its next stage of development, which will place the Company in the best position to benefit from the consolidation in the retail environment, and to enable the Company's brands to reach their potential. Consumer Direct. The Company's Consumer Direct segment, which operates full price retail and outlet stores, as well as catalogs and e-commerce, affords significant growth potential while simultaneously complementing the Company's existing Wholesale and Licensing businesses. The Company believes that the sale of footwear, handbags and licensed products through its consumer direct channels of distribution increases consumer awareness of the Company's brands, reinforces the Company's image and builds brand equity. The Company believes customers of our wholesale accounts in cities with a Kenneth Cole retail presence have an enhanced brand awareness compared to those in cities without a Kenneth Cole retail presence. The Company continues to pursue opportunities to expand its retail store operations. As of December 31, 2005, the Company operated 92 specialty retail and outlet stores as compared with 87 stores as of December 31, 2004. The Company plans to open or expand approximately 5 to 10 stores in 2006, expanding square footage by approximately 5% to 10%. This anticipated expansion includes outlet stores, which provide opportunities for the Company to sell excess and out-of-season merchandise, as well as unique "made for outlet products." To accommodate the Company's diversity of product offerings, the Company continues to open stores on an opportunistic basis and expand smaller current locations where retail space is available. The Company believes that its retail stores will generate increased sales and profitability as the stores allow for a true cross- section of both Company and licensee products, enabling the Company to present the broad lifestyle offering that consumers want to see. In 2005, the Company implemented a "Jewel Box" retail store model, approximately 2000 square feet in size, to focus on its core footwear and handbags categories, coupled with select key, high fashion, high demand accessory products. As it expands its retail business, the Company expects to realize leverage in several selling and administrative expense areas. The Company believes the Kenneth Cole model provides significant growth potential. The brand enjoys strong consumer support as evidenced by expansion of the Company's licensee product categories within the brand, a growing retail presence and improving wholesale operations. The Company continues to analyze the Kenneth Cole Reaction brand model for further growth potential in outlet stores, as well as within its licensing and wholesale product categories as the brand is repositioned throughout all of its distribution channels. The Company continues to invest in the enhancement, visual presentation and development of its websites to capitalize on the growth of its e-commerce and emerging technologies. The Company believes that web-based transactions will contribute to the Company's future, both as a source of consumer information and as a generator of new revenue. Among other things, the websites are designed to create additional revenues through a new distribution channel, build brand equity, fortify image, increase consumer awareness, improve customer service, provide entertainment and promote support for causes the Company believes are important to its customers. The Company has strengths in its existing capabilities in customer service, including telemarketing, merchandising, catalog, fulfillment and e-commerce. In addition to seasonal image campaigns via traditional advertising media, the Internet has enabled the Company and its customers to communicate directly with each other. The Company's use of its websites to capture and process this relevant market data on its consumer base provides a greater understanding of its customers and market trends. The Company believes this dynamic relationship is invaluable for building customer loyalty. Further, the Company's Internet presence through multiple websites has enabled the creation of a substantial e-mail database by which the Company's marketing and customer service departments regularly interact with its existing and new consumers online. Licensing. The growing strength of the Company's brands, Kenneth Cole New York, Kenneth Cole Reaction, and Unlisted, provides opportunities, through licensing agreements, to expand into new product categories and broaden existing distribution channels. The Company believes its strategic licensing relationships are essential to the growth of the Company both domestically and abroad as a lifestyle branded franchise. Many of the existing licensee businesses are still relatively small in their individual product classifications and the Company believes they hold impressive growth potential. The Company chooses its licensing partners with care, considering many factors, including the strength of their sourcing and distribution abilities, thereby attempting to maintain the same value and style that Kenneth Cole customers have come to expect. The Company continues to grow its market share in both the men's and women's apparel businesses and has started to penetrate new price tiers with Kenneth Cole Reaction branded products. The Company believes that women's apparel will further define and enhance the Company's brands, improving its ability to deliver the product that the Company's customers seek. As part of the Company's brand repositioning strategy, the Company signed an agreement in 2005 with Bernard Chaus, Inc. to distribute women's Kenenth Cole Reaction apparel. The Company also continues to expand its Kenneth Cole Reaction categories through an agreement with Syratech Corporation, a leading manufacturer and distributor of home decor, for distribution of housewares under the Kenneth Cole Reaction brand. The Company's strategic partnership with its fragrance licensee, Coty, Inc. ("Coty"), is designed to expand consumer awareness through Coty's global marketing group and provide an extension of brand awareness to the Company licensees and partnerships internationally and domestically. In 2005, the Company added Kenneth Cole Reaction fragrance for women, as well as Kenneth Cole Signature for men. These fragrances replaced the original Kenneth Cole fragrances allowing for fresh, new and exciting products for market penetration, growth and brand awareness. The Company is committed to strategically expanding its product classifications internationally and to building growth through brand awareness and diversity as it continues to aggressively grow the watch and optical categories abroad, focusing on certain specific international regions. In 2005, the Company's Licensees opened 12 new retail stores within international markets including Israel, Dubai, South Korea, Thailand, Mexico, Central America and the Dominican Republic. The Company's 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, Unlisted and Tribeca brand names, along with its licensed brand for footwear, Bongo, each targeted to appeal to different consumers. The Company believes that the products marketed under the Kenneth Cole New York brand names have developed into true aspirational brands, and while it has similar designer cache as other international designer brands, it has greater value credibility. Kenneth Cole New York Kenneth Cole New York products are designed for the fashion conscious consumer and reflect the relaxed urban sophistication that is the hallmark of the Kenneth Cole New York image. The distinctive styling of this line has established Kenneth Cole New York as a fashion authority for sophisticated men and women who are seeking a value alternative to other designer brands. As a result of strong brand recognition and a reputation for style, quality and value, the Company believes that Kenneth Cole New York has become an important resource for better department and specialty stores, and continues to provide significant growth opportunities. The Kenneth Cole New York product offering has evolved from a very trendy line into one with broad appeal, including both fashion-forward styling and core basics. The Company continues to leverage the strength of its name through brand extensions, in-store shops and the licensing of many new product categories. Recently, the Company implemented a new strategic initiative to reposition the Kenneth Cole New York brand as an accessible luxury brand. The Company believes that the repositioning of this brand will take the Company to its next stage of development, which will place the Company in the best position to benefit from the consolidation in the retail marketplace, maximize its retail store concept and grow internationally. Kenneth Cole New York men's footwear, manufactured through Italian and Chinese factories, is designed as contemporary, comfortable leather fashion footwear and is sold to the bridge- designer market at retail price points ranging from approximately $175 to $395. As versatile as it is sophisticated, Kenneth Cole New York men's footwear may be worn to work, for special occasions or on weekends with casual clothes. In addition, the Company uses the label "silver technology" in its line to denote enhanced comfort combined with its fine leather shoe craftsmanship. The silver technology product features a micro-tech midsole, a removable gel insole, and a fiberglass shank. Kenneth Cole New York women's footwear, primarily manufactured through Italian and Brazilian factories, includes sophisticated and elegant dress, casual and special occasion footwear that is sold to the bridge-designer market at retail price points ranging from approximately $185 to $400. Women's footwear is constructed by fine leather craftsmen to allow the customer high quality designer styling with value for the fashion conscious woman at work or in social gatherings. Kenneth Cole New York handbags are generally made of quality-crafted leathers and sold to the bridge-designer market at retail price points ranging from approximately $200 to $500. The seasonal line includes certain updated styles that offer the customer high-fashion bags, which are accompanied by tailored career bags for the sophisticated urban consumer. Kenneth Cole Reaction Kenneth Cole Reaction consists of a variety of product classifications, which address the growing trend toward flexible lifestyle dressing at affordable prices. Kenneth Cole Reaction includes a comfort-oriented casual line, as well as more dressy styles. Kenneth Cole Reaction women's footwear, primarily manufactured in China, is designed for the workplace as well as for outside the office, with an emphasis on comfort, versatility, contemporary styling and value. In addition, the Company has added "RXN comfort technology" which uses a pod system insole and gel heel pad to enhance comfort, support and flexibility. It is targeted to compete in the largest single category of footwear sold in department stores, women's "better," and the majority of the line retails primarily in the $60 to $100 price range. Kenneth Cole Reaction men's footwear, primarily manufactured in China, combines fashionable and versatile styling with affordable pricing and is positioned in 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 approximately in the $90 to $150 price range. Kenneth Cole Reaction handbags, primarily manufactured in China, are designed to be multifunctional with a contemporary look and are primarily made of leather and non-leather technical fabrications, such as nylon, microfiber and canvas. Kenneth Cole Reaction handbags have been styled to appeal to the same customer as the Kenneth Cole Reaction footwear line to meet the varying needs of the Company's customers. This line generally retails at price points ranging from approximately $60 to $160. Kenneth Cole Reaction children's footwear, primarily manufactured in China, includes dress and casual footwear sold at price points ranging from $35 to $55 and is targeted to boys and girls ages 6 to 12, who the Company believes are making more of their own fashion choices than ever before. The Company believes that children's footwear is a natural extension of its footwear business and that its use of styles based upon successful performers in its existing men's and women's styles, greatly enhances the likelihood of product performance. The success of children's footwear led the Company to introduce Kenneth Cole Reaction toddler footwear in 2003. This has improved its retail presence and has further penetrated the children's Kenneth Cole Reaction brand in the marketplace. 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 men's and women's casual and dress shoes each season. Unlisted footwear provides the young 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 $35 to $50 with approximately 60 styles per season. Unlisted men's footwear continues brand penetration through additional door expansion, continuing its strong growth, capitalizing on the large youth consumer base. The line includes casual and dress assortments with a variety of fashion styles to compliment the selection of approximately 50 styles per season. Unlisted men's footwear appeals to a broader young men's market with shoes that range at retail price points from $50 to $80. Bongo Bongo products are designed for the junior consumer market to be sold through mid-tier department and specialty stores. The brand brings fashion and style at reasonable price points to the junior market and includes children's and women's casual and dress shoes each season. Currently, Bongo footwear includes only women's and children's footwear lines. The women's footwear line has a wide variety of styles for casual, weekend, and special evening events including pumps, boots, and loafers, among others. The price points for the women's line range from $35 to $50 with approximately 40 styles per season. Children's price points range from $30 to $40. The brand provides a market that the Company was not previously penetrating with its branded products. Tribeca The Company introduced Tribeca footwear for women products in the second half of 2004. This brand was created for the young, trendier shopper in the department store channel of distribution. The lines include dress and casual styles leaning more toward the casual customer's expectations. The price points range from $50 to $70. Business Segments The Company manages its business through three segments: Wholesale, Consumer Direct and Licensing. During the periods presented below, the percentage of net revenues contributed by the Company's business segments were as follows:
Year Ended December 31, 2005 2004 2003 Wholesale 55% 54% 54% Consumer Direct 37 38 38 Licensing 8 8 8 --- --- --- 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 a sales force, as well as corporate account specialists, to sell its products and to manage its relationships with its wholesale customers, whose duties include analyzing and monitoring their selling information. The Company has previously increased the size of its corporate account specialists staff, as it believes its investment in account specialists is essential to the maintenance and growth of its wholesale businesses. The Company's products are distributed to more than 1,750 wholesale accounts for sale in approximately 6,000 store locations in the United States. The Company markets its branded products to major department stores and chains, such as Dillard Department Stores, Inc., Federated Department Stores (including Macy's, Bloomingdales, and Burdines) and upscale specialty retailers, including Saks Fifth Avenue and Nordstrom, Inc. In addition, the Company sells out-of-season branded products and overruns through the Company's outlet stores and to off-price retailers. The Company also sells its products, directly or through distributors or licensees, to customers in various international markets including Canada, Australia, Western Europe, parts of Asia, the Middle East, Latin America and parts of South America and the Caribbean through leasing agreements. The Company markets its product lines and introduces new styles at separate industry-wide footwear and handbag tradeshows that occur several times throughout the year in New York, Las Vegas and at various regional shows. These trade shows also afford the Company the opportunity to assess preliminary demand for its products. After each show, the Company's sales force 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 showrooms in New York. 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 typically incur any costs related to importing, shipping or warehousing of inventory, all of which are usually borne by the private label customer. Canada The Company assumed the Canadian footwear operations in 2003 and handbag operations in 2004 after its respective license agreements ended. The operations are managed from its New York City headquarters with a sales staff and distribution center in Canada. The Company markets its branded products in Canada to independent specialty retailers and large department stores, including Sears Canada, Browns, Townshoe, The Bay, Sterling and Friedmans. The branded products include Kenneth Cole New York, Kenneth Cole Reaction, and Unlisted men's and women's footwear, as well as Kenneth Cole New York handbags and Kenneth Cole Reaction children's footwear and handbags. In 2005, the Company began Canadian distribution of the Tribeca and Bongo footwear brands. Consumer Direct Operations Retail Operations The Company continues to pursue opportunities to enhance and expand its retail operations. At December 31, 2005, the Company operated 53 specialty Kenneth Cole New York retail stores and 39 outlet stores under the Kenneth Cole New York name. The Company believes its specialty retail stores develop consumer recognition of its brand names, provide a showcase for its branded products marketed by the Company and its licensees, and enhance the Company's overall profitability. The Company believes that these stores complement its wholesale business by building brand awareness. The customer is presented with the Company's core shoe and handbag business with selected key accessory styles. In addition, Kenneth Cole specialty retail stores enable the Company to reach consumers who prefer the environment of a specialty store. Approximately 10% of the Company's specialty retail store products are sourced exclusively for such stores to differentiate the product mix of its stores from that of its wholesale customers. The Company recently developed a smaller store format known as the "Jewel Box" model which the Company believes may be a more profitable store format. The Company opened 5 specialty retail stores and closed 3 stores in 2005, and plans to open 5 to 7 new specialty retail stores in 2006. The Company's outlet stores enable it to sell a portion of its excess wholesale, retail and catalog inventory in a manner that it believes does not have an adverse impact on its wholesale customers and the Company's retail operations. The Company generally does not typically make a style available in its outlet stores or to off-price retailers until wholesale customers have taken their first markdown on that style. In addition, the Company sources "Made for Outlet" product similar to its exclusive sourcing for retail stores and, thus, differentiates outlet from both retail store and wholesale customers. The Company opened 3 outlet stores in 2005. The success of the Company's new and existing stores will depend on various factors, including the political instability in certain countries in which the Company has a presence, the possibility of additional terrorist attacks, general economic and business conditions affecting consumer spending, the acceptance by consumers of the Company's retail concepts, the ability of the Company to successfully manage expansion, the ability of the Company to 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, including the implementation of SAP (see Management Information Systems). The Company believes that its retail stores further enhance its image and represent an opportunity for revenue and earnings growth. Catalog, Website and Customer Service The Company produces consumer catalogs and mailers that feature a variety of Kenneth Cole New York and Kenneth Cole Reaction branded products. The catalog order-taking process is performed in house and the fulfillment is performed by a third-party distribution center in New Jersey. The Company maintains websites to provide information regarding the Company and its products, as well as to conduct online business. The Company's websites www.kennethcole.com and www.kennethcolereaction.com are regularly enhanced to enable consumers to purchase directly from the Company online. The Company plans to continue to invest in the Internet and emerging technologies and believes that based on its existing merchandising, fulfillment and marketing capabilities, it is well positioned to deliver an online commerce solution with nonpareil customer service. The Company also maintains two toll-free telephone numbers (1-800-KEN-COLE and 1-800-UNLISTED), which provide customer service and answer product-related questions. The Company currently has a corporate gift program, whereby corporate customers are sold Kenneth Cole items for award and recognition programs. Orders are drop-shipped from the Company's licensees or its warehouse. The Company believes this is another avenue of distribution to expand its various brands to enhance customer awareness and strengthen market position. Licensing Domestic Licensing The Company views its licensing agreements as a vehicle to serve its customers better by extending its product offerings thereby allowing more consumers to meet their fashion accessory needs without compromising on price, value or style. The Company considers entering into licensing 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 that it believes 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 communicates its design ideas and coordinates all marketing efforts with its licensees. The Company generally grants licenses for three to five year terms with renewal options, limits licensees to certain territorial rights, and retains the right to terminate the licenses if certain specified sales levels are not attained. Each license provides the Company with the right to review, inspect and approve all product designs and quality and approve any use of its trademarks in packaging, advertising and marketing. The Company continues to elevate the quality, style and price of the Kenneth Cole New York brand through tailored clothing, watches, dress shirts, sportswear and outerwear. This is an important step in further defining Kenneth Cole New York as an accessible premier luxury lifestyle brand. The Company continues to grow the Kenneth Cole Reaction brand across expanding products and markets as it entered into agreements to introduce a home collection, as well as women's sportswear, and reposition the brand throughout the Company's distribution channels. The Company plans to continue to draw upon Kenneth Cole's creative strength and the Company's marketing resources to continue to build brand definition. The following table summarizes the Company's product categories under its licensing agreements: Kenneth Cole Kenneth Cole Unlisted Product Category New York Reaction Men's Tailored Clothing X X X Men's Sportswear X Men's Neckwear X X Men's Dress Shirts X X Men's Casual Pants X X Men's Leather & Fabric Outerwear X X Men's Small Leather Goods X X Men's Belts X X X Women's Sportswear X X Women's Small Leather Goods X X Women's Leather & Fabric Outerwear X X Women's Scarves & Wraps X X Men's/Women's Jewelry X X X Men's/Women's Swimwear X X X Men's/Women's Watches X X X Men's/Women's Optical Frames X X Men's/Women's Luggage/Briefcases X X Men's/Women's Sunglasses X X X Men's/Women's Fragrances X X X Children's Apparel X Home Collection X All of the Company's licensees are required to contribute to the Company a percentage of their net sales of licensed products, subject to minimum amounts, for the ongoing marketing of the Kenneth Cole brands. International Licensing The Company sells its products through distributors and licensees to wholesale customers and direct retailers in international markets including Canada, Australia, parts of Europe, the Middle East, parts of Asia, Central America, parts of South America, and the Caribbean Islands. The Company also continues to grow its international presence through broader wholesale distribution of watches, fragrance and sun and prescription eyewear. The Company's continued focus on the Asian market included opening and expanding shop-in-shops in South Korea through its licensee, Cheil Industries, and shop-in-shops and freestanding stores in the Philippines through the Company's Philippine licensee, Store Specialists, Inc. (Rustan's Department Store). The Company also maintains agreements for the wholesale distribution of handbags, women's small leather goods, mens sportswear, and men's and women's footwear in Australia. In addition, Apparel LLC, the Company's Gulf Region licensee, opened freestanding stores in the United Arab Emirates and one store in Kuwait during 2004. The Company anticipates expansion in the Israeli market in 2006, and recently signed an agreement for distribution in Thailand. In North America, the Company, directly and through licensing arrangements, continues to sell and market its products in Canada. The majority of product classifications available domestically are also available in Canada. Currently, the Company operates in Canada through two licensees and the use of shop-in-shops, while its footwear and handbag licensee businesses were taken in-house and are managed from its New York City headquarters through its Wholesale segment. The Latin American licensee agreement covers Latin America, South America and the Caribbean, with the exception of Brazil, Argentina and Uruguay. Currently, the Company's licensee operates 22 freestanding stores and 20 shop-in-shops in this region. In Europe, the Company's licensee operates a store in London and sells footwear, luggage, small leather goods, and handbags to department stores within the United Kingdom. The Company also sells footwear through footwear agents in France, the Benelux countries, Greece, Spain and Portugal. The Company continues to explore opportunities in this market as well as other new markets throughout the globe. The Company realizes the critical role that licensees have on the strategic plan to reposition Kenneth Cole as an accessible luxury brand, and on the growth and development of Kenneth Cole and its diffusion brands; and therefore, the Company assumes significant care to strategically align itself with viable business partners around the world. The Company is optimistic about the expansion of its international licensing programs as a means of developing a truly global brand. The Company currently generates approximately 2.0% of its total revenues internationally, and believes it can ultimately achieve a level of 20%. Design Kenneth D. Cole, Chairman and Chief Executive Officer, founded the Company in 1982 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 collaborate with Mr. Cole to create designs that they believe fit the Company's image, reflect 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 two 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. Instead, it sources its branded and private label products directly or indirectly through independently-owned manufacturers in Italy, Spain, Brazil, China and Korea, among other locations. The Company maintains an office in Florence, Italy 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. In addition, as part of its global sourcing strategy, the Company opened an office in China in 2005 as part of its plan to expand production in that region. The Company sources each of its product lines separately based on the individual design, styling and quality specifications of such products. 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 and China. However, approximately 46% and 42% of total handbag purchases came from two manufacturers in China during the years ended December 31, 2005 and 2004, respectively. Approximately 21% of Kenneth Cole New York and Kenneth Cole Reaction men's footwear purchases were from one manufacturer in China during the year ended December 31, 2005, and approximately 37% of those purchases were from one manufacturer in Italy utilizing many different factories during the year ended December 31, 2004. Also, approximately 32% of Kenneth Cole New York ladies' footwear was purchased from one Brazilian manufacturer during the year ended December 31, 2005, while 33% of those purchases were from one Italian manufacturer during the year ended December 31, 2004. Furthermore, approximately 44% of Kenneth Cole Reaction ladies' footwear purchases were sourced through one Chinese manufacturer during the year ended December 31, 2005, and 58% were purchased from one Italian manufacturer during the year ended December 31, 2004. 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. Many of these manufacturers, however, subcontract a portion of such purchases to ensure the consistent and timely delivery of quality products. The Company is a significant customer of several 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 its 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. In addition, the Company has a program, "test and react", whereby prototypes are rushed to its specialty retail stores immediately after completion to determine initial consumer reaction. Successful styles, consumer acceptance and demand are used to adjust factory production and line development prior to initial season shipping. 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 from its customers. Once an order has been placed, the manufacturing and delivery time ranges from three weeks to four months depending on whether the product is new or is currently in production. 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 as needed. Advertising and Marketing The Company believes that advertising to promote and enhance its brands is an integral 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 advertising appears in magazines such as Vogue, Elle, Harper's Bazaar, GQ, and InStyle, newspapers, and outdoor and media. The majority of the Company's licensees are required to contribute to the Company a percentage of their net sales of licensed products, subject to minimums, for the advertising and promotion of the image of the Company's brands. In addition, the Company believes personal appearances by Kenneth D. Cole further enhance the Company's brand awareness. The Company utilizes its in-house staff for marketing, advertising and public relations efforts enabling the Company to maintain the integrity of its brands. The Company occasionally will use advertising firms outside the United States to assist with coordination of an international advertising effort; however, all creative campaigns are designed by the Company's in-house staff. In order to continue to strengthen brand awareness of its products and increase sales, the Company is actively involved in development, marketing and merchandising programs for its customers. As part of this effort, the Company utilizes cooperative advertising programs, sales promotions and produces trade show sales tools and consumer catalogs which feature a variety of branded products marketed by the Company and its licensees. As a result of these internal productions, the Company believes that there is a singular focus, strong synergy and consistency in all of the Company's communications. An additional aspect of the Company's marketing efforts is the creation and placement of branded enhancements in key department and specialty store locations. These 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. These enhancements are achieved through the placement of fixturing, point of purchase displays and graphics. The Company believes that these in-store enhancements encourage longer-term commitment by retailers to the Company's products and heighten 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 the Company's distribution facilities located in the United States of America and Canada. The Company utilizes fully-integrated information systems and bar code technology to facilitate the receipt, processing and distribution of product through third-party warehouse distribution centers. The products are then shipped to the Company's wholesale and direct customers either in predetermined sizes, in case packs 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 as well as many fashion styles, 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 expects that affording customers improved flexibility in ordering specific stock keeping units ("SKUs") in smaller quantities will ultimately reduce the incidence of markdowns and allowances. The Company has capitalized on its centralized distribution facilities to provide additional support to its retail store operations on shipments of footwear and handbag products as well as direct shipments to its catalog and Internet customers. The Company's EDI program is also used to re-supply its retail store on a variety of products, thereby enhancing its service to the Company's retail operations through improved inventory management and customer response. To facilitate distribution, the Company has third-party public warehouses located on both the East and West Coasts of the United States, as well as in Canada to accommodate merchandise imported from Asia, Europe and South America. 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 continues to update and enhance its distribution and financial systems with newer technology that offers greater functionality and reporting capabilities. The Company also utilizes an EDI system that provides a computer link between the Company and many of its wholesale customers, as well as its retail operations that enable the Company to receive on-line orders and to accumulate sales information on its products shipped to its wholesale customers, retail stores, catalog and internet customers. 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 also uses point-of-sale registers to capture sales data, track inventories and generate EDI replenishment orders. The Company regularly evaluates the adequacy of its management information systems and upgrades such systems to support its growth. In 2006, the Company signed a software license agreement with SAP America, Inc. ("SAP") to implement an integrated business platform, using SAP software products, across the Company's retail and outlet stores. The estimated expenditures related to this implementation are expected to be approximately $8 million over the term of the contract. However, any failure by the Company to continue to upgrade its management information systems necessary to support growth or expansion, which could arise either with its internal systems or systems of its third parties, 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, Kenneth Cole Productions (LIC), Inc., owns federal registrations for its principal trademarks Kenneth Cole, Kenneth Cole New York, Kenneth Cole Reaction, Reaction, Kenneth Cole Collection, Tribeca and Unlisted as well as several other ancillary and derivative trademarks. Each of the federal registrations is currently in full force and effect and is not the subject of any legal proceedings. In addition, the Company has several federal applications pending in the United States Patent and Trademark office for trademarks and service marks. Moreover, the Company continues to expand its current international registrations in numerous countries throughout the world. 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, renew and protect the registrations, as well as vigorously defend all of its trademarks against infringements. Competition Competition in the footwear and handbags industries is intense and these product classifications are subject to rapidly changing consumer demands. 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 consumers, and the Company's licensed apparel and accessories also compete with a substantial number of designer and non-designer brands. Moreover, the general availability of contract manufacturing capacity allows access by new market entrants. The Company believes the success of its 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 the risks of doing business abroad, such as fluctuations in currency exchange rates, local market conditions, labor unrest, political instability, actions of a public enemy, military or other government intervention, priorities, restrictions or allocations and the imposition of additional regulations relating to imports, including quotas, duties or taxes and other charges on imports. There can be no assurance that these factors will not have a material adverse effect on the Company's operations in the future. 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 Euro. These Euro 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 most 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 effect on the Company's operations and its ability to import its products at 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. The majority of its products have import duties that range from approximately 6% to 37.5%, depending on the category and 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. 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 The Company's department store customers include major United States retailers, several of which are under common ownership. In 2005 and 2004, the Company had no customer or group under common ownership account for more than 10% of sales. The Company's ten largest customers represented 39.2% and 36.6% of the Company's net sales for the years ended December 31, 2005 and 2004, 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. Backlog The Company had unfilled wholesale customer orders of $81.3 million and $68.5 million at March 9, 2006 and March 9, 2005, 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, 2005, the Company had approximately 1,800 employees, none of whom are covered under a collective bargaining agreement. The Company considers its relationship with its employees to be satisfactory. The Company had a collective bargaining agreement, which expired in April 2004, at which time it outsourced its distribution operation and closed its New Jersey distribution center. Prior to that, the Company utilized 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. In connection with this transition in 2004, the Company incurred approximately $1.1 million in aggregate costs, including severance, the write-off of unamortized leasehold improvements and moving costs during 2004. These costs were expensed as incurred in accordance with SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activity" within the Selling, General and Administrative expenses caption on the face of the Consolidated Statement of Income. Directors and Executive Officers Name Age Present Position Kenneth D. Cole 51 Chief Executive Officer, Chairman of the Board of Directors Joel Newman 64 Chief Operating Officer, joined February 2006 David P. Edelman 44 Chief Financial Officer Michael F. Colosi 40 Corporate Vice President and General Counsel and Secretary Michael DeVirgilio 37 Executive Vice President, Business Development Richard S. Olicker 48 Executive Vice President, Wholesale Doug Jakubowski 42 Senior Vice President, Reaction Brand Harry Kubetz 52 Senior Vice President, Operations Carol Sharpe 51 Senior Vice President, Consumer Direct Henrik Madsen 39 Senior Vice President, International Operations Lori Wagner 41 Senior Vice President, Marketing Linda Nash Merker 49 Senior Vice President, Human Resources Martin E. Franklin 40 Director Robert C. Grayson 61 Director Denis F. Kelly 56 Director Philip B. Miller 67 Director Philip R. Peller 66 Director Kenneth D. Cole has served as the Company's Chief Executive Officer and Chairman of the Board since its inception in 1982 and was also President until February 2002. 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 Candies women's shoes. Mr. Cole is the Chairman of the Board of Directors of the American Foundation for AIDS Research (''AmFAR''). In addition, he is on the Board of Trustees of the Sundance Institute and the Council of Fashion Designers of America. Mr. Cole is also a Director and President of nearly all of the wholly-owned subsidiaries of the Company. Joel Newman joined the Company as Chief Operating Officer in February 2006. Prior to joining the Company, he held the positions of Chief Operating Officer of Tommy Hilfiger U.S.A., Inc., a subsidiary of Tommy Hilfiger Corporation, Inc., and Executive Vice President of Finance and Operations of Tommy Hilfiger Corporation, Inc., its parent company. Prior to joining Tommy Hilfiger U.S.A., Inc., Mr. Newman held various senior operations and financial positions with major companies in the apparel wholesale and retail industries. David P. Edelman was appointed as the Chief Financial Officer in July 2004. He joined the Company in January 1995 and served as the Company's Senior Vice President of Finance since April 2000. Before joining the Company, Mr. Edelman was Chief Financial Officer of a women's suit wholesaler, and he was employed 10 years as a CPA with Ernst & Young in various specialty groups including E&Y's National Consulting Office and its Retail and Apparel Audit Group. Michael F. Colosi has served as Corporate Vice President and General Counsel for the Company since July 2000 and as Corporate Secretary since July 2004. Previously, Mr. Colosi was the Associate General Counsel and Assistant Secretary for The Warnaco Group, Inc. from 1996 to 2000. After clerking for Judge J. Edward Lumbard of the U.S. Court of Appeals for the Second Circuit, he was engaged in the private practice of law from 1992 to 1996. Michael DeVirgilio has served as Executive Vice President of Business Development since January 2006. Mr. DeVirgilio previously served as Senior Vice President of Licensing from May 2005. Prior to that, he served as Corporate Vice President of Licensing and Design Services from March 2002 to May 2005. From 1999 to 2001, Mr. DeVirgilio served as Divisional Vice President of Licensing. Mr. DeVirgilio joined the Company as Director of Licensing in 1997. Prior to joining the Company, Mr. DeVirgilio was Director of Merchandising for the Joseph & Feiss Company (a Division of Hugo Boss, USA). Richard S. Olicker joined the Company as President of the Wholesale Division and Executive Vice President of the Corporation in January 2006. Mr. Olicker previously served Steven Madden, Ltd. where he held the position of President since 2001 and was responsible for seven independently operating wholesale footwear divisions, including Steve Madden, Stevies, l.e.i., and Candie's. Mr. Olicker also had visibility of the operation of the retail, licensing, Internet and international divisions. Prior to this, Mr. Olicker co-founded Aerogroup International, Inc. (Aerosoles), the footwear import and marketing firm, and previously also served as General Counsel and Licensing Business Director at El Greco Inc. - Candie's. Doug Jakubowski joined the Company as Senior Vice President of Kenneth Cole Reaction in July 2005. Prior to joining the Company, Mr. Jakubowski served as President of Perry Ellis Menswear from 2003 to 2005. From 1997 to 2003, he served as Executive Vice President of Merchandising and Design for Perry Ellis Sportswear. Prior to joining Perry Ellis, Mr. Jakubowski held the positions of Vice President of Sales and Marketing at International News, and Director of Marketing and Sales at Koral Industries. 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. Carol Sharpe joined the Company as Senior Vice President, Consumer Direct in July 2004. Ms. Sharpe was President of Retail at Donna Karan, Inc. from October 2002 to June 2004. From October 1989 to May 2002, Ms. Sharpe was at J. Crew where she held numerous positions, the last of which was Executive Vice President of Merchandising. Prior to that, she held the position of Divisional Merchandiser for Bloomingdale's, Chestnut Hill. Henrik Madsen joined the Company as Senior Vice President and General Manager of International Operations in January 2006. Prior to joining the Company, Mr. Madsen served as Chief Executive Officer and President of Kasper Europe Ltd., a subsidiary of Jones Apparel Group. Mr. Madsen has over 14 years of experience in the international fashion industry. Lori Wagner has served as Senior Vice President of Marketing since August 2001. Prior to joining the Company, Ms. Wagner spent 10 years at J. Crew Group in various visual and creative management marketing roles, the last of which was Senior Vice President Brand Creative. Linda Nash Merker joined the Company as Senior Vice President of Human Resources in May of 2004. Previously, she served as Senior Vice President of Human Resources at Perry Ellis from January 2002 to November 2003, and Senior Vice President of Human Resources at Loehmann's from 1994 until 2000. While at Macy's East from 1987 until 1994, Ms. Merker also held various positions, the last of which was Vice President of Human Resources - Merchandise Recruitment and Development. Martin E. Franklin has served as the Chairman and Chief Executive Officer of Jarden Corporation since September 2001, Director of FindSVP, Inc. since March 2003, and Director of Apollo Management, L.P. since April 2004. In addition, Mr. Franklin is a principal and executive officer of a number of private investment entities. Prior to this, Mr. Franklin served as Executive Chairman of Bolle Inc. from July 1997 to February 2000. He also held the position of Chairman and CEO of Lumen Technologies, Inc. (formerly BEC Group, Inc.) from May 1996 to December 1998, and its predecessor, Benson Eyecare Corporation, from October 1992 to May 1996. Mr. Franklin is currently a member of the Board of Directors of the Jewish Theological Seminary of America and One Family Fund, and other various charitable organizations. Robert C. Grayson is a partner in Berglass-Grayson, a management consulting and executive search firm. 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 1982 to 1985. He also serves as a director of Ann Taylor Corporation, Lillian August Inc., Urban Brands, and Know Fat. Denis F. Kelly is a Managing Partner of Scura, Rise & Partners, LLC. From July 1993 to December 2000, Mr. Kelly was the head of the Mergers and Acquisitions Department at Prudential Securities Incorporated. From 1991 to 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. Philip B. Miller is the principal of Philip B. Miller Associates, a consulting firm. Mr. Miller served as Chairman and Chief Executive Officer at Saks Fifth Avenue from 1993 to January 2000 and continued as Chairman until July 2001. Mr. Miller was formerly Chairman and Chief Executive Officer at Marshall Fields, joining that company in 1983 from Neiman Marcus, where he had been President since 1977. Prior to that, he served as Vice Chairman at Lord & Taylor and as Vice President and Merchandise Manager at Bloomingdales. Mr. Miller serves on the Board of Directors at Puig USA, St. John, DSW, and Tri-Artisan Partners. In addition, Mr. Miller also serves on the Board of Directors of the New York Botanical Gardens. Philip R. Peller was employed by Arthur Andersen LLP for 39 years. Prior to his retirement from Arthur Andersen in 1999, he served as Managing Partner of Practice Protection and Partner Matters for Andersen Worldwide SC, the coordinating entity for the activities of Arthur Andersen and Andersen Consulting, from 1996 to 1999. Prior to that appointment, Mr. Peller served as the Managing Director - Quality, Risk Management and Professional Competence for the worldwide audit practice. Mr. Peller joined Arthur Andersen in 1960 and was promoted to Audit Partner in 1970. Mr. Peller is a Certified Public Accountant. Mr. Peller is currently a member of the Board of Directors and Chair of the Audit Committee of MSC Industrial Direct Co., Inc. and serves as a consultant to other companies. Available Information The Company files its annual, quarterly and current reports and other information with the Securities and Exchange Commission. The Certifications required under Section 302 of the Sarbanes-Oxley Act of 2002 are filed as exhibits to the annual and quarterly reports on Form 10-K and Form 10-Q, respectively. In addition, the Company has provided the annual certification to the New York Stock Exchange. The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge in the "Investor" section under the subheading of "About Us" on the Company's website www.kennethcole.com. These reports, and any amendments to these reports, are made available on our website as soon as reasonably practicable after such reports are filed with or furnished to the Securities and Exchange Commission. The public may read and copy any materials filed by the Company with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding the Company, which is available at http://www.sec.gov. In addition, the Company's website, www.kennethcole.com, will include, free of charge, items related to corporate governance matters, including our Corporate Governance Guidelines, charters of various committees of our Board of Directors and our Code of Business Conduct and Ethics applicable to our employees, officers and directors. A printed copy of our Corporate Governance Guidelines and our Code of Business Conduct and Ethics is available without charge by sending a written request to: Investor Relations, Kenneth Cole Productions, Inc., 400 Plaza Drive, Secaucus, NJ 07094. Item 1A. Risk Factors The Company operates in a changing environment that involves numerous known risks and uncertainties that could materially adversely affect our operations. The risks described below highlight some of the factors that have affected and in the future could affect our operations. Additional risks we do not yet know or that we currently think are immaterial may also affect our business operations. If any of the events or circumstances described below actually occurs, our business, financial condition or results of operations could be materially adversely impacted. We may not be able to respond to changing fashion and consumer demands in a timely manner. The footwear, apparel and accessory industries are subject to changing consumer demands and fashion trends. The Company believes that its success depends in large part upon its ability to identify and interpret fashion trends and to anticipate and respond to such trends in a timely manner. The Company has generally been successful in this regard but there can be no assurance that the Company will be able to continue to meet changing consumer demands or to develop successful styles in the future. If the Company misjudges the market for a particular product or product line, it may result in an increased inventory of unsold and outdated finished goods, which may have an adverse effect on the Company's financial condition and results of operations. In addition, any failure by the Company to identify or respond to changing demands and trends could, in the long term, adversely affect consumer acceptance of the Company's brand names, which may have an adverse effect on the Company's business and prospects. The Company intends to market additional lines of footwear, apparel and fashion accessories in the future. As is typical with new products, demand and market acceptance for any new products introduce by the Company will be subject to uncertainty. Achieving market acceptance for each of these products may require substantial marketing efforts and the expenditure of significant funds to create customer demand. There can be no assurance that the Company's marketing effort will successfully generate sales or that the Company will have the funds necessary to undertake such an effort. Our sales are influenced by general economic cycles. Footwear, apparel and accessories are cyclical industries dependent upon the overall level of consumer spending. Our customers anticipate and respond to adverse changes in economic conditions and uncertainty by reducing inventories and canceling orders. As a result, any substantial deterioration in general economic conditions, increases in energy costs or interest rates, acts of nature or political events that diminish consumer spending and confidence in any of the regions in which we compete, could reduce our sales and adversely affect our business and financial condition. The footwear, apparel and accessory industries are highly competitive. Any increased competition could result in reduced sales or margins. Competition in the footwear, apparel and accessory industries is intense. The Company's products compete with other branded products within their product categories as well as with private label products sold by retailers, including some of the Company's customers. In varying degrees, depending on the product category involved, the Company competes on the basis of style, price, quality, comfort and brand prestige and recognition, among other considerations. The Company also competes with numerous manufacturers, importers and distributors of footwear, apparel and accessories for the limited shelf-space available for the display of such product to the consumer. Moreover, the general availability of contract manufacturing capacity allows ease of access by new market entrants. Some of the Company's competitors are 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 loss of any of our largest customers could have a material adverse effect on our financial results. Although currently no customer comprises more than ten percent of our customer base, should one of our larger customers be negatively impacted, it could adversely affect our business. In recent years the retail industry has experienced consolidation and other ownership changes. In the future, retailers may have financial problems or consolidate, undergo restructurings or reorganizations, or realign their affiliations, any of which could further increase the concentration of our customers. The loss of any of our largest customers, or the bankruptcy or material financial difficulty of any customer, could have a material adverse effect on our business. We do not have long-term contracts with any of our customers, and sales to customers generally occur on an order-by-order basis. As a result, customers can terminate their relationships with us at any time or under certain circumstances cancel or delay orders which could reduce our sales and adversely affect our business condition. The success of our business depends on our ability to attract and retain key employees. The Company is heavily dependent on its current executive officers and management. The loss of any of our executive officers or management, including but not limited to, Kenneth Cole, or the inability to attract and retain qualified personnel could delay the development and introduction of new products, harm our ability to sell products, damage the image of our brands and/or prevent us from executing our business strategy. Imposition of quotas and fluctuations in exchange rates could increase our costs and impact our ability to source goods. The Company's business is subject to risks of doing business abroad, including, but not limited to, fluctuations in exchange rates and the imposition of additional regulations relating to imports, including quotas, duties, taxes and other charges on imports. In order to reduce the risk of exchange rate fluctuations, the Company often enters into forward exchange contracts to protect the purchase price under its agreements with its manufacturers or purchases products in United States dollars. The Company cannot fully anticipate all of its currency needs and, therefore, cannot fully protect against the effect of such fluctuations. Although the majority of the goods sold 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 and the United States may impose new duties, tariffs and other restrictions on imported products, any of which could adversely affect the Company's operations and its ability to import its products at the Company's current or increase quantity levels. Other restrictions on the importation of footwear and the Company's other products are periodically considered by the United States Congress and no assurances can be given that tariffs or duties on the Company's goods may not be raised. If tariffs are raised in the future, they will result in higher costs to the Company, and if import quotas are imposed or made more restrictive, the Company may not be able to source its goods at historical factories or at similar prices. The voting shares of the Company's stock are concentrated in one majority shareholder. Currently, Kenneth D. Cole owns approximately 87% of the voting power and approximately 42% of the outstanding common stock of the Company. As a result, Mr. Cole has the ability to control (i) the election of all of the Company's directors other than the directors who will be elected by the holders of Class A Common Stock, voting separately as a class, and (ii) the results of all other shareholder votes. Mr. Cole's interests may differ from the interests of the other stockholders. War and acts of terrorism could affect our ability to procure, sell and deliver product. In the event of war or acts of terrorism or the escalation of existing hostilities, or if any are threatened, our ability to procure our products from our manufacturers for sale to our customers may be negatively affected. We import a substantial portion of our products from other countries. If it becomes difficult or impossible to import our products into the countries in which we sell our products, our sales and profit margins may be adversely affected. Additionally, war, military responses to future international conflicts and possible future terrorist attacks may lead to a downturn in the U.S. and/or international economies, which could have a material adverse effect on our results of operations. Our business is subject to risks associated with sourcing outside the United States. Substantially all of our apparel products are produced by independent manufacturers. We face the risk that these third-party manufacturers with whom we contract to produce our products may not produce and deliver our products on a timely basis, or at all. We cannot be certain that we will not experience operational difficulties with our manufacturers, such as reductions in the availability of production capacity, errors in complying with product specifications, insufficient quality control, and failures to meet production deadlines or increases in manufacturing costs. The failure of any manufacturer to perform to our expectations could result in supply shortages for certain products and harm our business. In addition, our foreign manufactures may be adversely effected by addition factors such as: political instability in countries where contractors and suppliers are located; imposition of regulations and quotas relating to imports; imposition of duties, taxes and other charges on imports; significant fluctuation of the value of the dollar against foreign currencies; and restrictions on the transfer of funds to or from foreign countries. The capacity of our manufacturers to manufacture our products also is dependent, in part, upon the availability of raw materials. Our manufacturers may experience shortages of raw materials, which could result in delays in deliveries of our products by our manufacturers or in increased costs to us. Any shortage of raw materials or inability of a manufacturer to manufacture or ship our products in a timely manner, or at all, could impair our ability to ship orders of our products in a cost-efficient, timely manner and could cause us to miss the delivery requirements of our customers. As a result, we could experience cancellations of orders, refusals to accept deliveries or reductions in our prices and margins, any of which could harm our financial performance and results of operations. We rely on licensees for revenues, supply of products and compliance with Company standards. We license our trademarks to third parties for manufacturing, marketing, distribution and sale of various products and intend to expand our licensing programs. While we enter into comprehensive licensing agreements with our licensees covering product design, product quality, sourcing, manufacturing, marketing and other requirements, our licensees may not comply fully with those agreements. Non-compliance could include marketing products under our brand names that do not meet our quality and other requirements or engaging in manufacturing practices that do not meet our supplier code of conduct. These activities could harm our brand equity, our reputation and our business. In addition, our results could be affected by the results of our licensees or distributors. The financial difficulties of any of our partners or their failure to produce and deliver acceptable product could have an adverse impact on our business in the future. In the event of a business failure of any such partner or of the breakdown of our relationship with any domestic or foreign partner, there is no guarantee that the Company could replace such business. Failure to anticipate and maintain proper inventory levels could have an adverse financial effect on our business. We maintain an inventory of selected products that we anticipate will be in high demand. We may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory. Inventory levels in excess of customer demand may result in inventory write-downs or the sale of excess inventory at discounted or closeout prices. These events could significantly harm our operating results and impair the image of our brands. Conversely, if we underestimate consumer demand for our products or if manufacturers fail to supply quality products in a timely manner, we may experience inventory shortages, which may result in unfilled orders, negatively impact customer relationships, diminish brand loyalty and result in lost revenues. We rely on third parties for distribution and warehousing. We rely on warehousing and distribution facilities in California and New Jersey. Any disruption at either of these facilities due to fire, earthquake, flood, terrorist attack or any other natural or manmade cause, including operational or financial hardship of the provider, could damage a portion of our inventory or impair our ability to use our warehousing and distribution facilities. In addition, we will be transitioning the facilities in California during the first quarter of 2006, and although we are working closely with both current and former providers, we may incur slight delays in product shipments as a result of the transition. Any of these occurrences could impair our ability to adequately supply our customers and negatively impact our operating results. Outcomes of litigation or changes in regulatory control could impact our financial condition. From time to time, we may be a party to lawsuits and regulatory actions relating to our business. Due to the inherent uncertainties of litigation and regulatory proceedings, we cannot accurately predict the ultimate outcome of any such proceedings. An unfavorable outcome could have a material adverse impact on our business, financial condition and results of operations. In addition, regardless of the outcome of any litigation or regulatory proceedings, such proceedings could result in substantial costs and may require that we devote substantial resources to defend the Company. Further, changes in government regulations both in the United States and in the countries in which we operate could have adverse affects on our business and subject us to additional regulatory actions. The loss or infringement of our trademarks and other proprietary rights could have a material adverse effect on our operations. We believe that our trademarks and other proprietary rights are important to our success and competitive position. Accordingly, we devote substantial resources to the establishment and protection of our trademarks on a worldwide basis. There can be no assurances that such actions taken to establish and protect our trademarks and other proprietary rights will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as violative of their trademarks and proprietary rights. Moreover, there can be no assurances that others will not assert rights in, or ownership of, our trademarks and other proprietary rights or that we will be able to successfully resolve such conflicts. In addition, the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States. Any litigation regarding our trademarks could be time consuming and costly, and the loss of such trademarks and other proprietary rights, or the loss of the exclusive use of such trademarks and other proprietary rights, could have a material adverse effect on our operations. Implementation of management information systems may impact our financial results. In 2006 and over the next few years we plan to implement SAP information management software in our retail operations. The implementation of such software could be delayed and we may encounter computer and operational complications in connection with such implementation that could have a material adverse effect on our business, financial condition or results of operations. Difficulties migrating existing systems to the new software could impact our ability to design, produce and ship our products on a timely basis. Seasonality of our business and the timing of new store openings could result in fluctuations in our financial performance. Our business is subject to seasonal fluctuations. Historically, fourth quarter's sales are typically higher due to holiday business. Therefore, results of operations for any single quarter are not necessarily indicative of the results that may be achieved for a full fiscal year. Quarterly results have been, and in the future will continue to be, significantly impacted by the timing of new store openings and their respective pre-opening costs. Adverse publicity could negatively affect public perception of the brand. Our results could be substantially affected by adverse publicity resulting from our products or our advertising. Our expectations of growth anticipate new store openings which are subject to many factors beyond our control. Future growth in sales and profits in our Consumer Direct division will depend to some extent on our ability to increase the number of our stores. The lease negotiation and development timeframes vary from location to location and can be subject to unforeseen delays. The number and timing of new stores actually opened during any given period, and their associated contribution to operating week growth for the period, will depend on a number of factors including, but not limited, to: (1) the identification and availability of suitable locations and leases; (2) the availability of suitable financing to us and our landlords; (3) the timing of the delivery of the leased premises to us from our landlords in order to commence build-out construction activities; (4) the ability of us and our landlords to obtain all necessary governmental licenses and permits to construct and operate our restaurants on a timely basis; (5) our ability to manage the construction and development costs of new restaurants, and the availability and/or cost of raw materials; (6) the rectification of any unforeseen engineering or environmental problems with the leased premises; (7) adverse weather during the construction period; and (8) the hiring and training of qualified operating personnel in the local market. Any of the above factors could have a material adverse impact on our financial condition. Item 1B. Unresolved Staff Comments None. Item 2. Properties The Company currently occupies 119,500 square feet at its worldwide corporate headquarters, located at 603 West 50th Street, New York, New York. In April 2004, the Company entered into an agreement to purchase this office building for $24 million. The closing date is scheduled for approximately May 2006. The specific timing will be determined by both parties, based on the ability of the current landlord to satisfy certain terms and conditions. The Company also holds a lease for its former executive offices and showrooms, which expires in December 2006, and is currently under a subtenant lease agreement, which also expires in December 2006. In 2004, the Company entered into a new 10-year lease for 51,000 square feet of office space in Secaucus, New Jersey for its administrative offices and completed the move in June 2004. The former distribution facility was moved to a third-party public warehouse and distribution center in New Jersey. In addition to these two leases, the Company also leases a 23,500 square foot facility in Secaucus used for outlet store space as well as an additional distribution warehousing facility. The Company also has a technical and administrative office in Florence, Italy, and the Company opened a similar office in China in 2005. The Company does not own or operate any manufacturing facilities. As of December 31, 2005, the Company leased space for all of its 53 specialty retail stores (aggregating approximately 243,000 square feet) and 39 outlet stores (aggregating approximately 200,000 square feet). Generally, the leases provide for an initial term of five to ten years and certain leases provide for renewal options permitting the Company to extend the term thereafter. Item 3. Legal Proceedings In April 2005, a purported class action lawsuit was filed against the Company in the Superior Court of California for the County of San Diego. The individual plaintiff is a floor supervisor in one of the Company's retail stores who purports to bring suit on behalf of him and other similarly situated current and former floor supervisors. Among other claims, the plaintiff alleges that he and other floor supervisors worked hours for which they were entitled to receive, but did not receive, overtime compensation under California law. The lawsuit seeks damages, penalties, restitution, equitable relief, interest and attorneys' fees and costs. The Company denies the allegations in the complaint and plans to defend the action vigorously. The Company does not believe the outcome will have a material adverse effect on its business operations. In September 2004, a purported class action lawsuit was filed against the Company in the Superior Court of California for the County of Los Angeles. The individual plaintiffs are current or former store managers or assistant managers who purport to bring suit on behalf of themselves and other similarly situated store managers and assistant managers. Among other claims, the plaintiffs allege that they worked hours for which they were entitled to receive, but did not receive, overtime compensation under California law. The lawsuit sought damages, penalties, restitution, reclassification and attorneys' fees and costs. The Company reached an agreement in principle to settle the matter, and in January 2006, the parties filed a fully executed Stipulation of Class Settlement and Release. In addition, the Court signed and entered an order granting preliminary approval to the settlement. The settlement provides for a maximum settlement of $900,000, including all payments to class members, incentive awards, attorney's fees and administration costs. While there is still uncertainty relating to the ultimate settlement amount, the Company believes that its reserves as of December 31, 2005 are adequate. The Company is, from time to time, a party to other litigation that arises in the normal course of its business operations. The Company is not presently a party to any other litigation that it believes might have a material adverse effect on its business operations. Item 4. Submission of Matters to a Vote of Security Holders None. PART II Item 5. Market for Registrant's Common Equity, Related Shareholder Matters, and Issuer Purchases of Equity Securities The Company's Class A Common Stock is listed and traded (trading symbol: KCP) on the New York Stock Exchange ("NYSE"). On March 1, 2006 the closing sale price for the Class A Common Stock was $27.48. The following table sets forth the high and low closing sale prices for the Class A Common Stock for each quarterly period for 2005 and 2004, as reported on the NYSE Composite Tape:
2005: High Low First Quarter 31.30 25.90 Second Quarter 32.32 28.09 Third Quarter 35.29 26.30 Fourth Quarter 29.60 23.81
2004: High Low First Quarter 36.62 29.15 Second Quarter 36.91 31.64 Third Quarter 34.60 26.98 Fourth Quarter 31.03 25.30
The number of shareholders of record of the Company's Class A Common Stock on March 1, 2006 was 64. There were 7 holders of record of the Company's Class B Common Stock on March 1, 2006. There is no established public trading market for the Company's Class B Common Stock. Dividend Policy The payment of any future dividends will be at the discretion of the Company's Board of Directors and will depend, among other things, upon, future earnings, operations, capital requirements, proposed tax legislation, the financial condition of the Company and general business conditions. The Company established a quarterly dividend policy in 2003 and made the following dividend payments to shareholders on record as of the close of business on the dates noted during the fiscal years ended December 31, 2005 and December 31, 2004: $0.18 per share November 23, 2005 $0.16 per share August 25, 2005 $0.16 per share May 24, 2005 $0.16 per share March 9, 2005 $0.14 per share November 24, 2004 $0.14 per share August 24, 2004 $0.12 per share May 24, 2004 $0.12 per share March 9, 2004 On March 1, 2006, the Board of Directors declared a quarterly cash dividend of $0.18 per share, payable on March 30, 2006, to shareholders of record at the close of business on March 9, 2006. The Company had the following securities authorized for issuance under equity compensation plans as of December 31, 2005: Plan Category Number of Weighted-average Number of securities securities to exercise price remaining available be issued upon of outstanding for future issuance exercise of options, warrants, under equity outstanding and rights compensation plans options, (excluding securities warrants, and reflected in rights column (a)) (a) (b) (c) Equity 2,600,717 $23.64 1,486,855 compensation plans approved by security holders Equity N/A N/A N/A compensation plans not approved by security holders 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. (Amounts, except for per share amounts, are in thousands.)
2005 2004 2003 2002 2001 Income Statement Data: Net sales $474,060 $473,438 $430,101 $404,336 $365,809 Royalty revenue 43,983 42,763 38,252 28,713 22,116 Net revenue 518,043 516,201 468,353 433,049 387,925 Cost of goods sold 283,727 284,817 258,457 235,255 217,221 Gross profit (2) 234,316 231,384 209,896 197,794 170,704 Selling and general administrative expenses (1) 188,953 174,519 157,824 152,618 145,919 Impairment of long- lived assets -- 448 1,153 4,446 -- Operating income 45,363 56,417 50,919 40,730 24,785 Interest and other income, net 4,151 1,411 825 1,102 2,135 Income before provision for income taxes 49,514 57,828 51,744 41,832 26,920 Provision for income Taxes 15,988 21,976 19,145 15,687 10,304 Net income 33,526 35,852 32,599 26,145 16,616 Earnings per share: Basic $1.69 $1.79 $1.66 $1.33 $.83 Diluted $1.65 $1.74 $1.59 $1.27 $.80 Weighted average shares outstanding: Basic 19,888 20,050 19,609 19,643 19,992 Diluted 20,318 20,652 20,486 20,590 20,745 Cash dividends per share $0.66 $0.52 $0.17 -- --
2005 2004 2003 2002 2001 Balance Sheet Data: Working capital $187,106 $173,007 $154,161 $124,103 $96,709 Cash 63,747 80,014 111,102 91,549 68,966 Marketable Securities 66,400 40,000 -- -- -- Inventory 45,465 47,166 44,851 43,724 30,753 Total assets 340,671 304,587 273,841 240,317 201,889 Total debt, including current maturities 3,000 -- -- 171 383 Total shareholders' equity 244,660 216,528 196,334 164,902 140,894
(1) Includes warehousing and receiving expenses. (2) Gross profit may not be comparable to other entities, since some entities include the costs related to their distribution network (receiving and warehousing) in cost of goods sold and other entities, similar to the Company, exclude these costs from gross profit, including them instead in a line item such as selling, general and administrative expenses. 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. Overview Kenneth Cole Productions, Inc., 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, Unlisted, Bongo, and Tribeca brand names. The Company's products are targeted to appeal to fashion conscious consumers, reflecting a casual urban perspective and a contemporary lifestyle uniquely associated with Kenneth Cole. The Company markets its products to more than 6,000 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 interactive websites, including online e-commerce. The popularity of the Kenneth Cole brand names among consumers has enabled the Company to expand its product offerings and channels of distribution through licensing agreements and offers through these agreements a lifestyle collection of men's product categories including tailored clothing, dress shirts, dress pants, sportswear, neckwear, briefcases, portfolios, jewelry, fragrance, belts, leather and fabric outerwear, swimwear, sunglasses, prescription eyewear, watches, fragrance, swimwear, luggage, hosiery and small leather goods. Women's product categories currently being sold pursuant to license agreements include sportswear, small leather goods, belts, scarves and wraps, hosiery, leather and fabric outerwear, sunglasses, prescription eyewear, watches, jewelry, fragrance, swimwear, and luggage. In addition, the Company licenses boys' and girls' apparel, as well as housewares, under the Kenneth Cole Reaction brand. The Company recorded record revenues of $518.0 million for the year ended December 31, 2005. Diluted earnings per share decreased 5.2% to $1.65 from $1.74 year over year. The Company's revenues for the year have improved over the prior year, primarily due to new product selection at retail, and continued success in a wide variety of licensed product classifications. The Company's Balance Sheet remains strong with $130.1 million in cash and marketable securities. Additionally, the Company expects to continue its quarterly cash dividend, currently set at $0.18. The Company continued its new strategic initiative to reposition the Kenneth Cole New York brand as an accessible luxury brand. The Company believes that the repositioning of this brand will take the Company to its next stage of development, which will place the Company in the best position to benefit from the consolidation in the retail marketplace, maximize its own retail store concept and grow internationally. While this will enable the Company's brands to reach their potential, it will take time to fully transition the brand and realize the full financial benefits. As such, the Company continues to focus on designing and delivering high quality, fashionable products, creating efficient and compelling retail environments, and maintaining close partnerships with its licensees to ensure brand quality and distribution integrity. Critical Accounting Policies and Estimates General The Company's management's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to product returns, bad debts, inventories, income taxes, financing operations, contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. Inventory The Company writes down its inventory for estimated obsolescence equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. Sales Returns and Allowances The Company's ability to collect factor chargebacks for deductions taken by its customers for returns, discounts, and allowances as well as potential future customer deductions is significant to its operations. The Company reserves against known chargebacks as well as potential future customer deductions based on a combination of historical activity and current market conditions. Actual results may differ from these estimates under different assumptions or conditions, which may have a significant impact on the Company's results. Allowance for Doubtful Accounts The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments, as well as royalties and advertising revenues from its licensing partners. These customers include non- factored accounts and credit card receivables from third party service providers. If the financial conditions of these customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Income Taxes The Company's income taxes are routinely under audit by federal, state, or local authorities. These audits include questioning of the timing and amount of deductions and the allocation of income among various tax jurisdictions. Based on its annual evaluations of tax positions, the Company believes it has appropriately accrued for probable exposures. To the extent the Company is required to pay amounts in excess of recorded income tax liabilities, the Company's effective tax rate in a given financial statement period could be materially impacted. Litigation The Company is periodically involved in various legal actions arising in the normal course of business. Management is required to assess the probability of any adverse judgements as well as the potential range of any losses. Management determines the required accruals after a careful review of the facts of each significant legal action. The Company's accruals may change in the future due to new developments in these matters. Contingencies In the ordinary course of business, the Company is involved in and subject to compliance and regulatory reviews and audits by numerous authorities, agencies and other governmental agents and entities from various jurisdictions. The Company is required to assess the likelihood of any adverse outcomes of these matters. A determination of the amount of reserves required, if any, for these reviews is made after careful analysis of each individual issue. The reserves may change in the future due to new developments or final resolution in each matter, which may have a significant impact on the Company's results. New Accounting and Tax Pronouncements In 2004, Internal Revenue Code Section 965 was enacted, as part of the American Jobs Creation Act. This is a temporary provision that allows U.S. companies to repatriate earnings from their foreign subsidiaries at a reduced tax rate provided that specified conditions and restrictions are satisfied. In addition, FASB Staff Position FAS 109-2 was issued to provide accounting and disclosure guidance relating to the repatriation provision. In 2005, the Company's Board of Directors approved and adopted a repatriation plan and, as such, the Company repatriated $12.5 million of unremitted foreign earnings, which resulted in a tax benefit of approximately $3.0 million for the year ended December 31, 2005, as a result of the Company providing for taxes for the foreign earnings at the prior statutory rate. In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, "Inventory Costs - An Amendment of ARB No. 43, Chapter 4" ("SFAS 151"). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing", to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS 151 is effective for fiscal years beginning after June 15, 2005 and, as such, the Company adopted SFAS 151 on January 1, 2006. The adoption of SFAS 151 did not have a material impact on the Company's consolidated results of operations, financial position, or cash flows. In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R, "Share-based Payments" ("SFAS 123R") which supersedes APB Opinion No. 25. SFAS 123R requires all share- based payments, including grants of employee stock options, to be recognized in the financial statements based on their fair values. Under SFAS 123R, public companies will be required to measure the cost of services received in exchange for stock options and similar awards based on the grant-date fair value of the award and recognize this cost in the income statement over the period during which an award recipient is required to provide service in exchange for the award. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition methods include modified prospective and retroactive adoption options. The Company adopted SFAS 123R on January 1, 2006 using the modified prospective method. Under this method, the Company will recognize compensation cost, on a prospective basis, for the portion of outstanding awards for which the requisite service has not yet been rendered as of January 1, 2006, based upon the grant-date fair value of those awards calculated under SFAS 123 for pro forma disclosure purposes. Earnings and diluted earnings per share are expected to decrease by approximately $5.4 million and $0.16, respectively, as a result of share-based grants in 2006, and those grants as of December 31, 2005 for which compensation expense has not been recognized under SFAS 123. Also in December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets-An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions ("SFAS 153"). SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, Accounting for Nonmonetary Transactions, and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The adoption of SFAS 153 on January 1, 2006, did not have a material impact on the Company's consolidated results of operations or financial condition. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections," ("SFAS 154"), a replacement of Accounting Principles Board Opinion (APB) No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements." This Statement requires retrospective application to prior periods' financial statements of a change in accounting principle. It applies both to voluntary changes and to changes required by an accounting pronouncement if the pronouncement does not include specific transition provisions. APB 20 previously required that most voluntary changes in accounting principles be recognized by recording the cumulative effect of a change in accounting principle. SFAS 154 is effective for fiscal years beginning after December 15, 2005. The Company adopted this statement on January 1, 2006, and does not anticipate that it will have a material effect on the Company's consolidated results of operations, financial position, or cash flows. In March 2005, the Financial Accounting Standards Board issued FASB Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations ("FIN 47"). FIN 47 is an interpretation of Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"), and clarifies the term conditional asset retirement obligation as used in SFAS 143, which refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, the Company is required to identify any conditional asset retirement obligations it may have with respect to its long-lived assets, and recognize a liability for the fair value of any conditional asset retirement obligations, if the fair value of the liability can be reasonably estimated. FIN 47 is effective for the fiscal year ending December 31, 2005. As such, the Company adopted FIN 47 in 2005, which did not impact the Company's results of operations, financial position, or cash flows. 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:
2005 2004 2003 Net sales 91.5% 91.7% 91.8% Royalty revenue 8.5 8.3 8.2 --- --- --- Net revenues 100.0 100.0 100.0 Cost of goods sold 54.8 55.2 55.2 --- --- --- Gross profit (1) 45.2 44.8 44.8 Selling, general and administrative expenses 36.5 33.8 33.7 Impairment of long-lived assets 0.0 0.1 0.2 Operating income 8.7 10.9 10.9 Income before provision for income taxes 9.6 11.2 11.1 Provision for income taxes 3.1 4.3 4.1 --- --- --- Net income 6.5% 6.9% 7.0%
(1) Gross profit may not be comparable to other entities, since some entities include the costs related to their distribution network (receiving and warehousing) in cost of goods sold and other entities, similar to the Company, exclude these costs from gross profit, including them instead in a line item such as selling, general and administrative expenses. Year Ended December 31, 2005 Compared to Year Ended December 31, 2004 Net revenues increased $1.8 million, or 0.4%, to $518.0 million in 2005 from $516.2 million in 2004. This increase was due to revenue increases in the Company's Wholesale and Licensing business segments, partially offset by decreases in the Company's Consumer Direct business. Wholesale net sales (excluding sales to the Consumer Direct business segment) increased $4.6 million, or 1.6%, to $284.0 million in 2005 from $279.4 million in 2004. The increase was primarily attributable to a 23.9% increase in Kenneth Cole Reaction ladies' and children's footwear, and an approximate 9.0% growth across its handbags businesses, as compared to December 31, 2004. This growth was offset by decreases of 15.8% in Kenneth Cole New York men's and women's footwear, and 11.7% in Unlisted footwear categories. In 2005, the Company accelerated its strategic initiative to reposition the Kenneth Cole New York brand as an accessible luxury brand and reduce the number of doors it was willing to distribute to. The Company believes that this transition is necessary to improve the Company's Wholesale net sales. The Company will continue to focus on improving product offerings, advertising campaigns, marketing efforts, website, catalogs and growing retail presence, combined with the marketing efforts of its licensees, which it believes will be significant factors in strengthening and defining all of its distinct brands, including Kenneth Cole Reaction, Tribeca, and Bongo across all product classifications, thereby increasing consumer demand for these brands in the future. Net sales in the Company's Consumer Direct segment decreased $3.9 million, or 2.0%, to $190.1 million in 2005 from $194.0 million in 2004. The decrease was primarily due to a decrease in retail store sales of $5.4 million, or 2.9%, as compared to year ended December 31, 2004. Comparable store sales decreased by $13.2 million, or 7.5%, offset by an increase of $7.8 million of new store sales in 2005 plus the portion of 2005 sales for stores not open for all of 2004. In addition, the retail store sales decline was offset by Catalog/Internet and Gift Program sales, which increased by 21.5% for the year ended December 31, 2005. The Company believes the decrease in net sales in the Consumer Direct segment is primarily due to the Company's repositioning of the Kenneth Cole New York brand in its retail stores, which was accelerated in 2005. The Company believes well-executed Kenneth Cole New York products will be embraced by its customers, as illustrated by the success of the Kenneth Cole New York handbags business. However, some of the other products were not as well executed, and did not provide the consumer with the Company's highest standard of price and value, and were not well received. The Company is focusing on the design, price and value of its Kenneth Cole New York products for 2006. In an effort to maintain, solidify, and build positive sales results, the Company will continue to analyze inventory, focus on products and further scrutinize consumer trends, as well as concentrate on quality, style and price to continue customer acceptance of its brand repositioning strategy. Royalty revenue increased $1.2 million, or 2.8%, to $44.0 million in 2005 from $42.8 million in 2004. The increase was primarily from incremental minimum royalties from the Company's existing licensees, sales increases from fragrance and children's apparel, and its European licensee, offset by a reduction in minimum royalties from the transition of the women's sportswear licensee. Brand repositioning has slowed growth in 2005, as a result of the Company's strategic plan. However, the Company believes consumers look toward brands they know and feel are compatible with their lifestyles; therefore 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 strengthen and define its brands to improve name recognition allowing growth in sales both domestically and internationally throughout 2006. Consolidated gross profit increased to 45.2% in 2005, as a percentage of net revenues, compared to 44.8% in 2004. The increase was primarily a result of an improvement in Consumer Direct margins and the change in mix of the Company's net revenues from its Wholesale, Consumer Direct and Licensing segments. The Consumer Direct segment's revenues decreased as a percentage of net revenues, to 36.7%, for the year ended December 31, 2005, from 37.6% for the year ended December 31, 2004, while the revenues in the Wholesale segment, which operates at a lower gross profit percentage as compared to the Consumer Direct segment, increased as a percentage of net revenues to 54.8% for the year ended December 31, 2005, compared to 54.1% for the year ended December 31, 2004. The revenues in the Licensing segment, which carries no cost of goods sold, increased as a percentage of revenue to 8.5% from the year ended December 31, 2005 compared to 8.3% for the year ended December 31, 2004. Consumer Direct segment margins increased from higher price points on better quality products, as part of the Company's strategic initiative to reposition Kenneth Cole New York as an accessible luxury brand. Selling, general and administrative expenses, including warehousing and receiving expenses ("SG&A"), increased $14.5 million, or 8.3%, to $189.0 million (or 36.5% of net revenues) in 2005 from $174.5 million (or 33.8% of net revenues) in 2004, which includes severance costs of approximately $0.8 million in 2005. SG&A, as a percentage of net revenues, increased primarily due to investments in people and systems, increases in fixed costs from new and expanding retail stores, and the Company's loss of leverage on its comparable stores' sales base. Included within SG&A for the year ended December 31, 2004 was a one-time cost of $1.1 million associated with the closing and transition of the Company's east cost distribution center to a third-party service provider. The Company did not record asset impairment charges for the year ended December 31, 2005, as compared to the year ended December 31, 2004, in which the Company recorded approximately $0.5 million for the write-down of stores' leasehold improvements, furniture, and fixtures in the Company's Florida Mall store, located in Orlando, Florida and the Lexington Avenue store located in New York City. Interest and other income increased to $4.2 million for the year ended December 31, 2005 from $1.4 million in 2004. The increase was primarily due to a $1.2 million gain on the sale of marketable securities during the year ended December 31, 2005 and an average higher rate of return on investments. The Company's effective tax rate decreased to 32.3% for the year ended December 31, 2005 from 38.0% for the year ended December 31, 2004, as a result of a temporary provision that allows U.S. companies to repatriate earnings from their foreign subsidiaries at a reduced tax. The Company repatriated approximately $12.5 million of prior years' foreign earnings, which resulted in approximately $3.0 million in tax savings for the year ended December 31, 2005. As a result of the foregoing, net income decreased by $2.4 million, or 6.7%, to $33.5 million (6.5% of net revenue), for the year ended December 31, 2005, from $35.9 million (6.9% of net revenue). Year Ended December 31, 2004 Compared to Year Ended December 31, 2003 Net revenues increased $47.8 million, or 10.2%, to $516.2 million in 2004 from $468.4 million in 2003. This increase was due to revenue increases in each of the Company's business segments: Wholesale, Consumer Direct and Licensing. Wholesale net sales (excluding sales to the Consumer Direct business segment) increased $24.8 million, or 9.7%, to $279.4 million in 2004 from $254.6 million in 2003. This increase was attributable to improved sales across the Company's footwear brands: Kenneth Cole New York, Kenneth Cole Reaction, Bongo licensed footwear and the handbag businesses. This growth was offset by a 15.6% decline in Unlisted footwear. The Company believes that selling products under these trademark names, among others, to multiple demographics through several distribution channels has improved the Company's wholesale net sales. In addition, the improvement of sell-thrus at retail from customer acceptance also contributed to the increase, as well as the Company's initiatives in repositioning its handbag businesses. The Company will continue to focus on improving product offerings, advertising campaigns, marketing efforts, website, catalogs and growing retail presence, combined with the marketing efforts of its licensees, which it believes will be significant factors to strengthen and define its distinct brands, Kenneth Cole New York, Kenneth Cole Reaction, Unlisted and Bongo across all product classifications, thereby increasing consumer demand for the Company's brands in the future. In addition, the Company believes that the launch of Tribeca will also contribute to the Company's growth. Net sales in the Company's Consumer Direct segment increased $18.4 million, or 10.5%, to $194.0 million in 2004 from $175.6 million in 2003. Of the total increase, $10.7 million was attributable to new store sales in 2004 plus that portion of 2004 sales for stores not open for all of 2003, as well as an increase of $4.6 million or 2.8% in comparable store sales. The remaining sales increase of $3.1 million was primarily derived from the Company's Corporate Gift Program. The Company believes the increase in net sales in the Consumer Direct segment is due in part to the economic strengthening generally seen throughout the retail and apparel industry and direct merchandising initiatives at its outlets. In an effort to maintain, solidify, and build on the positive sales results, the Company will continue to analyze inventory, focus on products and further scrutinize consumer trends. Royalty revenue increased $4.6 million, or 12.0%, to $42.8 million in 2004 from $38.2 million in 2003. The increase was primarily from incremental minimum royalties from the Company's existing licensees, most significantly women's apparel and fragrance, and from the Company's new men's casual pants licensee. This was offset by a decrease in royalties from the men's sportswear licensee. The Company believes consumers look toward brands they know and feel are compatible with their lifestyles. Therefore, 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 strengthen and define the Company's brands to improve name recognition allowing growth in sales both domestically and internationally through license partners. Consolidated gross profit remained at 44.8%, as a percentage of net revenues, in 2004 and 2003. This was primarily a result of an increase in the percentage of revenue and higher margins contributed by the Consumer Direct segment, offset by decreased margins within the Wholesale segment. The Consumer Direct segment increased as a percentage of net revenues, to 37.6%, for the year ended December 31, 2004, from 37.5% for the year ended December 31, 2003, while the wholesale segment, which operates at a lower gross profit percentage, decreased as a percentage of net revenues to 54.1% for the year ended December 31, 2004, compared to 54.3% for the year ended December 31, 2003. Consumer Direct segment margins increased from merchandising initiatives at its outlet stores, new assortments, which focus on wear-now products that limit vulnerability of the mix of products without compromising fashion and excitement, and a reduction of point of sale promotions. Wholesale segment margins were lower from the impact the Euro had on the US dollar, which reduced initial mark-ups in the segment during the first half of 2004. SG&A increased $16.7 million, or 10.6%, to $174.5 million (or 33.8% of net revenues) in 2004 from $157.8 million (or 33.7% of net revenues) in 2003. SG&A increased slightly as a percentage of net revenues, primarily due to professional fees from the implementation and compliance with the Sarbanes-Oxley Act of 2002 and higher labor costs in the Company's Wholesale and Licensing business segments. The Company recorded asset impairment charges of approximately $0.5 million and $1.2 million for the years ended December 31, 2004 and 2003, respectively, for the Company's Florida Mall store, located in Orlando, Florida and the Lexington Avenue store located in New York City. This asset impairment charge equaled 0.1% of net revenues for the year ended December 31, 2004 and 0.2% of net revenues for the year ended December 31, 2003, and is included as a separate item in the Consolidated Statement of Income, within operating income. The impairment related to the write-down of the stores' leasehold improvements, furniture, and fixtures. Interest and other income increased to $1.4 million for the year ended December 31, 2004 from $0.8 million in 2003. The increase is the result of higher average cash balances. In addition, average short-term interest rates have increased throughout 2004 improving investment rates of returns. The Company's effective tax rate increased to 38.0% for the year ended December 31, 2004 from 37.0% for the year ended December 31, 2003. The increase was a result of changes in tax laws from state and local jurisdictions to which the Company's earnings are subject. As a result of the foregoing, net income increased $3.3 million, or 10.0%, to $35.9 million (6.9% of net revenue), which includes an asset impairment charge of $0.5 million for the year ended December 31, 2004, from $32.6 million (7.0% of net revenue), which included an asset impairment charge of $1.2 million, for the year ended December 31, 2003. Liquidity and Capital Resources The Company's cash requirements are generated primarily from working capital needs, retail expansion, enhanced technology, and other corporate activities. The Company primarily relies upon internally generated cash flows from operations to finance its operations and growth; however, it also has the ability to borrow up to $25.0 million under its line of credit. Cash flows may vary from time to time as a result of seasonal requirements of inventory, the timing of the delivery of merchandise to customers and the level of accounts receivable and payable balances. At December 31, 2005, working capital was $187.1 million compared to $173.0 million at December 31, 2004. Net cash provided by operating activities was $33.9 million for the year ended December 31, 2005 compared to $37.9 million for the year ended December 31, 2004. This decrease was primarily attributable to decrease in net income offset by the benefit for deferred taxes from the dividend repatriation resulting from the American Jobs Creations Act, as well as the timing of receivables and payables from operations. Net cash used in investing activities decreased to $45.0 million for the year ended December 31, 2005 compared to $50.0 million for the year ended December 31, 2004. This was primarily due to the sale of marketable securities, in which the Company received $16.8 million in proceeds, which was offset by the purchase of $41.0 million of marketable securities in 2005 versus $40.0 million of purchases in 2004. Capital expenditures were approximately $13.9 million and $10.1 million for 2005 and 2004, respectively. Expenditures on furniture, fixtures, and leasehold improvements for new retail store openings and expansions were $8.3 million and $6.9 million in 2005 and 2004, respectively. The remaining expenditures were primarily for leasehold improvements for the renovation of the Company's corporate headquarters and administrative offices and information system enhancements. In addition, $6 million was used to purchase six million shares of Bernard Chaus, Inc., in connection with the Company's licensing agreement and strategic relationship with Bernard Chaus, Inc. Net cash used in financing activities was $5.1 million for the year ended December 31, 2005 compared to $19.0 million for the year ended December 31, 2004. The decrease is primarily attributable to the Company's repurchase of 500,000 of its treasury shares for $13.9 million in 2004. This was offset by cash dividend payments to Class A and B Common Stock shareholders of $13.1 million in 2005 compared to $10.5 million in 2004. The Company also received proceeds of $4.7 million for stock option exercises in 2005 compared to $5.2 million in 2004. In addition, the Company entered into a short-term loan agreement related to the Company's repatriation plan and received $3.0 million in proceeds. The Company currently sells substantially all of its accounts receivable to two factors 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. The Company's material obligations under contractual agreements, primarily commitments for future payments under operating lease agreements as of December 31, 2005 are summarized as follows: Payments Due by Period Total 1 year 2-3 years 4-5 years After 5 or less years Operating Leases and Other Obligations $215,487,000 $27,713,000 $54,161,000 $48,990,000 $84,623,000 Purchase Obligations 61,238,000 61,238,000 Building Purchase Commitment 24,000,000 24,000,000 Short-term Borrowings 3,000,000 3,000,000 ----------- ----------- ------------ ----------- ----------- Total Contractual Obligations $303,725,000 $115,951,000 $54,161,000 $48,990,000 $84,623,000
During 2006, the Company anticipates opening or expanding approximately 5 to 10 retail and outlet stores. These new and expanded stores will require approximately $9.5 million in aggregate capital expenditures and initial inventory requirements. The Company also anticipates that it will require increased capital expenditures to support its information systems over its historical spend. The Company signed an agreement with SAP to implement an integrated business platform across the Company's retail and outlet stores in 2006. The estimated expenditures related to the implementation are expected to be approximately $8.0 million. 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. The Company had no outstanding advances during 2005 and 2004 under this line of credit; however amounts available under the line were reduced to $18.3 million by $6.7 million standby letters of credit at December 31, 2005. In 2005, in connection with the Company's tax repatriation plan, one of the Company's foreign subsidiaries entered into a promissory note with a financial institution, which provided the foreign subsidiary with $3,000,000. The note is due in September 2006. Interest is payable monthly at an annual rate equal to the greater of the prime rate in effect on such date or the Federal Funds Rate in effect on such date plus 0.50%. The agreement contains a number of customary covenants and events of default. Upon the occurrence of an event of default, all borrowings and accrued interest shall become immediately due and payable. In addition, the Company entered into a Cash Collateral Pledge Agreement, for $3,000,000, with a financial institution, which serves as collateral on the loan to the foreign subsidiary. In 2004, the Company entered into an agreement to purchase the office building that it is currently leasing for its corporate headquarters in New York City providing approximately 119,500 square feet of office space for approximately $24 million. The closing date is scheduled for approximately May 2006, the specific timing to be determined by the parties, based on the ability of the current landlord to satisfy certain terms and conditions. The Company has incurred approximately $18.2 million as of December 31, 2005 in capital improvements and furniture expenditures in connection with this purchase. Also in 2004, the Company entered into a 10-year lease for its administrative offices located in New Jersey, for which it incurred approximately $0.2 million and $1.0 million in capital improvements and expenditures during 2005 and 2004, respectively. The Company believes that it will be able to satisfy its current expected cash requirements for 2006, including requirements for its retail expansion, corporate and administrative office build-outs, the purchase of the New York City corporate headquarters, enhanced information systems and the payments of its quarterly cash dividend, primarily with cash flow from operations and cash on hand. Exchange Rates The Company routinely enters into forward exchange contracts for its future purchases of inventory denominated in foreign currencies, primarily the Euro. At December 31, 2005, forward exchange contracts with a notional value totaling $7.0 million were outstanding with settlement dates ranging from January 2006 through May 2006. Gains and losses on forward exchange contracts that are used for hedges are accounted for on the balance sheet as inventory and an adjustment to equity, and are subsequently accounted for as part of the purchase price of the inventory upon execution of the contract. At December 31, 2005, the unrealized loss on these outstanding forward contracts is approximately $184,000, net of taxes, which is included in Accumulated Other Comprehensive Income in the Statement of Changes in Shareholders' Equity and a decrease to inventory, which is the underlying exposure on the consolidated balance sheet. 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 are 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. Inventory from contract manufacturers in the Far East and Brazil are purchased in United States dollars and the recent fluctuations 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 affect 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 effect on the Company. Effects of Inflation The Company does not believe that the relatively low 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. 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 Euro. 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. At December 31, 2005, the Company had forward exchange contracts totaling with notional values $7.0 million, which resulted in an unrealized loss of approximately $184,000, net of taxes. The Company's earnings may also be affected by changes in short-term interest rates as a result of borrowings under its line of credit facility. A two or less percentage point increase in interest rates affecting the Company's credit facility would not have had a material effect on the Company's 2005 and 2004 net income. Item 8. Financial Statements and Supplementary Data See page F-1 for an index to the consolidated financial statements, the Report of Management and the Reports of the Registered Public Accounting Firm submitted as part of this Annual Report. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure None. Item 9A. Controls and Procedures Evaluation of Disclosure Controls and Procedures As of December 31, 2005 the Company's Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d- 15(e) of the Securities Exchange Act of 1934, as amended) and have concluded that the Company's disclosure controls and procedures were effective and designed to ensure that material information relating to the Company and the Company's consolidated subsidiaries would be made known to them by others within those entities to allow timely decisions regarding required disclosures. Management's Report on Internal Control over Financial Reporting The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended. Under the supervision and with the participation of Management, including the Chief Executive Officer and Chief Financial Officer, the Company conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2005 based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, management concluded that the Company's internal control over financial reporting was effective as of December 31, 2005. Management's assessment of the effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included herein. Changes in Internal Control over Financial Reporting There were no changes in the Company's internal controls over financial reporting during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect the Company's internal control over financial reporting. Item 9B. Other Information None. 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 23, 2006 to be filed with the Securities and Exchange Commission within 120 days after December 31, 2005 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 23, 2006 to be filed with the Securities and Exchange Commission within 120 days after December 31, 2005 and is incorporated herein by reference in response to this item. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information required by this item will be contained in the Company's Proxy Statement for its Annual Shareholders Meeting to be held May 23, 2006 to be filed with the Securities and Exchange Commission within 120 days after December 31, 2005 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 23, 2006 to be filed with the Securities and Exchange Commission within 120 days after December 31, 2005, and is incorporated herein by reference in response to this item. Item 14. Principal Accountant Fees and Services The information required by this item will be contained in the Company's Proxy Statement for its Annual Shareholders Meeting to be held May 23, 2006 to be filed with the Securities and Exchange Commission within 120 days after December 31, 2005 and is incorporated herein by reference in response to this item. PART IV Item 15. Exhibits and Financial Statement Schedules (a) (1) See page F-1 for an index to the consolidated financial statements submitted as part of this Annual Report. (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. (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 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). *10.10 -Employment Agreement between Kenneth Cole Productions, Inc., and Paul Blum. (Previously filed as Exhibit 10.6 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. (Previously filed as Exhibit 10.14 to the Registrants Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated by reference). 10.15 -Common Stock Purchase Agreement, dated July 20, 1999, between Liz Claiborne, Inc. and Kenneth Cole Productions, Inc. (Previously filed as Exhibit 10.01 to the Registrants Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1999). 10.16 -Registration Rights Agreement, dated July 20, 1999, between Liz Claiborne, Inc. and Kenneth Cole Productions, Inc. (Previously filed as Exhibit 10.02 to the Registrants Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1999). 10.17 -License Agreement, dated July 20, 1999, by and between L.C.K.L., LLC and K.C.P.L., Inc. (Portions of this exhibit have been omitted pursuant to a request for confidential treatment and been filed separately with the Securities and Exchange Commission. Such portions are designated by a "*". (Previously filed as Exhibit 10.03 to the Registrants Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1999). 10.18 -Amended and Restated Employment Agreement, dated as of September 1, 2000, between Kenneth Cole Productions, Inc. and Paul Blum (Previously filed as Exhibit 10.10 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1996 and incorporated herein by reference). 10.19 -Kenneth Cole Productions, Inc. Employee Stock Purchase Plan (Incorporated by reference to the Company's Registration Statement on Form S-8 Registration No. 33-31868, filed on March 7, 2000.) 10.20 -Kenneth Cole Productions, Inc. 2004 Stock Incentive Plan (Incorporated by reference to the Company's Registration Statement on Form S-8 Registration No. 333-119101, filed on September 17, 2004.) 10.21 -Kenneth Cole Productions, Inc. 2004 Stock Incentive Plan (Incorporated by reference to the Company's Registration Statement on Form S-8 Registration No. 333-131724 filed on February 10, 2006.) 10.22 -Stock Purchase Agreement between Kenneth Cole Productions, Inc. and Bernard Chaus, Inc. dated June 13, 2005 (Previously filed as Exhibit 10.21 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2005 and incorporated herein by reference.) 10.23 -Termination Agreement between Kenneth Cole Productions, Inc. and Susan Q. Hudson dated October 5, 2005 (Previously filed as Exhibit 10.22 to the Registrant's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2005 and incorporated herein by reference). 10.24 -Employment Agreement between Kenneth Cole Productions, Inc. and Richard S. Olicker dated January 3, 2006 (Previously filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed on January 10, 2006.) 10.25 -Employment Agreement between Kenneth Cole Productions, Inc. and Joel Newman dated February 13, 2006 (Previously filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K, filed on February 16, 2006.) +21.01 -List of Subsidiaries. +23.01 -Consent of Independent Registered Public Accounting Firm. +31.1 -Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +31.2 -Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. +32.1 -Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 +32.2 -Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ____________________________ * Management contract or compensatory plan or arrangement required to be identified pursuant to Item 14(a) of this report. + Filed herewith. (b) See Item 15(a) (3) above for a listing of the exhibits included as a part of this report. (c) See Items 15(a)(1) and 15(a)(2) above. Kenneth Cole Productions, Inc. and Subsidiaries Index to Consolidated Financial Statements Page Reports of Independent Registered Public Accounting Firm F-2 Consolidated Balance Sheets as of December 31, 2005 and 2004 F-5 Consolidated Statements of Income for the years ended December 31, 2005, 2004 and 2003 F-7 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2005, 2004 and 2003 F-8 Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003 F-9 Notes to Consolidated Financial Statements F-10 Report of Independent Registered Public Accounting Firm To The Board of Directors and Shareholders of Kenneth Cole Productions, Inc. We have audited the accompanying consolidated balance sheets of Kenneth Cole Productions, Inc. and subsidiaries (the "Company") as of December 31, 2005 and 2004, and the related consolidated statements of income, cash flows and changes in shareholders' equity for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Kenneth Cole Productions, Inc. and subsidiaries internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 9, 2006 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP New York, New York March 9, 2006 Report of Independent Registered Public Accounting Firm To The Board of Directors and Shareholders of Kenneth Cole Productions, Inc. We have audited management's assessment, included in the accompanying Management's Report on Internal Control over Financial Reporting appearing in Item 9A, that Kenneth Cole Productions, Inc. and subsidiaries (the "Company") maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that Kenneth Cole Productions, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2005 is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Kenneth Cole Productions, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Kenneth Cole Productions, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, cash flows and changes in shareholders' equity for each of the three years in the period ended December 31, 2005 and our report dated March 9, 2006 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP New York, New York March 9, 2006 Kenneth Cole Productions, Inc. and Subsidiaries Consolidated Balance Sheets
December 31, 2005 2004 Assets Current assets: Cash and cash equivalents $63,747,000 $80,014,000 Marketable securities 66,400,000 40,000,000 Due from factors 33,975,000 34,936,000 Accounts receivable, less allowance for doubtful accounts of $298,000 and $302,000, respectively 18,691,000 16,978,000 Inventories 45,465,000 47,166,000 Prepaid expenses and other current assets 6,059,000 2,664,000 Deferred taxes, net 3,340,000 3,136,000 ------------ ------------ Total current assets 237,677,000 224,894,000 ------------ ------------ Property and equipment-at cost, less accumulated depreciation and amortization 42,975,000 38,510,000 Other assets: Deferred taxes, net 14,832,000 9,625,000 Deposits and sundry 16,776,000 8,826,000 Deferred compensation plans assets 28,411,000 22,732,000 ------------ ------------ Total other assets 60,019,000 41,183,000 ------------ ------------ Total Assets $340,671,000 $304,587,000 ============ ============
See accompanying notes to consolidated financial statements. Kenneth Cole Productions, Inc. and Subsidiaries Consolidated Balance Sheets (continued)
December 31, 2005 2004 Liabilities and Shareholders' Equity Current liabilities: Accounts payable $31,129,000 $35,767,000 Accrued expenses and other current liabilities 8,775,000 8,947,000 Short-term borrowings 3,000,000 Deferred income 3,835,000 2,920,000 Income taxes payable 3,832,000 4,253,000 ----------- ----------- Total current liabilities 50,571,000 51,887,000 Accrued rent and other long term liabilities 17,029,000 13,440,000 Deferred compensation plans liabilities 28,411,000 22,732,000 Commitments and contingencies Shareholders' Equity: Series A Convertible 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; 15,573,961 and 15,054,845 issued as of December 31, 2005 and 2004, respectively 156,000 150,000 Class B Convertible Common Stock, par value $.01, 9,000,000 shares authorized; 8,010,497 and 8,055,497 issued and outstanding as of December 31, 2005 and 2004, Respectively 80,000 81,000 Additional paid-in capital 89,351,000 78,417,000 Deferred Compensation (3,397,000) Accumulated other comprehensive income 1,257,000 1,053,000 Retained Earnings 237,369,000 216,983,000 ----------- ----------- 324,816,000 296,684,000 Class A Common Stock in treasury, at cost, 3,388,400 shares as of December 31, 2005 and 2004 (80,156,000) (80,156,000) ----------- ----------- Total Shareholders' Equity 244,660,000 216,528,000 ----------- ----------- Total Liabilities and Shareholders' Equity $340,671,000 $304,587,000 ============ ============
See accompanying notes to consolidated financial statements. Kenneth Cole Productions, Inc. and Subsidiaries Consolidated Statements of Income
Year ended December 31, 2005 2004 2003 Net sales $474,060,000 $473,438,000 $430,101,000 Royalty revenue 43,983,000 42,763,000 38,252,000 ----------- ----------- ----------- Net revenue 518,043,000 516,201,000 468,353,000 Cost of goods sold 283,727,000 284,817,000 258,457,000 ----------- ----------- ----------- Gross profit 234,316,000 231,384,000 209,896,000 Selling, general, and administrative expenses 188,953,000 174,519,000 157,824,000 Impairment of long-lived assets - 448,000 1,153,000 ----------- ----------- ----------- Operating income 45,363,000 56,417,000 50,919,000 Interest and other income, net 4,151,000 1,411,000 825,000 ----------- ----------- ----------- Income before provision for income taxes 49,514,000 57,828,000 51,744,000 Provision for income taxes 15,988,000 21,976,000 19,145,000 ----------- ----------- ----------- Net income $33,526,000 $35,852,000 $32,599,000 =========== =========== =========== Earnings per share: Basic $ 1.69 $ 1.79 $ 1.66 Diluted $ 1.65 $ 1.74 $ 1.59 Dividends declared per share $ 0.66 $ 0.52 $ 0.17 Shares used to compute earnings per share: Basic 19,888,000 20,050,000 19,609,000 Diluted 20,318,000 20,652,000 20,486,000
See accompanying notes to consolidated financial statements. Kenneth Cole Productions, Inc. and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity Class A Class B Common Stock Common Stock Number Number of Shares Amount of Shares Amount Balance at 12/31/02 Net Income 13,921,817 139,000 8,360,497 84,000 Translation adjustment, Foreign currency, net of taxes $(69,000) Forward contracts, net of taxes $126,000 Comprehensive income Exercise of stock options Related tax Benefit $2,370,000 408,368 4,000 Issuance of Class A Stock for ESPP 12,606 Dividends paid on common stock Purchase of Class A Stock Conversion of Class B to Class A Common Stock 192,000 2,000 (192,000) (2,000) ---------------------------------------- Balance at 12/31/03 14,534,791 145,000 8,168,497 82,000 Net Income Translation adjustment Foreign currency, net of taxes $199,000 Forward contracts, net of taxes $(32,000) Unrealized gain on available for sale security, net of taxes $18,000 Comprehensive income Exercise of stock options Related tax Benefit $3,031,000 398,113 4,000 Issuance of Class A Stock for ESPP 8,941 Dividends paid on common stock Purchase of Class A stock Conversion of Class B to Class A common stock 113,000 1,000 (113,000) (1,000) ----------------------------------------- Balance at 12/31/04 15,054,845 $150,000 8,055,497 $81,000 Net Income Translation adjustment Foreign currency, net of taxes $148,000 Forward contracts, net of taxes $(351,000) Unrealized gains on available for sale securities, net of taxes $301,000 Comprehensive income Issuance of Restricted Stock, net of forfeitures 152,960 2,000 Amortization of deferred compensation Shares surrendered by employees to pay taxes on restricted stock (4,509) Stock-based compensation acceleration expense Exercise of options, related tax benefit $1,403,000 312,064 3,000 Issuance of Class A Stock for ESPP 13,601 Dividends paid on common stock Conversion of Class B to Class A common stock 45,000 1,000 (45,000) (1,000) ------------------------------------------ Balance at 12/31/05 15,573,961 $156,000 8,010,497 $80,000 ==========================================
Additional Deferred Accumulated Paid-In Compensation Other Capital Comprehensive Income Balance at 12/31/02 63,476,000 654,000 Net Income Translation adjustment, Foreign currency, net of taxes $(69,000) (118,000) Forward contracts, net of taxes $126,000 215,000 Comprehensive income Exercise of stock options Related tax Benefit $2,370,000 6,304,000 Issuance of Class A Stock for ESPP 212,000 Dividends paid on common stock Purchase of Class A Stock Conversion of Class B to Class A Common Stock -------------------------------------------- Balance at 12/31/03 69,992,000 751,000 Net Income Translation adjustment Foreign currency, net of taxes $199,000 325,000 Forward contracts, net of taxes $(32,000) (53,000) Unrealized gain on available for sale security, net of taxes $18,000 30,000 Comprehensive income Exercise of stock options Related tax Benefit $3,031,000 8,204,000 Issuance of Class A Stock for ESPP 221,000 Dividends paid on common stock Purchase of Class A stock Conversion of Class B to Class A common stock ------------------------------------------ Balance at 12/31/04 $78,417,000 $1,053,000 Net Income Translation adjustment Foreign currency, net of taxes $148,000 310,000 Forward contracts, net of taxes $(351,000) (737,000) Unrealized gains on available for sale securities, net of taxes $301,000 631,000 Comprehensive income Issuance of Restricted Stock, net of forfeitures 4,554,000 (4,556,000) Amortization of deferred Compensation 1,120,000 Shares surrendered by employees to pay taxes on restricted stock (134,000) Stock-based compensation acceleration expense 100,000 39,000 Exercise of options, related tax benefit $1,403,000 6,085,000 Issuance of Class A Stock for ESPP 329,000 Dividends paid on common stock Conversion of Class B to Class A common stock ----------------------------------------- Balance at 12/31/05 $89,351,000 $(3,397,000) $1,257,000 ==========================================
Treasury Stock Retained Number Amount Earnings of Shares Balance at 12/31/02 162,244,000 (2,688,400) (61,695,000) Net Income 32,599,000 Translation adjustment, Foreign currency, net of taxes $(69,000) Forward contracts, net of taxes $126,000 Comprehensive income Exercise of stock options Related tax Benefit $2,370,000 Issuance of Class A Stock for ESPP Dividends paid on common stock (3,258,000) Purchase of Class A Stock (200,000) (4,526,000) Conversion of Class B to Class A Common Stock ------------------------------------------- Balance at 12/31/03 191,585,000 (2,888,400) (66,221,000) Net Income 35,852,000 Translation adjustment Foreign currency, net of taxes $199,000 Forward contracts, net of taxes $(32,000) Unrealized gain on available for sale security, net of taxes $18,000 Comprehensive income Exercise of stock options Related tax Benefit $3,031,000 Issuance of Class A Stock for ESPP Dividends paid on common stock (10,454,000) Purchase of Class A Stock (500,000) (13,935,000) Conversion of Class B to Class A common stock ------------------------------------------ Balance at 12/31/04 $216,983,000 (3,388,400) $(80,156,000) Net Income 33,526,000 Translation adjustment Foreign currency, net of taxes $148,000 Forward contracts, net of taxes $(351,000) Unrealized gains on available for sale securities, net of taxes $301,000 Comprehensive income Issuance of Restricted Stock, net of forfeitures Amortization of deferred compensation Shares surrendered by employees to pay taxes on restricted stock Stock-based compensation acceleration expense Exercise of options, related tax benefit $1,403,000 Issuance of Class A Stock for ESPP Dividends paid on common stock (13,140,000) Conversion of Class B to Class A common stock ------------------------------------------ Balance at 12/31/05 $237,369,000 (3,388,400) $(80,156,000) ==========================================
Total Balance at 12/31/02 164,902,000 Net Income 32,599,000 Translation adjustment, Foreign currency, net of taxes $(69,000) (118,000) Forward contracts, net of taxes $126,000 215,000 ----------- Comprehensive income 32,696,000 Exercise of stock options Related tax Benefit $2,370,000 6,308,000 Issuance of Class A Stock for ESPP 212,000 Dividends paid on common stock (3,258,000) Purchase of Class A Stock (4,526,000) Conversion of Class B to Class A Common Stock ----------- Balance at 12/31/03 196,334,000 Net Income 35,852,000 Translation adjustment Foreign currency, net of taxes $199,000 325,000 Forward contracts, net of taxes $(32,000) (53,000) Unrealized gain on available for sale security, net of taxes $18,000 30,000 ----------- Comprehensive income 36,154,000 Exercise of stock options Related tax Benefit $3,031,000 8,208,000 Issuance of Class A Stock for ESPP 221,000 Dividends paid on common stock (10,454,000) Purchase of Class A Stock (13,935,000) Conversion of Class B to Class A common stock ----------- Balance at 12/31/04 $216,528,000 Net Income 33,526,000 Translation adjustment Foreign currency, net of taxes $148,000 310,000 Forward contracts, net of taxes $(351,000) (737,000) Unrealized gains on available for sale securities, net of taxes $301,000 631,000 ----------- Comprehensive income 33,730,000 Issuance of Restricted Stock, net of forfeitures Amortization of deferred Compensation 1,120,000 Shares surrendered by employees to pay taxes on restricted stock (134,000) Stock-based compensation acceleration expense 139,000 Exercise of options, related tax benefit $1,403,000 6,088,000 Issuance of Class A Stock for ESPP 329,000 Dividends paid on common stock (13,140,000) Conversion of Class B to Class A common stock ----------- Balance at 12/31/05 $244,660,000 ============
See accompanying notes to consolidated financial statement Kenneth Cole Productions, Inc. and Subsidiaries Consolidated Statements of Cash Flows
For the years ended December 31, 2005 2004 2003 Cash flows from operating activities Net income $33,526,000 $35,852,000 $32,599,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 9,400,000 7,844,000 7,604,000 Impairment of long-lived assets - 448,000 1,153,000 Unrealized gain on deferred compensation plans (914,000) (1,127,000) (2,543,000) Realized gain on sale of property and equipment - (14,000) - Realized gain on sale of marketable securities (1,246,000) - - Provision for doubtful accounts 294,000 227,000 262,000 Benefit for deferred taxes (5,791,000) (1,709,000) (399,000) Tax benefit from stock options 1,403,000 3,031,000 2,370,000 Taxes related to restricted stock (134,000) - - Unrealized gains from available-for-sale securities (631,000) - - Stock based compensation expense 1,259,000 - - Changes in operating assets and liabilities: Decrease/(increase) in due from factors 961,000 (3,449,000) (601,000) Increase in accounts receivable (2,007,000) (5,951,000) (3,632,000) Decrease/(increase) in inventories 964,000 (2,368,000) (912,000) Increase in prepaid expenses and other current assets (3,395,000) (1,321,000) (269,000) Increase in other assets (5,073,000) (4,404,000) (4,909,000) (Decrease)/increase in income taxes payable (421,000) 1,314,000 (3,301,000) (Decrease)/increase in accounts payable (4,638,000) 1,920,000 213,000 Increase (decrease) in deferred income, accrued expenses and other current liabilities 1,057,000 1,044,000 (2,812,000) Increase in other non- current liabilities 9,268,000 6,604,000 8,067,000 ---------- --------- --------- Net cash provided by operating activities 33,882,000 37,941,000 32,890,000 Cash flows used in investing activities Acquisition of property and Equipment (13,865,000) (10,101,000) (9,510,000) Proceeds from sale of marketable Securities 16,755,000 - - Proceeds from sale of property and equipment - 68,000 - Purchase of stock (6,000,000) - - Purchases of marketable securities (41,909,000) (40,000,000) - ------------ ------------ ---------- Net cash used in investing Activities (45,019,000) (50,033,000) (9,510,000) Cash flows used in financing activities Proceeds from short-term Borrowings 3,000,000 - - Proceeds from exercise of stock options 4,685,000 5,177,000 3,938,000 Proceeds from issuance of stock from employee purchase plan 329,000 221,000 212,000 Principal payments of capital lease obligations - - (171,000) Dividends paid to shareholders (13,140,000) (10,454,000) (3,258,000) Purchase of treasury stock - (13,935,000) (4,526,000) ----------- ----------- ----------- Net cash used in financing Activities (5,126,000) (18,991,000) (3,805,000) Effect of exchange rate changes on cash (4,000) (5,000) (22,000) ----------- ----------- ----------- Net (decrease)/increase in cash and cash equivalents (16,267,000) (31,088,000) 19,553,000 Cash and cash equivalents, beginning of year 80,014,000 111,102,000 91,549,000 Cash and cash equivalents, end of year $63,747,000 $80,014,000 $111,102,000 =========== =========== ============ Supplemental disclosures of cash flow information Cash paid during the period for: Interest $68,000 $27,000 $40,000 Income taxes $21,194,000 $19,341,000 $20,583,000
See accompanying notes to consolidated financial statements. Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements 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, women's and children's apparel and accessories under its Kenneth Cole New York, Kenneth Cole Reaction, Unlisted, and Tribeca brands for the fashion conscious consumer. In addition, the Company added the Bongo trademark for footwear through a license agreement in 2003. The Company markets its products for sale to approximately 6,000 department stores and specialty store locations in the United States, as well as other locations throughout the world, 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. Intercompany transactions and balances have been eliminated in consolidation. 3. Use of estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 an original maturity of three months or less at the time of purchase to be cash equivalents. 5. Marketable securities In 2004, the Company began investing in auction rate securities, debt securities backed by student loans, and have maturity dates ranging from approximately 2023 to 2038. The Company accounts for these investments as marketable securities, and has classified them as available-for-sale securities under SFAS 115 "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). They are recorded at fair value, and are reset every 7 to 35 days, and repurchased based on the Company's cash needs. The purchase of these securities is included in the accompanying Statement of Cash Flows as an investing activity. Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements Note A - Summary of Significant Accounting Policies (continued) 6. Inventories Inventories, which consist of finished goods, are stated at the lower of cost or fair market value. Cost is determined by the first-in, first-out method. 7. Property and equipment Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the estimated useful lives of the related assets ranging from three to seven years on a straight-line basis. Leasehold improvements are amortized using 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 as measured by comparing the undiscounted future cash flows to the asset's net book value. Impaired assets are recorded at the lesser of their carrying value or fair value. 8. Income taxes Income taxes are accounted for in accordance with SFAS No. 109, "Accounting for Income Taxes." 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. 9. Revenue recognition Wholesale revenues are recognized upon shipment of products to customers since title passes upon shipment. Retail and outlet store revenues are recognized at the time of sale. Both wholesale and retail store revenues are shown net of returns, discounts, and other allowances. Reserves for estimated returns and allowances for discounts are provided when sales are recorded. The Company has also 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. In circumstances whereby licensee sales exceed the quarterly contractual minimums, but not the annual minimums, royalty contributions are deferred on the balance sheet. As the licensee sales exceed the annual contractual minimums, the royalty contributions are recognized. Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note A - Summary of Significant Accounting Policies (continued) 10. Advertising costs The Company incurred advertising costs, including certain in- house marketing expenses of $ 21.8 million, $20.0 million, and $16.8 million for the years ended December 31, 2005, 2004 and 2003, respectively. Advertising costs are expensed as incurred and are included in Selling, General, and Administrative expenses in the accompanying Consolidated Statement of Income. Included in advertising expenses are costs associated with cooperative advertising programs, under which the Company generally shares the cost of a customer's advertising expenditures. In addition, licensee contributions toward advertising are recognized when licensed products are sold by the Company's licensees. Such contributions are based on contractual percentages of sales and contain minimums. For licensees whose sales are not expected to exceed contractual sales minimums, contributions relating to advertising are recognized based on the contractual minimums. In circumstances whereby licensee sales exceed the quarterly contractual minimums, but not the annual minimums, such contributions toward advertising are deferred on the balance sheet. As the licensee sales exceed the annual contractual minimums, the licensee contributions toward advertising are recognized. 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. The Company has adopted disclosure only provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). Pro forma disclosures, as required by Statement of Financial Accounting Standard No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure", are computed as if the Company recorded compensation expense based on the fair value for stock-based awards or grants. The following pro forma information includes the effects of the options discussed above. Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note A - Summary of Significant Accounting Policies (continued)
Year Ended December 31, 2005 2004 2003 Net Income, as reported $33,526,000 $35,852,000 $32,599,000 Add: Stock-based compensation, related to restricted stock, included in reported net income, net of related tax effect 852,000 -- -- Deduct: Stock-based employee compensation expense determined under fair value method, net of related tax effects (7,318,000) (3,429,000) (2,855,000) ----------- ----------- ---------- Pro forma net income $27,060,000 $32,423,000 $29,744,000 =========== ========== ========== Earnings per share: Basic - as reported $1.69 $1.79 $1.66 Basic - pro forma $1.36 $1.62 $1.52 Diluted - as reported $1.65 $1.74 $1.59 Diluted - pro forma $1.33 $1.57 $1.45
The effects of applying SFAS 123 on this pro forma disclosure may not be indicative of future results, and additional awards in future years may or may not be granted. (See Note K.) 12. Derivative instruments and hedging activities The Company uses derivative instruments, typically forward contracts, to manage its risk associated with movements in the Euro exchange rates in purchasing inventory. In accordance with SFAS No. 133 "Accounting for Derivative Instruments and Hedge Activities" ("SFAS 133"), the Company recognizes all derivatives on the Balance Sheet. Also, derivative instruments that meet certain criteria in SFAS 133 are classified as cash flow hedges, and changes in fair value are recognized in Other Comprehensive Income, in the accompanying Statement of Changes in Shareholders' Equity, until the underlying transaction is completed and the derivative is settled. Upon settlement, any amounts remaining in Other Comprehensive Income are reclassified to earnings. Those derivatives that are not classified as cash flow hedges are adjusted to fair value through earnings. The Company does not hold derivative instruments for the purpose of trading or speculation, and designated all hedges as cash flow hedges in 2005. (See Note F.) Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note A - Summary of Significant Accounting Policies (continued) 13. Shipping and Handling Costs The Company includes amounts billed to customers for shipping costs in net sales. The related internal and external shipping and handling costs incurred by the Company are included in the Cost of Goods Sold line item in the accompanying Consolidated Statements of Income. Such costs include inbound freight costs, purchasing costs, inspection costs, internal transfer costs, and other product procurement related charges. 14. Cost of Goods Sold and Selling, General and Administrative Expenses Costs associated with the production and procurement of product are included in the Cost of Goods Sold line item in the accompanying Consolidated Statements of Income, including inbound freight costs, purchasing costs, inspection costs, and other product procurement related charges. All other expenses, excluding interest and income taxes, are included in selling, general, and administrative expenses, including receiving, warehousing, and distribution expenses, as the predominant expenses associated therewith, are general and administrative in nature. 15. Research and Development Costs The Company does not incur research and development costs. Note B - Earnings Per Share The Company calculates earnings per share in accordance with SFAS No. 128, "Earnings Per Share." Basic earnings per share are calculated by dividing net income by weighted average common shares outstanding. Diluted earnings per share are calculated similarly, except that it includes the dilutive effect of the assumed exercise of securities under the Company's stock incentive plans. Dilutive securities, which include stock options, are determined under the treasury stock method by calculating the assumed proceeds available to repurchase stock using the weighted average shares outstanding for the period. Stock options amounting to 946,000, 916,000 and 376,000 as of December 31, 2005, 2004, and 2003, respectively, have been excluded from the diluted per share calculations, since their effect would be antidilutive. Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note B - Earnings Per Share (continued) The following is an analysis of the differences between basic and diluted earnings per common share in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share".
For the Year Ended December 31, 2005 2004 2003 Weighted average common shares outstanding 19,888,000 20,050,000 19,609,000 Effect of dilutive securities: Restricted stock & shares issued through Employee Stock Purchase Plan 5,000 - - Stock options 425,000 602,000 877,000 ---------- ---------- ---------- Weighted average common shares outstanding and common share equivalents 20,318,000 20,652,000 20,486,000 ========== ========== ==========
Note C - Due from Factors and Accounts Receivable The Company sells substantially all of its accounts receivable to its factors, 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 factor at December 31, 2005 and 2004 is accounts receivable subject to recourse totaling approximately $1,115,000 and $1,132,000 respectively. The agreements with the factors provide for payment of a service fee on receivables sold. At December 31, 2005 and 2004, the balance due from factor, which includes chargebacks, is net of allowances for returns, discounts, and other deductions of approximately $8,068,000 and $8,377,000, respectively. The allowances are provided for known chargebacks reserved for but not written off the Company's financial records and for potential future customer deductions based on management's estimates. In the ordinary course of business, the Company has accounts receivable that are non-factored and are at the Company's risk. At December 31, 2005 and 2004, the accounts receivable balance includes allowance for doubtful accounts and consumer direct sales returns of approximately $1,108,000 and $1,002,000. These customers include non-factored accounts and credit card receivables from third party service providers. The allowances provided for sales returns are for potential future retail customer merchandise returns based on management's estimates. The allowance for doubtful accounts is provided for estimated losses resulting from the inability of its customers to make required payments. Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note D - Property and Equipment Property and equipment consist of the following:
December 31, 2005 2004 Property and equipment-at cost: Furniture and fixtures $27,871,000 $24,861,000 Machinery and equipment 17,473,000 14,311,000 Leasehold improvements 50,212,000 44,661,000 Leased equipment under capital lease -- 967,000 ----------- ---------- 95,556,000 84,800,000 Less accumulated depreciation 52,581,000 46,290,000 ----------- ----------- Net property and equipment $42,975,000 $38,510,000 =========== ===========
Note E - Impairment of Long-Lived Assets In 2004 and 2003, the Company recorded non-cash asset impairment charges of $448,000 and $1,153,000, respectively. Management reviews its retail stores' estimated undiscounted future cash flows and determines whether or not a write-down to current value is required. The impairment charges related to stores' leasehold improvements, and furniture and fixtures, and were separately disclosed in the accompanying Consolidated Statement of Income. Note F - Foreign Currency Transactions, Derivative Instruments and Hedging Activities The Company, in the normal course of business, routinely enters into forward contracts in anticipation of future purchases of inventory denominated in foreign currencies. These forward contracts are used to hedge against the Company's exposure to changes in Euro exchange rates to protect the purchase price of merchandise under such commitments. The Company has classified these contracts as Cash Flow Hedges under SFAS 133. The Company had forward contracts of $7,000,000, $24,000,000, and $9,500,000 at December 31, 2005, 2004 and 2003, respectively. At December 31, 2005, forward contracts have maturity dates through May 2006. All terms and conditions of the forward contracts are included in the measurement of the related hedge effectiveness. The critical terms of the forward contracts are the same as the underlying forecasted transactions; therefore changes in the fair value of the contracts should be highly effective in offsetting changes in the expected cash flows from the forecasted transactions. No gains or losses related to ineffectiveness of cash flow hedges were recognized in earnings during 2005, 2004, and 2003. At December 31, 2005, the Company's notional $7,000,000 in forward exchange contracts Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note F - Foreign Currency Transactions, Derivative Instruments and Hedging Activities (continued) resulted in an unrealized loss of approximately $184,000, net of taxes, which is included in Accumulated Other Comprehensive Income in the Statement of Changes in Shareholders' Equity and a decrease to inventory, which is the underlying exposure on the Consolidated Balance Sheet. The Company expects to reclassify all of the unrealized loss from Other Comprehensive Income into earnings within the next five-month period due to the actual executions of forward contracts to purchase merchandise and the Company's ultimate sale of that merchandise. Note G - 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 approximately 6,000 department and specialty store locations and to the Company's Consumer Direct segment. The Consumer Direct segment markets a 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, catalogs, and e-commerce (at website addresses www.kennethcole.com and www.kennethcolereaction.com). The Licensing segment, through third party licensee agreements, has evolved the Company from a footwear resource to a diverse lifestyle brand competing effectively in approximately 30 apparel and accessories categories for both men and women. The Company maintains control over quality, image and distribution of the licensees. This segment primarily consists of royalties earned on licensee sales to third parties of the Company's branded products and royalties earned on the purchase and sale to foreign retailers, distributors, or to consumers in foreign countries. The Company's reportable segments are business units that offer products to overlapping consumers through different channels of distribution. Each segment is managed separately, although planning, implementation and results are reviewed internally by the executive management committee. 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 segment include a markup, which is eliminated in consolidation. Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note G - Segment Reporting (continued) Financial information of the Company's reportable segments is as follows (dollars in thousands):
Consumer Wholesale Direct Licensing Totals Year Ended December 31, 2005 Revenues $283,991 $190,069 $43,983 $518,043 Intersegment revenues 38,932 38,932 Interest income, net 4,151 4,151 Depreciation expense 3,059 6,333 8 9,400 Segment income (1) (2) 27,291 6,763 35,974 70,028 Segment assets 272,848 57,657 13,157 343,662 Expenditures for long-lived assets 3,048 10,817 13,865 Year Ended December 31, 2004 Revenues $279,440 $193,998 $42,763 $516,201 Intersegment revenues 35,133 35,133 Interest income, net 1,411 1,411 Depreciation expense 2,745 5,087 12 7,844 Impairment of long-lived assets 448 448 Segment income (1)(3) 29,135 12,232 35,454 76,821 Segment assets 249,226 49,929 8,190 307,345 Expenditures for long-lived assets 3,150 6,949 2 10,101 Year Ended December 31, 2003 Revenues $254,524 $175,577 $38,252 $468,353 Intersegment revenues 32,671 32,671 Interest income, net 825 825 Depreciation expense 2,698 4,893 13 7,604 Impairment of long-lived assets 1,153 1,153 Segment income (1) 30,644 6,843 31,556 69,043 Segment assets 219,111 48,454 8,414 275,979 Expenditures for long-lived assets 4,924 4,584 2 9,510
(1) Before elimination of intersegment profit, unallocated corporate overhead and provision for income taxes. (2) Segment income for the Wholesale segment includes one-time payment of $0.8 million for severance. (3) Segment income for the Wholesale segment includes one-time payment of $1.1 million for costs associated with the Company's transfer to a third-party distribution center. Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note G - Segment Reporting (continued) The reconciliation of the Company's reportable segment revenues, profit and loss, and assets are as follows (dollars in thousands):
Revenues 2005 2004 2003 Revenues for reportable segments $518,043 $516,201 $468,353 Intersegment revenues for reportable segments 38,932 35,133 32,671 Elimination of intersegment revenues (38,932) (35,133) (32,671) ------- ------- ------- Total consolidated revenues $518,043 $516,201 $468,353 ======== ======== ======= Income Total profit for reportable segments 70,028 $76,821 $69,043 Elimination of intersegment profit (11,005) (9,303) (8,524) Unallocated corporate overhead (9,509) (9,690) (8,775) -------- ------- -------- Total income before provision for income taxes $49,514 $57,828 $51,744 ======= ======== ======== Assets Total assets for reportable segments $343,662 $307,345 $275,979 Elimination of inventory profit in consolidation (2,991) (2,758) (2,138) -------- -------- -------- Total consolidated assets $340,671 $304,587 $273,841 ======== ======== ========
Revenues from international customers were approximately 2.4%, 1.9%, and 1.0% of the Company's consolidated revenues for the years ended December 31, 2005, 2004, and 2003 respectively. Note H - Accrued Expenses and Other Liabilities Accrued expenses and other current liabilities consist of the following:
December 31, 2005 2004 Rent $ 723,000 $ 448,000 Compensation 4,268,000 5,454,000 Customer credits 2,020,000 1,989,000 Other 1,764,000 1,056,000 ---------------------------- $8,775,000 $8,947,000 ============================
Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note I - Short-term Borrowings In 2005, one of the Company's foreign subsidiaries entered into a promissory note with a financial institution, which provided the foreign subsidiary with $3,000,000. The note is due in September 2006. Interest is payable monthly at an annual rate equal to the greater of the prime rate in effect on such date or the Federal Funds Rate in effect on such date plus .50%. The agreement contains a number of customary covenants and events of default. Upon the occurrence of an event of default, all borrowings and accrued interest shall become immediately due and payable. At December 31, 2005, the subsidiary was in compliance with all covenants. The carrying value of the loan approximates fair market value. In addition, the Company entered into a Cash Collateral Pledge Agreement, for $3,000,000, with a financial institution, which serves as collateral on the loan to the foreign subsidiary. The collateral will be released to the Company at the time that the promissory note is settled with the financial institution, and is included in Prepaid Expenses and Other Current Assets in the accompanying Consolidated Balance Sheet. Note J - 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, 2005, 2004 and 2003 were approximately $487,000, $395,000, and $268,000, respectively. 2. Deferred compensation plans The Kenneth Cole Productions, Inc. Deferred Compensation Plans are non-qualified plans maintained primarily to provide deferred compensation benefits for the Company's Chief Executive Officer, as well as a select group of "highly compensated employees", which includes certain Company management. The Company accounts for the investments in the deferred compensation plans as trading securities in accordance with SFAS 115. The amounts, deferred at the election of the employee, are invested based upon various asset alternatives. The assets are included in Deferred compensation plan assets, and the related liability is included in Deferred compensation plan liabilities. In 2005, 2004 and 2003, the Company deposited $1,215,000, $1,516,000, and $247,000, respectively, into Supplemental Executive Retirement Plans ("SERP") for certain key executives. The amounts have been recorded in Deposits and Sundry in the accompanying Consolidated Balance Sheets. These plans are non-qualified deferred compensation plans. Benefits payable under these plans are based upon the performance of the individual directed investments from the Company's cumulative and future contributions. Benefits earned Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note J - Benefit Plans (continued) under the SERP begin vesting after 3 years from issuance, and become 60% vested after 9 years of service, 75% vested upon the participant retiring at age 60 or later and 100% vested if the employee dies while in the Company's employment. The value of these investments at December 31, 2005 and 2004 were $5,818,000 and $5,206,000, respectively, which the Company accounts for as trading securities in accordance with SFAS 115. The unrealized gains and losses on the investments were recorded in Selling, General and Administrative Expenses in the accompanying Consolidated Statements of Income. In addition, the Company has recorded an accumulated long-term vested benefit obligation of approximately $2,377,000 and $1,814,000 at December 31, 2005 and 2004, respectively, within Accrued Rent and Other Long Term liabilities in the accompanying Consolidated Balance Sheets. In addition, SERP participants are covered by life insurance through a portion of the Company's contribution. 3. Employee Stock Purchase Plan During 2000, the Company established a qualified employee stock purchase plan ("ESPP"), the terms of which allow for qualified employees (as defined) to participate in the purchase of designated shares of the Company's Class A Common Stock at a price equal to 85% of the lower of the closing price at the beginning or end of each quarterly stock purchase period. For the years ended December 31, 2005, 2004, and 2003, employees purchased 13,601, 8,941, and 12,606 shares, respectively. Total shares purchased through December 31, 2005 were 76,555. Note K - Stock -Based Compensation The Company's 2004 Incentive Stock Option Plan (the "Plan"), authorizes the grant of options to employees for up to 5,320,162 shares of the Company's Class A Common Stock. The Company amended the Plan in 2005 and authorized an additional 1,000,000 shares. 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 under the "Plan" have ten-year terms. Non-employee Director stock options granted have ten-year terms and vest 50% on the first anniversary of the date of grant and become fully exercisable at the end of two years. In 2005, the Company accelerated the vesting of 250,000 "out- of-the-money" stock options held by Kenneth D. Cole. These options were originally granted on August 4, 2004 and would have vested ratably in annual installments on the next three anniversaries of the date of grant. The per share exercise price for these options was $32.09, which was above the $30.34 fair market value of the Company's Class A common stock on the date of acceleration. The purpose of the acceleration was to eliminate future compensation expense recognition the Company would otherwise have been required to recognize with respect to these accelerated options once Statement of Financial Accounting Standards No. 123R "Share-Based Payment" ("SFAS 123R") becomes effective in January 2006. The estimated future expense recognition that was eliminated was Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note K - Stock-Based Compensation (continued) approximately $2,115,000. The acceleration of these options did not trigger an expense for accounting purposes, as the stock options had no intrinsic value at the date of acceleration. Also in 2005, the Company accelerated the vesting of 224,500 stock options held by various employees. These options were originally granted on July 1, 2004 and would have vested ratably in annual installments on the next two anniversaries of the date of grant. The per share exercise price for these options was $34.27, which was above the $25.50 fair market value of the Company's Class A common stock on the date of acceleration. The estimated future expense recognition that was eliminated was approximately $1,400,000. The acceleration of these options did not trigger an expense for accounting purposes, as the stock options had no intrinsic value at the date of acceleration. In 2005, the Company granted 152,960 Class A common shares of restricted stock to selected employees, net of 5,084 of forfeited shares, which had a fair value of $4,556,000 on the grant dates. The shares have graded vesting periods of up to four years. The Company has recorded the total compensation expense as Deferred Compensation in the Condensed Consolidated Statement of Changes in Shareholders' Equity, and recognized $1,259,000 ($852,000 net of related taxes) of compensation expense in the Condensed Consolidated Statement of Income for the year ended December 31, 2005, which represents the amortization of the original deferred compensation on a straight-line basis over the vesting period. Included in the compensation expense is approximately $139,000 related to the expenses incurred upon termination of one of the Company's senior executives. The weighted-average grant-date fair value of the nonvested shares as of December 31, 2005 was $4,265,000. The following table summarizes information about currently outstanding and exercisable stock options at December 31, 2005:
Outstanding Stock Options Exercisable Stock Options Range of Outstanding Weighted Weighted Exercisable Weighted Exercise Shares Average Average Shares Average Prices Remaining Exercise Exercise Contractual Price Price Life $4.00 to $12.00 192,356 1.79 11.36 192,356 11.36 $12.01 to $24.00 1,156,996 5.49 18.68 715,830 24.47 $24.01 to $36.00 1,251,365 6.43 30.11 1,064,116 31.69
Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note K - Stock-Based Compensation (continued) The following table summarizes all stock option transactions from December 31, 2002 through December 31, 2005.
Shares Weighted-Average Exercise Price Outstanding at December 31, 2002 2,631,980 $17.44 Granted 657,500 $23.33 Exercised (316,216) $11.68 Forfeited (41,929) $19.87 ---------- Outstanding at December 31, 2003 2,931,335 $19.36 Granted 574,900 $32.97 Exercised (398,113) $12.97 Forfeited (159,186) $22.20 ---------- Outstanding at December 31, 2004 2,948,936 $22.71 Granted 46,667 $29.28 Exercised (312,064) $15.01 Forfeited (82,822) $26.31 ---------- Outstanding at December 31, 2005 2,600,717 $23.64 ==========
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 2005, 2004 and 2003, respectively: risk-free interest rate of 4.1%, 3.2% and 4.0%; expected volatility factors of 49.1%, 59.7% and 64.5% and expected lives of 7.6, 5.2 and 5.0 years. Dividend yield assumptions were 2.19%, 1.68% and 1.38% for 2005, 2004 and 2003, respectively. The weighted-average fair value of options granted during 2005, 2004 and 2003 were $13.14, $15.63 and $14.48, 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. As a result of the Company's employee stock options having 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. Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note L - Income Taxes In 2004, Internal Revenue Code Section 965 was enacted, as part of the American Job Creation Act. This is a temporary provision that allows U.S. companies to repatriate earnings from their foreign subsidiaries at a reduced tax rate provided that specified conditions and restrictions are satisfied. In addition, FASB Staff Position FAS 109-2 was issued to provide accounting and disclosure guidance relating to the repatriation provision. In 2005, the Company's Board of Directors approved and adopted a repatriation plan and, as such, the Company repatriated $12.5 million of unremitted foreign earnings, which resulted in a tax benefit of approximately $3.0 million for the year ended December 31, 2005, as a result of the Company providing for taxes for the foreign earnings at the prior statutory rate. The Company borrowed $3 million through its foreign subsidiary to fund a portion of these remittances (see Note I). The components of income before provision for income taxes are as follows:
Years Ended December 31 2005 2004 2003 Domestic $45,341,000 $54,460,000 $51,063,000 International 4,173,000 3,368,000 681,000 ----------- ----------- ----------- $49,514,000 $57,828,000 $51,744,000
Significant items comprising the Company's deferred tax assets and liabilities are as follows:
December 31, 2005 2004 Deferred tax assets: Inventory allowances and capitalization $1,927,000 $2,105,000 Allowance for doubtful accounts and sales allowances 940,000 1,031,000 Deferred rent 4,449,000 4,379,000 Deferred compensation 10,137,000 8,406,000 Asset impairment 1,835,000 1,879,000 Deferred Income - Licensing Agreements 791,000 493,000 Other 511,000 38,000 ----------- ------------ $20,590,000 $18,331,000 ----------- ------------ Deferred tax liabilities: Depreciation (1,662,000) (2,680,000) Tax effect on unrealized gains on available-for-sale securities (381,000) -- Undistributed foreign earnings (375,000) (2,890,000) ------------ ------------ (2,418,000) (5,570,000) ------------ ------------ Net deferred tax assets $18,172,000 $12,761,000 ============ ============
Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note L - Income Taxes (continued) The provision (benefit) for income taxes consists of the following:
December 31, 2005 2004 2003 Current: Federal $19,477,000 $21,005,000 $16,816,000 State and local 1,882,000 2,483,000 2,587,000 Foreign 420,000 197,000 141,000 ----------- ----------- ----------- 21,779,000 23,685,000 19,544,000 Deferred: Federal (5,486,000) (1,574,000) (368,000) State and local (305,000) (135,000) (31,000) ---------- ----------- ----------- (5,791,000) (1,709,000) (399,000) ---------- ----------- ----------- $15,988,000 $21,976,000 $19,145,000 ========== ========== ===========
The reconciliation of income tax computed at the U.S. federal statutory tax rate to the effective income tax rate for 2005, 2004 and 2003 is as follows:
2005 2004 2003 Federal income tax at statutory rate 35.0% 35.0% 35.0% State and local taxes, net of federal tax benefit 3.0% 3.0% 2.0% Repatriation Benefit (5.7%) ----- ----- ----- 32.3% 38.0% 37.0% ===== ===== =====
Note M - Commitments and Contingencies 1. Operating leases and Other Property Agreements 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, 2005:
2006 $27,713,000 2007 27,333,000 2008 26,828,000 2009 25,463,000 2010 23,527,000 Thereafter 84,623,000 ----------- Total minimum cash payments $215,487,000 ===========
Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note M - Commitments and Contingencies (continued) In addition, certain of these leases contain rent escalation provisions and require additional percentage rent payments to be made. Step rent provisions and escalation clauses are taken into account in computing the minimum lease payments, recognized on a straight-line basis over the minimum lease term. The Company may also receive capital improvement funding from landlords, primarily as an incentive for the Company to lease retail and outlet store space from the landlords. Such amounts are amortized as a reduction of rent expense over the life of the related lease. Rent expense is as follows:
For the years ended December 31, 2005 2004 2003 Minimum Rent $27,711,000 $24,340,000 $23,173,000 Contingent Rent and other 6,413,000 7,530,000 7,995,000 ---------- ---------- ----------- Total Rent Expense $34,124,000 $31,870,000 $31,168,000
Sub-tenants rental income for 2005, 2004, and 2003 was $849,000, $1,073,000, and $1,225,000, respectively. Future minimum rental income from sub-tenants is $849,000 for 2006. Future minimum rental income from sub-tenants does not include rent escalation and other charges that are subsequently passed through to the sub- tenant. In 2004, the Company entered into an agreement to purchase the office building that it is currently leasing for its New York City worldwide headquarters for approximately $24 million. The contracted closing date is May 2006. The specific timing of an earlier closing date can be determined by the parties, based on the ability of the current landlord to satisfy certain terms and conditions of the agreement. Also in 2004, the Company entered into a new 10-year lease for 51,000 square feet in Secaucus, New Jersey for its administrative offices and completed the move in June 2004. In 2004, the distribution facility was moved to a third-party public warehouse and distribution center in New Jersey. In addition to these two leases, the Company also leases a 23,500 square foot facility in Secaucus used for outlet store space as well as an additional distribution warehousing facility. The Company also has a technical and administrative office in Florence, Italy, and signed a lease for a similar office in China in November 2005. The Company does not own or operate any manufacturing facilities. The Company leases space for all of its 53 specialty retail stores (aggregating approximately 243,000 square feet) and 39 outlet stores (aggregating approximately 200,000 square feet). Generally, the leases provide for an initial term of five to ten years and certain leases provide for renewal options permitting the Company to extend the term thereafter. Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note M - Commitments and Contingencies (continued) 2. Letters of credit The Company was not contingently liable for any open letters of credit as of December 31, 2005, and was contingently liable for $91,000 of open letters of credit as of December 31, 2004. In addition, at December 31, 2005 and 2004, the Company was contingently liable for approximately $6,679,000 and $6,576,000 of standby letters of credit, respectively. 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. The Company had no customer account for more than 10% of consolidated net sales for the years ended December 31, 2005, 2004, and 2003. 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, and China. However, approximately 46% and 42% of total handbag purchases came from two manufacturers in China during the years ended December 31, 2005 and 2004, respectively. Approximately 21% of Kenneth Cole and Kenneth Cole Reaction men's footwear purchases were from one manufacturer in China during the year ended December 31, 2005, and approximately 37% of those purchases were from one manufacturer in Italy utilizing many different factories during the year ended December 31, 2004. Also, approximately 32% of Kenneth Cole ladies' footwear was purchased from one Brazilian manufacturer during the year ended December 31, 2005, while 33% of those purchases were from one Italian manufacturer during the year ended December 31, 2004. Furthermore, approximately 44% of Kenneth Cole Reaction ladies' footwear purchases were sourced through one Chinese manufacturer during the year ended December 31, 2005, and 58% were purchased from one Italian manufacturer during the year ended December 31, 2004. 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. Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note M - Commitments and Contingencies (continued) 4. Severance In October 2005, the Company entered into an agreement with a senior executive of the Company relating to termination of employment. The Company incurred expenses of approximately $900,000 of severance and other benefits related to such agreement, substantially all in the three months ended December 31, 2005. In 2004, in conjunction with the Company's decision to close its east coast distribution center and transfer the operation to a third-party service provider, the Company entered into a shutdown agreement in 2004, with a local affiliate of the International Leather Goods, Plastics, Handbags and Novelty Workers Union, Local I Division of Local 342-50 United Food and Commercial Workers Union, which provided for, among other things, severance payments for employees covered by the expiring collective bargaining agreement. In connection with this transition, the Company incurred approximately $1.1 million in aggregate costs, including severance from the aforementioned agreement, the write-off of unamortized leasehold improvements and moving costs. These costs were expensed as incurred in accordance with SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activity" and recorded in Selling, General and Administrative expenses in the Consolidated Statement of Income. As of December 31, 2005 and 2004, the Company did not have any employees covered under a collective bargaining agreement with a local union. As of December 31, 2003, the Company had approximately 6% of its employees covered under a collective bargaining agreement with a local union. 5. Line of Credit Facility The Company has a Line of Credit Facility (the "Facility") that, as amended, allows for uncommitted borrowings, letters of credit 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, 2005, and 2004. Amounts available under the Facility at December 31, 2005 were reduced by $6,679,000 of standby letters of credit. In connection with the line of credit, the Company has agreed to eliminate all the outstanding Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note M - Commitments and Contingencies (continued) advances under the Facility for at least 30 consecutive days during each calendar year, which the Company has complied with. In addition, borrowings under the line of credit are secured by certain assets of the Company. 6. Other In April 2005, a purported class action lawsuit was filed against the Company in the Superior Court of California for the County of San Diego. The individual plaintiff is a floor supervisor in one of the Company's retail stores who purports to bring suit on behalf of him and other similarly situated current and former floor supervisors. Among other claims, the plaintiff alleges that he and other floor supervisors worked hours for which they were entitled to receive, but did not receive, overtime compensation under California law. The lawsuit seeks damages, penalties, restitution, equitable relief, interest and attorneys' fees and costs. The Company denies the allegations in the complaint and plans to defend the action vigorously. The Company does not believe that the outcome will have a material adverse effect on its business operations. In September 2004, a purported class action lawsuit was filed against the Company in the Superior Court of California for the County of Los Angeles. The individual plaintiffs are current or former store managers or assistant managers who purport to bring suit on behalf of themselves and other similarly situated store managers and assistant managers. Among other claims, the plaintiffs allege that they worked hours for which they were entitled to receive, but did not receive, overtime compensation under California law. The lawsuit sought damages, penalties, restitution, reclassification and attorneys' fees and costs. In January 2006, the Company reached an agreement in principle to settle the matter, and the parties filed a fully executed Stipulation of Class Settlement and Release. The Court signed and entered an order granting preliminary approval to the settlement. The settlement provides for a maximum settlement of $900,000, which includes all payments to class members, incentive awards, attorney's fees and administration costs. While there is still uncertainty relating to the ultimate settlement amount, the Company believes that its reserves as of December 31, 2005 are adequate. The Company is, from time to time, a party to other litigation that arises in the normal course of its business operations. The Company is not presently a party to any other litigation that it believes might have a material adverse effect on its business operations. Note N - 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 Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note N - Shareholders' Equity (continued) Class A Common Shareholders vote together with Class B Common Shareholders on all matters subject to shareholder approval, except that 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. 3. Common Stock Repurchase In December 2004, the Company repurchased 500,000 of its shares from Liz Claiborne, Inc. at an aggregate price of $13.9 million, which were originally acquired by Liz Claiborne, Inc. in connection with its licensing agreement with the Company. In December 2003, 2,888,400 shares were repurchased in the open market at an aggregate price of $66,221,000. The Company's stock purchase plan authorizes the repurchase of an aggregate of 4,250,000 of shares of Class A common stock. No shares were repurchased in 2005, and the Company had 861,600 shares available for repurchase as of December 31, 2005. In 2006, the Company's Board of Directors increased the authorization for the Company's repurchase plan by approximately 1,138,400 shares, and now has an aggregate of 2 million shares available for repurchase. Note O - Licensing Agreements In 2005, the Company entered into a Stock Purchase Agreement (the "Stock Purchase Agreement") with Bernard Chaus, Inc., ("Chaus"), pursuant to which the Company purchased 6,000,000 shares of Chaus common stock for an aggregate purchase price of $6,000,000. The Stock Purchase Agreement provides the Company with one demand and one piggyback registration right. The Company recorded the shares at their fair value at the date of acquisition, and classified the shares as "available for sale" under SFAS 115, which is included in Deposits and Sundry in the accompanying Consolidated Balance Sheet. The Company has recorded unrealized gains of $414,000, net of taxes, related to the Chaus shares, in Accumulated Other Comprehensive Income in the accompanying Statement of Changes in Shareholders' Equity. In addition, the Company also entered into a license agreement ("License Agreement") with Chaus, dated June 13, 2005. The License Agreement grants Chaus an exclusive license to design, manufacture, sell and distribute women's sportswear under the Company's trademark, Kenneth Cole Reaction. The initial term of the License Agreement expires on December 31, 2010. Chaus has the option to renew the License Agreement for an additional term of three years if it meets specified sales targets and is in compliance with the License Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note O - Licensing Agreements (continued) Agreement. The License Agreement provides that the Company receives payment of specified royalties on net sales. The License Agreement also requires Chaus to achieve certain minimum sales levels, to pay certain minimum royalties and to maintain a minimum net worth. Chaus is also obligated to pay specified percentages of net sales to support advertising and to expend a specified amount in the period ending December 31, 2007 to support the initial launch of the Licensed Products, as defined. In November 2004, the Company entered into a licensing agreement with G-III Apparel Group, LTD ("G-III"), in connection with worldwide manufacturer, sale, and distribution of women's and men's outerwear. The agreement commenced on January 1, 2005 and continues through December 31, 2008, with options to renewbased on certain milestones to be met by G-III. As part of the agreement, the Company will earn royalties based on a percentage of G-III's net sales. The Company will receive $3,000,000 over the term of the agreement, as consideration for the grant of the license, and also received 50,000 shares of its G-III's unregistered stock, with a value of $297,000 at the date of receipt. The cash and stock consideration are being amortized over the term of the agreement as part of the royalty stream. In addition, the Company recorded the shares as an "available for sale" investment under SFAS 115, which is included in Deposits and Sundry in the accompanying Consolidated Balance Sheet. Note P - Related Party Transactions The Company has an exclusive license agreement with Iconix Brand Group, Inc., formerly Candies, Inc., and its trademark holding company, IP Holdings, LLC ("Candies"), to use the Bongo trademark in connection with worldwide manufacture, sale and distribution of women's, men's and children's footwear. The Chief Executive Officer and Chairman of Candies is the brother of the Company's Chief Executive Officer and Chairman. The initial term of the agreement is through December 31, 2007, with options to renew through December 31, 2016 based upon the Company reaching certain sales thresholds. The license agreement with Candies was entered into at arm's-length. During these periods, the Company is obligated to pay Candies a percentage of net sales based upon the terms of the agreement. The Company recorded approximately $1,260,000 and $1,070,000 in aggregate royalty and advertising expense with respect to Candies for the years ended December 31, 2005 and December 31, 2004, respectively. Note Q - New Accounting Pronouncements In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, "Inventory Costs - An Amendment of ARB No. 43, Chapter 4" ("SFAS 151"). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing", to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS 151 is effective for fiscal years beginning after June 15, 2005 and, as such, the Company adopted SFAS 151 on January 1, 2006. The adoption of SFAS 151 did not have a material impact on the Company's consolidated results of operations, financial position, or cash flows. Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note Q - New Accounting Pronouncements (continued) In December 2004, the FASB issued SFAS 123R, which supersedes APB Opinion No. 25. SFAS 123R requires all share-based payments, including grants of employee stock options, to be recognized in the financial statements based on their fair values. Under SFAS 123R, public companies will be required to measure the cost of services received in exchange for stock options and similar awards based on the grant-date fair value of the award and recognize this cost in the income statement over the period during which an award recipient is required to provide service in exchange for the award. The pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition methods include modified prospective and retroactive adoption options. The Company adopted SFAS 123R on January 1, 2006 using the modified prospective method. Under this method, the Company will recognize compensation cost, on a prospective basis, for the portion of outstanding awards for which the requisite service has not yet been rendered as of January 1, 2006, based upon the grant-date fair value of those awards calculated under SFAS 123 for pro forma disclosure purposes. Earnings and diluted earnings per share are expected to decrease by approximately $5.4 million and $0.16, respectively, as a result of share-based grants in 2006, and those grants as of December 31, 2005 for which compensation expense has not been recognized under SFAS 123. Also in December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets-An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions ("SFAS 153"). SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, Accounting for Nonmonetary Transactions, and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The adoption of SFAS 153 on January 1, 2006, did not have a material impact on the Company's consolidated results of operations or financial condition In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections," ("SFAS 154"), a replacement of Accounting Principles Board Opinion (APB) No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements." This Statement requires retrospective application to prior periods' financial statements of a change in accounting principle. It applies both to voluntary changes and to changes required by an accounting pronouncement if the pronouncement does not include specific transition provisions. APB 20 previously required that most voluntary changes in accounting principles be recognized by recording the cumulative effect of a change in accounting principle. SFAS 154 is effective for fiscal years beginning after December 15, 2005. The Company adopted this statement on January 1, 2006, and does not anticipate that it will have a material effect on the Company's consolidated results of operations, financial position, or cash flows. Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note Q - New Accounting Pronouncements (continued) In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations ("FIN 47"). FIN 47 is an interpretation of Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" ("SFAS 143"), and clarifies the term conditional asset retirement obligation as used in SFAS 143, which refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, the Company is required to identify any conditional asset retirement obligations it may have with respect to its long- lived assets, and recognize a liability for the fair value of any conditional asset retirement obligations, if the fair value of the liability can be reasonably estimated. FIN 47 is effective for the fiscal year ending December 31, 2005. As such, the Company adopted FIN 47 in 2005, which did not materially impact the Company's consolidated results of operations, financial position, or cash flows. Note R- Quarterly Financial Data (Unaudited) Summarized quarterly financial data for 2005 and 2004 appear below (in thousands, except per share data):
First Second Third Fourth Quarter Quarter Quarter Quarter 2005 Net sales $120,292 $109,281 $124,720 $119,767 Royalty revenue 9,606 10,054 11,059 13,264 Net revenues 129,898 119,335 135,779 133,031 Gross profit 56,166 55,369 60,533 62,248 Operating income 11,184 11,208 12,618 10,353 Net income 7,489 7,708 10,853 7,476 Earnings per share basic $0.38 $0.39 $0.54 $0.37 Earnings per share diluted $0.37 $0.38 $0.53 $0.37 Dividends Declared $0.16 $0.16 $0.16 $0.18 2004 Net sales $113,351 $103,720 $132,929 $123,438 Royalty revenue 9,026 9,337 11,784 12,616 Net revenues 122,377 113,057 144,713 136,054 Gross profit 52,468 51,374 63,624 63,918 Operating income 11,676 10,992 19,280 14,469 Net income 7,393 7,027 12,158 9,274 Earnings per share basic $0.37 $0.35 $0.60 $0.46 Earnings per share diluted $0.36 $0.34 $0.59 $0.45 Dividends Declared $0.12 $0.12 $0.14 $0.14
Kenneth Cole Productions, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) Note S- Subsequent Event On March 1, 2006, the Board of Directors declared a quarterly cash dividend of $0.18 per share payable on March 30, 2006 to shareholders of record at the close of business on March 9, 2006. 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 Chief Executive Officer Date: March 10, 2006 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 Chief Executive Officer March 10, 2006 Kenneth D. Cole and Chairman of the Board /s/ DAVID P. EDELMAN Chief Financial Officer March 10, 2006 David P. Edelman /s/ ROBERT C. GRAYSON Director March 10, 2006 Robert C. Grayson /s/ DENIS F. KELLY Director March 10, 2006 Denis F. Kelly /s/ PHILIP B. MILLER Director March 10, 2006 Phillip B. Miller /s/ PHILIP R. PELLER Director March 10, 2006 Philip R. Peller /s/ MARTIN E. FRANKLIN Director March 10, 2006 Martin E. Franklin Kenneth Cole Productions, Inc. Schedule II Valuation and Qualifying Accounts For the Years Ended December 31, 2005, 2004, and 2003
Balance at Charged to Balance Beginning Costs and at End of Period Expenses Deductions of Period Description Year ended December 31, 2005 Allowance for doubtful accounts $(302,000) $(290,000) $294,000 $(298,000) Reserve for returns and sales allowances $(8,377,000) 309,000 $(8,068,000) ------------ ---------- --------- ------------ $(8,679,000) $(290,000) $603,000 $(8,366,000) ============ ========== ========= ============ Year ended December 31, 2004 Allowance for doubtful accounts $(475,000) $(54,000) $227,000 $(302,000) Reserve for returns and sales allowances $(9,425,000) 1,048,000 $(8,377,000) ------------ --------- --------- ------------ $(9,900,000) $(54,000) $1,275,000 $(8,679,000) ============ ========= ========= ============ Year ended December 31, 2003 Allowance for doubtful accounts $(475,000) $(262,000) $262,000 $(475,000) Reserve for returns and sales allowances $(9,400,000) (25,000) $(9,425,000) ------------ --------- ---------- ------------ $(9,875,000) $(287,000) $262,000 $(9,900,000) ============ ========== ========== ============
Exhibit 21.01 Kenneth Cole Productions, Inc. Affiliate Group Members location of Subsidiaries at: 12/31/2005 incorporation Cole 57th. St., LLC Delaware Cole Amsterdam, B.V. Amsterdam Cole Amsterdam, Inc. Delaware Cole Broadway, Inc. New York Cole Clinton, Inc. Connecticut Cole Dawsonville, Inc. Delaware Cole Fashion Valley, Inc. Delaware Cole Forum, Inc. Delaware Cole Garden State, Inc. Delaware Cole Georgetown, Inc. District of Columbia Cole Grand Central, Inc. Delaware Cole Grant, Inc. Delaware Cole Las Vegas, Inc. Delaware Cole Michigan Avenue, Inc. Delaware Cole New Orleans, Inc. Delaware Cole Pike, Inc. Delaware Cole Reading Outlet, Inc. Pennsylvania Cole SFC, LLC Delaware Cole Short Hills, Inc. New Jersey Cole South Beach, Inc. Florida Cole Tyson, Inc. Virginia Cole Waikele, Inc. New York K.C.P.L., Inc. Delaware KCP Beneficiary Services, LLC Delaware KCP Consulting (Dongguan), Co. Ltd. PRC KCP Trust, LLC Delaware Kenneth Cole Asia, Inc. Delaware Kenneth Cole Canada, Inc. Canada Kenneth Cole Catalog, Inc. Virginia Kenneth Cole Productions, (LIC), Inc. Bahamas Kenneth Cole Productions, Inc. New York Kenneth Cole Productions, LP Delaware Kenneth Cole Services (NY), Inc. Delaware Kenneth Cole Services, Inc. Delaware Kenneth Cole Trading, Inc. Delaware Kenneth Cole, Inc. New Jersey Kenneth Productions, Inc. Delaware Kenth, Ltd. Hong Kong Riviera Holding, LLC Delaware South Side, LLC Delaware Kenneth Cole International Services, LLC Delaware Exhibit 23.01 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in Registration Statement (Form S-8 No. 333-92094) pertaining to the Kenneth Cole Productions, Inc. 1994 Stock Option Plan, Registration Statement (Form S-8 No. 333-31868) pertaining to the Kenneth Cole Productions, Inc. Employee Stock Purchase Plan, Registration Statement (Form S-8 No. 333-119101) pertaining to the Kenneth Cole Productions, Inc. 2004 Stock Incentive Plan, and Registration Statement (Form S-8 No. 333-131724) pertaining to the Kenneth Cole Productions, Inc. 2004 Stock Incentive Plan of our reports dated March 9, 2006, with respect to the consolidated financial statements and schedule of Kenneth Cole Productions, Inc., Kenneth Cole Productions, Inc. management's assessment of the effectiveness of internal control over financial reporting, and the effectiveness of internal control over financial reporting of Kenneth Cole Productions, Inc., included in the Annual Report (Form 10-K) for the year ended December 31, 2005. /s/ Ernst & Young LLP New York, New York March 9, 2006 Exhibit 31.1 CERTIFICATIONS PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION I, Kenneth D. Cole, certify that: 1. I have reviewed this annual report of Kenneth Cole Productions, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a- 15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. By: /s/ Kenneth D. Cole ------------------ Kenneth D. Cole Chief Executive Officer Date: March 10, 2006 Exhibit 31.2 CERTIFICATIONS PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION I, David P. Edelman, certify that: 1. I have reviewed this annual report of Kenneth Cole Productions, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a- 15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. By: /s/ David P. Edelman ------------------ David P. Edelman Chief Financial Officer Date: March 10, 2006 Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Kenneth Cole Productions, Inc. (the "Company") on Form 10-K for the period ending December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Kenneth D. Cole, Chairman and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Kenneth D. Cole Kenneth D. Cole Chairman and Chief Executive Officer Kenneth Cole Productions, Inc. March 10, 2006 Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Kenneth Cole Productions, Inc. (the "Company") on Form 10-K for the period ending December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, David P. Edelman, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ David P. Edelman David P. Edelman Chief Financial Officer Kenneth Cole Productions, Inc. March 10, 2006 -----END PRIVACY-ENHANCED MESSAGE-----