Investment Analysis of

By Ray Szutu

Mar 26, 2009

What do they do?

The Classic Shoe

Business

• Founded in 1966

• Designs, develops and markets shoes

• Sells wholesale to footwear retailers

• Sales: 42% domestic (U.S.), 58% international

Investment Thesis

• Cheap relative to long term earning power

• Great balance sheet

• Well managed, simple company

K-Swiss Shoes

Figures in US$

• $65 retail price

• $26 wholesale price

• $15 production cost (China)

• $7.80 SG&A cost

~ 15% operating margin, historically

Unit PriceAvg wholesale price

$23.00

$24.00

$25.00

$26.00

$27.00

$28.00

$29.00

2008 2007 2006 2005 2004 2003 2002 2001 2000

Volume

5.00

7.00

9.00

11.00

13.00

15.00

17.00

19.00

2008 2007 2006 2005 2004 2003 2002 2001 2000 1999

Pa

irs

so

ld (

mil

's)

Margins

-5.0%

5.0%

15.0%

25.0%

35.0%

45.0%

55.0%

2008 2007 2006 2005 2004 2003 2002 2001 2000 1999

Operating Margin Gross Margin

Selling, General & Admin Costs

• > $10M spent on data implementation since 2007

• Increased stock option expense

• Non-recurring

• International expansion

Earning Power

Figures in US$, averages since 1997:

• Net income = $33.4M

• Free cash flow = $34M

• Bal Sheet earnings = $41.7M

Ugly near-term outlook

Free Cash Flow

(20.0)

-

20.0

40.0

60.0

80.0

100.0

2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997

Fre

e C

as

h F

low

Capital Structure

• Almost no debt ($9M)

• $207M in cash

• $312M market cap ($8.95/sh)

• $52M in lease and purchase obligations

**Very conservatively financed

Liquidation Value

Figures in mil’s $ 2008 Recvry Adj.

Cash 207.4 1.00 207.4

A/R 35.0 0.90 31.5

Inventory 74.4 0.70 52.1

PP&E 25.7 0.33 8.5

Total Assets 395.1 299.4

Liabilities 70.3 1.00 70.3

Liquidation Value 229.1

Management

• CEO: Steven Nichols (since 1987)• CFO: George Powlick (since 1988)

• Invested alongside shareholders• Experienced• Long-term orientated• Good capital allocation• Re-priced stock options

Competition

• Nike, Adidas, Skechers

• Gross margins and ROE just as high

• Less development costs

Valuation

Typical metrics:

• P/E = 15.2 x

• P/B = 0.96x

• Div yield = 2.5%

These are not applicable

Valuation

• EV / FCF = 3.35x

• Private market valuation– “What a reasonable buyer would pay for the

business in the private market in a cash financed, arms-length transaction”

• Give away price = $5.50

Private Market ValuationTarget Buyer Date EV (mil's US$) EV / FCF

Umbro Nike 10/23/2007 584 10.50

Stride Rite Payless Shoes 5/23/2007 815 11.11

Reebok Adidas 8/3/2005 3,527 14.29

Maxwell Shoe Co Jones Apparel 7/7/2004 274 11.98

Converse Nike 7/10/2003 335 11.11

Saucony Stride Rite 7/1/2005 140 7.78

Private Market Valuation

• Min @ 7.8x: $604M

• Max @ 14.3x: $869M

• Avg @ 11.1x: $740M

Current market cap: $312M

The market…

“… is a voting machine in the short-term, and a weighing machine in the long-term”