<DAILY DOUBLE>
Thursday, April 29, 1999

K-Swiss, Inc.
(Nasdaq: KSWS)
Phone: 818-706-5100
Website: http://www.kswiss.com
Price (4/28/99): $41 5/16


HOW DID IT DOUBLE?

With Air Jordan sputtering in the wake of the captain's retirement, some investors have climbed aboard shoe designer Air Swiss. And what a ride! K-Swiss has proven that you don't need to fly at 30,000 feet with megamillion-dollar star appeal to enjoy a slamming, jamming, dunk-o-rama of an investment. Michael was the Man, but now K-Swiss is the Brand.

Special K has been shakin' and bakin' by avoiding the highly competitive b-ball niche, limiting its shoe allocations to ensure that the brand's cachet doesn't grow stale on the discount rack, boosting its ad spending, and delivering classic white-on-white styling for casual wear.

There's nothing casual about the company's results. FY98 sales hopped 39% to $162 million, thanks to record domestic sales of $145 million, up 59%. Net income screamed ahead 201% to $12.5 million, with EPS up 214% to $1.10 per share thanks to a buyback. Overall footwear sales increased 30% to 6.3 million pairs while the average wholesale price rose 7.9% to $24.54, as sales of K-Swiss Classics increased 31% thanks to popular new products like the Sentir. Meanwhile, unit sales of children's shoes leaped 60%.

Fourth quarter earnings of $0.33 a share bested estimates by 25%, quite a feat considering the analysts had pumped up their projections after K-Swiss toasted the Q3 consensus by 56%. And the good news just keeps coming.

Q1 results announced April 22 showed that sales soared 110% to $88.6 million, as domestic sales jumped 113% and international revenues picked up, rising 79%. EPS vaulted 271% to $1.15, crushing the $0.75 consensus estimate. The trend continued, with Classic unit sales up 98%, children's sales up 118%, and average selling prices edging up to $26.36 from $24.56 a year ago. Gross margins increased to 43.3% from 40.6% while the booming sales cut operating expenses to just 18.8% of revenues from 27.5% a year ago.

With no holes in this cheese, investors have eaten up K-Swiss. The stock has tripled in 1999 alone.

BUSINESS DESCRIPTION

Founded in 1966, K-Swiss designs, develops, and markets athletic and casual footwear and some apparel.

Unlike its giant competitors Nike (NYSE: NKE) and Reebok (NYSE: RBK), which change their styles frequently, K-Swiss has succeeded by sticking closely to its Classic, a relatively unchanged all-leather tennis shoe now marketed for casual wear. The company also sells performance tennis shoes.

The Classic line includes three subcategories. The traditional Classic is a white shoe with five white stripes and silver D-rings for the laces. K-Swiss maintains an inventory of these perennial favorites. Meanwhile, its K-S Collection includes shoes without D-rings and with either diffused stripes or no stripes. These run for three to five seasons, with K-Swiss holding light inventory. Finally, the Limited Edition series offers one-season-only styles, with no inventory risks.

For FY98, men's shoes accounted for 38% of sales and women's shoes for 36%. By product line, this broke down as 61% of revenue from the K-Swiss Classic line and 13% from Tennis/Court. The fast-growing children's line made up 22% of sales with the remaining 4% from apparel. With weakness overseas, the U.S. market became even more important, accounting for 90% of sales versus 79% in FY97.

K-Swiss shoes are sold by specialty footwear retailers, with Venator's (NYSE: Z) Foot Locker accounting for 26% of sales last year. The company also has an attractive online store.

Including some 3.1 million Class B shares, insiders own about 32% of the stock, with most held by a trust controlled by Chairman Steven Nichols. The stock split two-for-one in March.

FINANCIAL FACTS

Income Statement
12-month sales: $207.8 million
12-month income: $22.3 million
12-month EPS: $1.94
Profit Margin: 10.7%
Market Cap: $476.7 million

Balance Sheet
Cash: $22.8 million
Current Assets: $125.5 million
Current Liabilities: $27.3 million
Long-term Debt: None

Ratios
Price-to-earnings: 21.3
Price-to-sales: 2.3

HOW COULD YOU HAVE FOUND THIS DOUBLE?

The Fool's Rising Margins screen, baby! Companies with rising profit margins and increasing sales often make terrific investment candidates, especially when they start out as cheap as K-Swiss. We cover some of these investment candidates in each Tuesday's Foolish Workshop column. I'm pleased to say K-Swiss has made multiple appearances.

On November 3, with the stock at $12 per share (all prices split-adjusted), I noted that net of cash, the stock traded for just 5.5 times the then-current FY99 earnings. "This one definitely deserves further research. Either it's dirt cheap and has simply been ignored because of its tiny float and small market cap, or there's something else to the story."

After pounding the table again two weeks later, I returned to the story February 9 after Q4 earnings were released. With the stock at $22, I concluded that "the good story looks intact" and "it's not too late to take a closer look at K-Swiss." This wasn't rocket science. The company's results were simply terrific.

Of course, you might have found K-Swiss even earlier. A year ago, with the stock around $10 a share, the board authorized the repurchase of $20 million worth of stock. Since then, the company has bought back over 300,000 shares, paying about $17 a share. The company has been buying back stock for a while, though, retiring 2.7 million shares at about $8.25 apiece over the last three years. Clearly, the board was buying on the cheap.

WHERE TO FROM HERE?

Despite some modest insider selling, the outlook is still bright for Swissy. Domestic future orders with shipping dates between now and September stood at $135 million on March 31. That's 130% above the year-ago level. The international backlog has also improved 13% from a year ago to $7 million.

The company is also looking to get more aggressive on the ad front, boosting spending from $9 million last year to $17 million in 1999. Following up on last year's successful "Club K-Swiss" ads, the company just started a television campaign running on ESPN, Fox Sports, and MTV highlighting four up-and-coming athletes. It's a smart move. K-Swiss gets high production value sweat on the cheap while further enhancing its own up-and-comer image.

Indeed, what the recent slump in the athletic shoe market suggests is not so much that brown shoes are taking over the world, but that the important urban teen market has rebelled somewhat against the mega-marketing might of Nike in favor of little guys who can deliver quality and style. K-Swiss has been a major beneficiary of this changing taste.

The new high-side earnings estimates call for $2.03 per share for FY99 and $2.50 for the following year. So the stock now trades at about 21 times forward earnings. The analyst restraint in that estimate may be related to the higher ad spending, but it looks easily beatable assuming the company's momentum continues.

Fashions can shift quickly in the shoe business, and the return of pro basketball could give a boost to the recently faltering athletic shoe giants. But one also gets a sense that young Americans may be permanently put off by Nike's domineering presence. At some point, shoes just can't be cool if everyone's wearing them.

In that context, K-Swiss may still be in the early stages of a resurgence. Even with its soaring sales, the company remains tiny compared to Nike's $8.9 billion in sales.

Moreover, the company appears to be managing its growth pretty well. Year-over-year, inventories are up just 27% despite the booming sales. Meanwhile, accounts receivable has increased in line with sales. K-Swiss is growing so rapidly that operating cash flow actually declined $13.9 million to finance the much higher receivables, but the company still has $23 million in cash and no debt.

Though the stock is no longer as cheap as it was in November, it could easily top $50 in the year ahead, making it a likely market beater.

--Louis Corrigan
(TMFSeymor@aol.com)

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