K•SWISS INC.

EVA Bonus Plan, as amended

 

MEASURING OUR PERFORMANCE

 

Our mission has one simple goal - to create greater value for our shareowners, employees and other stakeholders. That is the main purpose of K•Swiss Inc. and that goal is built upon a simple economic premise - that value is created by consistently increasing the Company’s economic profit year after year.

 

While our mission is easy enough to understand, how we accomplish it is somewhat more complex.

 

In 1996, we adopted a simple easy-to-use tool to measure our financial performance. Known as Economic Value Added or EVA, this measurement tool helps us to determine how well we are doing in our primary mission. EVA tells us how much value we have added from one year to the next by calculating the growth in our economic profit.

 

Because it is a key factor in the financial health of the Company, EVA also plays a significant role in our future. So, it is important that we all learn what we can do to positively affect the Company’s EVA - for the benefit of our shareowners, the Company and ourselves.

 

WHAT IS EVA?

 

EVA is a financial performance measurement tool that is easily calculated. Put simply, EVA measures the increase in economic profit generated from one year to the next.

 

Let’s start by defining economic profit. Economic profit is the Company’s net operating profit after taxes (NOPAT) minus a charge for operating capital. This charge reflects the cost of acquiring that capital from our shareowners and our lenders. Calculating our economic profit shows if we are obtaining a return greater than the cost of that capital.

 

To measure whether we are improving our economic profit each year, we use the formula for Economic Value Added. EVA is calculated by subtracting last year’s economic profit from this year’s. The result is the economic value added to the Company - how much additional value we have created for shareowners in that particular year.

 

WHY USE EVA?

 

Not only is it an ideal financial measurement tool, EVA is also the most accurate method for making business decisions that truly create additional economic value for our Company.

 

Used by themselves, other financial measurements, such as operating income growth, can be misleading. Unless a business consistently earns more than the cost of its capital, it will lose value for its shareowners … even if it is growing operating income.

 

HOW DOES EVA ACTUALLY WORK?

 

Using EVA is simple. Just follow these four steps:

 

First, calculate your NOPAT.

 

Second, calculate your capital charge. To do that, multiply your average operating capital times the Company’s cost of capital. Operating capital is your working capital (cash, inventories and receivables minus payables) plus your fixed assets (property, plant and equipment).

 

Next, subtract your capital charge from your NOPAT. This is your economic profit.

 

Finally, subtract last year’s economic profit from this year’s economic profit … and the result is the economic value you have added.

 

WHO IS ACCOUNTABLE FOR EVA?

 

Each Company operation is accountable for its economic profit and EVA. Specifically, it is responsible for the two key drivers of EVA - net income and operating capital.

 

Previously, operating managers were judged on several net income measures over which they had varying degrees of control. In the future, financial performance will be based on measures that can be influenced. Treasury-related items - interest income and expense - will be charged to Corporate Treasury.

 

In addition, the Company’s effective tax rate will be charged to all operations.

 

Also, more focus will be given to the second driver of EVA - operating capital. The capital invested in an operation directly affects its economic profit through the capital charge. If each operation and each business segment earn returns in excess of the cost of capital, the Company will consistently grow its economic profit and EVA.

 

K•Swiss Inc.

Your EVA Award Calculation

 

Overview

 

The EVA award is a formula-driven plan that is based upon two factors: (1) a bonus target and (2) a financial performance factor.

 

Incentive Award = Bonus Target x Performance Factor

 

The Bonus Target is a percentage of base salary that is defined by the plan. The Performance Factor is a multiplier derived by comparing actual financial performance to expected financial performance. For example, if you have an established Bonus Target of $10,000 and your business unit’s actual performance equaled 110% of expected performance last year, your incentive award equals $11,000 ($10,000 x 110%).

 

 

 

 

Incentive Award

 

= Bonus Target x Performance Factor

 

 

= $10,000 x 110%

 

 

= $11,000

 

This booklet will explain our plan and how to calculate your EVA award.

 

THE EVA AWARD

 

Your Bonus Target

 

K•Swiss’ EVA incentive program has set competitive targets for individual participants. Each participant has a Bonus Target that is determined by multiplying a Target Percentage by the incumbent’s base salary. The Target Percentage for each participant has been established by the compensation committee based on job requirements, scope and duties of each position. For example, if your Target Percentage is equal to 10 and your salary is $90,000, your Bonus Target would be 10% x $90,000 = $9,000.

 

 

 

 

Bonus Target

 

= Target Percentage x Participant’s Base Salary

 

 

= 10% x $90,000

 

 

= $9,000

 

EVA Performance Factor

 

EVA is an exciting new development in incentive compensation design. It makes managers into stakeholders in two powerful ways:

 

1. Your EVA Award will be based solely on the EVA Performance of your business unit.

 

2. Your EVA Bonus Declaration (the amount credited to the Bonus Bank at year end) is unlimited because, far from being an expense, it is a share of the value you are adding to K•Swiss.

 

One of the core values in our incentive pay program is that each participant should receive a portion of the value that they help create. K•Swiss uses EVA to measure the Company’s performance. The EVA Award is designed so that you receive an award based on your business unit’s contribution to K•Swiss’ EVA.

 

Our shareholders expected return on their investment can be measured in terms of EVA growth on an annual basis. This is called Expected EVA Improvement (EI). This improvement is not based upon your business plan, but rather on the expectations of our shareholders.

 

The EVA Interval represents the amount of deviation from Expected EVA Improvement (EI) that eliminates (negative deviation) or doubles (positive deviation) the bonus declaration. The EVA Interval and the expected EVA Improvement have been established to take economic and financial data for K•Swiss and our industry into account to develop the EVA Interval and expected EVA Improvement. The EVA Interval establishes the leverage (risk) of the plan; that is, the smaller the interval, the more quickly the bonus declaration doubles or goes to zero. The slope of the line, which is determined by the EVA Interval, establishes the extent to which you will be rewarded (or penalized) for actual EVA performance greater (or less) than E1.

 

It is important for the K•Swiss’ incentive pay program to provide you with part of the value you help create. To do this, the bonus calculation has to increase EVA Bonus Declarations as EVA Improvement increases. EVA Bonus Declarations will equal the EVA Target when Actual EVA Improvement equals the Expected EVA Improvement (EI) for your business unit.

 

In the next few pages you will be walked through calculating the EVA Bonus Declaration and EVA Award. As you will see, an EVA Bonus Declaration can be positive or negative depending upon your business unit’s actual performance. The purpose of these calculations is to take the process shown in the chart and apply it to your situation.

 

EVA Award Calculation Summarized:

 

1. The Actual EVA Improvement (AI) is measured by subtracting the Prior Year EVA from the Current Year EVA of your business unit.

 

2. Excess EVA Improvement is calculated by subtracting the Expected EVA Improvement (EI) from the Actual EVA Improvement (AI).

 

3. The Performance Multiple is calculated by dividing your Excess EVA Improvement by your EVA Interval.

 

4. Your Bonus Multiple is calculated by adding the Performance Multiple and the Target Multiple (always 1).

 

5. Your EVA Bonus Declaration is calculated by multiplying the Bonus Multiple in Step 4 by your Bonus Target.

 

6. Your EVA Bonus Declaration is credited to the Bonus Bank.

 

7. The Bonus Bank pays out your EVA Award based on certain rules.

 

Measuring EVA Performance

 

Performance is measured based on Actual EVA Improvement in your business unit compared to the Expected EVA Improvement. Your business unit’s performance is measured after the Current Year EVA is known. Remember that this measurement is not based on budget or business plan performance.

 

Step 1 First, the Prior Year EVA is subtracted from the Current Year EVA. The difference - called Actual EVA Improvement - is the amount of growth in EVA from one year to the next.

 

Step 2 Calculate the Excess EVA Improvement by subtracting the Expected EVA Improvement (EI) from the Actual EVA Improvement (AI).

 

Actual EVA Improvement (AI) = Current Year EVA - Prior Year EVA

 

Excess EVA Improvement = Actual EVA Improvement (AI) – Expected EVA Improvement

 

Calculating the EVA Bonus Declaration

 

Once the amount of Excess EVA Improvement is known, the Bonus Declaration, the amount credited to the Bonus Bank, can be calculated.

 

Step 3 Calculate the Performance Multiple by dividing the Excess EVA Improvement by the EVA Interval.

 

Step 4 Calculate the Bonus Multiple by adding the Performance Multiple and the Target Multiple (always 1).

 

Step 5 Multiply the Bonus Multiple by the Bonus Target and you will get the current year Bonus Declaration.

 

Performance Multiple = Excess EVA/EVA Interval

 

Bonus Multiple = Performance Multiple + Target Multiple (always 1)

 

Bonus Declaration = Bonus Multiple × Bonus Target

 

The bottom line is, if the Actual EVA Improvement (AI) is greater than Expected EVA Improvement (EI), the EVA Bonus Declaration will be greater than the EVA Target.

 

The Bonus Bank

 

Once the EVA Bonus Declaration is calculated, it is deposited in the Bonus Bank. Payments you receive are drawn from the Bonus Bank balance. The Bonus Bank:

 

 

 

Links cumulative pay to cumulative performance by reserving a portion of negative and exceptionally positive bonus declarations against future EVA Improvement.

 

 

 

Constantly extends an individual’s time horizon forward when making business decisions.

 

 

 

Smooths the bumps and grinds of the business cycle.

 

Here’s how the bank works:

 

Step 6 The EVA Bonus Declaration is deposited into the Bonus Bank

 

Step 7a The amount of the Bonus Bank balance, up to your full Bonus Target, will be paid to you from the Bonus Bank balance.

 

Step 7b If there is a remaining positive balance, you will receive an additional payment of one-third of the Bonus Bank balance. The amount of this additional payment cannot exceed your Bonus Target. That is, the maximum amount paid from the Bonus Bank in any year is 2 times your Bonus Target. Of course, if you reach this limit, any remaining amounts will remain in the Bonus Bank and are available for future payout.

 

In extreme situations, it would be possible that negative Bonus Declaration could result in a negative Bonus Bank. If you end the year with a negative Bonus Bank balance, that negative balance will be carried forward to the next year and must be offset by future positive Bonus Declarations.

 

Your Bonus Worksheet

 

The following worksheet is provided for you to complete with your own information.

 

 

 

 

 

 

1. Annual Base Salary

 

$

 

 

2. × Target Percentage

 

                    %

 

 

3. Bonus Target

 

$

 

 

 

STEP 1

 

4. Current Year EVA

 

$                    

 

 

 

STEP 1

 

5. - Prior Year EVA

 

$

 

 

 

STEP 1

 

6. = Actual EVA Improvement (AI)

 

$

 

 

 

STEP 2

 

7. - Expected EVA Improvement (EI)

 

$

 

 

 

STEP 2

 

8. = Excess EVA Improvement

 

$

 

 

 

STEP 3

 

9. ÷ EVA Interval

 

$

 

 

 

STEP 3

 

10. = Performance Multiple

 

$

 

 

 

STEP 4

 

11. + Target Multiple (always 1)

 

$

 

 

 

STEP 4

 

12. = Bonus Multiple

 

$

 

 

 

STEP 5

 

13. × Bonus Target

 

$

 

 

 

STEP 5

 

14. = EVA Bonus Declaration

 

$

 

 

 

STEP 6

 

15. Beginning Bonus Bank Balance

 

$

 

 

 

STEP 6

 

16. + EVA Bonus Declaration (line 14)

 

$

 

 

 

STEP 6

 

17. = Available Bonus Bank Balance

 

$

 

 

 

STEP 7a

 

18. – Payout up to EVA Target

 

$

 

 

 

STEP 7a

 

19. = Excess Bonus Bank Balance

 

$

 

 

 

STEP 7b

 

20. + Payout of excess Bonus Bank Balance *

 

$

 

 

 

STEP 7b

 

21. TOTAL EVA Award (line 18 + line 20)

 

$


 

*

Not to exceed EVA target

 

Other Rules

 

Maximum Annual Payments

 

As described above, the maximum bonus payment in any given plan year to any participant is limited to two times his or her target bonus amount. In addition, no participant may be paid more than $2,000,000 under this EVA Bonus Plan for any given plan year.

 

Transfers

 

If you are transferred from one EVA business unit to another EVA business unit during a given year, you will receive a bonus declaration and payment according to the following rules:

 

 

 

The award declared for the year of the transfer will be determined according to the full year EVA results of both EVA business units in which you worked during the plan year, and prorated based on the number of months of service in each EVA business unit.

 

 

 

Any positive Bonus Bank balance you have at the time of transfer will be paid out over three years beginning at the end of the year of the transfer. A new Bonus Bank (with a beginning balance of zero) will be established for you based on awards earned in the new EVA business unit.

 

 

 

Any negative Bonus Bank balance you have at the time of transfer will be carried over and amortized against awards earned at your new EVA business unit.

 

Terminations

 

Awards

 

If employment with K•Swiss terminates during the year, you will not be eligible for an EVA incentive award for that year.

 

Bonus Bank

 

Bonus Bank balances will be forfeited upon termination except in the following cases:

 

 

 

Termination due to death, disability or retirement (at or after age 62).

 

 

 

In cases of terminations due to death or disability, the Bonus Bank balance will be paid in one lump sum within thirty (30) days of the termination date. In cases of termination due to retirement at or after age 62, any Bonus Bank balance you have will be paid over three years, beginning at the end of the year in which you retire.

 

A Program That Rewards Your Performance

 

By providing you a share of all the value you help create, K•Swiss’ EVA Award program gives you an incentive to make decisions in the best interest of K•Swiss, our shareholders, customers and employees. By encouraging good business decisions, cost improvements and productivity, it also reinforces the goals of K•Swiss’ Strategic Plan.

 

The incentive compensation plans established by K•Swiss Inc. should not be construed to be a guarantee or contract of employment nor are employees vested in these benefits. As is customary with such plans, the Board of Directors of K•Swiss Inc. reserves the right to change or discontinue any plan at any time and for any reason, with or without notice.

 

Glossary

 

Actual EVA Improvement (AI)-Current Year EVA minus Prior Year EVA.

 

Bonus Bank-Links cumulative pay to cumulative performance by reserving a portion of negative and exceptionally positive bonus declarations against future EVA improvement.

 

Bonus Multiple-A number that is the sum of your Performance Multiple and Target Multiple (always 1).

 

Bonus Target-The amount calculated by multiplying the Target Percentage and the participant’s base salary.

 

Current Year EVA-The EVA for a participant’s business unit at the end of the current year being measured.

 

EVA Award-The amount of EVA bonus paid in any plan year. This amount cannot exceed 2 times the participant’s EVA Target Bonus.

 

EVA Bonus Declaration-The dollar amount deposited in the Bonus Bank at year-end, before any payments are made.

 

EVA Interval-The amount based on K•Swiss’ financial information and other economic data that determines the leverage of the EVA Plan Component. It is the amount of deviation from Expected EVA Improvement that eliminates or doubles the EVA Target bonuses.

 

Excess EVA Improvement-The amount by which Actual EVA Improvement is greater than (+) or less than (-) Expected EVA Improvement, that is (AI) - (EI).

 

Expected EVA Improvement (EI)-The expected EVA Improvement in a participant’s business unit in a given year. Provides the performance measure and standard for target awards that is consistent with shareholder expectations.

 

Performance Multiple-Excess EVA Improvement divided by the EVA Interval. This percentage represents your share of the excess EVA improvement in your business unit.

 

Prior Year EVA-The EVA for a participant’s business unit at the end of the year prior to the year being measured.

 

Target Percentage-The percentage of your base salary that is used to calculate the Bonus Target. This percentage is determined by the compensation committee.