Skechers U.S.A.
Annual Report 2001

Plain-text annual report

================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- FORM 10-K ----------------[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 OR[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO ____________ . COMMISSION FILE NUMBER: 001-14429 SKECHERS U.S.A., INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-4376145 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 228 MANHATTAN BEACH BLVD. MANHATTAN BEACH, CALIFORNIA 90266 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (310) 318-3100 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED Class A Common Stock, $0.001 par value New York Stock Exchange Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item405 of Regulation S-K is not contained herein, and will not be contained, to thebest of registrant's knowledge, in definitive proxy or information statementsincorporated by reference in Part III of the Form 10-K or any amendment to thisForm 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of theregistrant based upon the closing sales price of its Class A Common Stock onMarch 25, 2002 on the New York Stock Exchange was approximately $341 million. The number of shares of Class A Common Stock outstanding as of March 25,2002 was 15,667,855. The number of shares of Class B Common Stock outstanding as of March 25,2002 was 21,246,777. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Definitive Proxy Statement issued in connectionwith the 2002 Annual Meeting of the Stockholders of the Registrant areincorporated by reference into Part III.================================================================================ SKECHERS U.S.A., INC. FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 INDEX TO ANNUAL REPORT ON FORM 10-K PAGEPART IItem 1. Business........................................................... 3Item 2. Properties.........................................................19Item 3. Legal Proceedings..................................................20Item 4. Submission of Matters to a Vote of Security Holders................21 PART IIItem 5. Market for Registrant's Common Equity and Related Stockholder Matters................................................22Item 6. Selected Financial Data............................................23Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..........................................23Item 7a. Quantitative and Qualitative Disclosures About Market Risk.........30Item 8. Financial Statements and Supplementary Data........................31Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure...........................................31 PART IIIItem 10. Directors and Executive Officers of the Registrant.................32Item 11. Executive Compensation.............................................32Item 12. Security Ownership of Certain Beneficial Owners and Management.....32Item 13. Security Relationships and Related Transactions....................32 PART IVItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....33Signatures...................................................................37Consolidated Financial Statements............................................F-1 2 PART IITEM 1. BUSINESS Certain information contained in this report constitutes forward-lookingstatements which involve risks and uncertainties including, but not limited to,information with regard to our plans to increase the number of retail locationsand styles of footwear, the maintenance of customer accounts and expansion ofbusiness with such accounts, the successful implementation of our strategies,future growth and growth rates and future increases in net sales, expenses,capital expenditures and net earnings. The words "believes," "anticipates,""plans," "expects," "endeavors," "may," "will," "intends," "estimates," andsimilar expressions are intended to identify forward-looking statements. Theseforward-looking statements involve risks and uncertainties, and our actualresults could differ materially from those anticipated in these forward-lookingstatements as a result of certain factors, including, but not limited to, thoseset forth under "Risk Factors" and elsewhere in this Report.GENERAL We design and market a collection of contemporary footwear for men, womenand children under the Skechers brand, one of the most recognized names in thefootwear industry. Our footwear reflects a combination of style, quality andvalue that appeals to a broad range of customers. Our shoes are sold through awide range of department stores and leading specialty stores, a growing networkof our own retail stores and our e-commerce website. Our objective is tocontinue to profitably grow our domestic operations, while leveraging our brandname to expand internationally. We seek to offer consumers a collection of fashionable footwear thatsatisfies their casual, active and dress footwear needs. Our product linecurrently consists of over 1,500 active styles that are organized in sevendistinct collections. Our core customer is a style-conscious consumer betweenthe ages of 12 and 25 who is attracted to our youthful brand image and fashionforward designs. Over the last several years, we have introduced and expandedseveral footwear lines that have broadened our customer base. These shoescombine styling themes found elsewhere in our product line with colors andmaterials that reflect a playful image appropriate for children. We have alsorecently introduced or expanded several other lines such as Skechers Collectionand Skechers by Michelle K that appeal to young adults interested insophisticated fashions for the workplace and social occasions. We believe that a well-recognized brand is an important element for successin the footwear business. We have aggressively promoted the Skechers brandthrough a comprehensive marketing campaign. This ongoing program has includedendorsements from celebrities such as Britney Spears, Rick Fox, Robert Downey,Jr., Matt Dillon and Rob Lowe, print advertisements in publications such as GQ,Vogue and Seventeen and commercials aired on major networks and leading cablechannels such as MTV, ESPN and Nickelodeon. We believe that this campaign, whichis image oriented rather than product specific, has resulted in a high level ofrecognition of the Skechers brand across a variety of footwear categories.Product Lines In December 1992, we introduced our first Skechers-branded line calledSkechers Sport Utility Footwear. Since that time, we have expanded our productofferings and grown our net sales while substantially increasing the breadth andpenetration of our account base. Each of our product lines benefits from theumbrella of the Skechers brand, which is recognized for contemporary andprogressive styling, quality, comfort, and affordability. To promote innovationand brand relevance, we manage our product lines separately by utilizingdedicated design and marketing teams. Our product lines share back officeservices in order to limit our operating expenses and fully utilize ourmanagement's vast experience in the footwear industry. Skechers USA. Our Skechers USA category for men and women includes six typesof footwear: (i) Casuals, (ii) Utility, (iii) Steel Toe, (iv) Classics, (v)Outdoor, and (vi) Comfort (for men only). - The Casuals category includes "Black & Brown" boots and shoes that generally have a rugged, less refined design - some with industrial-inspired fashion features. This category is defined by the heavy-lugged outsole and value-oriented materials employed in the uppers. We design and price this category to appeal primarily to young persons with broad acceptance across age groups. Suggested retail price points range from $45.00 to $70.00 for this category. 3 - Our Utility styles consist of a single category of boots that are designed to meet the functional demands of a work boot but are marketed as casual footwear. The Utility outsoles are designed to be durable and wearable with Goodyear welted and hardened rubber outsoles. Uppers are constructed of thicker, better grades of heavily oiled leathers, and may include water-resistant or waterproof construction and/or materials, padded collars and Thermolite insulation. Styles include logger boots and demi-boots, engineer boots, motorcycle boots and six- and eight-eyelet work boots. Suggested retail price points range from $80.00 to $100.00 for this category. - Steel Toe, an expanded category within Skechers USA, includes boots, shoes and athletic sneakers with steel toe construction. This category is designed for men and women whose jobs have certain safety requirements. Suggested retail price points range from $45.00 to $100.00 for this category. - The Classics category of boots and shoes employ softer outsoles, which are often constructed of polyvinyl carbon ("PVC"). The more refined design of this footwear utilizes better grades of leather and linings. Designs are sportier than the Casuals category and feature oxfords, wingtips, monk straps, demi-boots and boots. Suggested retail price points range from $55.00 to $75.00 for this category. - Our Outdoor styles primarily consist of hiker-influenced constructions that include boots and shoes. While this category includes many comfort and technical performance features, we market it primarily on the basis of style and comfort rather than on performance. However, many of the technical performance features in the Outdoor category contribute to the level of comfort this footwear provides. Outsoles generally consist of molded and contoured hardened rubber. Many designs may include gussetted tongues to prevent penetration of water and debris, cushioned mid-soles, motion control devices such as heel cups, water-resistant or water-proof construction and materials and heavier, more durable hardware such as metal D-rings instead of eyelets. Uppers are generally constructed of heavily oiled nubuck and full-grain leathers. Suggested retail price points range from $55.00 to $100.00 for this category. - Launched in stores in Fall 2001, Skechers Comfort is the latest category of Skechers USA. With comfortable outsoles, more cushioned insoles and leather uppers, the line of stylish casuals is for trend-savvy men of all ages who want more edge in their black and brown footwear. Skechers Comfort is intended to be available in many of the same stores that carry Skechers USA as well as additional mid-tier and better department stores. Suggested retail price points range from $55.00 to $75.00 for this category. Skechers Sport. Our Skechers Sport footwear for men and women includes (i)Joggers, Trail runners, Sport hikers, "Terrainers" (multi-functional shoesinspired by cross-trainers), (ii) Court, and (iii) "Street" active sneakers. Wedistinguish our Skechers Sport category by its technical performance-inspiredlooks; however, generally we do not promote the technical performance featuresof these shoes. - Our Jogger, Trail runner, Sport hiker and Terrainer designs are lightweight constructions that include cushioned heels, polyurethane midsoles, phylon and other synthetic outsoles, and white leather or synthetic uppers such as durabuck, cordura and nylon mesh. Careful attention is devoted to the design, pattern and construction of the outsoles, which vary greatly depending on the intended use. This category features earth tones and athletic-inspired hues with popular colors in addition to the traditional athletic white. The Jogger, Trail runner, Sport hiker and Terrainer styles are marketed through athletic footwear specialty retailers as well as basic existing accounts. Suggested retail price points range from $40 to $80 for this category. - The Court category is inspired from classic court shoes and includes technical features, but is not meant to be a performance shoe. The court shoes feature lightweight constructions that include polyurethane and phylon midsoles, rubber low-profile outsoles, and some with heel airbag inserts for additional comfort and performance. The uppers are mostly mid-cut with some low tops, and constructed with better quality smooth, full-grain and tumbled leathers, typically in white. The court styles are marketed through athletic footwear specialty retailers as well as basic existing accounts. Suggested retail price points range from $40.00 to $70.00 for this category. - Street active sneakers are everyday, everywhere casual shoes for females of all ages. Active sneakers are intended to be retailed through specialty casual shoe stores and department stores. Suggested retail price points range from $40.00 to $65.00 for this category. 4 Skechers Collection. The Skechers Collection line features stylish dresscasual, dress and EuroSport shoes for the fashion-forward young male consumer.With some basic "essential" styles, this category is primarily comprised of moresophisticated designs influenced, in part, by prevailing trends in Italy andother European countries. As such, this footwear is more likely than othercategories to be sourced from Italy and Portugal. The dress and dress casualsinclude classic tailored and fashion-forward square, rounder and pointed lastsin a variety of styles, such as bicycle toes, monk straps, wingtips, oxfords,cap toes, demi-boots and boots. The outsoles project a sleeker profile and canbe either man-made or leather. The uppers are in high-quality leathers includingglossy, "box," and aniline. Inspired by the latest in European fashion,EuroSport blends classic dress casual styling with sport to create a versatileand comfortable casual shoe. First delivered in 2001, EuroSport is marked bydetails, high-quality leathers and suede in multiple colorations, andsport-inspired rubber outsoles. We have promoted Skechers Collection withadvertising campaigns featuring Rick Fox, Robert Downey, Jr., Matt Dillon andRobe Lowe. Suggested retail price points range from $65.00 to $155.00 for thiscategory. Skechers Kids. The Skechers Kids line features a range of products includingboots, shoes and sneakers. Comprised primarily of shoes that are designed liketheir adult counterparts but in "takedown" versions, the line offers the youngerset the same popular styles as their older siblings and schoolmates. This"takedown" strategy maintains the product integrity with premium leathers,hardware and outsoles without the attendant costs involved in designing anddeveloping new products. In addition, we adapt current fashion from our men'sand women's lines by modifying designs and choosing colors and materials thatare more suitable to the playful image we have established in the children'sfootwear market. Skechers Kids includes variations on Skechers Sport, SkechersUSA and Skechers Collection adult shoes. Unique to Skechers Kids is S-Lights, aline of lighted footwear combining sequencing patterns and lights in the outsoleand other areas of the shoes. Our children's footwear is offered at retailprices ranging from $20.00 to $50.00. Somethin' Else from Skechers. Launched in stores in Fall 2001, Somethin'Else from Skechers is a junior line that features an array of stylish shoes,boots and sandals. We target to 12- to 25-year old style conscious females, andSomethin' Else from Skechers is focused on current styling with numerous detailsand various silhouettes - including wedges and sculpted wedges. Many of theboots and shoes are made from more affordable materials such as man-madeleather. Somethin' Else from Skechers is designed to be a complementary line forjuniors who already wear Skechers USA and Skechers Sport styles. Suggestedretail price points range from $20.00 to $70.00 for this category. Skechers by Michelle K. The Skechers by Michelle K line, also launched instores in Fall 2001, is a designer line for trend-savvy young women between theages of 18 and 34. A signature line from our head designer, Michelle Kelchak,the category is comprised of high fashion boots, shoes and sandals. Noticing ahole in the market for affordable high-fashion footwear, Michelle and her teamof designers have created a line reflective of the latest European, Asian andAmerican trends at a reasonable price and of the highest quality. Most stylesare crafted in Italy, Portugal and Spain, with others made in Brazil. Skechersby Michelle K is marked by high-grade leathers, fine detailing and design andflattering silhouettes, including sculpted heels and lower kitten heels.Suggested retail price points range from $60.00 to $250.00 for this category. 4 Wheelers by Skechers. Launched in stores in Fall 2001, 4 Wheelers bySkechers is a line of technical fashion roller skates for men, women andchildren. The skates incorporate our most popular sneaker uppers, including theEnergy and Energy II, on quality aluminum and nylon chassis and polyurethanewheels. The uppers are in cool color combinations and feature fashion detailssuch as glimmer trim for some women and girls' styles. Technical featuresinclude: full precision ABEC-1, 3 and 5 bearings, unique heel brake for easycontrol, durable chassis, controllable steering, and reinforced upper. Designedfor the entire family, 4 Wheelers by Skechers are street skates that can be wornindoors, and are ideal for fun and fitness. We have promoted 4 Wheelers bySkechers with an advertising campaign featuring Britney Spears. Suggested retailprice points for adults range from $80.00 to $100.00, and for children from$60.00 to $75.00. In addition to the previously mentioned lines, we offer seasonal sandalizedfootwear, which features open-toe and open-side constructions consistent withour offerings in the Skechers USA, Skechers Sport and Skechers Collectioncategories of footwear. Such footwear includes fisherman's sandals, showersandals, beach sandals, slides, comfort-oriented land sandals and technicallyinspired water sport sandals. Sandalized footwear includes both leather andsynthetic constructions and may feature suede footbeds with form-fittingmidsoles. We typically deliver our sandalized footwear to retailers fromFebruary to August. Suggested retail price points range from $20.00 to $60.00for this category.PRODUCT DESIGN AND DEVELOPMENT Our principal goal in product design is to generate new and excitingfootwear with contemporary and progressive styles and comfort enhancingperformance features. All of our footwear is designed with an active, youthfullifestyle in mind. We design most 5new styles to be fashionable and marketable to the 12 to 25 year old consumer,while substantially all of our lines appeal to the broader range of 5 to 40 yearold consumers. While many of our shoes have performance features, we generallydo not position our shoes in the marketplace as technical performance shoes. We believe that our product success is related in a large part to ourability to recognize trends in the footwear markets and to design products thatanticipate and accommodate consumers' ever-evolving preferences. We strive toanalyze, interpret and translate current and emerging lifestyle trends.Lifestyle trend information is compiled by our designers through various methodsdesigned to monitor changes in culture and society, including (1) review andanalysis of modern music, television, cinema, clothing, alternative sports andother trend-setting media, (2) travel to domestic and international fashionmarkets to identify and confirm current trends, (3) consultation with our retailcustomers for information on current retail selling trends, (4) participation inmajor footwear trade shows to stay abreast of popular brands, fashions andstyles and (5) subscription to various fashion and color information services.In addition, a key component of our design philosophy is to continuallyreinterpret our successful styles in the Skechers image. The footwear design process typically begins about nine months before thestart of a season. Our products are designed and developed by our in-housestaff. To promote innovation and brand relevance, we utilize dedicated designteams that focus on each of the men's, women's and children's categories, andreport to our senior design executives. In addition, we utilize outside designfirms on an item-specific basis to supplement our design efforts. The designprocess is extremely collaborative; members of the design staff meet weekly withthe heads of retail and merchandising, sales, production and sourcing to furtherrefine our products to meet the particular needs of our markets. After a design team arrives at a consensus regarding the fashion themes forthe coming season, the designers then translate these themes into our products.These interpretations include variations in product color, material structureand decoration, which are arrived at after close consultation with ourproduction department. Prototype blueprints and specifications are created andforwarded to our prototype manufacturers located in Taiwan, which then forwarddesign prototypes back to our domestic design team. New design concepts areoften also reviewed by our major retail customers. Customer input not onlyallows us to measure consumer reaction to the latest designs, but also affordsus an opportunity to foster deeper and more collaborative relationships with ourcustomers. Our design teams can easily and quickly modify and refine a designbased on customer input. We occasionally order limited production runs which may initially be testedin our concept stores. By working closely with store personnel, we obtaincustomer feedback that often influences product design and development. Webelieve that sales in our concept stores can help forecast sales in nationalretail stores. We strive to determine within seven to 14 days after initialintroduction of a product whether there is substantial demand for the style,thereby aiding us in our sourcing decisions. Styles that have substantialconsumer appeal are highlighted in upcoming collections or offered as part ofour periodic style offerings. The ability to initially test our products allowsus to discontinue less popular styles after only a limited production run whichaffords us an indicator of future production and a hedge to fashion risks. Also,we strive to monitor five- and 10-week trailing trends of orders of our retailaccount base in order to manage future production of styles that are increasingor decreasing in popularity. Generally, the production process takesapproximately six months from design concept to commercialization.SOURCING Factories. Our products are produced by independent contract manufacturersprimarily located in China and, to a lesser extent, in Italy, the Philippines,Brazil and various other countries. Substantially all of our products aremanufactured in China. We do not own or operate any manufacturing facilities. Webelieve the use of independent manufacturers increases our productionflexibility and capacity while at the same time substantially reduces capitalexpenditures and avoids the costs of managing a large production work force. We seek to use, whenever possible, manufacturers that have previouslyproduced our footwear, which we believe enhances continuity and quality whilecontrolling production costs. We attempt to monitor our selection of independentfactories to ensure that no one manufacturer is responsible for adisproportionate amount of our merchandise. We source product for styles thataccount for a significant percentage of our net sales from at least fourdifferent manufacturers. During 2001, we had four manufacturers that accountedfor approximately 51.9% of total purchases. No one manufacturer accounted for20.0% or more of our total purchases for this period. To date, we have notexperienced difficulty in obtaining manufacturing services. We maintain an in-stock position for selected styles of footwear in order tominimize the time necessary to fill customer orders. In order to maintain anin-stock position, we place orders for selected footwear with our manufacturersprior to the time we receive customers' orders for such footwear. In order toreduce the risk of overstocking, we seek to assess demand for our products by 6soliciting input from our customers and monitoring retail sell-through. Inaddition, we analyze historical and current sales and market data to developinternal product quantity forecasts which helps reduce inventory risks. We finance our production activities in part through the use ofinterest-bearing open purchase arrangements with certain of our Asianmanufacturers. These facilities currently bear interest at a rate between 0.5%and 1.5% for 30 to 60 days financing, depending on the factory. We believe thatthe use of these arrangements affords us additional liquidity and flexibility.While we have long-standing relationships with many of our manufacturers andbelieve our relationships to be good, there are no long-term contracts betweenus and any of our manufacturers. Production Oversight. To safeguard product quality and consistency, weoversee the key aspects of production from initial prototype manufacture throughinitial production runs to final manufacture. Monitoring is performeddomestically by our in-house production department and in Asia through anapproximately 130-person staff working from our offices in China and Taiwan. Webelieve that our Asian presence allows us to negotiate supplier and manufacturerarrangements more effectively, decrease product turnaround time, and ensuretimely delivery of finished footwear. In addition, we require our manufacturersto certify that neither convict, forced, indentured labor (as defined under U.S.law) nor child labor (as defined by the manufacturer's country) is used in theproduction process, that compensation will be paid according to local law andthat the factory is in compliance with local safety regulations. Quality Control. We believe that quality control is an important andeffective means of maintaining the quality and reputation of our products. Ourquality control program is designed to ensure that finished goods not only meetour established design specifications, but also that all goods bearing ourtrademarks meet our standards for quality. Quality control personnel perform anarray of inspection procedures at various stages of the production process,including examination and testing of prototypes of key raw materials prior tomanufacture, samples and materials at various stages of production and finalproducts prior to shipment. Our employees are on-site at each of our majormanufacturers to oversee key phases of production. In addition, unannouncedvisits to the manufacturing sites, to further monitor compliance with ourmanufacturing specifications, are made by our employees and agents.ADVERTISING AND MARKETING Our advertising and marketing focus is to maintain and enhance recognitionof the Skechers brand name as a casual, active youthful brand that stands forquality, comfort and design innovation. Senior management is directly involvedin shaping our image and the conception, development and implementation of ouradvertising and marketing activities. We have and continue to increase ouradvertising budget consistent with projected sales, which has included suchavenues as magazines, television, trade shows, billboards, and buses. Weendeavor to spend approximately 8% to 10% of annual net sales in the marketingof Skechers footwear through advertising, promotions, public relations, tradeshows and other marketing efforts.Advertising Substantially all of our advertising is conceived and designed by ourin-house staff. By retaining our advertising functions in-house, we believe thatwe are able to maintain a greater degree of control over both the creativeprocess and the integrity of the Skechers brand image, while realizingsubstantial cost savings compared to using outside agencies. We believe that our success to date is due in large part to our advertisingstrategies and methods. Our in-house advertising team has developed acomprehensive program to promote the Skechers brand name through lifestyle andimage advertising. While all advertisements feature our footwear, ouradvertisements generally seek to build and increase brand awareness by linkingthe Skechers brand to youthful, contemporary lifestyles and attitudes ratherthan to market a particular footwear product. We have made a conscious effort toavoid the association of the Skechers name with any single category of shoe toprovide merchandise flexibility and to aid the ability to take the brand andproduct design in the direction of evolving footwear fashions and consumerpreferences. We use a variety of media for our national advertising. Print efforts arerepresented by one and two page ads displayed in popular fashion and lifestyleconsumer publications that appeal to our target customer group, such as Spin,Details, Seventeen, GQ, Vibe, Rolling Stone, Vogue and many others. Ourprogressive television advertisements are primarily produced in-house and airfrequently on top television shows on major networks and the cable channels.Different advertisements are created for each of the 5 to 11, 12 to 24 and 25 to35 year old male and female consumer groups. Our in-house media buyerstrategically selects during which program and in which geographic area certainof our commercials will air in order to reach the appropriate target audience. Endorsements. We believe that the high profile image and diverse appeal ofeach of our celebrity endorsements will help the Skechers brand reach newmarkets. In 2000, we signed our first celebrity endorsement agreements,including signing singer Britney Spears for an international (worldwideexcluding the United States) print media campaign through June 2002. We expandedupon our 7successful relationship with Britney Spears in 2002 by signing a three-yearworldwide licensing agreement for her to promote our collection of BritneySpears 4 Wheelers, which is fashioned after our 4 Wheelers by Skechers line oftechnical fashion roller skates. We also recently signed professional basketballplayer and actor Rick Fox and actor Robert Downey, Jr. to separate limited termworldwide print media campaigns. We previously had similar relationships withactors Matt Dillon and Rob Lowe. From time to time, we may sign othercelebrities to endorse our brand name and image and to strategically focusmarketing of our products among specific consumer groups. Marketing and Promotions. By applying creative sales techniques to a broadspectrum of mediums, the marketing and promotions team develops Skechers brandname recognition, serving as a catalyst for increased product sales. Skecherspromotional strategies have encompassed in-store specials, concert promotions,product tie-ins and giveaways, and collaborations with national retailers andradio stations. Our imaginative promotions draw customers to Skechers retailstores and to our retail partners' locations, which results in an expandedcustomer base and strong product sell-throughs. Public Relations. During 2001, we received notable press coverage in printpublications, including a Forbes cover story and being ranked ninth inBusinessWeek's Top 100 Growth Companies. In addition, we were noted in Money,Vogue, Movieline, Entertainment Weekly, Elle and Sportswear International, amongothers. We have repeatedly received recognition in the footwear industry for ourexciting and innovative products, including Excellence in Children's DesignAward by Footwear Plus magazine. Skechers was awarded the 2001 "Corporate Vendorof the Year" and "Children's Vendor of the Year" awards from Shoe Carnival. TheShoe Carnival awards recognize brands that have the largest sales increases andprofit margin in the shoe chains stores throughout the retail fiscal year. Withour strategy tied to promoting the newest styles produced by our design anddevelopment teams, our products are often featured in fashion and pop culturemagazines, and in a select group of films and popular television shows. Forexample, our shoes have been prominently displayed and referenced on The TodayShow, Oprah, Good Morning America, Dharma & Greg and Malcolm in the Middle.Merchandising Our in-house display merchandising department supports retailers anddistributors by developing point-of-purchase advertising to further promote ourproducts in our wholesale customers' stores and to leverage recognition of theSkechers brand name at the retail level. Our field service representativescoordinate with our sales department to ensure better sell-through at the retaillevel. Our representatives communicate with and visit our wholesale customers ona regular basis to aid in the proper visual display of our merchandise and todistribute and display such point-of-purchase items as signage, packaging,displays, counter cards, banners and other visual merchandising displays. Thesematerials mirror the look and feel of our national print advertising in order toreinforce brand image at the point-of-purchase. We believe these efforts helpstimulate impulse sales and repeat purchases. Our merchandise personnel also work closely with our wholesale customers toensure the optimal exposure of our products through our shop-in-shops, which areexclusive selling areas within stores that offer our products and incorporateSkechers signage and customized fixture designs. The shop-in-shop conceptenhances brand recognition and ensures the consistent presentation of ourproducts in our wholesale customers' stores. As of December 31, 2001, ourwholesale customers' stores included more than 300 shop-in-shops. We plan to addadditional shop-in-shops during 2002. Trade Shows. To best showcase our diverse products to footwear buyers acrossthe nation, we exhibited at 23 trade shows during 2001. Our dynamic,state-of-the-art trade show exhibits, which are designed by our in-housearchitect and feature our latest product offerings, are specially planned andbuilt to accommodate each trade show and are enhanced with lifestyle images thatcapture the image of our brand. By investing in innovative displays andindividual rooms showcasing each line, our sales force can present a sales planfor each line and buyers are able to truly understand the breadth and depth ofour offerings, optimizing commitments and sales at the retail level. Ourinnovative exhibits continually win awards, including Best Booth Design at theWorld Shoe Association, February 2001. Internet. We also promote our brand image through our website atwww.skechers.com to customers who directly access the Internet. This websitecurrently enables us to present information on our products and store locationsto consumers. The website is interactive, affording customers the ability todirectly order products on the Internet and to allow us to receive and responddirectly to customer feedback. Our website is intended to enhance the Skechersbrand without the associated costs of advertising. Our website provides fashioninformation, provides a mechanism for customer feedback, promotes customerloyalty and further enhances the Skechers brand image through interactivecontent, photos, interviews and information on Skechers-sponsored events. 8DOMESTIC SALES AND DISTRIBUTION CHANNELS Our products are sold in the United States through three primarydistribution channels: to a network of wholesale accounts, in our own retailstores and, to a lesser extent, through electronic commerce on our interactivewebsite. Each of these channels and the three distinct categories of our retailstores - concept stores, factory outlet stores and warehouse outlet stores -serves an integral function in the domestic distribution of our products.Wholesale Distribution As of December 31, 2001, we distributed our footwear to over 3,500 wholesale accounts in the United States. We believe that our broad product lineenables us to appeal to a variety of wholesale accounts, many of whom mayoperate stores within the same mall or other retail locations, because retailerscan select those styles of ours that best satisfy the fashion, function andprice criteria of their clients. Management has implemented a strategy ofcontrolling the growth of our wholesale distribution channels. Our strategy isto continue offering our accounts the highest level of customer service so thatour products will be more fully represented in existing retail locations and newlocations within each account. We have approximately 100 sales and 15 field service representatives toservice our wholesale accounts. In an effort to provide knowledgeable andpersonalized service to our wholesale accounts, the sales force is segregatedinto men's, women's and children's divisions. The men's and women's divisionshave a combined six regional sales managers and the children's division hasthree dedicated regional sales managers. Additionally, Skechers by Michelle K,Skechers Collections, and 4 Wheelers by Skechers are each headed by its ownnational sales manager. Each of these sales managers reports to our ExecutiveVice President, Domestic U.S. Sales, who has over 20 years of experience in thebranded consumer products industry. Each of the sales staff is compensated on asalary plus commission basis with none of the representatives sellingcompetitive products. Senior management is actively involved in selling to andmaintaining relationships with Skechers' major retail accounts. We believe that we have developed a loyal customer base of wholesaleaccounts through a heightened level of customer service. We believe that ourclose relationships with these accounts help us to maximize their retailsell-through, maintained margins and inventory turns which in turn minimizes ourinventory markdowns and customer returns and allowances. Our field servicerepresentatives work with our wholesale accounts to ensure that our merchandiseand point-of-purchase marketing materials are properly presented. Salesexecutives and merchandise personnel work closely with accounts to ensure theappropriate styles are purchased for specific accounts and for specific storeswithin those accounts as well as ensure that appropriate inventory levels arecarried at each store. Such information is then utilized to help develop salesprojections and determine the product needs of wholesale accounts. The valueadded services we provide our wholesale customers help us maintain strongrelationships with our existing wholesale customers and attract potential newwholesale customers.Retail Stores We pursue our retail store strategy through our three integrated retailformats: the concept store, the factory outlet and the warehouse outlet store.Our three store format enables us to promote the full Skechers line in anattractive environment, appeal to a broad group of customers that are segmentedby price points and manage inventory in an efficient and brand sensitive manner.In addition, most of our retail stores are profitable and have a positive effecton our operating results. As of December 31, 2001, we operated 29 conceptstores, 29 factory outlet stores and 20 warehouse outlet stores in the UnitedStates. We plan to open between 10 to 15 retail stores during 2002. - Concept Stores. Our concept stores are located at either marquee street locations or in major shopping malls in large metropolitan cities. Our concept stores serve a threefold purpose in our operating strategy. First, concept stores serve as a showcase for a wide range of our product offerings for the current season, providing the customer with the entire product story. The concept stores feature modern music and lighting and present an open floor design to allow customers to readily view the merchandise on display. In contrast, we estimate that our average retail customer carries no more than 5.0% of the complete Skechers line. Second, retail locations are generally chosen to generate maximum marketing value for the Skechers brand name through signage, store front presentation and interior design. These locations include concept stores on 34th Street in New York City and in Santa Monica's Third Street Promenade. The stores are typically designed to create a distinctive Skechers look and feel and enhance customer association of the Skechers brand name with current youthful lifestyle trends and styles. Third, the concept stores serve as marketing and product testing venues that provide rapid product feedback from customers. We believe that product sell-through information 9 derived from our concept stores enables our sales, merchandising and production staff to respond to market changes and new product introductions. Such responses serve to augment sales and limit our inventory markdowns and customer returns and allowances. We strive to adjust our product and sales strategy based upon seven to 14 days of retail sales information. The prototypical Skechers concept store is approximately 2,500 square feet although in certain selected markets we have opened concept stores as large as 7,000 square feet or as small as 1,100 square feet. When deciding where to open concept stores, we identify top geographic markets in the larger metropolitan cities in the United States. When selecting a specific site, we evaluate the proposed sites' traffic pattern, co-tenancies, average sales per square foot achieved by neighboring concept stores, lease economics and other factors considered important within the specific location. If we are considering opening a concept store in a shopping mall, our strategy is to obtain space as centrally located as possible in the mall where we expect foot traffic to be most concentrated. We believe that the strength of the Skechers brand name has enabled us to negotiate more favorable terms with shopping malls that want us to open up concept stores to attract customer traffic to these malls. We opened two new concept stores during 2000 and five new concept stores during 2001. - Factory Outlet Stores. Our factory outlet stores are generally located in manufacturers' outlet centers throughout the United States. Our factory outlet stores provide opportunities for us to sell discontinued and excess merchandise, thereby reducing the need to sell such merchandise to discounters at excessively low prices, which could otherwise compromise the Skechers brand image. Skechers factory outlet stores range in size from approximately 1,900 to 6,000 square feet. Inventory in these stores is supplemented by certain first-line styles sold at full retail price points generally of $60.00 or lower. We opened five new factory outlet stores during 2000 and 11 new factory outlet stores during 2001. - Warehouse Outlet Stores. Our free-standing warehouse outlet stores, which are located throughout the United States, enable us to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. Skechers warehouse outlet stores range in size from approximately 5,600 to 14,800 square feet. Our warehouse outlet stores enable us to sell discontinued and excess merchandise that would otherwise typically be sold to discounters at excessively low prices, thus compromising the Skechers brand image. We seek to open our warehouse outlet stores in areas that are in close proximity to our other retail stores in order to facilitate the timely transfer of inventory that we want to liquidate as soon as practicable. We opened three new warehouse outlet stores during 2000 and 10 new warehouse outlet stores during 2001. Electronic Commerce. Our electronic commerce sales represented less than1.0% of total net sales for each of 2000 and 2001. Our website,www.skechers.com, is a virtual storefront that promotes the Skechers brand name.Designed as a customer center, our website showcases our products in aneasy-to-navigate format, allowing customers to see and purchase our footwear.This virtual store has become a successful additional retail distributionchannel, has improved customer service and is a fun and entertainingalternative-shopping environment.INTERNATIONAL OPERATIONS We market our products in countries and territories throughout the world. Wegenerate revenues from outside the United States from three principal sources:(1) sales of our footwear directly to foreign distributors who distribute suchfootwear to department stores and specialty retail stores in Europe, Asia, LatinAmerica, South America and numerous other countries and territories, (2) inFrance, Germany and the United Kingdom, we sell footwear directly to departmentstores and specialty retail stores and through retail stores that we own andoperate and (3) to a lesser extent, royalties from licensees who manufactureand distribute our products outside the United States. We believe that international distribution of our products represents asignificant opportunity to increase revenues and profits. Although we are in theearly stages of our international expansion, our products are currently sold inmore than 100 countries and territories around the world. We intend to furtherincrease our share of the international footwear market by heightening ourmarketing presence in those countries through our international advertisingcampaigns, which are designed to establish Skechers as a global brand synonymouswith casual shoes. 10Europe We have historically sold our footwear to selected wholesale customers inEurope through our foreign distributors. In 2001, we expanded our Europeanoperations and began to directly sell our footwear to certain wholesale accountsand retail stores in Europe in an effort to increase profit margins and moreeffectively market and promote the Skechers brand name. We organized SkechersU.S.A. Ltd. in the United Kingdom and Ireland and opened the subsidiary'sheadquarters in London to establish direct control over wholesale distribution,merchandising, and marketing of our products in these countries. We alsoorganized Skechers U.S.A. SAS with its office in Paris, France and SkechersU.S.A. Deutschland GmbH with its office in Dietzenbach, Germany, with each ofthese subsidiaries formed to establish direct control over our products in theirrespective countries of organization. In 2001, we began to utilize a contractwarehouse located in Belgium to distribute our footwear to our customers andretail stores in France, Germany and the United Kingdom. Additionally, we are beginning to selectively open flagship retail storesinternationally on our own or through joint ventures with local distributors. Inthe first three months of 2001, we opened our first European flagship retailstores on Oxford Street in London, at the Forum Les Halles in Paris and in theprestigious Centro Mall in Oberhausen, Germany. We intend to open additionalwholly-owned flagship retail stores in the European Union (EU) countries andenter into agreements with distributors to operate flagship retail stores innon-EU countries.Asia In December 2001, we opened our first Asian flagship retail store inKichijuoji, Japan by agreement with Japanese distributor Achilles Corporation.Achilles Corporation is responsible for the store's operations and selecting abroad collection of our products to sell to Japanese consumers. In order tomaintain a globally consistent image, we provided architectural, graphic andvisual guidance and materials for the design of the store, and we trained thelocal staff on our products and corporate culture. We intend to expand ourinternational presence and global recognition of the Skechers brand name in Asiaby continuing to sell our footwear to foreign distributors and opening flagshipretail stores with distributors that have local market expertise.LICENSING We believe that selective licensing of the Skechers brand name tonon-footwear-related manufacturers may broaden and enhance the Skechers brandimage without requiring significant capital investments or additionalincremental operating expenses by us. Our diverse group of products presentsmany potential licensing opportunities on terms with licensees that we believewill provide more effective manufacturing, distribution or marketing of productssuch as accessories, backpacks and children's clothing than could be achievedin-house; however, we intend to be selective in granting any use of the Skechersbrand name for such licensed products. We believe that the strength of theSkechers brand name and the size of our business will enable us to attractpremier licensing partners with a proven track record of brand sensitivity. Weare also interested in exploring the possibility of licensing our othertrademarks and trade names for use with non-footwear products that could enableus to successfully enter and compete in non-footwear markets that we would notbe likely to succeed in using the Skechers brand name and without having tocompromise the Skechers brand image. In addition, we periodically reviewpotential international licensing arrangements for footwear in variousgeographical regions that present favorable business opportunities. We intend tomaintain substantial control over the design, manufacturing specifications,advertising and distribution of any licensed products and to maintain a policyof evaluating any future licensing arrangements to ensure consistentrepresentation of the Skechers image.DISTRIBUTION We believe that strong distribution support is a critical factor in ouroperations. Once manufactured, our products are packaged in shoe boxes bearingbar codes and are shipped either (1) to our approximately 1.4 million squarefeet of internally managed distribution center located in Ontario, California,(2) to an approximately 130,000 square foot contract warehouse located in Gent,Belgium for distribution to our European customers and retail stores or (3)directly from the manufacturer to our other international customers. Uponreceipt at the central distribution centers, merchandise is inspected andrecorded in our management information system and packaged according tocustomers' orders for delivery. Merchandise is shipped to the customer bywhatever means the customer requests, which is usually by common carrier. Thecentral distribution centers have multi-access docks, enabling us to receive andship simultaneously and to pack separate trailers for shipments to differentcustomers at the same time. We have an electronic data interchange system, orEDI system, to which some of our larger customers are linked. This system allowsthese customers to automatically place orders with us, thereby eliminating thetime involved in transmitting and inputting orders, and includes direct billingand shipping information. 11 The following table sets forth a summary of the facilities that comprise ourOntario distribution center: ADDRESS STATUS SQUARE FOOTAGE ------- ------ -------------- 1661 South Vintage Avenue Leased since November 1997 127,800 1777 South Vintage Avenue Leased since November 1997 284,600 1670 Champagne Avenue Owned since October 2000 263,700 4100 East Mission Blvd. Leased since June 2001 763,300 --------- 1,439,400(1) ========= ----------------(1) Excludes 285,600 square feet located at 5725 East Jurupa Street that we leased in April 1998 and occupied until we subleased the facility in June 2001. We believe that we have the capacity at our Ontario distribution center toincrease our current operations to meet projected demand, and if we should everneed to expand our distribution facilities to allow for further growth, webelieve there is presently enough space available in close proximity that leadsus to believe leasing or purchasing additional property will not be a problem inthe foreseeable future.BACKLOG We generally receive the bulk of our orders for each of the spring and fallseasons a minimum of three months prior to the date the products are shipped tocustomers. As of December 31, 2001, our backlog was $222.2 million, compared to$221.6 million as of December 31, 2000. While backlog orders are subject tocancellation by customers, we have not experienced significant cancellation oforders in the past and we expect that substantially all the orders will beshipped in 2002. However, for a variety of reasons, including the timing ofshipments, product mix of customer orders and the amount of in-season orders,backlog may not be a reliable measure of future sales for any succeeding period.INTELLECTUAL PROPERTY RIGHTS We own and utilize a variety of trademarks, including the Skecherstrademark. We have a significant number of both registrations and pendingapplications for our trademarks in the United States. In addition, we havetrademark registrations and trademark applications in approximately 85 foreigncountries. We also have design patents, and pending design and utility patentapplications, in both the United States and various foreign countries. Wecontinuously look to increase the number of our patents and trademarks, bothdomestically and internationally, where necessary to protect valuableintellectual property. We regard our trademarks and other intellectual propertyas valuable assets and believe that they have significant value in the marketingof our products. We vigorously protect our trademarks against infringement,including through the use of cease and desist letters, administrativeproceedings and lawsuits. We rely on trademark, patent, copyright, trade secret protection,non-disclosure agreements and licensing arrangements to establish, protect andenforce intellectual property rights in our logos, tradenames and in the designof our products. In particular, we believe that our future success will largelydepend on our ability to maintain and protect the Skechers trademark. Despiteour efforts to safeguard and maintain our intellectual property rights, wecannot assure you that we will be successful in this regard. Furthermore, wecannot assure you that our trademarks, products and promotional materials orother intellectual property rights do not or will not violate the intellectualproperty rights of others, that our intellectual property would be upheld ifchallenged, or that we would, in such an event, not be prevented from using ourtrademarks or other intellectual property rights. Such claims, if proven, couldmaterially and adversely affect our business, financial condition and results ofoperations. In addition, although any such claims may ultimately prove to bewithout merit, the necessary management attention to and legal costs associatedwith litigation or other resolution of future claims concerning trademarks andother intellectual property rights could materially and adversely affect ourbusiness, financial condition and results of operations. We have sued and havebeen sued by third parties for infringement of intellectual property. It is ouropinion that none of these claims have materially impaired our ability toutilize our intellectual property rights. The laws of certain foreign countries do not protect intellectual propertyrights to the same extent or in the same manner as do the laws of the UnitedStates. Although we continue to implement protective measures and intend todefend our intellectual property rights vigorously, these efforts may not besuccessful or the costs associated with protecting our rights in certainjurisdictions may be prohibitive. From time to time, we discover products in themarketplace that are counterfeit reproductions of our products or that 12otherwise infringe upon intellectual property rights held by us. Actions takenby us to establish and protect our trademarks and other intellectual propertyrights may not be adequate to prevent imitation of our products by others or toprevent others from seeking to block sales of our products as violatingtrademarks and intellectual property rights. If we are unsuccessful inchallenging a third party's products on the basis of infringement of ourintellectual property rights, continued sales of such products by that or anyother third party could adversely impact the Skechers brand, result in the shiftof consumer preferences away from us and generally have a material adverseeffect on our business, financial condition and results of operations.COMPETITION Competition in the footwear industry is intense. Although we believe that wedo not compete directly with any single company with respect to its entire rangeof products, our products compete with other branded products within theirproduct category as well as with private label products sold by retailers,including some of our customers. Our utility footwear and casual shoes competewith footwear offered by companies such as The Timberland Company, Dr. Martens,Kenneth Cole Productions, Steven Madden, Ltd. and Wolverine World Wide, Inc. Ourathletic shoes compete with brands of athletic footwear offered by companiessuch as Nike, Inc., Reebok International Ltd., Adidas-Salomon AG and NewBalance. Our children's shoes compete with brands of children's footwear offeredby The Stride Rite Corporation. In varying degrees, depending on the productcategory involved, we compete on the basis of style, price, quality, comfort andbrand name prestige and recognition, among other considerations. These and othercompetitors pose challenges to our market share in our major domestic marketsand may make it more difficult to establish our products in Europe, Asia andother international regions. We also compete with numerous manufacturers,importers and distributors of footwear for the limited shelf space available forthe display of such products to the consumer. Moreover, the general availabilityof contract manufacturing capacity allows ease of access by new market entrants.Many of our competitors are larger, have achieved greater recognition for theirbrand names, have captured greater market share and/or have substantiallygreater financial, distribution, marketing and other resources than us. Wecannot assure you that we will be able to compete successfully against presentor future competitors or that competitive pressures faced by us will not have amaterial adverse effect on our business, financial condition and results ofoperations.EMPLOYEES As of February 28, 2002, we employed 1,964 persons, 1,111 of which wereemployed on a full-time basis and 853 of which were employed on a part-timebasis. None of our employees are subject to a collective bargaining agreement.We believe that our relations with our employees are satisfactory. We offer ouremployees a discount on Skechers merchandise to encourage enthusiasm for theproduct and Skechers loyalty.RISK FACTORS In addition to the other information in this Form 10-K, the followingfactors should be considered in evaluating us and our business.OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO RESPOND TO CHANGING CONSUMERDEMANDS, IDENTIFY AND INTERPRET FASHION TRENDS AND SUCCESSFULLY MARKET NEWPRODUCTS. The footwear industry is subject to rapidly changing consumer demands andfashion trends. Accordingly, we must identify and interpret fashion trends andrespond in a timely manner. Demand for and market acceptance of new products areuncertain and achieving market acceptance for new products generally requiressubstantial product development and marketing efforts and expenditures. If we donot continue to meet changing consumer demands and develop successful styles inthe future, our growth and profitability will be negatively impacted. Wefrequently make decisions about product designs and marketing expendituresseveral months in advance of the time when consumer acceptance can bedetermined. If we fail to anticipate, identify or react appropriately to changesin styles and trends or are not successful in marketing new products, we couldexperience excess inventories, higher than normal markdowns or an inability toprofitably sell our products. Because of these risks, a number of companies inthe footwear industry specifically, and the fashion and apparel industry ingeneral, have experienced periods of rapid growth in revenues and earnings andthereafter periods of declining sales and losses, which in some cases haveresulted in companies in these industries ceasing to do business. Similarly,these risks could have a severe negative effect on our results of operations orfinancial condition.OUR BUSINESS AND THE SUCCESS OF OUR PRODUCTS COULD BE HARMED IF WE ARE UNABLE TOMAINTAIN OUR BRAND IMAGE. Our success to date has been due in large part to the strength of our brand.If we are unable to timely and appropriately respond to changing consumerdemand, our brand name and brand image may be impaired. Even if we reactappropriately to changes in 13consumer preferences, consumers may consider our brand image to be outmoded orassociate our brand with styles of footwear that are no longer popular. In thepast, several footwear companies have experienced periods of rapid growth inrevenues and earnings followed by periods of declining sales and losses. Ourbusiness may be similarly affected in the future.OUR BUSINESS COULD BE HARMED IF WE FAIL TO MAINTAIN PROPER INVENTORY LEVELS. We place orders with our manufacturers for some of our products prior to thetime we receive all of our customers' orders. We do this to minimize purchasingcosts, the time necessary to fill customer orders and the risk of non-delivery.We also maintain an inventory of certain products that we anticipate will be ingreater demand. However, we may be unable to sell the products we have orderedin advance from manufacturers or that we have in our inventory. Inventory levelsin excess of customer demand may result in inventory write-downs, and the saleof excess inventory at discounted prices could significantly impair our brandimage and have a material adverse effect on our operating results and financialcondition. Conversely, if we underestimate consumer demand for our products orif our manufacturers fail to supply the quality products that we require at thetime we need them, we may experience inventory shortages. Inventory shortagesmight delay shipments to customers, negatively impact retailer and distributorrelationships, and diminish brand loyalty.WE MAY BE UNABLE TO SUCCESSFULLY EXECUTE OUR GROWTH STRATEGY OR MANAGE ORSUSTAIN OUR GROWTH. We have grown quickly since we started our business. Our ability to grow inthe future depends upon, among other things, the continued success of ourefforts to expand our footwear offerings and distribution channels. However, ourrate of growth may decline or we may not be profitable in future quarters orfiscal years. Furthermore, as our business becomes larger, we may not be able tomaintain our historical growth rate or effectively manage our growth. Weanticipate that as our business grows, we will have to improve and enhance ouroverall financial and managerial controls, reporting systems and procedures. Wemay be unable to successfully implement our current growth strategy or othergrowth strategies or effectively manage our growth, any of which wouldnegatively impair our net sales and earnings.OUR BUSINESS MAY BE NEGATIVELY IMPACTED AS A RESULT OF CHANGES IN THE ECONOMY. Our business depends on the general economic environment and levels ofconsumer spending that affect not only the ultimate consumer, but alsoretailers, our primary direct customers. Purchases of footwear tend to declinein periods of recession or uncertainty regarding future economic prospects, whenconsumer spending, particularly on discretionary items, declines. During periodsof recession or economic uncertainty, we may not be able to maintain or increaseour sales to existing customers, make sales to new customers, open and operatenew retail stores, maintain sales levels at our existing stores, maintain orincrease our international operations on a profitable basis, or maintain orimprove our earnings from operations as a percentage of net sales. As a result,our operating results may be adversely and materially affected by downwardtrends in the economy or the occurrence of events that adversely affect theeconomy in general. Furthermore, in anticipation of continued increases in netsales, we have significantly expanded our infrastructure and workforce toachieve economies of scale. Because these expenses are fixed in the short term,our operating results and margins will be adversely impacted if we do notcontinue to grow as anticipated. For example, due in large part to the slowdownin the global economy, our net sales for 2001 were lower than anticipated. Thislower level of sales adversely affected our operating results for 2001 and couldcontinue to do so in 2002 and beyond.ECONOMIC, POLITICAL, MILITARY OR OTHER EVENTS IN A COUNTRY WHERE WE MAKESIGNIFICANT SALES OR HAVE SIGNIFICANT OPERATIONS COULD INTERFERE WITH OURSUCCESS OR OPERATIONS THERE AND HARM OUR BUSINESS. We market and sell our products and services throughout the world. TheSeptember 11, 2001 attacks disrupted commerce throughout the United States andother parts of the world. The continued threat of similar attacks throughout theworld and the military action taken by the United States and other nations maycause significant disruption to commerce throughout the world. To the extentthat such disruptions further slow the global economy or, more particularly,result in delays or cancellations of purchase orders for our products, ourbusiness and results of operations could be materially adversely affected. Weare unable to predict whether the threat of new attacks or the responses theretowill result in any long-term commercial disruptions or if such activities orresponses will have a long-term material adverse effect on our business, resultsof operations or financial condition. 14WE DEPEND UPON A RELATIVELY SMALL GROUP OF CUSTOMERS FOR A LARGE PORTION OF OURSALES. During 2001, our net sales to our five largest customers accounted forapproximately 25.7% of total net sales. No one customer accounted for 10.0% ormore of our net sales during 2001. As of December 31, 2001, one customeraccounted for 10.2% of our net trade accounts receivable. Although we havelong-term relationships with many of our customers, our customers do not have acontractual obligation to purchase our products and we cannot be certain that wewill be able to retain our existing major customers. Furthermore, the retailindustry regularly experiences consolidation, contractions and closings. Ifthere are further consolidations, contractions or closings in the future, we maylose customers or be unable to collect accounts receivables of major customersin excess of amounts that we have insured. If we lose a major customer,experience a significant decrease in sales to a major customer, or are unable tocollect the accounts receivable of a major customer in excess of amountsinsured, our business could be harmed.OUR OPERATING RESULTS COULD BE NEGATIVELY IMPACTED IF OUR SALES ARE CONCENTRATEDIN ANY ONE STYLE OR GROUP OF STYLES. If any one style or group of similar styles of our footwear were torepresent a substantial portion of our net sales, we could be exposed to riskshould consumer demand for such style or group of styles decrease in subsequentperiods. We attempt to hedge this risk by offering a broad range of products,and no style comprised over 5.0% of our gross wholesale sales for the yearsended either December 31, 2000 or 2001. However, this may change in the futureand fluctuations in sales of any given style that represents a significantportion of our future net sales could have a negative impact on our operatingresults.WE RELY ON INDEPENDENT CONTRACT MANUFACTURERS AND, AS A RESULT, ARE EXPOSED TOPOTENTIAL DISRUPTIONS IN PRODUCT SUPPLY. Our footwear products are currently manufactured by independent contractmanufacturers. During 2001, the top four manufacturers of our manufacturedproducts produced approximately 51.9% of our total purchases, but noneindividually accounted for more than 20.0%. We do not have long-term contractswith manufacturers and we compete with other footwear companies for productionfacilities. We could experience difficulties with these manufacturers, includingreductions in the availability of production capacity, failure to meet ourquality control standards, failure to meet production deadlines or increasedmanufacturing costs. This could result in our customers canceling orders,refusing to accept deliveries or demanding reductions in purchase prices, any ofwhich could have a negative impact on our cash flow and harm our business. If our current manufacturers cease doing business with us, we couldexperience an interruption in the manufacture of our products. Although webelieve that we could find alternative manufacturers, we may be unable toestablish relationships with alternative manufacturers that will be as favorableas the relationships we have now. For example, new manufacturers may have higherprices, less favorable payment terms, lower manufacturing capacity, lowerquality standards or higher lead times for delivery. If we are unable to provideproducts consistent with our standards or the manufacture of our footwear isdelayed or becomes more expensive, our business would be harmed.OUR INTERNATIONAL SALES AND MANUFACTURING OPERATIONS ARE SUBJECT TO THE RISKS OFDOING BUSINESS ABROAD, WHICH COULD AFFECT OUR ABILITY TO SELL OR MANUFACTURE OURPRODUCTS IN INTERNATIONAL MARKETS, OBTAIN PRODUCTS FROM FOREIGN SUPPLIERS ORCONTROL THE COSTS OF OUR PRODUCTS. Substantially all of our net sales during 2001 were derived from sales offootwear manufactured in foreign countries, with most manufactured in China and,to a lesser extent, in Italy, the Philippines and Brazil. We also sell ourfootwear in several foreign countries and plan to increase our internationalsales efforts as part of our growth strategy. Foreign manufacturing and salesare subject to a number of risks, including: - political and social unrest; - changing economic conditions; - international political tension and terrorism; - work stoppages; - transportation delays; - loss or damage to products in transit; - expropriation; 15 - nationalization; - the imposition of tariffs and trade duties both international and domestically; - import and export controls and other nontariff barriers; - exposure to different legal standards (particularly with respect to intellectual property); - compliance with foreign laws; and - changes in domestic and foreign governmental policies. In particular, because substantially all of our products are manufactured inChina, adverse change in trade or political relations with China or politicalinstability in China would severely interfere with the manufacture of ourproducts and would materially adversely affect our operations. In addition, if we, or our foreign manufacturers, violate United States orforeign laws or regulations, we may be subjected to extra duties, significantmonetary penalties, the seizure and the forfeiture of the products we areattempting to import or the loss of our import privileges. Possible violationsof United States or foreign laws or regulations could include inadequate recordkeeping of our imported product, misstatements or errors as to the origin, quotacategory, classification, marketing or valuation of our imported products,fraudulent visas, or labor violations. The effects of these factors could renderour conduct of business in a particular country undesirable or impractical andhave a negative impact on our operating results.OUR BUSINESS COULD BE HARMED IF OUR CONTRACT MANUFACTURERS, SUPPLIERS ORLICENSEES VIOLATE LABOR OR OTHER LAWS. We require our independent contract manufacturers, suppliers and licenseesto operate in compliance with applicable United States and foreign laws andregulations. Manufacturers are required to certify that neither convicted,forced or indentured labor (as defined under United States law) nor child labor(as defined by the manufacturer's country) is used in the production process,that compensation is paid in accordance with local law and that their factoriesare in compliance with local safety regulations. Although we promote ethicalbusiness practices and our sourcing personnel periodically visit and monitor theoperations of our independent contract manufacturers, suppliers and licensees,we do not control them or their labor practices. If one of our independentcontract manufacturers, suppliers or licensees violates labor or other laws ordiverges from those labor practices generally accepted as ethical in the UnitedStates, it could result in adverse publicity for us, damage our reputation inthe United States, or render our conduct of business in a particular foreigncountry undesirable or impractical, any of which could harm our business.OUR PLANNED EXPANSION INVOLVES A NUMBER OF RISKS THAT COULD PREVENT OR DELAY THESUCCESSFUL OPENING OF NEW STORES AS WELL AS IMPACT THE PERFORMANCE OF OUREXISTING STORES. Our ability to open and operate new stores successfully depends on manyfactors, including, among others, our ability to: - identify suitable store locations, the availability of which is outside of our control; - negotiate acceptable lease terms, including desired tenant improvement allowances; - source sufficient levels of inventory to meet the needs of new stores; - hire, train and retain store personnel; - successfully integrate new stores into our existing operations; and - satisfy the fashion preferences in new geographic areas. In addition, many of our new stores will be opened in regions of the UnitedStates in which we currently have few or no stores. The expansion into newmarkets may present competitive, merchandising and distribution challenges thatare different from those currently encountered in our existing markets. Any ofthese challenges could adversely affect our business and results of operations.In addition, to the extent our new store openings are in existing markets, wemay experience reduced net sales volumes in existing stores in those markets. 16MANY OF OUR RETAIL STORES DEPEND HEAVILY ON THE CUSTOMER TRAFFIC GENERATED BYSHOPPING AND FACTORY OUTLET MALLS OR BY TOURISM. Many of our concept stores are located in shopping malls and some of ourfactory outlet stores are located in manufacturers' outlet malls where we dependon obtaining prominent locations in the malls and the overall success of themalls to generate customer traffic. We cannot control the development of newmalls, the availability or cost of appropriate locations within existing or newmalls or the success of individual malls. Some of our concept stores occupystreet locations which are heavily dependent on customer traffic generated bytourism. Any substantial decrease in tourism resulting from the September 11,2001 attacks, a downturn in the economy or otherwise, is likely to adverselyaffect sales in our existing stores, particularly those with street locations.The effects of these factors could hinder our ability to open retail stores innew markets or reduce sales of particular existing stores, which couldnegatively affect our operating results.OUR QUARTERLY REVENUES AND OPERATING RESULTS FLUCTUATE AS A RESULT OF A VARIETYOF FACTORS, INCLUDING SEASONAL FLUCTUATIONS IN DEMAND FOR FOOTWEAR AND DELIVERYDATE DELAYS, WHICH MAY RESULT IN VOLATILITY OF OUR STOCK PRICE. Our quarterly revenues and operating results have varied significantly inthe past and can be expected to fluctuate in the future due to a number offactors, many of which are beyond our control. For example, sales of footwearproducts have historically been somewhat seasonal in nature with the strongestsales generally occurring in the third and fourth quarters. Also, delays inscheduling or pickup of purchased products by our domestic customers couldnegatively impact our net sales and results of operations for any given quarter.As a result of these specific and other general factors, our operating resultswill likely vary from quarter to quarter and the results for any particularquarter may not be necessarily indicative of results for the full year. Anyshortfall in revenues or net income from levels expected by securities analystsand investors could cause a decrease in the trading price of our Class A commonshares.WE FACE INTENSE COMPETITION, INCLUDING COMPETITION FROM COMPANIES WITHSIGNIFICANTLY GREATER RESOURCES THAN OURS, AND IF WE ARE UNABLE TO COMPETEEFFECTIVELY WITH THESE COMPANIES, OUR MARKET SHARE MAY DECLINE AND OUR BUSINESSCOULD BE HARMED. We face intense competition in the footwear industry from other establishedcompanies. A number of our competitors have significantly greater financial,technological, engineering, manufacturing, marketing and distribution resourcesthan we do. Their greater capabilities in these areas may enable them to betterwithstand periodic downturns in the footwear industry, compete more effectivelyon the basis of price and production and more quickly develop new products. Inaddition, new companies may enter the markets in which we compete, furtherincreasing competition in the footwear industry. We believe that our ability to compete successfully depends on a number offactors, including the style and quality of our products and the strength of ourbrand name, as well as many factors beyond our control. We may not be able tocompete successfully in the future, and increased competition may result inprice reductions, reduced profit margins, loss of market share, and inability togenerate cash flows that are sufficient to maintain or expand our developmentand marketing of new products, which would adversely impact the trading price ofour Class A common shares.OBTAINING ADDITIONAL CAPITAL TO FUND OUR OPERATIONS AND FINANCE OUR GROWTH COULDMAKE IT DIFFICULT FOR US TO SERVICE OUR DEBT OBLIGATIONS. If our working capital needs exceed our current expectations, we may need toraise additional capital through public or private equity offerings or debtfinancings. If we cannot raise needed funds on acceptable terms, we may not beable to successfully execute our growth strategy, take advantage of futureopportunities or respond to competitive pressures or unanticipated requirements.To the extent we raise additional capital by issuing debt, it may becomedifficult for us to meet debt service obligations. To the extent we raiseadditional capital by issuing equity securities, our stockholders may experiencesubstantial dilution. Also, any new equity securities may have greater rights,preferences or privileges than our existing Class A common shares.WE DEPEND ON KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY IN A RAPIDLYCHANGING MARKET, AND IF WE ARE UNABLE TO RETAIN EXISTING PERSONNEL, OUR BUSINESSCOULD BE HARMED. Our future success depends upon the continued services of Robert Greenberg,Chairman of the Board and Chief Executive Officer, Michael Greenberg, President,and David Weinberg, Executive Vice President and Chief Financial Officer. Theloss of the services of any of these individuals or any other key employee couldharm us. Our future success also depends on our ability to identify, attract andretain additional qualified personnel. Competition for employees in our industryis intense and we may not be successful in attracting and retaining suchpersonnel. 17OUR TRADEMARKS, DESIGN PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS MAY NOT BEADEQUATELY PROTECTED OUTSIDE THE U.S. We believe that our trademarks, design patents and other proprietary rightsare important to our success and our competitive position. We devote substantialresources to the establishment and protection of our trademarks and designpatents on a worldwide basis. In the course of our international expansion, wehave, however, experienced conflicts with various third parties that haveacquired or claimed ownership rights in certain trademarks similar to ours orhave otherwise contested our rights to our trademarks. We have in the pastsuccessfully resolved these conflicts through both legal action and negotiatedsettlements, none of which we believe has had a material impact on our financialcondition and results of operations. Nevertheless, we cannot assure you that theactions we have taken to establish and protect our trademarks and otherproprietary rights outside the U.S. will be adequate to prevent imitation of ourproducts by others or to prevent others from seeking to block sales of ourproducts as a violation of the trademarks and proprietary rights of others.Also, we cannot assure you that others will not assert rights in, or ownershipof, trademarks, designs and other proprietary rights of ours or that we will beable to successfully resolve these types of conflicts to our satisfaction. Inaddition, the laws of certain foreign countries may not protect proprietaryrights to the same extent as do the laws of the U.S. We may face significantexpenses and liability in connection with the protection of our intellectualproperty rights outside the U.S. and if we are unable to successfully protectour rights or resolve intellectual property conflicts with others, our businessor financial condition may be adversely affected.OUR ABILITY TO COMPETE COULD BE JEOPARDIZED IF WE ARE UNABLE TO PROTECT OURINTELLECTUAL PROPERTY RIGHTS OR IF WE ARE SUED FOR INTELLECTUAL PROPERTYINFRINGEMENT. We use trademarks on nearly all of our products and believe that havingdistinctive marks that are readily identifiable is an important factor increating a market for our goods, in identifying us, and in distinguishing ourgoods from the goods of others. We consider our Skechers(R) and S Design(R)trademarks to be among our most valuable assets and we have registered thesetrademarks in many countries. In addition, we own many other trademarks, whichwe utilize in marketing our products. We continue to vigorously protect ourtrademarks against infringement. We also have a number of design patentscovering components and features used in various shoes. We believe that oursuccess depends primarily upon skills in design, research and development,production and marketing rather than upon our patent position. However, we havefollowed a policy of filing applications for United States and foreign patentson designs that we deem valuable. We believe that our patents and trademarks are generally sufficient topermit us to carry on our business as presently conducted. We cannot, however,know whether we will be able to secure patents or trademark protection for ourintellectual property in the future or that protection will be adequate forfuture products. Further, we face the risk of ineffective protection ofintellectual property rights in the countries where we source and distribute ourproducts. We have been sued for patent and trademark infringement and cannot besure that our activities do not and will not infringe on the proprietary rightsof others. If we are compelled to prosecute infringing parties, defend ourintellectual property, or defend ourselves from intellectual property claimsmade by others, we may face significant expenses and liability which couldnegatively impact our business or financial condition.ENERGY SHORTAGES, NATURAL DISASTERS OR A DECLINE IN ECONOMIC CONDITIONS INCALIFORNIA COULD INCREASE OUR OPERATING EXPENSES OR ADVERSELY AFFECT OUR SALESREVENUE. A substantial portion of our operations are located in California, including37 of our retail stores, our headquarters in Manhattan Beach and our domesticdistribution center in Ontario. Because California has and may in the futureexperience energy and electricity shortages, we may be subject to increasedoperating costs as a result of higher electricity and energy rates and may besubject to rolling blackouts which could interrupt our business. Any such impactcould be material and adversely affect our profitability. In addition, because asignificant portion of our net sales is derived from sales in California, adecline in the economic conditions in California, whether or not such declinespreads beyond California, could materially adversely affect our business.Furthermore, a natural disaster or other catastrophic event, such as anearthquake affecting California, could significantly disrupt our business. Wemay be more susceptible to these issues than our competitors whose operationsare not as concentrated in California.ONE PRINCIPAL STOCKHOLDER IS ABLE TO CONTROL SUBSTANTIALLY ALL MATTERS REQUIRINGA VOTE OF OUR STOCKHOLDERS AND HIS INTERESTS MAY DIFFER FROM THE INTERESTS OFOUR OTHER STOCKHOLDERS. As of December 31, 2001, Robert Greenberg, Chairman of the Board and ChiefExecutive Officer, beneficially owned 74.4% of our outstanding Class B commonshares and members of Mr. Greenberg's immediate family beneficially owned theremainder of our outstanding Class B common shares. The holders of Class Acommon shares and Class B common shares have identical rights except 18that holders of Class A common shares are entitled to one vote per share whileholders of Class B common shares are entitled to ten votes per share on allmatters submitted to a vote of our stockholders. As a result, as of December 31,2001, Mr. Greenberg held approximately 69.5% of the aggregate number of voteseligible to be cast by our stockholders and together with shares held by othermembers of his immediate family held approximately 93.4% of the aggregate numberof votes eligible to be cast by our stockholders. Therefore, Mr. Greenberg isable to control substantially all matters requiring approval by ourstockholders. Matters that require the approval of our stockholders include theelection of directors and the approval of mergers or other business combinationtransactions. Mr. Greenberg also has control over our management and affairs. Asa result of such control, certain transactions are not possible without theapproval of Mr. Greenberg, including, proxy contests, tender offers, open marketpurchase programs, or other transactions that can give our stockholders theopportunity to realize a premium over the then-prevailing market prices fortheir shares of our Class A common shares. The differential in the voting rightsmay adversely affect the value of our Class A common shares to the extent thatinvestors or any potential future purchaser view the superior voting rights ofour Class B common shares to have value.OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY INHIBIT A TAKEOVER, WHICH MAY CAUSE ADECLINE IN THE VALUE OF OUR STOCK. Provisions of Delaware law, our certificate of incorporation, or our bylawscould make it more difficult for a third party to acquire us, even if closingsuch a transaction would be beneficial to our stockholders. Mr. Greenberg'ssubstantial beneficial ownership position, together with the authorization ofPreferred Stock, the disparate voting rights between the Class A common sharesand Class B common shares, the classification of the Board of Directors and thelack of cumulative voting in our certificate of incorporation and bylaws, mayhave the effect of delaying, deferring or preventing a change in control, maydiscourage bids for our Class A common shares at a premium over the market priceof the Class A common shares and may adversely affect the market price of theClass A common shares.SPECIAL NOTE ON FORWARD LOOKING STATEMENTS AND REPORTS PREPARED BY ANALYSTS. This Form 10-K contains forward-looking statements within the meaning of thePrivate Securities Litigation Reform Act of 1995, including statements withregards to our revenues, earnings, spending, margins, cash flow, orders,inventory, products, actions, plans, strategies and objectives. Forward-lookingstatements include, without limitation, any statement that may predict,forecast, indicate or simply state future results, performance or achievements,and may contain the words "believe," "anticipate," "expect," "estimate,""intend," "plan," "project," "will be," "will continue," "will," "result,""could," "may," "might," or any variations of such words with similar meanings.Any such statements are subject to risks and uncertainties that would cause ouractual results to differ materially from those which are management's currentexpectations or forecasts. Such information is subject to the risk that suchexpectations or forecasts, or the assumptions underlying such exceptions orforecasts, become inaccurate. In addition, the risks included here are notexhaustive. Other sections of this report may include additional factors whichcould adversely impact our business and financial performance. Moreover, weoperate in a very competitive and rapidly changing environment. New risk factorsemerge from time to time and we cannot predict all such risk factors, nor can weassess the impact of all such risk factors on our business or the extent towhich any factor, or combination of factors, may cause actual results to differmaterially from those contained in any forward looking statements. Given theserisks and uncertainties, investors should not place undue reliance onforward-looking statements as a prediction of actual results. Investors shouldalso be aware that while we do, from time to time, communicate with securitiesanalysts, we do not disclose any material non-public information or otherconfidential commercial information to them. Accordingly, individuals should notassume that we agree with any statement or report issued by any analyst,regardless of the content of the report. Thus, to the extent that reports issuedby securities analysts contain any projections, forecasts or opinions, suchreports are not our responsibility.ITEM 2. PROPERTIES Our corporate headquarters and additional administrative offices are locatedat five premises in Manhattan Beach, California, and consist of an aggregate ofapproximately 110,000 square feet. We own and lease portions of our corporateheadquarters and administrative offices. The leased property expires betweenAugust 2002 and February 2008, with options to extend in some cases,the current aggregate annual rent for the leased property is approximately $1.2million. Our distribution center consists of four facilities located in Ontario,California. The three leased facilities aggregate approximately 1,176,000 squarefeet, with an annual base rental of approximately $5.2 million. The leasedproperty expires between August 2002 and May 2011, and contains rent escalationprovisions. The owned distribution facility is approximately 264,000 squarefeet. All of our retail stores and showrooms are leased with terms expiringbetween January 2003 and August 2012. The leases provide for rent escalationstied to either increases in the lessor's operating expenses or fluctuations inthe consumer price index in the relevant 19geographical area, and in some cases a percentage of the store's gross sales inexcess of the base annual rent. Total rent expenses related to our retail storesand showrooms was $9.3 million for the year ended December 31, 2001. In February 2001, we completed the purchase of three adjacent propertieslocated in Manhattan Beach, California for a total of $4.5 million. We financedthe purchase of the properties through internally generated funds and currentlyavailable short-term borrowings. We intend to build additional administrativeoffices on these properties. We also lease all of our administrative offices, retail stores and showroomslocated in France, Germany, Switzerland, and the United Kingdom. The leasedproperty expires at various dates between July 2002 and March 2016. Total rentfor this leased property aggregated approximately $1.4 million during 2001.ITEM 3. LEGAL PROCEEDINGS On December 29, 1999, a complaint captioned SHAPIRO, ET AL., V. SKECHERSU.S.A., INC., ET AL. was filed against Skechers and two of its officers anddirectors in the United States District Court, Central District of California,Case No. 99-13559. The complaint is a purported class action claiming damagesfor alleged violations of the Securities Act of 1933 and the Securities ExchangeAct of 1934. The complaint also names as defendants the underwriters forSkechers' June 9, 1999 initial public offering of its Class A Common Stock. OnJanuary 12, 2000, a complaint captioned Abraham, et al., v. Skechers U.S.A.,Inc., et al. was filed against Skechers and two of its officers and directors inthe United States District Court, Central District of California, Court Case No.00-00471. The complaint is a purported class action claiming damages for allegedviolations of the Securities Act of 1933 and the Securities Exchange Act of1934. On January 24, 2000, a complaint captioned Astrolio, et al., v. SkechersU.S.A., Inc., et al. was filed against Skechers and two of its officers anddirectors in the United States District Court, Central District of California,Case No. 00-00772. The complaint is a purported class action claiming damagesfor alleged violations of the Securities Act of 1933 and the Securities ExchangeAct of 1934. The complaint also names the underwriters for Skechers' initialpublic offering of its Class A Common Stock as defendants in the case. OnJanuary 19, 2000, a complaint captioned Pugliesi, et al., v. Skechers U.S.A.,Inc., et al. was filed against Skechers and two of its officers and directors inthe United States District Court, Central District of California, Case No.00-00631. The complaint is a purported class action claiming damages for allegedviolations of the Securities Act of 1933 and the Securities Exchange Act of1934. All four securities actions were subsequently consolidated into one matterand a consolidated complaint was filed on June 1, 2000. The consolidatedcomplaint named as defendants Skechers, two officers of Skechers, and theunderwriters of Skechers' initial public offering of its Class A Common Stock onJune 9, 1999. The class alleged in the consolidated complaint, consists of allpersons who purchased securities in, or traceable to, Skechers' initial publicoffering of its Class A Common Stock on June 9, 1999 or thereafter on the openmarket prior to June 15, 1999.In response to the consolidated complaint, Skechers filed a motion to dismissthe entire case. On September 25, 2000, a tentative order was issued to dismissthe consolidated complaint in its entirety, with leave to amend, and on June 20,2001, an order was issued dismissing the case in its entirety with leave toamend. The class filed an amended complaint on or about August 3, 2001, and onSeptember 26, 2001, Skechers filed a motion to dismiss the amended complaint inits entirety. In response to the motion, and after discussions between classcounsel and counsel for defendants, the class agreed to dismiss with prejudicethe entire consolidated class action as to Skechers, its two named officers anddefendants and the underwriters. The class agreed to dismiss with prejudicewithout any settlement from defendants. Thus, the stipulation had no materialimpact on operations or financial results. A stipulation of dismissal withprejudice was executed by the parties in late December 2001. The court signedthe stipulation without modification and entered the order of dismissal onJanuary 30, 2002.On September 29, 2000, a complaint captioned MADISON TRADING LIMITED CORPORATIONAND MERCURY INTERNATIONAL TRADING CORPORATION V. SKECHERS USA, INC., LOVITTFILMS, INC. AND BERT LOVITT was filed against Skechers in the United StatesDistrict Court in Massachusetts, Civil Case No. CV-12016JLT. The lawsuit allegesquantum meruit, intentional interference with contract, intentional interferencewith advantageous relationship, unfair practices and declaratory relief arisingout of a business arrangement between Skechers and inventor Bert Lovitt. Thecomplaint seeks an injunction preventing Skechers from using certain technology,compensatory damages, exemplary damages and treble damages. The court denied theplaintiffs' motion for a preliminary injunction. In February 2002, all partiesagreed to settlement in principle and as of this filing are reducing thesettlement agreement to writing. The terms of the settlement are confidential.Notwithstanding, the terms will not have a material impact on the financialposition or results of operations of Skechers. 20 We occasionally become involved in litigation arising from the normal courseof business. Other than the foregoing, we believe that any liability withrespect to pending legal actions, individually or in the aggregate, will nothave a material adverse effect on our business, financial condition and resultsof operations.ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to our security holders to be voted on during thefourth quarter of 2001. 21 PART IIITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our Class A Common Stock began trading on the New York Stock Exchange onJune 9, 1999 after we completed the initial public offering of 7,000,000 sharesof our Class A Common Stock at $11.00 per share. Our Class A Common Stock tradesunder the symbol "SKX". The following table sets forth, for the periodsindicated, the high and low sales prices of our Class A Common Stock. HIGH LOW YEAR ENDED DECEMBER 31, 2001 First Quarter............................. $32.20 $14.50 Second Quarter............................ 40.30 22.80 Third Quarter............................. 29.40 11.33 Fourth Quarter............................ 15.05 10.00 YEAR ENDED DECEMBER 31, 2000 First Quarter............................. $ 7.69 $ 3.25 Second Quarter............................ 16.31 7.50 Third Quarter............................. 19.94 12.50 Fourth Quarter............................ 16.75 11.44 YEAR ENDED DECEMBER 31, 1999 Second Quarter (1)........................ $11.81 $ 9.75 Third Quarter............................. 10.25 4.75 Fourth Quarter............................ 5.19 3.44----------(1) For the period from June 9, 1999 to June 30, 1999. As of March 25, 2002, there were 104 holders of record of our Class ACommon Stock (including holders who are nominees for an undetermined number ofbeneficial owners) and 9 holders of record of our Class B Common Stock. Thesefigures do not include beneficial owners who hold shares in nominee name. TheClass B Common Stock is not publicly traded but each share is convertible uponrequest of the holder into one share of Class A Common Stock. In May 1992, we elected to be treated for federal and state income taxpurposes as an S Corporation under Subchapter S of the Internal Revenue Code of1986, as amended (the "Code"), and comparable state laws. As a result, ourearnings, since such initial election, were included in the taxable income ofour stockholders for federal and state income tax purposes, and we were notsubject to income tax on such earnings, other than franchise and net worthtaxes. Prior to the closing of the initial public offering of our Class A commonshares on June 9, 1999, we terminated our S Corporation status, and since thenwe have been treated for federal and state income tax purposes as a corporationunder Subchapter C of the Code and, as a result, are subject to state andfederal income taxes. By reason of our treatment as an S Corporation for federaland state income tax purposes, we, since inception, have provided to ourstockholders funds for the payment of income taxes on our earnings as well asour conversion from an S Corporation to a C Corporation during 1999. We declareddistributions relating to our S Corporation status of $35.4 million and $7.9million in 1999 and 1998, respectively. Purchasers of shares in the initialpublic offering of our Class A common shares on June 9, 1999 did not receive anyportion of these S Corporation distributions. Since the termination of our SCorporation status earnings have been and will be retained for the foreseeablefuture in the operations of our business. We have not declared or paid any cashdividends on our Class A common shares and do not anticipate paying any cashdividends in the foreseeable future. Our current policy is to retain all of ourearnings to finance the growth and development of our business. 22ITEM 6. SELECTED FINANCIAL DATA The following tables set forth selected consolidated financial data ofSkechers as of and for each of the years in the five-year period ended December31, 2001. SUMMARY FINANCIAL DATA (IN THOUSANDS, EXCEPT EARNINGS PER SHARE) YEARS ENDED DECEMBER 31, ------------------------ 1997 1998 1999 2000 2001 ---- ---- ---- ---- ---- STATEMENT OF EARNINGS DATA: Net sales................................. $183,827 $372,680 $424,601 $675,036 $960,385 Gross profit.............................. 68,723 154,580 174,608 284,225 554,205 Operating expenses: Selling................................ 21,584 49,983 57,332 77,451 111,401 General and administrative............. 32,397 71,461 79,114 125,827 205,989 Earnings from operations.................. 15,636 33,991 38,830 81,263 88,487 Interest expense.......................... 4,186 8,631 6,554 9,230 13,852 Earnings before income taxes.............. 11,413 25,121 32,691 72,351 75,955 Net earnings.............................. 11,023 24,471 24,056 43,751 47,270PRO FORMA OPERATIONS DATA:(1) Earnings before income taxes.............. $ 11,413 $ 25,121 $ 32,691 $ 72,351 $ 75,955 Income taxes.............................. 4,565 10,048 12,880 28,600 28,685 Net earnings.............................. 6,848 15,073 19,811 43,751 47,270 Net earnings per share:(2) Basic.................................. $ 0.25 $ 0.54 $ 0.62 $ 1.24 $ 1.30 Diluted................................ $ 0.23 $ 0.49 $ 0.60 $ 1.20 $ 1.24 Weighted average shares:(2) Basic.................................. 27,814 27,814 31,765 35,142 36,409 Diluted................................ 29,614 30,610 33,018 36,563 38,059 AS OF DECEMBER 31, ------------------ BALANCE SHEET DATA: 1997 1998 1999 2000 2001 ------------------- ---- ---- ---- ---- ---- Working capital................ $17,081 $ 23,106 $ 65,003 $ 93,305 $139,972 Total assets................... 90,881 146,284 177,914 303,400 407,486 Total debt..................... 39,062 70,933 33,950 85,321 115,931 Stockholders' equity........... 11,125 27,676 86,000 134,046 199,016----------(1) Reflects adjustments for federal and state income taxes as if Skechers had been taxed as a C Corporation rather than as an S Corporation for periods prior to its initial public offering on June 9, 1999.(2) Basic earnings per share represents net earnings divided by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if options to issue common stock were exercised or converted into common stock. The weighted average diluted shares outstanding gives effect to the sale by Skechers of those shares of common stock necessary to fund the payment of (i) stockholder distributions paid or declared from January 1, 1998 to June 7, 1999, the S Corporation termination date, in excess of (ii) the S Corporation earnings from January 1, 1998 to December 31, 1998 for 1996 through 1998, and January 1, 1999 to June 7, 1999 for 1999, based on an initial public offering price of $11 per share, net of underwriting discounts.ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS Certain information contained in the following Management's Discussion andAnalysis of Financial Condition and Results of Operations constituteforward-looking statements within the meaning of the Securities Act and theSecurities Exchange Act, which can be identified by the use of forward-lookingterminology such as "believes," "anticipates," "plans," "expects," "endeavors,""may," "will," "intends," "estimates" and similar expressions that are intendedto identify forward-looking statements. These forward-looking statements involverisks and uncertainties, and our actual results may differ materially from theresults discussed in the forward-looking statements as a result of certainfactors set forth in "Risk Factors" and elsewhere in this report. 23OVERVIEW We design, market and sell contemporary footwear for men, women and childrenunder the Skechers brand. Our footwear is sold through a wide range ofdepartment stores and leading specialty retail stores, a growing network of ourown retail stores and our e-commerce website. Our objective is to continue toprofitably grow our domestic operations, while leveraging our brand name toexpand internationally. We generate revenues from three principal sources: - WHOLESALE. We sell footwear directly to department stores and specialty retail stores both domestically and internationally. - RETAIL. We own and operate our own retail stores both domestically and, on a smaller scale, internationally through three integrated retail formats. Our retail formats are as follows: Concept Stores. Our concept stores are located in marquee street locations and high performing regional malls, promote awareness of the Skechers brand and showcase a broad assortment of our in-season footwear styles. Factory Outlet Stores. Our factory outlet stores are generally located in manufacturers' outlet centers and provide opportunities to sell an assortment of in-season, discontinued and excess merchandise at lower price points. Warehouse Outlet Stores. Our freestanding warehouse outlet stores appeal to our most value conscious customers and enable us to liquidate excess merchandise, discontinued lines and odd-size inventory in a cost-efficient manner. - DISTRIBUTORS. Internationally, we sell our footwear to our foreign distributors who distribute such footwear to department stores and specialty retail stores in Europe, Asia, Latin America, South America and numerous other countries and territories. The substantial portion of our revenues are derived from domestic wholesalesales. Typically, retail sales achieve higher gross margins as a percentage ofnet sales than wholesale sales. Sales through foreign distributors result inlower gross margins as a percentage of net sales than retail or wholesale sales.None of our domestic retail sales, international wholesale sales, internationalretail sales, or international distributor sales comprised more than 10% of ourconsolidated net sales for either fiscal 1999, 2000 or 2001. We have implemented a strategy of controlling the growth of the distributionchannels through which our products are sold in order to protect the Skechersbrand name, properly secure customer accounts and better manage the growth ofthe business. We seek wholesale accounts that we believe can best support theSkechers brand name in the market as part of our efforts to expand our wholesaledistribution. We seek to selectively open retail stores in high profile, hightraffic locations in major metropolitan areas both domestically andinternationally. Domestically, we are currently planning to open approximately10 to 15 retail stores during fiscal 2002 as compared to 26 in fiscal 2001. Weseek to increase the number of international wholesale accounts which we selldirectly to, thereby reducing our reliance on foreign distributors and may seekto open additional international retail stores on a selected basis. We have realized rapid growth since inception, increasing net sales at acompound annual growth rate of 40.1% from $90.8 million in 1994 to $960.4million in 2001. This momentum continued into 2001 with a 42.3% increase insales and an 8.0% increase in net earnings compared to 2000. However, given thecurrent global economic environment and the world events triggered on September11, 2001, we currently do not anticipate achieving similar sales growth duringthe year ending December 31, 2002. Based on our current estimates, we anticipatesales levels during the first six months of fiscal 2002 to be consistent withthe first six months of fiscal 2001, and any sales growth to be realized duringthe second half of 2002. These estimates may be affected by the continued threatof terrorist attacks throughout the world and any military action taken by theUnited States and other nations that could cause additional significantdisruption to commerce throughout the world. As our sales growth accelerated, we focused on investing in ourinfrastructure to support continued expansion in a disciplined manner. During2000, we expanded our distribution and administrative facilities, hiredadditional personnel, developed product sourcing and quality control offices inChina and Taiwan, upgraded our management information systems, opened additionalretail stores and expanded the offerings available through our web site. During2001, we made planned infrastructure additions to support the addition of 26 newdomestic retail stores, commenced our international expansion with theestablishment of international subsidiaries in the United Kingdom, France andGermany to manage our direct selling efforts in those areas, opened our firstthree 24international flagship retail stores and increased the number of product linesto expand the breadth of our product offerings. The fixed costs incurred duringthis expansion period have not yet been leveraged over a full year's sales. Weestablished this infrastructure to achieve economies of scale in anticipation ofcontinued increases in sales. Because expenses relating to this infrastructureare fixed, at least in the short-term, operating results and margins would beadversely affected if we do not achieve our anticipated sales growth. Forexample, due in large part to the slowdown in the global economy, our net salesin 2001 were lower than anticipated. This lower level of sales adverselyaffected our operating results for 2001 and could continue to do so in 2002 andbeyond. Our gross margins have improved annually from 41.1% in 1999 to 42.1% in 2000to 42.3% in 2001. During the fourth quarter ended December 31, 2001, our grossmargin was 39.7% compared to 43.3% in the same period during 2000. Given thecontinuing weak retail environment, we currently anticipate that margins duringthe first half of fiscal 2002 will be consistent with gross margins during thefourth quarter of fiscal 2001 and, if any, improvement to take place during thesecond half of fiscal 2002. Operating margin as a percentage of net salesincreased from 9.1% in 1999 to 12.0% in 2000 but decreased to 9.2% during 2001.Increasing sales and maintaining or improving gross margins and operatingmargins depends on various factors, including, strength of our brand name,competitive conditions and our ability to efficiently manage sales through alldistribution channels. In the future, our rate of growth will be dependent upon,among other things, the continued success of our efforts to expand our footwearofferings within the Skechers brand or developing alternative, successfulbrands. We can not assure you that the rate of growth will not decline in futureperiods or that we will improve or maintain gross margins or operating margins. Given the increase in 2001 of selling and general and administrativeexpenses on both an absolute dollar basis and as a percentage of net sales, andgiven the state of the global economy following the events of September 11,2001, we initiated various cost cutting measures in the fourth quarter of 2001to better leverage our cost infrastructure over our newly expanded operations.From a selling expense standpoint, we reorganized our sales force byconsolidating some regions, which resulted in staff reductions. We alsoeliminated our mail order operations and related selling expenses associatedwith the mail order catalog, and we estimate the annual savings from theseactions will be approximately $6.0 million in 2002. From the general andadministrative expense standpoint, we eliminated some administrative positionsand reduced temporary staff at our distribution center without reducing ourorder fulfillment rate. Notwithstanding our cost cutting measures, we remain committed to theoverall marketing strategy that has been largely responsible for the increase inthe market presence, product visibility and product demand over the past threeyears. We have and continue to increase our advertising budget consistent withprojected sales, which has included such avenues as magazines, television, tradeshows, billboards, and buses. We endeavor to spend approximately 8% to 10% ofannual net sales in the marketing of Skechers footwear through advertising,promotions, public relations, trade shows and other marketing efforts. We believe that selective licensing of the Skechers brand name tonon-footwear-related manufacturers may broaden and enhance the Skechers imagewithout requiring us to expend significant capital investments or incursignificant incremental operating expenses. Although we have licensed certainmanufacturers to produce and market certain Skechers products on a limitedbasis, to date we have not derived any significant royalty income from theselicensing arrangements. Royalty income is recognized as revenue when earned. Webelieve that revenues from licensing agreements will not be a material source ofgrowth for us in the near term; however, we believe that licensing arrangementsmay present attractive long-term opportunities with minimal near-term costs. We contract with third parties for the manufacture of all our products. Wedo not own or operate any manufacturing facilities. In 2001, the top foursuppliers of our products accounted for 51.9% of our total purchases, but no onemanufacturer accounted for more than 20.0%. To date, substantially all productsare purchased in U.S. dollars, but this may not continue to be the case. Webelieve the use of independent manufacturers increases our productionflexibility and capacity yet at the same time allows us to substantially reducecapital expenditures and avoid the costs of managing a large production workforce. Substantially all of our products are produced in China. We finance ourproduction activities in part through the use of interest-bearing open purchasearrangements with certain of our Asian suppliers. These facilities currentlybear interest at a rate between 0.5% and 1.5% with financing for 30 to 60 days.We believe that the use of these arrangements affords us additional liquidityand flexibility.YEAR ENDED DECEMBER 31, 2001 COMPARED TO THE YEAR ENDED DECEMBER 31, 2000Net Sales Net sales for 2001 increased 42.3% to $960.4 million compared to $675.0million in 2000. The increase in net sales was due in part to a 37.0% increasein domestic wholesale revenues over 2000 levels as a result of increased salesin all product lines, primarily Women's Sport and Kids lines, the introductionof three new product lines during 2001, and additional styles added within each 25product line. Domestic wholesale volume increased to 42.1 million pairs in 2001from 29.4 million pairs in 2000. Domestic retail sales increased 50% over 2000levels largely due to the addition of 26 retail stores during 2001. Net salesfrom our direct mail and web based distribution channels remained consistent in2001 as compared to 2000. However, in October 2001, we elected to discontinueour mail order and catalog operations, which represented less 1% of net sales in2001, although we continue to offer a selected assortment of merchandise throughour interactive website. During 2001, total international sales increased 85.7% over 2000 levels.International sales consist of distributor sales, which increased 47.4% due tocontinued acceptance of our product offerings in the international marketplace.International wholesale revenues increased substantially from nominal levels in2000 due to marketing and advertising campaigns in support of the establishmentof our three international subsidiaries located in the United Kingdom, Franceand Germany, where we began to sell direct to department stores and specialtyretailers in 2001. During 2001, we generated our first international retailsales as we opened our first three international flagship retail stores locatedin the United Kingdom, France and Germany.Gross Profit Gross profit for 2001 was $406.2 million, an increase of 42.9% over $284.2million in 2000. Gross margin was 42.3% for 2001 compared to 42.1% for 2000. Theslight margin increase was the result of reduced cargo costs partly offset byreduced margins during the three months ended December 31, 2001 for priceconcessions given to our wholesale customers and price reductions at our factoryoutlet and warehouse outlet stores to help stimulate inventory sell through atthe retail level.Selling expenses Selling expenses for 2001 were $111.4 million, an increase of 43.8% overlast year's $77.5 million. Selling expenses as a percent of net sales increasedslightly to 11.6% from 11.5% in 2000. The increase in the level of spending wasprimarily due to increased advertising in both print and television media andadditional advertising to support the increase in sales activities in the UnitedKingdom, Germany and France where we commenced selling direct to departmentstores and specialty retailers. During 2001 advertising expenses were $86.6million, or 9.0% of net sales, compared to $59.1 million, or 8.8% of net salesin 2000.General and administrative expenses General and administrative expenses for 2001 were $206.0 million compared to$125.8 million in 2000. General and administrative expenses as a percentage ofnet sales was 21.4% in 2001 compared to 18.6% in 2000. The increase in generaland administrative expenses in absolute dollars and as a percentage of net saleswas due to planned infrastructure additions to support the 26 domestic retailstores added during 2001 and to establish operating entities, and flagshipretail stores, in the United Kingdom, France and Germany to support our directselling efforts in those countries. In addition, we increased our distributioncapacity with facility and capital asset additions and enhanced our informationsystems to support the increase in sales volume.Interest expense Interest expense increased to $13.9 million in 2001 from $9.2 million in2000. The increase was due to increased short-term borrowings to support ourworking capital requirements and retail store additions and increased capitalasset financing to support the increase in sales volume and capacity expansion.Other income Other income increased to $1.3 million in 2001 compared to $318,000 in 2000.The increase in other income is due to rental income related to the leasing ofoffices at our administrative office building and legal settlements, partiallyoffset by the disposal of fixed assets. We expect rental income to decreaseduring 2002 as tenant leases expire.Income taxes The effective tax rate in 2001 was 37.8% compared to 39.5% in 2000. Thedecrease in the effective tax rate is due to changes in income in differing taxjurisdictions as a result of our international expansion. We are expanding ourinternational operations and plan to reinvest any undistributed earnings fromour non-U.S. subsidiaries, thereby indefinitely postponing their remittance. Asa result, we do not plan to provide for deferred income taxes on any accumulatedundistributed earnings that our non-U.S. subsidiaries earn in the future. 26YEAR ENDED DECEMBER 31, 2000 COMPARED TO THE YEAR ENDED DECEMBER 31, 1999Net sales Net sales for 2000 were $675.0 million, an increase of $250.4 million or59.0% from $424.6 million in 1999. The increase was due in large part to a 59%increase in our domestic wholesale revenues over 1999 levels. In addition, werealized a 51.5% increase in domestic wholesale units sold to 29.4 million unitsin 2000 from 19.4 million units in 1999. The increase in the domestic wholesalebusiness is primarily due to expansion of the domestic sales force, continuedconsumer acceptance of our product offerings, and increased marketing campaigns.During 2000, we continued to introduce, and generate sales from, new productcategories in the women's, men's, children's athletic shoes, and our men'squality dress line. Domestic retail sales for 2000 increased 50% from 1999levels due to increased sales at stores open for at least one year andfrom the addition of 10 new locations added during 2000. Net sales from ourdirect mail and web based distribution channels increased substantially in 2000largely due to an increase in the number of direct mailings and an increase inthe circulation of the mailings. Fiscal 2000 international sales consisted almost entirely of sales throughdistributors and increased 48.4% over 1999 levels primarily due to increasedbrand acceptance and increased advertising campaigns. During 2000, we began ourinternational direct selling efforts, through which we sold direct to departmentstores and specialty retainers and therefore generated nominal sales in 2000.Gross profit In 2000, gross profit increased to $284.2 million, a 62.8% increase from$174.6 million in 1999. Gross margin was 42.1% in 2000 compared to 41.1% in1999. The increase in gross margin was due to (i) an increase in the proportionof sales derived from our women's footwear line, which have a higher grossmargin than the men's footwear line, (ii) fewer markdowns as a percentage ofsales and (iii) increased sales at retail.Selling expenses Selling expenses were $77.5 million in 2000, an increase of 35.1% over $57.3million in 1999. However, selling expense as a percentage of net sales decreasedto 11.5% in 2000 from 13.5% in 1999. The increase in absolute dollars wasprimarily due to increased print advertising, both internationally anddomestically, increased promotional expenses, and additional sales commissionsdue to increased sales volume. During 2000, advertising expenses were $59.1million, or 8.8% of net sales, compared to $47.4 million, or 11.2% of net salesin 1999.General and administrative expenses General and administrative expenses in 2000 were $125.8 million compared to$79.1 million in 1999. As a percent of sales, general and administrativeexpenses remained at 18.6% for both 2000 and 1999. The increase in absolutedollars was primarily due to additional personnel costs reflected in the form ofadditional salary, wages and temporary help costs to support the higher level ofsales, and increased warehousing and distribution costs associated withincreased sales volume. In addition, we realized increased operating costs fromthe 10 new retail facilities added during 2000, and, although to a lesserextent, we incurred additional general and administrative expenses related toinfrastructure additions to support our international operations.Interest expense Interest expense increased to $9.2 million in 2000 from $6.6 million in1999. The increase was due to increased financing costs associated withadditional borrowings to support our working capital requirements, capitaladditions made during the year, increased purchases of inventory and the buildup of accounts receivable commensurate with our growth.Other, net Other, net consists primarily of a gain from the settlement of commerciallawsuits and net gains from foreign exchange rate fluctuations. 27Income taxes The 2000 effective tax rate was 39.5%, which is comparable to the pro formaeffective rate of 39.4% in 1999. The prior years pro forma taxes represent thosetaxes that would have been reported had we been subject to federal and stateincome taxes as a C corporation for the full year. We continually review andevaluate various tax strategies to minimize our tax liability. We are expanding our international operations and plan to reinvest anyundistributed earnings from our non-U.S. subsidiaries, thereby indefinitelypostponing their remittance. As a result, we do not plan to provide for deferredincome taxes on any accumulated undistributed earnings that our non-U.S.subsidiaries earn in the future. Assuming that our international operations aresuccessful, our effective tax rates should decrease accordingly.LIQUIDITY AND CAPITAL RESOURCES Our capital needs are derived primarily from working capital requirementsand the continued growth of the business. Our working capital at December 31,2001 was $140.0 million, an increase of $46.7 million over working capital of$93.3 million at December 31, 2000. The increase in working capital wasprimarily due to the increase in accounts receivable, inventory, and prepaid andother current assets consisting primarily of prepaid income taxes offset byincreased short-term borrowings and to a lesser extent accounts payable andaccrued expenses. Inventories increased $46.0 million or 41.1% to $157.7 million at December31, 2001, from $111.7 million at December 31, 2000. Our sales backlog of $222.2million at December 31, 2001 is consistent with the level at December 31, 2000.Our commitment to inventory at December 31, 2001, which includes inventory onhand, inventory in transit (for which we have title), and merchandise inprocess, for which we do not have title, increased slightly over our commitmentto inventory at December 31, 2000. Also, the increase in our inventoriesreflects a greater breadth of products and support for the expansion of ourinternational operations. At December 31, 2001, we had purchase commitments ofapproximately $89.4 million. Net cash used in operating activities for the year ended December 31, 2001was $1.7 million, compared to cash used in operating activities of $1.0 millionfor the same period last year. The increase in cash used in operating activitieswas primarily due to increases in receivables, inventories, and prepaid taxes. Net cash used in investing activities was $31.5 million for the year endedDecember 31, 2001, an increase of $9.7 million over the $21.8 million for theyear ended December 31, 2000. The increase in cash used in investing activitieswas due to increased capital expenditures related to the addition of 26 domesticretail stores, the addition of three international stores, capital expendituresrelated to establishing our international operating units, and the acquisitionof real properties in Manhattan Beach, California that is expected to beconverted into an administrative office facility. Net cash provided by financing activities for the year ended December 31,2001 was $40.0 million, compared to $20.8 million for the year ended December31, 2000. The net cash provided by financing activities was derived primarilyfrom our short-term credit facilities, and, to a lesser extent, proceeds fromthe exercise of stock options and our employee stock purchase plan, partiallyoffset by reductions in long-term debt. In July 2001, we renegotiated our line of credit facility which now providesfor borrowings of up to $150.0 million, with actual borrowings limited toavailable collateral and certain limitations on total indebtedness(approximately $54.2 million of availability as of December 31, 2001) with CITGroup, a subsidiary of TYCO, as agents for the lenders. At December 31, 2001,there was approximately $84.2 million outstanding under the revolving line ofcredit. The revolving line of credit bears interest at prime rate (4.75% atDecember 31, 2001) minus .5%. Interest on the line of credit is payable monthlyin arrears. The revolving line of credit expires on December 31, 2003. Therevolving line of credit provides a sub-limit for letters of credit of up to$30.0 million to finance our foreign purchases of merchandise inventory. As ofDecember 31, 2001, we had approximately $5.4 million of letters of credit underthe revolving line of credit. In February 2002, we borrowed an additional $ 43.0million under the line of credit. The credit facility contains covenantsindicating that stockholders' equity shall not decrease by more than 20% in anycalendar quarter, and limits the payment of dividends if we are in default ofany provision of the agreement. We were in compliance with these covenants as ofDecember 31, 2001. We finance our production activities in part through the use ofinterest-bearing open purchase arrangements with certain of our Asianmanufacturers. These facilities currently bear interest at a rate between 0.5%and 1.5% for 30 to 60 days financing, depending on the factory. We believe that anticipated cash flows from operations, available borrowingsunder our revolving line of credit, cash on hand and our financing arrangementswill be sufficient to provide us with the liquidity necessary to fund ouranticipated working capital and 28capital requirements through fiscal 2002. However, in connection with our growthstrategy, we will incur significant working capital requirements and capitalexpenditures. Our future capital requirements will depend on many factors,including, but not limited to, the levels at which we maintain inventory, themarket acceptance of our footwear, the levels of promotion and advertisingrequired to promote our footwear, the extent to which we invest in new productdesign and improvements to our existing product design and the number and timingof new store openings. To the extent that available funds are insufficient tofund our future activities, we may need to raise additional funds through publicor private financings. We cannot assure you that additional financing will beavailable or that, if available, it can be obtained on terms favorable to ourstockholders and us. Failure to obtain such financing could delay or prevent ourplanned expansion, which could adversely affect our business, financialcondition and results of operations. In addition, if additional capital israised through the sale of additional equity or convertible securities, dilutionto our stockholders could occur.CRITICAL ACCOUNTING POLICIESUse of Estimates. The preparation of financial statements in conformity withaccounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amounts ofassets and liabilities and disclosures of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenues andexpenses during the reporting period. Specifically, management must makeestimates in the following areas:Allowance for bad debts, returns, and customer chargebacks. We insure selectedcustomer account balances both greater than $200,000 and accepted by theinsurance company should our customer not pay. We also provide a reserve againstour receivables for estimated losses that may result from our customers'inability to pay, and disputed and returned items. We determine the amount ofthe reserve by analyzing known uncollectible accounts, aged receivables,economic conditions in the customers' country or industry, historical losses andour customers' credit-worthiness. Amounts later determined and specificallyidentified to be uncollectible are charged or written off against this reserve.To minimize the likelihood of uncollectibility, customers' credit-worthiness isreviewed periodically based on external credit reporting services and ourexperience with the account and adjusted accordingly. Should a customer'saccount become past due, we generally place a hold on the account anddiscontinue further shipments to that customer, minimizing further risk of loss.The likelihood of a material loss on an uncollectible account would be mainlydependent on deterioration in the overall economic conditions in a particularcountry or environment. Reserves are fully provided for all probable losses ofthis nature. Gross trade accounts receivable balance was $127.4 million and theallowance for doubtful accounts was $7.1 million at December 31, 2001.Inventory adjustments. Inventories are stated at lower of cost or market. Wereview our inventory on a regular basis for excess and slow moving inventorybased on prior sales and net realizable value. The likelihood of any materialinventory write-down is dependent primarily on consumer demand and competitorproduct offerings. Inventories were stated at $157.7 million at December 31,2001.Valuation of intangible and other long-lived assets. When circumstances warrant,we assess the impairment of intangible and other long-lived assets that requireus to make assumptions and judgments regarding the carrying value of theseassets. The assets are considered to be impaired if we determine that thecarrying value may not be recoverable based upon our assessment of the followingevents or changes in circumstances: - the asset's ability to continue to generate income; - loss of legal ownership or title to the asset; - significant changes in our strategic business objectives and utilization of the asset(s); or - the impact of significant negative industry or economic trendsIf the assets are considered to be impaired, the impairment we recognize is theamount by which the carrying value of the assets exceeds the fair value of theassets. In addition, we base the useful lives and related amortization ordepreciation expense on our estimate of the period that the assets will generaterevenues or otherwise be used by us. If a change were to occur in any of theabove-mentioned factors or estimates, the likelihood of a material change in ourreported results would increase.Litigation reserves. Estimated amounts for claims that are probable and can bereasonably estimated are recorded as liabilities in the consolidated balancesheets. The likelihood of a material change in these estimated reserves would bedependent on new claims as they may arise and the favorable or unfavorableoutcome of the particular litigation. Both the amount and range of loss on the 29remaining pending litigation is uncertain. As such, we are unable to make areasonable estimate of the liability that could result from unfavorable outcomesin litigation. As additional information becomes available, we will assess thepotential liability related to our pending litigation and revise our estimates.Such revisions in our estimates of the potential liability could materiallyimpact our results of operation and financial position.Valuation of deferred income taxes. Valuation allowances are established, whennecessary, to reduce deferred tax assets to the amount expected to be realized.The likelihood of a material change in our expected realization of these assetsdepends on future taxable income, and the effectiveness of our tax planning andstrategies among the various tax jurisdictions in which we operate.INFLATION We do not believe that the relatively moderate rates of inflationexperienced in the United States over the last three years have had asignificant effect on our sales or profitability. However, we cannot accuratelypredict the effect of inflation on future operating results. Although higherrates of inflation have been experienced in a number of foreign countries inwhich our products are manufactured, we do not believe that inflation has had amaterial effect on our sales or profitability. While we have been able to offsetour foreign product cost increases by increasing prices or changing suppliers inthe past, we cannot assure you that we will be able to continue to make suchincreases or changes in the future.EXCHANGE RATES We receive U.S. dollars for substantially all of our product sales and ourroyalty income. Inventory purchases from offshore contract manufacturers areprimarily denominated in U.S. dollars; however, purchase prices for our productsmay be impacted by fluctuations in the exchange rate between the U.S. dollar andthe local currencies of the contract manufacturers, which may have the effect ofincreasing our cost of goods in the future. During 2001 and 2000, exchange ratefluctuations did not have a material impact on our inventory costs. We donot engage in hedging activities with respect to such exchange rate risk.ITEM 7(a) QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKMARKET RISKWe do not hold any derivative securities.Market risk is the potential loss arising from the adverse changes in marketrates and prices, such as interest rates and foreign currency exchange rates.Changes in interest rates and, in the future, changes in foreign currencyexchange rates have and will have an impact on our results of operations.Interest rate fluctuations. At December 31, 2001, approximately $84.2 million ofour outstanding borrowings are subject to changes in interest rates; however, wedo not use derivatives to manage this risk. This exposure is linked to the primerate of interest. We believe that moderate changes in the prime rate will notmaterially affect our operating results or financial condition. For example, a1% change in interest rates would result in approximately $842,000 annual impacton pretax income (loss) based upon those outstanding borrowing at December 31,2001.Foreign exchange rate fluctuations. We face market risk to the extent thatchanges in foreign currency exchange rates affect our non-U.S. dollar functionalcurrency foreign subsidiary's assets and liabilities. In addition, changes inforeign exchange rates may affect the value of our inventory commitments. Also,inventory purchases of our products may be impacted by fluctuations in theexchange rates between the U.S. dollar and the local currencies of the contractmanufacturers, which could have the effect of increasing cost of goods sold inthe future. We manage these risks by primarily denominating these purchases andcommitments in U.S. dollars. We do not engage in hedging activities with respectto such exchange rate risks.FUTURE ACCOUNTING CHANGES Effective January 1, 2001, we adopted Statement of Financial AccountingStandards No. 133 ("SFAS 133"), Accounting for Derivative Instruments andHedging Activities. As a result, we recognize financial instruments, such asforeign currency forward contracts, at fair value regardless of the purpose orintent for holding the instrument. Changes in the fair value of derivativefinancial instruments are either recognized periodically through the statementof earnings or through stockholders' equity as a component of accumulated othercomprehensive income or loss. The classification depends on whether thederivative financial instrument qualifies 30for hedge accounting, and if so, whether it qualifies as a fair value hedge orcash flow hedge. Generally, changes in fair values of derivatives designated asfair value hedges are matched in the statement of earnings against therespective gain or loss relating to the hedged items. Changes in fair values ofderivatives accounted for as cash flow hedges, to the extent they are effectiveas hedges, are recorded in accumulated other comprehensive income net ofdeferred taxes. Changes in fair values of derivatives not qualifying as hedgesare currently reported in earnings. The implementation of this standard did nothave a significant impact on our financial statements. During April 2001, the Emerging Issues Task Force ("EITF") issued EITF No.00-14, Accounting for Certain Sales Incentives, and EITF No. 01-9, Accountingfor Consideration Given by a Vendor to a Customer (including A Reseller of theVendor's Products), which are effective for the first quarter beginning afterDecember 15, 2001. These EITF's prescribe guidance regarding the timing ofrecognition and income statement classification of costs incurred for certainsales incentive programs to retailers and end consumers. We expect that theadoption of EITF No. 00-14 and EITF No. 01-9 will not have a material impact onour financial position or results of operations. In July 2001, the FASB issued Statement of Financial Accounting StandardsNo. 141 ("SFAS 141"), Business Combinations, and Statement of FinancialAccounting Standards No. 142 ("SFAS 142"), Goodwill and Other Intangible Assets.SFAS 141 requires that the purchase method be used for all business combinationsinitiated after June 30, 2001. SFAS 142 requires that goodwill and intangibleassets with indefinite useful lives no longer be amortized to earnings, butinstead be reviewed for impairment in accordance with the provisions of SFAS142. The amortization of goodwill and intangible assets with indefinite usefullives ceases upon adoption of SFAS 142 which is effective for fiscal yearsstarting after December 15, 2001. We are in the process of quantifying theanticipated impact of adopting the provisions of SFAS 142, which is not expectedto be material. In October 2001, the Financial Accounting Standards Board ("FASB") issuedStatement of Financial Accounting Standards No. 144 ("SFAS 144"), Accounting forthe Impairment or Disposal of Long-Lived Assets, which addresses financialaccounting and reporting for the impairment or disposal of long-lived assets.While SFAS 144 supersedes Statement of Financial Accounting Standards No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets toBe Disposed Of, it retains many of the fundamental provisions of that statement.The standard is effective for fiscal years beginning after December 15, 2001. Weexpect that the adoption of SFAS 144 will not have a material impact on ourfinancial position or results from operations.ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item 8 is incorporated by reference to ourConsolidated Financial Statements and Independent Auditors' Report beginning atpage F-1 of this Form 10-K.ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ANDFINANCIAL DISCLOSURE None. 31 PART IIIITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item 10 is hereby incorporated by referencefrom our definitive proxy statement, to be filed pursuant to Regulation 14Awithin 120 days after the end of our 2001 fiscal year.ITEM 11. EXECUTIVE COMPENSATION The information required by this Item 11 is hereby incorporated by referencefrom our definitive proxy statement, to be filed pursuant to Regulation 14Awithin 120 days after the end of our 2001 fiscal year.ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item 12 is hereby incorporated by referencefrom our definitive proxy statement, to be filed pursuant to Regulation 14Awithin 120 days after the end of our 2001 fiscal year.ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item 13 is hereby incorporated by referencefrom our definitive proxy statement, to be filed pursuant to Regulation 14Awithin 120 days after the end of our 2001 fiscal year. PART IVITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Consolidated financial statements and schedules required to be filed hereunder are indexed on Page F-1 hereof. (b) Reports on Form 8-K -- There were no reports on Form 8-K filed during the last quarter of the fiscal year ended December 31, 2001. (c) Exhibits EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------ ---------------------- 2.1 Agreement of Reorganization and Plan of Merger (incorporated by reference to exhibit number 3.2(a) of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on May 12, 1999). 3.1 Certificate of Incorporation (incorporated by reference to exhibit number 3.1 of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on July 29, 1998). 3.2 Bylaws (incorporated by reference to exhibit number 3.2 of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on July 29, 1998). 3.2(a) Amendment to Bylaws (incorporated by reference to exhibit number 3.2(a) of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on May 12, 1999). 4.1 Form of Specimen Class A Common Stock Certificate (incorporated by reference to exhibit number 4.1 of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on May 12, 1999). 10.1 Amended and Restated 1998 Stock Option, Deferred Stock and Restricted Stock Plan (incorporated by reference to exhibit number 10.1 of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on July 29, 1998). 10.1(a) Amendment No. 1 to Amended and Restated 1998 Stock Option, Deferred Stock and Restricted Stock Plan (incorporated by reference to exhibit number 4.4 of the Registrant's Registration Statement on Form S-8 (File No. 333-71114), filed with the Securities and Exchange Commission on October 5, 2001). 10.2 Amended and restated 1998 Employee Stock Purchase Plan (incorporated by reference to exhibit number 10.1 of the Registrant's Form 10-Q, for the period ending June 30, 2000) 10.3 Employment Agreement dated June 14, 1999, between the Registrant and Robert Greenberg (incorporated by reference to exhibit number 10.3 of the Registrant's Form 10-Q for the period ending June 30, 1999). 10.3(a) Amendment No. 1 to Employment Agreement between the Registrant and Robert Greenberg dated December 31, 1999 (incorporated by reference to exhibit number 10.3(a) of the Registrant's Form 10-K for the year ending December 31, 1999). 10.4 Employment Agreement dated June 14, 1999, between the Registrant and Michael Greenberg (incorporated by reference to exhibit number 10.4 of the Registrant's Form 10-Q for the period ending June 30, 1999). 10.4(a) Amendment to Employment Agreement between the Registrant and Michael Greenberg dated December 31, 2000 (incorporated by reference to exhibit number 10.4(a) of the Registrant's Form 10-K for the year ending December 31, 1999). 10.5 Employment Agreement dated June 14, 1999, between the Registrant and David Weinberg (incorporated by reference to exhibit number 10.5 of the Registrant's Form 10-Q for the period ending June 30, 1999). 10.5(a) Amendment No. 1 to Employment Agreement between the Registrant and David Weinberg dated December 31, 2000 (incorporated by reference to exhibit number 10.5(a) of the Registrant's Form 10-K for the year ending December 31, 1999). 33 EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------ ---------------------- 10.6 Indemnification Agreement dated June 7, 1999 between the Registrant and its directors and executive officers (incorporated by reference to exhibit number 10.6 of the Registrant's Form 10-K for the year ending December 31, 1999). 10.6(a) List of Registrant's directors and executive officers who entered into Indemnification Agreement referenced in Exhibit 10.6 with the Registrant (incorporated by reference to exhibit number 10.6(a) of the Registrant's Form 10-K for the year ending December 31, 1999). 10.7 Registration Rights Agreement dated June 9, 1999, between the Registrant, the Greenberg Family Trust, and Michael Greenberg (incorporated by reference to exhibit number 10.7 of the Registrant's Form 10-Q for the period ending June 30, 1999). 10.8 Tax Indemnification Agreement dated June 8, 1999, between the Registrant and certain shareholders (incorporated by reference to exhibit number 10.8 of the Registrant's Form 10-Q for the period ending June 30, 1999). 10.9 Lease Agreement, dated July 1, 1999, between the Registrant and Richard and Donna Piazza, regarding 1108-B Manhattan Avenue, Manhattan Beach, California (incorporated by reference to exhibit number 10.22 of the registrant's Form 10-K for the year ending December 31, 1999). 10.10 Amended and Restated Loan and Security Agreement between the Registrant and Heller Financial, Inc., dated September 4, 1998 (incorporated by reference to exhibit number 10.10 of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on April 9, 1999). 10.10(a) Term Loan A Note, dated September 4, 1998, between the Registrant and Heller Financial, Inc. (incorporated by reference to exhibit number 10.10(a) of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on April 9, 1999). 10.10(b) Revolving Note dated September 4, 1998, between the Registrant and Heller Financial, Inc. (incorporated by reference to exhibit number 10.10(b) of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on April 9, 1999). 10.10(c) First Amendment to Amended and Restated Loan and Security Agreement, dated September 11, 1998 (incorporated by reference to exhibit number 10.10(c) of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on April 9, 1999). 10.10(d) Second Amendment to Amended and Restated Loan and Security Agreement, dated December 23, 1998 (incorporated by reference to exhibit number 10.10(d) of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on April 9, 1999). 10.10(e) Third Amendment to Amended and Restated Loan and Security Agreement dated February 1, 2000 (incorporated by reference to exhibit number 10.10(e) of the Registrant's Form 10-K for the year ending December 31, 2000). 10.10(f) Fourth Amendment to Amended and Restated Loan and Security Agreement dated June 1, 2000 (incorporated by reference to exhibit number 10.10(f) of the Registrant's Form 10-K for the year ending December 31, 2000). 10.10(g) Fifth Amendment to Amended and Restated Loan and Security Agreement dated July 11, 2001 (incorporated by reference to exhibit number 10.10(g) of the Registrant's Form 10-Q for the period ending September 30, 2001). 10.11 Lease Agreement, dated April 15, 1998, between the Registrant and Holt/Hawthorn and Victory Partners, regarding 228 Manhattan Beach Boulevard, Manhattan Beach, California (incorporated by reference to exhibit number 10.11 of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on April 9, 1999). 10.12 Commercial Lease Agreement, dated February 19, 1997, between the Registrant and Richard and Donna Piazza, regarding 1110 Manhattan Avenue, Manhattan Beach, California (incorporated by reference to exhibit number 10.12 of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on July 29, 1998). 10.13 Lease Agreement, dated June 12, 1998, between the Registrant and Richard and Donna Piazza, regarding 1112 Manhattan Avenue, Manhattan Beach, California (incorporated by reference to exhibit number 10.13 of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on July 29, 1998). 34 EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------ ---------------------- 10.14 Lease Agreement, dated November 21, 1997, between the Registrant and The Prudential Insurance Company of America, regarding 1661 So. Vintage Avenue, Ontario, California (incorporated by reference to exhibit number 10.14 of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on July 29, 1998). 10.15 Lease Agreements, dated November 21, 1997, between the Registrant and The Prudential Insurance Company of America, regarding 1777 So. Vintage Avenue, Ontario, California (incorporated by reference to exhibit number 10.15 of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on July 29, 1998). 10.16 Commercial Lease Agreement, dated April 10, 1998, between the Registrant and Proficiency Ontario Partnership, regarding 5725 East Jurupa Street (incorporated by reference to exhibit number 10.16 of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on July 29, 1998). 10.17 Lease Agreement and Addendum, dated June 11, 1998, between the Registrant and Delores McNabb, regarding Suite 3 on the first floor of the north building, Suite 9 on the first floor of the south building at 904 Manhattan Avenue, Manhattan Beach, California (incorporated by reference to exhibit number 10.17 of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on April 9, 1999). 10.18 Addendum to Lease Agreement, dated September 14, 1998, between the Registrant and Delores McNabb, regarding Suites 3, 4 and 5 on the second floor of the north building at 904 Manhattan Avenue, Manhattan Beach, California (incorporated by reference to exhibit number 10.18 of the Registrant's Registration Statement on Form S-1, as amended (File No. 333-60065), filed with the Securities and Exchange Commission on April 9, 1999). 10.18(a) Addendum to Lease Agreement, dated April 15, 2000, between the Registrant and Delores McNabb, regarding Suites 7, 8 and 9 on the second floor of the south building at 904 Manhattan Avenue, Manhattan Beach, California. 10.19 Standard Offer, Agreement and Escrow Instructions, Addendum and Additional Provisions, dated October 12, 2000, between the Registrant and/or its assignees and Champagne Building Group L.P., for the purchase of property located at 1670 South Champagne Avenue, Ontario, California (incorporated by reference to exhibit number 10.19 of the Registrant's Form 10-K for the year ending December 31, 2000). 10.20 Lease Agreement, dated November 15, 1999, between the Registrant and Champagne Building Group L.P., regarding 1670 South Champagne Avenue, Ontario, California (incorporated by reference to exhibit number 10.20 of the Registrant's Form 10-K for the year ending December 31, 1999). 10.21 Amendment of Lease Agreement dated December 20, 2000, between the Registrant and Yale Investments, LLC (a wholly owned subsidiary of the Registrant), regarding 1670 South Champagne Avenue, Ontario, California (incorporated by reference to exhibit number 10.21 of the Registrant's Form 10-K for the year ending December 31, 2000). 10.22 Purchase and Sale Agreement with Escrow Instructions, dated November 13, 2000, between the Registrant and Pacifica California/Apollo, LLC, for the purchase of property located at 225 South Sepulveda Boulevard, Manhattan Beach, California (incorporated by reference to exhibit number 10.22 of the Registrant's Form 10-K for the year ending December 31, 2000). 10.22(a) First Amendment to Purchase and Sale Agreement, dated November 29, 2000, between the Registrant and Pacifica California/Apollo, LLC, for the purchase of property located at 225 South Sepulveda Boulevard, Manhattan Beach, California (incorporated by reference to exhibit number 10.22(a) of the Registrant's Form 10-K for the year ending December 31, 2000). 10.23 Promissory Note, dated December 27, 2000, between the Registrant and Washington Mutual Bank, FA, for the purchase of property located at 225 South Sepulveda Boulevard, Manhattan Beach, California (incorporated by reference to exhibit number 10.23 of the Registrant's Form 10-K for the year ending December 31, 2000). 10.24 Assignment and Assumption Agreement, dated December 27, 2000, between the Registrant and Pacifica California/Apollo, LLC, regarding 225 South Sepulveda Boulevard, Manhattan Beach, California (incorporated by reference to exhibit number 10.24 of the Registrant's Form 10-K for the year ending December 31, 2000). 35 EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------ ---------------------- 10.25 Loan Agreement, dated December 21, 2000, between Yale Investments, LLC, and MONY Life Insurance Company, for the purchase of property located at 1670 South Champagne Avenue, Ontario, California (incorporated by reference to exhibit number 10.25 of the Registrant's Form 10-K for the year ending December 31, 2000). 10.26 Promissory Note, dated December 21, 2000, between Yale Investments, LLC, and MONY Life Insurance Company, for the purchase of property located at 1670 Champagne Avenue, Ontario, California (incorporated by reference to exhibit number 10.26 of the Registrant's Form 10-K for the year ending December 31, 2000). 10.27 Lease Agreement, dated April 28, 2000, between the Registrant and Manhattan Corners, LLC, regarding 1100 Highland Avenue, Manhattan Beach, California. 10.28 Lease Agreement, dated April 10, 2001, between the Registrant and ProLogis California I LLC, regarding 4100 East Mission Boulevard, Ontario, California. 21.1 Subsidiaries of the Registrant 23.1 Consent of KPMG LLP 24.1 Power of Attorney (included on signature page) 36 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signed onits behalf by the undersigned, thereunto duly authorized, in the City ofManhattan Beach, State of California on the 27th day of March, 2002. SKECHERS U.S.A, INC. By: /s/ ROBERT GREENBERG ----------------------------------- Robert Greenberg Chairman of the Board and Chief Executive Officer POWER OF ATTORNEY We, the undersigned officers and directors of Skechers U.S.A., Inc., dohereby constitute and appoint Robert Greenberg, Michael Greenberg and DavidWeinberg, or either of them, our true and lawful attorneys and agents, to do anyand all acts and things in our names in the capacities indicated below, whichsaid attorneys and agents, or either of them, may deem necessary or advisable toenable said corporation to comply with the Securities Exchange Act of 1934, asamended, and any rules, regulations, and requirements of the Securities andExchange Commission, in connection with this report, including specifically, butwithout limitation, power and authority to sign for us or any of us in our namesand in the capacities indicated below, any and all amendments to this report,and we do hereby ratify and confirm all that the said attorneys and agents, oreither of them, shall do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, thisreport 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/ ROBERT GREENBERG Chairman of the Board and Chief March 27, 2002----------------------------------------------------- Executive Officer (Principal Robert Greenberg Executive Officer) /S/ MICHAEL GREENBERG President and Director March 27, 2002----------------------------------------------------- Michael Greenberg /S/ DAVID WEINBERG Executive Vice President, Chief March 27, 2002----------------------------------------------------- Financial Officer and Director David Weinberg (Principal Financial and Accounting Officer) Director ----------------------------------------------------- Jeffrey Greenberg Director ----------------------------------------------------- J. Geyer Kosinski /S/ THOMAS J. POLETTI Director March 27, 2002----------------------------------------------------- Thomas J. Poletti Director ----------------------------------------------------- Richard Siskind 37 SKECHERS U.S.A., INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE ---- Independent Auditors' Report............................................................................................. F-2Consolidated Balance Sheets -- December 31, 2000 and 2001................................................................ F-3Consolidated Statements of Earnings -- Each of the years in the three-year period ended December 31, 2001................ F-4Consolidated Statements of Stockholders' Equity and Comprehensive Income -- Each of the years in the three-year periodended December 31, 2001.................................................................................................. F-5Consolidated Statements of Cash Flows -- Each of the years in the three-year period ended December 31, 2001.............. F-6Notes to Consolidated Financial Statements............................................................................... F-7Schedule II -- Valuation and Qualifying Accounts......................................................................... S-1 F-1 INDEPENDENT AUDITORS' REPORTThe Board of Directors and StockholdersSkechers U.S.A., Inc.: We have audited the accompanying consolidated financial statements ofSkechers U.S.A., Inc. and subsidiaries as listed in the accompanying index. Inconnection with our audits of the consolidated financial statements, we alsohave audited the financial statement schedule as listed in the accompanyingindex. These consolidated financial statements and financial statement scheduleare the responsibility of the Company's management. Our responsibility is toexpress an opinion on these consolidated financial statements and financialstatement schedule based on our audits. We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we planand perform the audit to obtain reasonable assurance about whether theconsolidated financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the consolidated financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, 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 consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of SkechersU.S.A., Inc. and subsidiaries as of December 31, 2000 and 2001 and the resultsof their operations and their cash flows for each of the years in the three-yearperiod ended December 31, 2001 in conformity with accounting principlesgenerally accepted in the United States of America. Also, in our opinion, therelated financial statement schedule, when considered in relation to the basicconsolidated financial statements taken as a whole, presents fairly, in allmaterial respects, the information set forth therein. KPMG LLPLos Angeles, CaliforniaFebruary 13, 2002 F-2 SKECHERS U.S.A., INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2000 AND 2001 (IN THOUSANDS) ASSETS 2000 2001 ---- ---- Current assets: Cash ..................................................................... $ 8,781 $ 15,554 Trade accounts receivable, less allowances of $5,152 in 2000 and $7,113 in 2001 .................................. 96,628 120,285 Due from officers and employees .......................................... 540 1,013 Other receivables ........................................................ 1,016 1,816 -------- -------- Total receivables ................................................ 98,184 123,114 -------- -------- Inventories .............................................................. 111,708 157,659 Prepaid expenses and other current assets ................................ 6,457 17,695 Deferred tax assets ...................................................... 4,414 4,804 -------- -------- Total current assets ............................................. 229,544 318,826Property and equipment, at cost, less accumulated depreciation and amortization ........................................................ 70,405 85,739Intangible assets, at cost, less applicable amortization ................... 559 458Other assets, at cost ...................................................... 2,892 2,463 -------- -------- $303,400 $407,486 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITYCurrent liabilities: Short-term borrowings .................................................... $ 49,754 $ 84,175 Current installments of long-term borrowings ............................. 2,452 2,140 Accounts payable ......................................................... 72,865 77,498 Accrued expenses ......................................................... 11,168 15,041 -------- -------- Total current liabilities ........................................ 136,239 178,854 -------- --------Long-term borrowings, excluding current installments ....................... 33,115 29,616Commitments and contingencies (footnote 9)Stockholders' equity: Preferred stock, $.001 par value. Authorized 10,000 shares; none issued and outstanding ........................................... -- -- Class A Common stock, $.001 par value. Authorized 100,000 shares; issued and outstanding 10,789 and 15,329 shares at December 31, 2000 and 2001, respectively .......................................................... 10 15 Class B Common stock, $.001 par value. Authorized 60,000 shares; issued and outstanding 24,805 and 21,482 shares at December 31, 2000 and 2001, respectively .......................................................... 25 21 Additional paid-in capital ............................................... 74,243 91,909 Accumulated other comprehensive income ................................... -- 33 Retained earnings ........................................................ 59,768 107,038 -------- -------- Total stockholders' equity ....................................... 134,046 199,016 -------- -------- $303,400 $407,486 ======== ======== See accompanying notes to consolidated financial statements. F-3 SKECHERS U.S.A., INC. CONSOLIDATED STATEMENTS OF EARNINGS YEARS ENDED DECEMBER 31, 1999, 2000, and 2001 (IN THOUSANDS, EXCEPT PER SHARE DATA) 1999 2000 2001 --------- --------- --------- Net sales ............................ $ 424,601 $ 675,036 $ 960,385Cost of sales ........................ 249,993 390,811 554,205 --------- --------- --------- Gross profit ............... 174,608 284,225 406,180Royalty income, net .................. 668 316 (303) --------- --------- --------- 175,276 284,541 405,877 --------- --------- ---------Operating expenses: Selling ............................ 57,332 77,451 111,401 General and administrative ......... 79,114 125,827 205,989 --------- --------- --------- 136,446 203,278 317,390 --------- --------- --------- Earnings from operations ... 38,830 81,263 88,487 --------- --------- ---------Other income (expense): Interest, net ...................... (6,554) (9,230) (13,852) Other, net ......................... 415 318 1,320 --------- --------- --------- (6,139) (8,912) (12,532) --------- --------- --------- Earnings before income taxes 32,691 72,351 75,955Income taxes ......................... 8,635 28,600 28,685 --------- --------- --------- Net earnings ............... $ 24,056 $ 43,751 $ 47,270 ========= ========= =========Net earnings per share: Basic .............................. $ 1.24 $ 1.30 Diluted ............................ $ 1.20 $ 1.24 ========= =========Weighted-average shares: Basic .............................. 35,142 36,409 Diluted ............................ 36,563 38,059 ========= =========Pro forma operations data (unaudited): Earnings before income taxes ....... $ 32,691 Income taxes ....................... 12,880 --------- Net earnings ............... $ 19,811 =========Net earnings per share: Basic .............................. $ 0.62 Diluted ............................ $ 0.60 =========Weighted-average shares: Basic .............................. 31,765 Diluted ............................ 33,018 ========= See accompanying notes to consolidated financial statements. F-4 SKECHERS U.S.A., INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME YEARS ENDED DECEMBER 31, 1999, 2000, and 2001 (IN THOUSANDS) COMMON STOCK ------------------------------------------- SHARES AMOUNT ADDITIONAL --------------------- --------------------- PAID-IN CLASS A CLASS B CLASS A CLASS B CAPITAL ---------- ---------- ---------- ---------- ---------- Balance at December 31, 1998 ........................ -- 27,814 -- $ 2 -- Net earnings ....................................... -- -- -- -- -- Proceeds from issuance of common stock in connection with initial public offering .......... 7,000 -- $ 7 26 $ 69,687 Proceeds from issuance of common stock under the employee stock purchase plan ........... 91 -- -- -- 261 S Corporation distribution: Cash ............................................. -- -- -- -- -- Cross Colours trademark .......................... -- -- -- -- -- --------- --------- --------- --------- --------- Balance at December 31, 1999 ........................ 7,091 27,814 7 28 69,948 Net earnings ....................................... -- -- -- -- -- Proceeds from issuance of common stock under the employee stock purchase plan ........... 267 -- -- -- 1,073 Proceeds from issuance of common stock under the employee stock option plan ............. 422 -- -- -- 1,499 Tax effect of non-qualified stock options .......... -- -- -- -- 1,636 Deferred compensation .............................. -- -- -- -- 87 Conversion of Class B common stock into Class A common stock ............................. 3,009 (3,009) 3 (3) -- --------- --------- --------- --------- --------- Balance at December 31, 2000 ........................ 10,789 24,805 10 25 74,243 Comprehensive income: Net earnings ........................................ -- -- -- -- -- Foreign currency translation adjustment ........... -- -- -- -- -- Proceeds from issuance of common stock under the employee stock purchase plan ............. 1,081 -- 1 -- 7,679 Proceeds from issuance of common stock under the employee stock option plan ............. 136 -- -- -- 1,689 Tax effect of non-qualified stock options .......... -- -- -- -- 8,298 Conversion of Class B common stock into Class A common stock ............................. 3,323 (3,323) 4 (4) -- --------- --------- --------- --------- --------- Balance at December 31, 2001 ........................ 15,329 21,482 $ 15 $ 21 $ 91,909 ========= ========= ========= ========= ========= ACCUMULATED OTHER TOTAL COMPREHENSIVE RETAINED STOCKHOLDERS' INCOME EARNINGS EQUITY ------ -------- -------- Balance at December 31, 1998 ........................ -- $ 27,674 $ 27,676 Net earnings ....................................... -- 24,056 24,056 Proceeds from issuance of common stock in connection with initial public offering .......... -- -- 69,720 Proceeds from issuance of common stock under the employee stock purchase plan ........... -- -- 261 S Corporation distribution: Cash ............................................. -- (35,363) (35,363) Cross Colours trademark .......................... -- (350) (350) --------- --------- ---------Balance at December 31, 1999 ........................ -- 16,017 86,000 Net earnings ....................................... -- 43,751 43,751 Proceeds from issuance of common stock ............ under the employee stock purchase plan ........... -- -- 1,073 Proceeds from issuance of common stock ............ under the employee stock option plan ............. -- 1,499 Tax effect of non-qualified stock options .......... -- -- 1,636 Deferred compensation .............................. -- -- 87 Conversion of Class B common stock into Class A common stock ............................. -- -- -- --------- --------- ---------Balance at December 31, 2000 ........................ -- 59,768 134,046Comprehensive income: Net earnings ....................................... -- 47,270 47,270 Foreign currency translation adjustment ........... 33 -- 33 Proceeds from issuance of common stock under the employee stock purchase plan ........... -- -- 1,689 Proceeds from issuance of common stock under the employee stock option plan ............. -- -- 7,680 Tax effect of non-qualified stock options .......... -- -- 8,298 Conversion of Class B common stock into Class A common stock ............................. -- -- -- --------- --------- ---------Balance at December 31, 2001 ........................ $ 33 $ 107,038 $ 199,016 ========= ========= ========= See accompanying notes to consolidated financial statements. F-5 SKECHERS U.S.A., INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1999, 2000, and 2001 (IN THOUSANDS) 1999 2000 2001 -------- -------- -------- Cash flows from operating activities: Net earnings .............................................. $ 24,056 $ 43,751 $ 47,270 Adjustments to reconcile net earnings to net cash provided by (used in) operating activities: Depreciation and amortization of property and equipment 3,752 5,894 15,202 Amortization of intangible assets ...................... 108 104 101 Provision (recovery) for bad debts and returns ......... (176) 1,915 1,961 Tax effect of non-qualified stock options .............. -- 1,636 8,298 Deferred taxes ......................................... (2,810) (1,604) (390) Deferred compensation .................................. -- 87 -- Loss on disposal of equipment .......................... 903 78 983 Gain (loss) on distribution of intangibles ............. (118) -- -- Increase (decrease) in assets: Receivables .......................................... (17,282) (33,426) (26,891) Inventories .......................................... (3,569) (42,749) (45,951) Prepaid expenses and other current assets ............ (2,514) (1,327) (11,238) Other assets ......................................... 466 (1,437) 429 Increase in liabilities: Accounts payable ..................................... 9,551 25,169 4,633 Accrued expenses ..................................... 738 900 3,873 -------- -------- -------- Net cash provided by (used in) operating activities 13,105 (1,009) (1,720) -------- -------- --------Cash flows used in investing activities: Capital expenditures ...................................... (10,846) (21,897) (31,519) Proceeds from the sales of property and equipment ......... -- 51 -- -------- -------- -------- Net cash used in investing activities ............. (10,846) (21,846) (31,519) -------- -------- --------Cash flows from financing activities: Net proceeds from initial public offering of common stock . 69,720 -- -- Net proceeds from issuance of common stock ................ 261 2,572 9,369 Net proceeds (payments) related to short-term borrowings .. (23,697) 19,372 34,421 Payments on long-term debt ................................ (1,042) (1,144) (3,811) Payments on notes payable to stockholder .................. (12,244) -- -- Distributions paid to stockholders ........................ (35,363) -- -- -------- -------- -------- Net cash provided by (used in) financing activities (2,365) 20,800 39,979 -------- -------- -------- Net increase (decrease) in cash ........................... (106) (2,055) 6,740 Effect of exchange rates on cash .......................... -- -- 33Cash at beginning of year ................................... 10,942 10,836 8,781 -------- -------- --------Cash at end of year ......................................... $ 10,836 $ 8,781 $ 15,554 ======== ======== ========Supplemental disclosures of cash flow information: Cash paid during the year for: Interest ............................................... $ 6,782 $ 8,386 $ 13,613 Income taxes ........................................... 10,619 27,712 27,220 ======== ======== ========SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES: During 1999, the Company declared a noncash distribution of intangibles of$350. During 2000, the Company acquired $14,444 of property and equipment undercapital lease arrangements. In addition, the Company acquired an office buildingand distribution facility and issued two notes for $10,850 and $ 7,850,respectively. See accompanying notes to consolidated financial statements. F-6 SKECHERS U.S.A., INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 AND 2001(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) The Company Skechers U.S.A., Inc. (the Company) designs, develops, markets and distributes footwear. The Company also operates retail stores and e-commerce businesses. The accompanying consolidated financial statements include the accounts ofthe Company and its wholly owned subsidiaries. All significant intercompanybalances and transactions have been eliminated in consolidation. (b) Revenue Recognition Revenue is recognized upon shipment of product or at point of sale forretail operations. Allowances for estimated returns, discounts, bad debts, andchargebacks are provided when the related revenue is recorded. Revenues from royalty agreements are recognized as earned. (c) Inventories Inventories, principally finished goods, are stated at the lower of cost(based on the first-in, first-out method) or market. The Company provides forestimated losses from obsolete or slow-moving inventories and writes down thecost of inventory at the time such determinations are made. (d) Income Taxes The Company accounts for income taxes under the asset and liability method.Deferred tax assets and liabilities are recognized for the future taxconsequences attributable to the differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbasis. The effect on deferred tax assets and liabilities of a change in taxrates is recognized in income in the period that includes the enactment date. (e) Depreciation and Amortization Depreciation and amortization of property and equipment is computed usingthe straight-line method based on the following estimated useful lives: Buildings 20 years Building improvements 20 years or useful life, whichever is shorter Furniture, fixtures and equipment 5 years Leasehold improvements Useful life or remaining lease term, whichever is shorter Intangible assets consist of trademarks and are amortized on a straight-linebasis over ten years. The accumulated amortization as of December 31, 2000 and2001 is $492,000 and $593,000, respectively. (f)Long-Lived Assets The Company reports long-lived assets, including intangibles, at amortizedcost. Management assesses the carrying value of assets if facts andcircumstances suggest that such assets may be impaired. If this review indicatesthat the assets will not be recoverable, as determined by a nondiscounted cashflow projection over the remaining amortization period, their carrying value isreduced to F-7estimated fair value, based on discounted cash flows. The Company will implementSFAS No. 142, Goodwill and Other Intangible Assets, on January 1, 2002 and SFASNo. 144, Accounting for the Impairment or Disposal of Long Lived Assets. Seenote (1)(m). (g) Advertising Costs Advertising costs are expensed in the period in which the advertisements arefirst run or over the life of the endorsement contract. Advertising expense forthe years ended December 31, 1999, 2000 and 2001 were approximately $47,400,000,$59,122,000 and $86,625,000, respectively. Prepaid advertising costs at December31, 2000 and 2001 were $2,605,000 and $1,440,000, respectively. Prepaid amountsoutstanding at December 31, 2000 and 2001 represents the unamortized portion ofendorsement contracts and advertising in trade publications which had not run asof December 31, 2000 and 2001, respectively. (h) Earnings Per Share Basic earnings per share represents net earnings divided by theweighted-average number of common shares outstanding for the period. Dilutedearnings per share reflects the potential dilution that could occur if optionsto issue common stock were exercised or converted into common stock. Theweighted average diluted shares outstanding for 1999 gives effect to the sale bythe Company of those shares of common stock necessary to fund the payment of (i)stockholder distributions paid or declared from January 1, 1998 to June 7, 1999,the S Corporation termination date, in excess of (ii) the S Corporation earningsfrom January 1, 1998 to June 7, 1999 for 1999, based on an initial publicoffering price of $11 per share, net of underwriting discounts. The reconciliation of basic to diluted weighted-average shares is as follows(in thousands): 1999 2000 2001 ------- ------- ------ Weighted-average shares used in basic computation................. 31,765 35,142 36,409 Shares to fund stockholder distributions.......................... 533 -- -- Dilutive effect of stock options.................................. 720 1,421 1,650 ------- ------- ------- Weighted-average shares used in diluted computation............... 33,018 36,563 38,059 ======= ======= ======= Options to purchase 1,411,000, 1,117,920 and 279,500 shares of common stockat prices ranging from $6.13 to $24.00 were outstanding at December 31, 1999,2000 and 2001, respectively, but were not included in the computation of dilutedearnings per share because the options' exercise price was greater than theaverage market price of the common shares and therefore their inclusion would beanti-dilutive. (i)Use of Estimates Management has made a number of estimates and assumptions relating to thereporting of assets, liabilities, revenues and expenses and the disclosure ofcontingent assets and liabilities to prepare these consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America. Significant areas requiring the use of managementestimates relate primarily to the valuation of inventories, accounts receivableallowances, the useful lives of assets for depreciation, evaluation ofimpairment, recoverability of deferred taxes and litigation reserves. Actualresults could differ from those estimates. (j)Product Design and Development Costs The Company charges all product design and development costs to expense whenincurred. Product design and development costs aggregated approximately$2,600,000, $3,700,000 and $5,493,000 during the years ended December 31, 1999,2000 and 2001, respectively. (k) Comprehensive Income Other comprehensive income at December 31, 2000 and 2001, consists of netearnings and foreign currency translation gains of $0 and $33,000 respectively. (l)Fair Value of Financial Instruments The carrying amount of the Company's financial instruments, whichprincipally include cash, accounts receivable, accounts payable and accruedexpenses, approximates fair value due to the relatively short maturity of suchinstruments. F-8 The fair value of the Company's short-term and long-term borrowings reflectsthe fair value based upon current rates available to the Company for similardebt.(m) New Accounting Standards Effective January 1, 2001, the Company adopted Statement of FinancialAccounting Standards No. 133 ("SFAS 133"), Accounting for Derivative Instrumentsand Hedging Activities. As a result, the Company recognizes financialinstruments, such as foreign currency forward contracts, at fair valueregardless of the purpose or intent for holding the instrument. Changes in thefair value of derivative financial instruments are either recognizedperiodically through the statement of earnings or through stockholders' equityas a component of accumulated other comprehensive income or loss. Theclassification depends on whether the derivative financial instrument qualifiesfor hedge accounting, and if so, whether it qualifies as a fair value hedge orcash flow hedge. Generally, changes in fair values of derivatives designated asfair value hedges are matched in the statement of earnings against therespective gain or loss relating to the hedged items. Changes in fair values ofderivatives accounted for as cash flow hedges, to the extent they are effectiveas hedges, are recorded in accumulated other comprehensive income net ofdeferred taxes. Changes in fair values of derivatives not qualifying as hedgesare currently reported in earnings. The implementation of this standard did nothave any impact on the company's financial statements. During April 2001, the Emerging Issues Task Force ("EITF") issued EITF No.00-14, Accounting for Certain Sales Incentives, and EITF No. 01-9, Accountingfor Consideration Given by a Vendor to a Customer (Including A Reseller of theVendor's Products), which are effective for the first quarter beginning afterDecember 15, 2001. These EITF's prescribe guidance regarding the timing ofrecognition and income statement classification of costs incurred for certainsales incentive programs to retailers and end consumers. The Company expectsthat the adoption of EITF No. 00-14 and EITF No. 01-9 will not have a materialimpact on its financial position or results of operations. In July 2001, the FASB issued Statement of Financial Accounting StandardsNo. 141 ("SFAS 141"), Business Combinations, and Statement of FinancialAccounting Standards No. 142 ("SFAS 142"), Goodwill and Other Intangible Assets.SFAS 141 requires that the purchase method be used for all business combinationsinitiated after June 30, 2001. SFAS 142 requires that goodwill and intangibleassets with indefinite useful lives no longer be amortized to earnings, butinstead be reviewed for impairment in accordance with the provisions of SFAS142. The amortization of goodwill and intangible assets with indefinite usefullives ceases upon adoption of SFAS 142 which is effective for fiscal yearsstarting after December 15, 2001. The Company is in the process of quantifyingthe anticipated impact of adopting the provisions of SFAS 142, which is notexpected to be material. In October 2001, the Financial Accounting Standards Board ("FASB") issuedStatement of Financial Accounting Standards No. 144 ("SFAS 144"), Accounting forthe Impairment or Disposal of Long-Lived Assets, which addresses financialaccounting and reporting for the impairment or disposal of long-lived assets.While SFAS 144 supersedes Statement of Financial Accounting Standards No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets toBe Disposed Of, it retains many of the fundamental provisions of that statement.The standard is effective for fiscal years beginning after December 15, 2001.The Company expects that the adoption of SFAS 144 will not have a materialimpact on its financial position or results of operations.(2) PROPERTY AND EQUIPMENT Property and equipment is summarized as follows (in thousands): 2000 2001 ---- ---- Land........................................................ $ 7,858 $ 12,358 Buildings and improvements.................................. 18,639 20,527 Furniture, fixtures and equipment........................... 37,529 46,468 Leasehold improvements...................................... 21,029 35,765 --------- --------- Total property and equipment...................... 85,055 115,118 Less accumulated depreciation and amortization.............. 14,650 29,379 --------- --------- Property and equipment, net....................... $ 70,405 $ 85,739 ========= ========= F-9(3) SHORT-TERM BORROWINGS The Company has available a secured line of credit, as amended on July 11,2001, permitting borrowings up to $150.0 million based upon eligible accountsreceivable and inventories. Borrowings bear interest at the prime rate (4.75% atDecember 31, 2001) minus 0.50%, and the agreement expires on December 31, 2003.The agreement provides for the issuance of letters of credit up to a maximum of$30.0 million of which 50% decreases the amount available for borrowings underthe agreement. Outstanding letters of credit at December 31, 2001 were $5.4million. Available borrowings under the line of credit at December 31, 2001 were$54.2 million. The Company pays an unused line of credit fee of .25% annually.The agreement provides that stockholders' equity shall not decrease by more than20% in any given calendar quarter, and limits the payment of dividends if it isin default of any provision of the agreement. The Company was in compliance withthese covenants at December 31, 2001. In February 2002, the Company borrowed anadditional $ 43.0 million under the line of credit.(4) LONG-TERM BORROWINGS Long-term debt at December 31, 2000 and 2001 is as follows (in thousands): 2000 2001 ------- ------- Note payable to bank, due in monthly installments of $82.2 (includes principal and interest), fixed rate interest at 7.79%, secured by property, balloon payment of $8,716 due January 2011 ........................................................... $10,850 $10,716Note payable to bank, due in monthly installments of $57.6 (includes principal and interest), fixed rate interest at 7.89%, secured by property, balloon payment of $6,776 due February 2011 ...................................................................... 7,850 7,782Note payable to bank, due in monthly installments of $25 plus interest at prime (4.75% at December 31, 2001) plus 1%, secured by equipment, repaid during 2001 ................ 2,100 --Capital lease obligation, due in aggregate monthly installments of $195, interest rate of 7.66%, secured by equipment, balloon payment of $4,431 due February 2006 ............................ 12,661 11,367Capital lease obligations, due in aggregate monthly installments of $74, interest rates from7.25%-18.28%, secured by equipment, maturing in various installments through February 2006 .... 2,106 1,891 ------- ------- 35,567 31,756Less current installments ...................................................................... 2,452 2,140 ------- ------- $33,115 $29,616 ======= ======= The aggregate maturities of long-term borrowings at December 31, 2001 are asfollows: 2002........ $ 2,140 2003........ 2,596 2004........ 2,552 2005........ 2,342 2006........ 5,005 Thereafter.. 17,121 ------- $31,756 =======(5) STOCKHOLDERS' EQUITY (a) Stock Issuances Effective as of May 28, 1999, the Company was reincorporated in Delaware.The existing California corporation was merged into a newly formed Delawarecorporation and each outstanding share of common stock of the existingCalifornia corporation was exchanged, for a share of $.001 par value Class Bcommon stock of the new Delaware corporation. In addition, pursuant to thereincorporation merger, an approximate 13,907-for-1 common stock split wasauthorized. The authorized capital stock of the Delaware corporation consists of100,000,000 shares of Class A common stock, par value $.001 per share, and60,000,000 shares of Class B common stock, par value $.001 per share. TheCompany has also authorized 10,000,000 shares of preferred stock, $.001 parvalue per share. F-10 The Class A common stock and Class B common stock have identical rightsother than with respect to voting, conversion and transfer. The Class A commonstock is entitled to one vote per share, while the Class B common stock isentitled to ten votes per share on all matters submitted to a vote ofstockholders. The shares of Class B common stock are convertible at any time atthe option of the holder into shares of Class A common stock on ashare-for-share basis. In addition, shares of Class B common stock will beautomatically converted into a like number of shares of Class A common stockupon any transfer to any person or entity which is not a permitted transferee. On June 9, 1999, the Company issued 7,000,000 shares of Class A common stockin an initial public offering and received net proceeds of $69,720,000. During 2000 and 2001 certain Class B stockholders converted 3,008,704 and3,323,300 shares of Class B common stock to Class A common stock, respectively. (b) Stock Option Plan In January 1998, the Board of Directors of the Company adopted the 1998Stock Option, Deferred Stock and Restricted Stock Plan (Stock Option Plan) forthe grant of qualified incentive stock options (ISO), stock options notqualified and deferred stock and restricted stock. The exercise price for anyoption granted may not be less than fair value (110% of fair value for ISOsgranted to certain employees). In June 2001, the stockholders approved anamendment to the plan to increase the number of shares of Class A common stockauthorized for issuance under the plan to 8,215,154. The options expire tenyears from the date of grant. Shares subject to option under the Stock Option Plan were as follows: WEIGHTED SHARES OPTION PRICE ------ ------------ Outstanding at December 31, 1998...................... 1,390,715 $ 2.78 Granted............................................. 1,209,636 11.00 Canceled............................................ (84,777) 11.00 ----------- ----- Outstanding at December 31, 1999...................... 2,515,574 6.41 Granted............................................. 1,532,695 10.79 Exercised........................................... (422,370) 3.55 Canceled............................................ (136,998) 10.23 ----------- ----- Outstanding at December 31, 2000...................... 3,488,901 8.51 Granted............................................. 2,177,880 14.31 Exercised........................................... (1,080,995) 7.10 Canceled............................................ (87,628) 15.08 ----------- Outstanding at December 31, 2001...................... 4,498,158 11.53 =========== Options available for grant at December 31, 2001...... 2,215,631 ===========The following table summarizes information about stock options outstanding andexercisable at December 31, 2001. OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------- ------------------- WEIGHTED NUMBER WEIGHTED WEIGHTED NUMBER AVERAGE RANGE OF OUTSTANDING AVERAGE REMAINING AVERAGE EXERCISABLE AT EXERCISE EXERCISE PRICE DECEMBER 31, 2001 CONTRACTUAL LIFE EXERCISE PRICE DECEMBER 31, 2001 PRICE -------------- ----------------- ---------------- -------------- ----------------- ----- $ 2.78 to $ 6.13 742,556 6.7 years $ 3.19 218,616 $ 3.08$10.48 to $12.38 1,896,290 8.7 years 10.76 518,182 10.78$13.00 to $15.75 1,541,312 8.7 years 14.05 446,208 13.41$18.00 to $29.45 318,000 9.3 years 23.36 66,675 23.60 --------- --------- 4,498,158 8.4 years $11.53 1,249,681 $ 11.06 --------- --------- F-11 At December 31, 1999, 2000 and 2001, the number of options exercisablefor each year was 347,678, 862,111, and 1,249,681 respectively. Theweighted-average exercise price of those options was $2.78, $7.87 and $11.06respectively. (c) Stock Purchase Plan Effective July 1, 1998, the Company adopted the 1998 Employee Stock PurchasePlan (1998 Stock Purchase Plan). Under the terms of the 1998 Stock PurchasePlan, 2,781,415 shares of common stock are reserved for sale to employees at aprice no less than 85% of the lower of the fair market value of the Class Acommon stock at the beginning of the one-year offering period or the end of eachof the six-month purchase periods. During 2000 and 2001, 266,865 and 135,600shares were issued under the 1998 Stock Purchase Plan for which the Companyreceived $1,073,000 and $1,689,000, respectively. (d) Stock Compensation The Company accounts for stock compensation under SFAS No. 123, Accountingfor Stock-Based Compensation, and has elected to measure compensation cost underAccounting Principles Board Opinion No. 25 and comply with the pro formadisclosure requirements of SFAS 123. Had compensation cost been determined usingthe fair value at the grant date for awards during 1999, 2000, and 2001consistent with the provisions of SFAS No. 123, the Company's pro forma netearnings (in thousands) and earnings per share would have been reduced to theamounts as indicated below. 1999 2000 2001 --------- --------- --------- Pro forma net earnings............... $ 19,077 $ 41,458 $ 42,281 ========= ========= ========= Pro forma net earnings per share: Basic.............................. $ .60 $ 1.18 $ 1.16 Diluted............................ .58 1.13 1.11 ========= ========= ========= The fair value of each option is estimated on the date of grant. The Companyused the minimum value method for stock awards prior to its initial publicoffering and the Black-Scholes option pricing models for stock awardsafterwards. The following weighted-average assumptions used for grants were asfollows: 1999 2000 2001 ------ ------ ----- Dividend yield..................... -- -- -- Expected volatility................ 55% 70% 80% Risk-free interest rate............ 6.2% 6.3% 4.2% Expected life of option............ 5 5 5 ==== ==== ==== The weighted-average fair value of options granted during 1999, 2000, and2001 were $6.93, $6.83, and $9.55, respectively.(6) INCOME TAXES The pro forma unaudited income tax adjustments for 1999 represent taxes,which would have been reported assuming the Company had been subject to federaland state income taxes as a C Corporation the entire year. The actual and proforma provisions for income tax expense were as follows (in thousands): 1999 2000 2001 --------- ---------- ------- Actual income taxes: Federal: Current.............................. $ 8,012 $ 25,420 $ 24,134 Deferred............................. (792) (1,360) 16 --------- --------- --------- Total federal................... 7,220 24,060 24,150 --------- --------- --------- State: Current.............................. 1,480 4,784 4,627 Deferred............................. (65) (244) (406) --------- --------- --------- Total state..................... 1,415 4,540 4,221 --------- --------- --------- Foreign: Current.............................. -- -- 314 Deferred............................. -- -- -- --------- --------- --------- Total foreign................... -- -- 314 --------- --------- --------- F-12 Total actual income taxes....... 8,635 28,600 28,685 --------- --------- --------- Pro forma adjustments: Federal................................. 3,533 State................................... 712 --------- Total pro forma adjustments..... 4,245 --------- Total pro forma income taxes.... $ 12,880 ========= Income taxes (pro forma for 1999) differs from the statutory tax rate asapplied to earnings before income taxes as follows: 1999 2000 2001 --------- --------- --------- Expected income tax expense............................. $ 11,569 $ 25,323 $ 26,584 State income tax, net of federal benefit................ 1,311 2,951 2,744 Rate differential on foreign income.......................... -- -- (822) Other................................................... -- 326 179 --------- --------- --------- Total provision for income taxes.............. $ 12,880 $ 28,600 $ 28,685 ========= ========= ========= The tax effects of temporary differences that give rise to significantportions of deferred tax assets and deferred tax liabilities at December 31,2000 and 2001 are presented below: DEFERRED TAX ASSETS: 2000 2001 -------------------- -------- -------- Inventory adjustments...................... $ 1,176 $ 1,749 State taxes................................ 1,490 -- Allowances for receivables................. 2,100 2,898 Other...................................... 1,060 1,379 -------- -------- Total deferred tax assets.......... 5,826 6,026 -------- -------- Deferred tax liabilities: Depreciation of property and equipment..... 1,386 1,222 Other...................................... 26 -- -------- -------- Total deferred tax liabilities..... 1,412 1,222 -------- -------- Net deferred tax assets................. $ 4,414 $ 4,804 ======== ======== Management believes it is more likely than not that the results of futureoperations will generate sufficient taxable income to realize the net deferredtax assets. Prior to June 7, 1999, the Company was treated for federal and state incometax purposes as an S Corporation under Subchapter S of the Internal Revenue Codeand comparable state laws. As a result, the earnings of the Company through June7, 1999 were included in the taxable income of the Company's stockholders forfederal and state income tax purposes, and the Company was generally not subjectto income tax on such earnings, other than California and other state franchisetaxes. In connection with the Company's initial public offering of its Class Acommon stock in June 1999, the Company terminated its S Corporation status andbecame a C Corporation subject to federal and state income taxes. The Company'schange of status to a C Corporation resulted in the recording of deferred taxassets amounting to $1,800,000. This amount is reflected as a reduction ofactual income tax expense in the accompanying 1999 consolidated statement ofearnings. Consolidated U.S. income before taxes was $32.7 million, $72.4 million, and$69.7 million for the years ended December 31, 1999, 2000, and 2001,respectively. The corresponding income (loss) before taxes for non U.S. basedoperations was $0, ($.1), and $6.3 million for the years ended December 31,1999, 2000, and 2001, respectively. The Company has not provided withholding and U.S. federal income taxes onapproximately $6.2 million of undistributed earnings of its foreign subsidiariesbecause such earnings are or will be invested indefinitely in such subsidiariesor will be offset by approximate credits for foreign taxes paid. It is notpracticable to determine the U.S. federal income tax liability, if any, thatwould be payable if such earnings were not reinvested indefinitely. F-13(7) BUSINESS AND CREDIT CONCENTRATIONS The Company operates in the footwear industry and generates most of itssales in the United States, although it's products are sold into various foreigncountries. The footwear industry is impacted by the general economy. Changes inthe marketplace may significantly affect management's estimates and theCompany's performance. Management performs regular evaluations concerning theability of customers to satisfy their obligations and provides for estimateddoubtful accounts. Domestic accounts receivable amounted to $87,825,000 and$102,543,000 before allowances for bad debts and returns at December 31, 2000and 2001, respectively, which generally do not require collateral fromcustomers. Foreign accounts receivable amounted to $13,955,000 and $24,855,000before allowance for bad debts and returns at December 31, 2000 and 2001,respectively, which generally are collateralized by letters of credit.International net sales amounted to $43,900,000, $65,159,000 and $121,001,000for the years ended December 31, 1999, 2000 and 2001, respectively. TheCompany's credit losses for the years ended December 31, 1999, 2000 and 2001were $1,699,000, $537,000 and $1,459,000, respectively, and did notsignificantly differ from management's expectations. Net sales to customers in the United States of America exceeded 87% of totalnet sales for each of the years in the three-year period ended December 31,2001. Assets located outside of the United States of America consists primarilyof cash, accounts receivable, inventory, property and equipment, and otherassets and totaled $22,959,000 and $59,795,000, at December 31, 2000 and 2001,respectively. During 1999, 2000 and 2001, no customer accounted for 10% or more of netsales. The Company had one customer which accounted for 15.3% of trade accountsreceivable at December 31, 2000. At December 31, 2001, one customer accountedfor 10.2% of trade accounts receivable. During 1999, the Company had four manufacturers that accounted for between12.3% and 15.5% each of total purchases. During 2000, the Company had fourmanufacturers that accounted for between 9.2% and 20.2% each of total purchases.During 2001, the company had four manufacturers that accounted for between 7.9%and 19.9%, each, of total purchases. Substantially all of the Company's products are produced in China. TheCompany's operations are subject to the customary risks of doing businessabroad, including, but not limited to, currency fluctuations, custom duties andrelated fees, various import controls and other monetary barriers, restrictionson the transfer of funds, labor unrest and strikes and, in certain parts of theworld, political instability. The Company believes it has acted to reduce theserisks by diversifying manufacturing among various factories. To date, these riskfactors have not had a material adverse impact on the Company's operations.(8) BENEFIT PLAN The Company has adopted a profit sharing plan covering all employees who are21 years of age and have completed one year of service. The plan was amended inApril 2001 to allow employees to enter into the plan after six months ofservice. Employees may contribute up to 15.0% of annual compensation. Companycontributions to the plan are discretionary and vest over a five-year period. The Company's contributions to the plan amounted to $259,000, $500,000, and$703,000 for the years ended December 31, 1999, 2000 and 2001, respectively. Asits contribution to the plan in 2001, the Company issued 48,072 shares of itsClass A common stock. The shares contributed to the plan contain certainrestrictions regarding the subsequent sales of those shares.(9) COMMITMENTS AND CONTINGENCIES (a) Leases The Company leases facilities under operating lease agreements expiringthrough August 2012. The leases are on an all-net basis, whereby the Companypays taxes, maintenance and insurance. The Company also leases certain equipmentand automobiles under operating lease agreements expiring at various datesthrough July 2005. Rent expense for the years ended December 31, 1999, 2000 and2001 approximated $9,800,000, $13,200,000 and $18,014,000, respectively. The Company also leases certain property and equipment under capital leaseagreements requiring monthly installment payments through February 2006. Thecost of this property and equipment was $16,154,000 with a net book value of $12,501,000 at December 31, 2001. Future minimum lease payments under noncancellable leases at December 31,2001 are as follows (in thousands): F-14 CAPITAL OPERATING LEASES LEASES ------ ------ Year ending December 31: 2002............................................. $ 3,118 $ 21,416 2003............................................. 2,909 20,818 2004............................................. 2,909 19,970 2005............................................. 2,571 19,976 2006............................................. 4,721 16,342 Thereafter....................................... 1 52,293 --------- --------- $ 16,229 $150,815 ======== Less imputed interest............................ 2,971 --------- Present value of net minimum lease payments...... $ 13,258 ========= The Company leases office space to unrelated third parties undernoncancellable operating leases expiring through November 2004, annual rentalsare approximately $311,000, $119,000 and $106,000 for the years ended December31, 2002, 2003, and 2004, respectively. (b) Litigation In December 1999 and January 2000, the Company and two officers/directorswere named as defendants in four purported class-action lawsuits. Two of thelawsuits also named the underwriters of the Company's initial public offering asdefendants. All of the complaints seek damages and rescission on behalf of aclass of persons who purchased securities in, or traceable to, the Company'sinitial public offering or thereafter on the open market prior to July 6, 1999.All four actions were subsequently consolidated into one matter and aconsolidated complaint was filed on June 1, 2000. The consolidated complaintnamed as defendants the Company, two officers of the Company, and theunderwriters of the Company's Offering. The class, as currently alleged in theconsolidated complaint now on file, consists of all persons who purchasedsecurities in, or traceable to, the Company's June 9, 1999 Offering orthereafter on the open market prior to June 15, 1999. The court issued an order on June 20, 2001 dismissing the consolidatedcomplaint in its entirety with leave to plaintiffs to amend. The class filed anamended complaint on August 3, 2001 and the Company filed a motion to dismissthe amended complaint. In response to the motion, and after discussions betweenclass counsel and counsel for defendants, the class agreed to dismiss withprejudice the entire consolidated class action as to the Company, its two namedofficers and defendants and the underwriters. The class agreed to dismiss withprejudice without any settlement from defendants. Thus, the stipulation had nomaterial impact on operations or financial results. A stipulation of dismissalwith prejudice was executed by the parties in late December 2001. The courtsigned the stipulation without modification and entered the order of dismissalon January 30, 2002. The Company is involved in other litigation arising from the ordinary courseof business. Management does not believe that the disposition of these matterswill have a material effect on the Company's financial position or results ofoperations. (c) Purchase Commitments At December 31, 2001, the Company had purchase commitments of approximately$89,353,000. The Company finances production activities in part through the use ofinterest-bearing open purchase arrangements with certain of its Asianmanufacturers. These arrangements currently bear interest at rates between 0.5%and 1.5% per 30 to 60 day term. The amounts outstanding under these arrangementsat December 31, 2000 and 2001 were $48,484,000 and $49,255,000, respectively,which are included in accounts payable in the accompanying consolidated balancesheets. Interest expense incurred by the Company under these arrangementsamounted to $3,000,000 in 1999, $6,400,000 in 2000 and $5,900,000 in 2001. (d) Compensation Certain officers and key employees of the company are entitled to incentive bonuses under employment contracts. The bonuses are based on Company performance.(10) SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED) F-15 Summarized unaudited financial data are as follows (in thousands):2000 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31---- ----------- ----------- ---------------- -------------- Net sales................................ $ 133,344 $ 163,899 $ 205,749 $ 172,044Gross profit............................. 53,634 69,137 86,911 74,543Net earnings............................. 6,734 12,010 15,286 9,721 ========== =========== ========== ==========Net earnings per share: Basic.................................. $ .19 $ .34 $ .43 $ .27 Diluted................................ .19 .33 .40 .26 ========== =========== ========== ==========2001 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31---- ----------- ----------- ---------------- -------------- Net sales................................ $ 227,494 $ 230,899 $ 287,900 $ 214,092Gross profit............................. 99,314 99,175 122,595 85,096Net earnings............................. 17,100 16,822 11,378 1,970 ========== =========== ========== ==========Net earnings per share: Basic.................................. $ .48 $ .46 $ .31 $ .05 Diluted................................ .45 .44 .30 .05 ========== =========== ========== ========== F-16 SKECHERS U.S.A., INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1999, 2000, AND 2001 BALANCE AT CHARGED TO DEDUCTIONS BALANCE BEGINNING OF COSTS AND AND AT END DESCRIPTION PERIOD EXPENSES WRITE-OFFS OF PERIOD ----------- ---------------- --------------- ---------------- ------------ As of December 31, 1999: Allowance for doubtful accounts...................... 1,466,000 740,000 (1,699,000) 507,000 Reserve for sales returns and allowances............. $ 1,947,000 $ 13,600,000 $ (12,817,000) $ 2,730,000 As of December 31, 2000: Allowance for doubtful accounts...................... 507,000 1,326,000 (537,000) 1,296,000 Reserve for sales returns and allowances............. $ 2,730,000 $ 15,651,000 $ (14,525,000) $ 3,856,000 As of December 31, 2001 Allowance for chargebacks................................ -- 3,618,000 -- 3,618,000 Allowance for doubtful accounts...................... 1,296,000 1,235,000 (1,459,000) 1,072,000 Reserve for sales returns and allowances............. $ 3,856,000 $ 29,615,000 $ (31,048,000) $ 2,423,000 ============ ============= =============== ============= S-1 EXHIBIT 10.18(a) EXHIBIT "A" ADDENDUM TO LEASE FOR PREMISES COMMONLY KNOWN AND DESIGNATED AS: OFFICES #7, 8, AND 9, SECOND FLOOR OF THE SOUTH BUILDING 904 MANHATTAN AVENUE, MANHATTAN BEACH, CALIFORNIA This Addendum to Lease executed on March _____, 2000, by and between DOLORES MCNABB, as Landlord, and SKECHERS U.S.A., Inc., a Delaware corporation, as Tenant, is an integral part of said Lease as if fully set forth therein. A. OPTION TO EXTEND LEASE TERM. So long as Tenant has fully performed all the obligations on its part to beperformed, Landlord hereby grants to Tenant two (2) consecutive options toextend this lease for five (5) years each, on the same terms and conditions asare contained herein except as to increases in real estate taxes as hereinafterprovided. It is contemplated that Tenant's occupancy shall be continuous;therefore, in the event Tenant fails to exercise any of the options grantedherein, the remaining options shall immediately expire and be of no furtherforce or effect. The parties specifically acknowledge that the Lease rent termsprovide for annual increases of 3%. Such increases shall continue to be appliedannually during each and every option exercised hereunder. Tenant shall exercise each such option by delivering written notice toLandlord at least six (6) months, but not more that twelve (12) months, prior tothe end of each five (5) year term. TIME IS OF THE ESSENCE IN REGARD TO THEDELIVERY OF THE NOTICE. In the event Tenant fails to deliver written notice asherein provided, the options granted herein shall expire and be of no furtherforce or effect. B. RENT. Tenant shall pay to Landlord rent, free from all claims, demands or set-offs against Landlord of any kind or character whatsoever, except as otherwise expressly provided to the contrary, in advance, in the amount of $199,804.15, payable $3,800.00 on execution of this lease and thereafter on the first day of each month (except May 1, 2000) as follows: June 1, 2000 to March 31, 2001 $3,800.00 per month April 1, 2001 to March 31, 2002 $3,914.00 per month April 1, 2002 to March 31, 2003 $4,031.42 per month April 1, 2003 to March 31, 2004 $4,152.36 per month April 1, 2004 to June 30, 2004 $4,276.93 per monthLandlord agrees that Tenant shall be given possession on April, 2000 to install such tenant improvements as it deems necessary and proper for its purposes, however, nothing in this paragraph shall eliminate the requirement that Tenant obtain Landlord's approval prior to making any such tenant improvements. LATE PAYMENTS: In the event that Tenant shall fail to pay to landlordwithin 5 days of the date when due, any payment owing to Landlord pursuant tothe terms of this Lease, Tenant shall pay Landlord a late charge in the amountof ten percent (10%) of the rent payment then due in addition to said rent. SQUARE FOOTAGE DISCLAIMER: The parties hereto hereby acknowledge that during the negotiations for this Lease, the parties discussed the rent as a function of an amount per square feet of rentable space. Prior to the execution of this Lease, Tenant has had the opportunity to inspect the space and satisfy itself as to the size and suitability of the space for its intended purposes. The parties hereto hereby agree the above dollar figures of rent shall be due and payable regardless of the actual square feet in the demised premises and Tenant acknowledges that Landlord makes no representation or warranty as to the actual size of the premises. Any discussions concerning a rental per square foot of space is superceded by this provision. C. USE. The sole permitted use of the premised shall be commercial office and related activities. D. REAL ESTATE TAXES-OPTION PERIODS Upon the exercise of the options hereinabove provided for, Tenantagrees to pay during the term of each such option period, or periods, as thecase may be, its pro rata share of any increase in real estate taxes andassessments levied or imposed against the real property of which the demisedpremises are a part over an above the taxes imposed on said real property duringthe fifth year of the original term of this Lease (the base year). The partieshereto acknowledge and agree that Tenant occupies approximately 20% of thebuilding and agree that for purposes of this provision that Tenant shall pay 20%of any such increase. Landlord shall provide Tenant with a copy of the tax billfor the fiscal year July 2003- June 2004 (the base year) of the initial termalong with a copy of the tax bill for each year during any option period thatTenant continues in possession under this Lease. Tenant shall pay to Landlordone half of its pro rata share (20%) of such increase on or before December 10of each year and the remaining on half of its pro rata share (20%) on or beforeApril 10 of each year. E. AIR CONDITIONING REPAIR AND MAINTENANCE. Landlord has provided an air conditioner in good working condition that services Officers 7, 8 and 9 on the second floor of the south building. Tenant hereby agrees that it will pay any and all costs related to the repair and maintenance of said air conditioner. F. SECURITY DEPOSIT Tenant shall pay Landlord on execution of this Lease the sum of $4,000.00 as a security deposit in accordance with the provisions of Paragraph 19 of the lease. G. PARKING Landlord hereby grants to Tenant the exclusive use of one (1) parking space, the location of which will be designated by Landlord. H. RULES AND REGULATIONS The Rules and regulations attached hereto and hereby incorporated by this reference as if fully set forth herein and shall be an integral part of this Lease. I. ASSIGNMENT Notwithstanding the provisions of Paragraph 11 of the Lease, no consent from Landlord shall be required for the assignment of this Lease under the following circumstances, each of which shall be considered a Permitted Assignment: (1) the transfer of stock of Tenant to members of the immediate family of a shareholder of Tenant, to a living trust for estate- planning purposes, or by will or intestacy, or, (2) Tenant sells or offers for sale its voting stock to the public in accordance with the qualifications or registration requirements of the State of California and the Security Act of 1933, as amended. H. TENANT'S RIGHT TO TERMINATE IN THE EVENT OF DESTRUCTION OF THE PREMISES Notwithstanding the provisions of Paragraph 16. DESTRUCTION OF PREMISES ofthe Lease, in the event Landlord cannot complete the repairs and returnpossession to Tenant within a period of six (6) months, Tenant shall have theoption of terminating this Lease. Notice of such election to terminate shall begiven by Tenant to landlord within ten (10) days of Tenant's receipt of writtennotice from Landlord that the repair period is projected to exceed (6) months.In the event Tenant fails to so notify Landlord in writing, this right toterminate shall expire. I. MUTUAL INDEMNIFICATION Tenant Agrees to defend, with counsel reasonably satisfactory to Landlord,indemnify and hold harmless, Landlord, its agents, employees, officers,directors, shareholders, partners, members and representatives (collectively"Landlord") from and against any and all loss, cost, action liability, damage orexpense, including but not limited to, penalties, fines, attorneys' fees orcosts (collectively "claims"), to any person, property or entity resulting fromthe following: (i) the negligence or wilful misconduct of Tenant, its agents,employees or contractors; (ii) Tenant's default or breach of any of the termsand conditions of this Lease; and (iii) any occurrences within the Premises, notresulting from the negligence or wilful misconduct of Landlord, its agents,employees or contractors. Landlord agrees to defend with counsel reasonably satisfactory toTenant, indemnify and hold harmless, Tenant, its agents, employees, officers,directors, shareholders, partners, members and representatives (collectively"Tenant") from and against any and all loss, costs, action, liability, damage or expense, including but not limited to, penalties, fines,attorneys' fees or costs (collectively "claims"), to any person, property orentity resulting from the following: (i) the negligence or wilful misconduct ofLandlord, its agents, employees or contractors; (ii) Landlord's default orbreach of any of the terms and conditions of this Lease; and (iii) anyoccurrences within the Premises, not resulting from the negligence or wilfulmisconduct of Tenant its agents, employees or contractors. Notwithstanding the foregoing, however, because Landlord is required tomaintain property insurance on the Building, and because of the existence ofwaivers of subrogation set forth in this Lease, Landlord hereby agrees todefend, indemnify and hold Tenant harmless on any Claims to the extent suchclaim is covered by such insurance, even if resulting from the negligent acts,omissions or misconduct of Tenant or those of its agents, employees orcontractors. Similarly, since Tenant must carry insurance to cover its personalproperty within the premises, and because of the waivers of subrogation setforth in this Lease, Tenant hereby agrees to defend, indemnify and hold Landlordharmless from any claims to the extent any such claim is covered by suchinsurance, if resulting from the negligent acts, omissions or misconduct ofLandlord or those of its agents, employees or contractors. The provisions ofthis section shall survive the expiration or sooner termination of the Leasewith respect to any occurrences, claims or liabilities occurring prior to suchexpiration or termination.LANDLORD TENANTDOLORES MC NABB SKECHERS USA, INC., a Delaware corporationDelores L. Mc Nabb by /s/ Michael Greenberg--------------------------- ------------------------- Date April 15 , 2000 by Michael Greenberg -------------- ------------------------- Date 4/14 , 2000 -----------  EXHIBIT 10.27 [LOGO] AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION STANDARD INDUSTRIAL/COMMERCIAL SINGLE-TENANT LEASE -- NET (DO NOT USE THIS FORM FOR MULTI-TENANT BUILDINGS)1. BASIC PROVISIONS ("BASIC PROVISIONS"). 1.1 PARTIES: This Lease ("LEASE"), dated for reference purposes onlyApril 28, 2000, is made by and between MANHATTAN CORNERS, LLC, A CaliforniaLimited Liability Company ("LESSOR") and SKECHERS U.S.A., INC., A DelawareCorporation ("LESSEE"), (collectively the "PARTIES," or individually a "PARTY"). 1.2 PREMISES: That certain real property, including all improvementstherein or to be provided by Lessor under the terms of this Lease, and commonlyknown as 1100 Highland Avenue, Manhattan Beach, located in the County ofLos Angeles, State of California, and generally described as (describe brieflythe nature of the property and, if applicable, the "PROJECT", if the property islocated within a Project) 3200 square foot office building ("PREMISES").(See also Paragraph 2) 1.3 TERM: Five (5) years and 0 months ("ORIGINAL TERM") commencingSee Addendum Paragraph 51 ("COMMENCEMENT DATE") and ending _________("EXPIRATION DATE"). (See also Paragraph 3) Subject to one (1) option to extend- See Addendum Paragraph 66 1.4 EARLY POSSESSION: See Addendum Paragraph 51 ("EARLY POSSESSION DATE"). (See also Paragraphs 3.2 and 3.3) 1.5 BASE RENT: $9,600.00 per month ("BASE RENT"), payable on the 1st day of each month commencing __________________________________________.(See also Paragraph 4)[x] If this box is checked, there are provisions in this Lease for the Base Rent to be adjusted. 1.6 BASE RENT PAID UPON EXECUTION: $None as Base Rent for theperiod ___________________________________________________. 1.7 SECURITY DEPOSIT: $5,000.00 payable upon execution of this Lease("SECURITY DEPOSIT"). (See also Paragraph 5) 1.8 AGREED USE: general office and no other use or purpose (See also Paragraph 6) 1.9 INSURING PARTY: Lessor is the "INSURING PARTY" unless otherwisestated herein. (See also Paragraph 8) 1.10 REAL ESTATE BROKERS: (See also Paragraph 15) (a) REPRESENTATION: The following real estate brokers(collectively, the "BROKERS") and brokerage relationships exist in thistransaction (check applicable boxes):[ ] Not Applicable represents Lessor exclusively ("LESSOR'S BROKER");[ ] Not Applicable represents Lessee exclusively ("LESSEE'S BROKER"); or[ ] Not Applicable represents both Lessor and Lessee ("DUAL AGENCY"). 1.12 ADDENDA AND EXHIBITS. Attached hereto is an Addendum or Addendaconsisting of Paragraphs 50 through 69 and Exhibits _____________________________________________________, all of which constitute a part of this Lease.2. PREMISES. 2.1 LETTING. Lessor hereby leases to Lessee, and Lessee herebyleases from Lessor, the Premises, for the term, at the rental, and upon all ofthe terms, covenants and conditions set forth in this Lease. Unless otherwiseprovided herein, any statement of size set forth in this Lease, or that may havebeen used in calculating rental, is an approximation which the Parties agree isreasonable and the rental based thereon is not subject to revision whether ornot the actual size is more or less. 2.2 CONDITION. Lessor shall deliver the Premises to Lessee broomclean and free of debris on the Commencement Date or the Early Possession Date,whichever first occurs ("START DATE"), and, so long as the required servicecontracts described in Paragraph 7.1(b) below are obtained by Initials________ Page 1 of 15 Lessee within thirty (30) days following the Start Date, warrants that theexisting electrical, plumbing, fire sprinkler, lighting, heating, ventilatingand air conditioning systems ("HVAC"), loading doors, if any, and all other suchelements in the Premises, other than those constructed by Lessee, shall be ingood operating condition on said date and that the structural elements of theroof, bearing walls and foundation of any buildings on the Premises (the"BUILDING") shall be free of material defects. If a non-compliance with saidwarranty exists as of the Start Date, Lessor shall, as Lessor's sole obligationwith respect to such matter, except as otherwise provided in this Lease,promptly after receipt of written notice from Lessee setting forth withspecificity the nature and extent of such non-compliance, rectify same atLessor's expense. If, after the Start Date, Lessee does not give Lessor writtennotice of any non-compliance with this warranty within: (i) one year as to thesurface of the roof and the structural portions of the roof, foundations andbearing walls, (ii) six (6) months as to the HVAC systems, (iii) (6) months asto the remaining systems and other elements of the Building, correction of suchnon-compliance shall be the obligation of Lessee at Lessee's sole cost andexpense. 2.3 COMPLIANCE. Lessor warrants that the improvements on thePremises comply with all applicable laws, covenants or restrictions of record,building codes, regulations and ordinances ("APPLICABLE REQUIREMENTS") in effecton the Start Date. Said warranty does not apply to the use to which Lessee willput the Premises or to any Alterations or Utility Installations (as defined inParagraph 7.3(a)) made or to be made by Lessee. NOTE: Lessee is responsible fordetermining whether or not the zoning is appropriate for Lessee's intended use,and acknowledges that past uses of the Premises may no longer be allowed. If thePremises do not comply with said warranty, Lessor shall, except as otherwiseprovided, promptly after receipt of written notice from Lessee setting forthwith specificity the nature and extent of such non-compliance, rectify the sameat Lessor's expense. If Lessee does not give Lessor written notice of anon-compliance with this warranty within six (6) months following the StartDate, correction of that non-compliance shall be the obligation of Lessee atLessee's sole cost and expense. If the Applicable Requirements are hereafterchanged (as opposed to being in existence at the Start Date, which is addressedin Paragraph 6.2(e) below) so as to require during the term of this Lease theconstruction of an addition to or an alteration of the Building, the remediationof any Hazardous Substance, or the reinforcement or other physical modificationof the Building ("CAPITAL EXPENDITURE"), Lessor and Lessee shall allocate thecost of such work as follows: (a) Subject to Paragraph 2.3(c) below, if such CapitalExpenditures are required as a result of the specific and unique use of thePremises by Lessee as compared with uses by tenants in general, Lessee shall befully responsible for the cost thereof, provided, however that if such CapitalExpenditure is required during the last two (2) years of this Lease and the costthereof exceeds six (6) months' Base Rent, Lessee may instead terminate thisLease unless Lessor notifies Lessee, in writing, within ten (10) days afterreceipt of Lessee's termination notice that Lessor has elected to pay thedifference between the actual cost thereof and the amount equal to six (6)months' Base Rent. If Lessee elects termination, Lessee shall immediately ceasethe use of the Premises which requires such Capital Expenditure and deliver toLessor written notice specifying a termination date at least ninety (90) daysthereafter. Such termination date shall, however, in no event be earlier thanthe last day that Lessee could legally utilize the Premises without commencingsuch Capital Expenditure. (b) If such Capital Expenditure is not the result of the specificand unique use of the Premises by Lessee (such as, governmentally mandatedseismic modifications), then Lessor and Lessee shall allocate the obligation topay for such costs pursuant to the provisions of Paragraph 7.1(c); provided,however, that if such Capital Expenditure is required during the last two yearsof this Lease or if Lessor reasonably determines that it is not economicallyfeasible to pay its share thereof, Lessor shall have the option to terminatethis Lease upon ninety (90) days prior written notice to Lessee unless Lesseenotifies Lessor, in writing, within ten (10) days after receipt of Lessor'stermination notice that Lessee will pay for such Capital Expenditure. If Lessordoes not elect to terminate, and fails to tender its share of any such CapitalExpenditure, Lessee may advance such funds and deduct same, with Interest, fromRent until Lessor's share of such costs have been fully paid. If Lessee isunable to finance Lessor's share, or if the balance of the Rent due and payablefor the remainder of this Lease is not sufficient to fully reimburse Lessee onan offset basis, Lessee shall have the right to terminate this Lease upon thirty(30) days written notice to Lessor. (c) Notwithstanding the above, the provisions concerning CapitalExpenditures are intended to apply only to non-voluntary, unexpected, and newApplicable Requirements. If the Capital Expenditures are instead triggered byLessee as a result of an actual or proposed change in use, change in intensityof use, or modification to the Premises then, and in that event, Lessee shall befully responsible for the cost thereof, and Lessee shall not have any right toterminate this Lease. 2.4 ACKNOWLEDGEMENTS. Lessee acknowledges that: (a) it has beenadvised by Lessor to satisfy itself with respect to the conditionof the Premises (including but not limited to the electrical, HVAC and firesprinkler systems, security, environmental aspects, and compliance withApplicable Requirements), and their suitability for Lessee's intended use; (b)Lessee has made such investigation as it deems necessary with reference to suchmatters and assumes all responsibility therefor as the same relate to itsoccupancy of the Premises; and (c) neither Lessor, Lessor's agents, nor anyBroker has made any oral or written representations or warranties with respectto said matters other than as set forth in this Lease. In addition, Lessoracknowledges that: (a) Broker has made no representations, promises orwarranties concerning Lessee's ability to honor the Lease or suitability tooccupy the Premises; and (b) it is Lessor's sole responsibility to investigatethe financial capability and/or suitability of all proposed tenants.3. TERM. 3.1 TERM. The Commencement Date, Expiration Date and Original Termof this Lease are as specified in Paragraph 1.3. 3.2 EARLY POSSESSION. If Lessee totally or partially occupies thePremises prior to the Commencement Date, the obligation to pay Base Rent shallbe abated for the period of such early possession. All other terms of this Leaseshall, however, be in effect during such period. Any such early possession shallnot affect the Expiration Date. 3.3 DELAY IN POSSESSION. Lessor agrees to use its best commerciallyreasonable efforts to deliver possession of the Premises to Lessee by theCommencement Date. If, despite said efforts, Lessor is unable to deliverpossession as agreed, Lessor shall not be subject to any liability therefor, norshall such failure affect the validity of this Lease. Lessee shall not, however,be obligated to pay Rent or perform its other obligations until it receivespossession of the Premises. If possession is not delivered within sixty (60)days after the Commencement Date, Lessee may, at its option, by notice inwriting within ten (10) days after the end of such sixty (60) day period, cancelthis Lease, in which event the Parties shall be discharged from all obligationshereunder. If such written notice is not received by Lessor within said ten (10)day period, Lessee's right to cancel shall terminate. Except as otherwiseprovided, if possession is not tendered to Lessee by the Start Date and Lesseedoes not terminate this Lease, as aforesaid, any period of rent abatement thatLessee would otherwise have Page 2 of 15enjoyed shall run from the date of delivery of possession and continue for aperiod equal to what Lessee would otherwise have enjoyed under the terms hereof,but minus any days of delay caused by the acts or omissions of Lessee. Ifpossession of the Premises is not delivered by November 1, 2000, this Leaseshall terminate unless other agreements are reached between Lessor and Lessee,in writing. 3.4 LESSEE COMPLIANCE. Lessor shall not be required to tenderpossession of the Premises to Lessee until Lessee complies with its obligationto provide evidence of insurance (Paragraph 8.5). Pending delivery of suchevidence, Lessee shall be required to perform all of its obligations under thisLease from and after the Start Date, including the payment of Rent,notwithstanding Lessor's election to withhold possession pending receipt of suchevidence of insurance. Further, if Lessee is required to perform any otherconditions prior to or concurrent with the Start Date, the Start Date shalloccur but Lessor may elect to withhold possession until such conditions aresatisfied.4. RENT. 4.1. RENT DEFINED. All monetary obligations of Lessee to Lessor underthe terms of this Lease (except for the Security Deposit) are deemed to be rent("RENT"). 4.2 PAYMENT. Lessee shall cause payment of Rent to be received byLessor in lawful money of the United States, without offset or deduction (exceptas specifically permitted in this Lease), on or before the day on which it isdue. Rent for any period during the term hereof which is for less than one (1)full calendar month shall be prorated based upon the actual number of days ofsaid month. Payment of Rent shall be made to Lessor at its address stated hereinor to such other persons or place as Lessor may from time to time designate inwriting. Acceptance of a payment which is less than the amount then due shallnot be a waiver of Lessor's rights to the balance of such Rent, regardless ofLessor's endorsement of any check so stating.5. SECURITY DEPOSIT. Lessee shall deposit with Lessor upon execution hereofthe Security Deposit as security for Lessee's faithful performance of itsobligations under this Lease. If Lessee fails to pay Rent, or otherwise Defaultsunder this Lease, Lessor may use, apply or retain all or any portion of saidSecurity Deposit for the payment of any amount due Lessor or to reimburse orcompensate Lessor for any liability, expense, loss or damage which Lessor maysuffer or incur by reason thereof. If Lessor uses or applies all or any portionof said Security Deposit, Lessee shall within ten (10) days after writtenrequest therefor deposit monies with Lessor sufficient to restore said SecurityDeposit to the full amount required by this Lease. Should the Agreed Use beamended to accommodate a material change in the business of Lessee or toaccommodate a sublessee or assignee, Lessor shall have the right to increase theSecurity Deposit to the extent necessary, in Lessor's reasonable judgment, toaccount for any increased wear and tear that the Premises may suffer as a resultthereof. If a change in control of Lessee occurs during this Lease and followingsuch change the financial condition of Lessee is, in Lessor's reasonablejudgment, significantly reduced, Lessee shall deposit such additional monieswith Lessor as shall be sufficient to cause the Security Deposit to be at acommercially reasonable level based on said change in financial condition.Lessor shall not be required to keep the Security Deposit separate from itsgeneral accounts. Within fourteen (14) days after the expiration or terminationof this Lease, if Lessor elects to apply the Security Deposit only to unpaidRent, and otherwise within thirty (30) days after the Premises have been vacatedpursuant to Paragraph 7.4(c) below, Lessor shall return that portion of theSecurity Deposit not used or applied by Lessor. No part of the Security Depositshall be considered to be held in trust, to bear interest or to be prepaymentfor any monies to be paid by Lessee under this Lease.6. USE. 6.1 USE. Lessee shall use and occupy the Premises only for theAgreed Use and for no other purpose. Lessee shall not use or permit the use ofthe Premises in a manner that is unlawful, creates damage, waste or a nuisance,or that disturbs owners and/or occupants of, or causes damage to neighboringproperties. 6.2 HAZARDOUS SUBSTANCES. (a) REPORTABLE USES REQUIRE CONSENT. The term "HAZARDOUSSUBSTANCE" as used in this Lease shall mean any product, substance, or wastewhose presence, use, manufacture, disposal, transportation, or release, eitherby itself or in combination with other materials expected to be on the Premises,is either: (i) potentially injurious to the public health, safety or welfare,the environment or the Premises, (ii) regulated or monitored by any governmentalauthority, or (iii) a basis for potential liability of Lessor to anygovernmental agency or third party under any applicable statute or common lawtheory. Hazardous Substances shall include, but not be limited to, hydrocarbons,petroleum, gasoline, and/or crude oil or any products, by-products or fractionsthereof. Lessee shall not engage in any activity in or on the Premises whichconstitutes a Reportable Use of Hazardous Substances without the express priorwritten consent of Lessor and timely compliance (at Lessee's expense) with allApplicable Requirements. "REPORTABLE USE" shall mean (i) the installation or useof any above or below ground storage tank, (ii) the generation, possession,storage, use, transportation, or disposal of a Hazardous Substance that requiresa permit from, or with respect to which a report, notice, registration orbusiness plan is required to be filed with, any governmental authority, and/or(iii) the presence at the Premises of a Hazardous Substance with respect towhich any Applicable Requirements requires that a notice be given to personsentering or occupying the Premises or neighboring properties. Notwithstandingthe foregoing, Lessee may use any ordinary and customary materials reasonablyrequired to be used in the normal course of the Agreed Use, so long as such useis in compliance with all Applicable Requirements, is not a Reportable Use, anddoes not expose the Premises or neighboring property to any meaningful risk ofcontamination or damage or expose Lessor to any liability therefor. In addition,Lessor may condition its consent to any Reportable Use upon receiving suchadditional assurances as Lessor reasonably deems necessary to protect itself,the public, the Premises and/or the environment against damage, contamination,injury and/or liability, including, but not limited to, the installation (andremoval on or before Lease expiration or termination) of protectivemodifications (such as concrete encasements) and/or increasing the SecurityDeposit. (b) DUTY TO INFORM LESSOR. If Lessee knows, or has reasonablecause to believe, that a Hazardous Substance has come to be located in, on,under or about the Premises, other than as previously consented to by Lessor,Lessee shall immediately give written notice of such fact to Lessor, and provideLessor with a copy of any report, notice, claim or other documentation which ithas concerning the presence of such Hazardous Substance. (c) LESSEE REMEDIATION. Lessee shall not cause or permit anyHazardous Substance to be spilled or released in, on, under, or about thePremises (including through the plumbing or sanitary sewer system) and shallpromptly, at Lessee's expense, take all investigatory and/or remedial actionreasonably recommended, whether or not formally ordered or required, for thecleanup of any contamination of, and for the maintenance, security and/ormonitoring of the Premises or neighboring properties, that was caused ormaterially contributed to by Lessee, or pertaining to or involving any Hazardous Page 3 of 15Substance brought onto the Premises during the term of this Lease, by or forLessee, or any third party. (d) LESSEE INDEMNIFICATION. Lessee shall indemnify, defend andhold Lessor, its agents, employees, lenders and ground lessor, if any, harmlessfrom and against any and all loss of rents and/or damages, liabilities,judgments, claims, expenses, penalties, and attorneys' and consultants' feesarising out of or involving any Hazardous Substance brought onto the Premises byor for Lessee, or any third party (provided, however, that Lessee shall have noliability under this Lease with respect to underground migration of anyHazardous Substance under the Premises from adjacent properties). Lessee'sobligations shall include, but not be limited to, the effects of anycontamination or injury to person, property or the environment created orsuffered by Lessee, and the cost of investigation, removal, remediation,restoration and/or abatement, and shall survive the expiration or termination ofthis Lease. NO TERMINATION, CANCELLATION OR RELEASE AGREEMENT ENTERED INTO BYLESSOR AND LESSEE SHALL RELEASE LESSEE FROM ITS OBLIGATIONS UNDER THIS LEASEWITH RESPECT TO HAZARDOUS SUBSTANCES, UNLESS SPECIFICALLY SO AGREED BY LESSOR INWRITING AT THE TIME OF SUCH AGREEMENT. (e) LESSOR INDEMNIFICATION. Lessor and its successors and assignsshall indemnify, defend, reimburse and hold Lessee, its employees and lenders,harmless from and against any and all environmental damages, including the costof remediation, which existed as a result of Hazardous Substances on thePremises prior to the Start Date or which are caused by the gross negligence orwillful misconduct of Lessor, its agents or employees. Lessor's obligations, asand when required by the Applicable Requirements, shall include, but not belimited to, the cost of investigation, removal, remediation, restoration and/orabatement, and shall survive the expiration or termination of this Lease. (f) INVESTIGATIONS AND REMEDIATIONS. Lessor shall retain theresponsibility and pay for any investigations or remediation measures requiredby governmental entities having jurisdiction with respect to the existence ofHazardous Substances on the Premises prior to the Start Date, unless suchremediation measure is required as a result of Lessee's use (including"Alterations", as defined in Paragraph 7.3(a) below) of the Premises, in whichevent Lessee shall be responsible for such payment. Lessee shall cooperate fullyin any such activities at the request of Lessor, including allowing Lessor andLessor's agents to have reasonable access to the Premises at reasonable times inorder to carry out Lessor's investigative and remedial responsibilities. (g) LESSOR TERMINATION OPTION. If a Hazardous Substance Conditionoccurs during the term of this Lease, unless Lessee is legally responsibletherefor (in which case Lessee shall make the investigation and remediationthereof required by the Applicable Requirements and this Lease shall continue infull force and effect, but subject to Lessor's rights under Paragraph 6.2(d) andParagraph 13), Lessor may, at Lessor's option, either (i) investigate andremediate such Hazardous Substance Condition, if required, as soon as reasonablypossible at Lessor's expense, in which event this Lease shall continue in fullforce and effect, or (ii) if the estimated cost to remediate such conditionexceeds twelve (12) times the then monthly Base Rent or $100,000, whichever isgreater, give written notice to Lessee, within thirty (30) days after receipt byLessor of knowledge of the occurrence of such Hazardous Substance Condition, ofLessor's desire to terminate this Lease as of the date sixty (60) days followingthe date of such notice. In the event Lessor elects to give a terminationnotice, Lessee may, within ten (10) days thereafter, give written notice toLessor of Lessee's commitment to pay the amount by which the cost of theremediation of such Hazardous Substance Condition exceeds an amount equal totwelve (12) times the then monthly Base Rent or $100,000, whichever is greater.Lessee shall provide Lessor with said funds or satisfactory assurance thereofwithin thirty (30) days following such commitment. In such event, this Leaseshall continue in full force and effect, and Lessor shall proceed to make suchremediation as soon as reasonably possible after the required funds areavailable. If Lessee does not give such notice and provide the required funds orassurance thereof within the time provided, this Lease shall terminate as of thedate specified in Lessor's notice of termination. 6.3 LESSEE'S COMPLIANCE WITH APPLICABLE REQUIREMENTS. Except asotherwise provided in this Lease, Lessee shall, at Lessee's sole expense, fully,diligently and in a timely manner, materially comply with all ApplicableRequirements, the requirements of any applicable fire insurance underwriter orrating bureau, and the recommendations of Lessor's engineers and/or consultantswhich relate in any manner to the Premises, without regard to whether saidrequirements are now in effect or become effective after the Start Date. Lesseeshall, within ten (10) days after receipt of Lessor's written request, provideLessor with copies of all permits and other documents, and other informationevidencing Lessee's compliance with any Applicable Requirements specified byLessor, and shall immediately upon receipt, notify Lessor in writing (withcopies of any documents involved) of any threatened or actual claim, notice,citation, warning, complaint or report pertaining to or involving the failure ofLessee or the Premises to comply with any Applicable Requirements. 6.4 INSPECTION; COMPLIANCE. Lessor and Lessor's "Lender" (as definedin Paragraph 30 below) and consultants shall have the right to enter intoPremises at any time, in the case of an emergency, and otherwise at reasonabletimes, for the purpose of inspecting the condition of the Premises and forverifying compliance by Lessee with this Lease. The cost of any such inspectionsshall be paid by Lessor, unless a violation of Applicable Requirements, or acontamination is found to exist or be imminent, or the inspection is requestedor ordered by a governmental authority. In such case, Lessee shall upon requestreimburse Lessor for the cost of such inspections, so long as such inspection isreasonably related to the violation or contamination.7. MAINTENANCE; REPAIRS, UTILITY INSTALLATIONS; TRADE FIXTURES AND ALTERATIONS. 7.1 LESSEE'S OBLIGATIONS. See Addendum Paragraph 67 (a) IN GENERAL. Subject to the provisions of Paragraph 2.2(Condition), 2.3 (Compliance), 6.3 (Lessee's Compliance with ApplicableRequirements), 7.2 (Lessor's Obligations), 9 (Damage or Destruction), and 14(Condemnation), Lessee shall, at Lessee's sole expense, keep the Premises,Utility Installations, and Alterations in good order, condition and repair(whether or not the portion of the Premises requiring repairs, or the means ofrepairing the same, are reasonably or readily accessible to Lessee, and whetheror not the need for such repairs occurs as a result of Lessee's use, any prioruse, the elements or the age of such portion of the Premises), including, butnot limited to, all equipment or facilities, such as plumbing, heating,ventilating, air-conditioning, electrical, lighting facilities, boilers,pressure vessels, fire protection system, fixtures, walls (interior ceilings,roofs, floors, windows, doors, plate glass, skylights, landscaping, driveways,parking lots, fences, retaining walls, signs, sidewalks and parkways located in,on, or adjacent to the Premises. Lessee, in keeping the Premises in good order,condition and repair, shall exercise and perform good maintenance practices,specifically including the procurement and maintenance of the service contractsrequired by Paragraph 7.1(b) below. Lessee's obligations shall includerestorations, replacements or renewals when necessary to keep the Premises andall improvements thereon or a part thereof in good order, condition and state ofrepair. Lessee shall, during the term of this Lease, keep the exteriorappearance of the Building in a first-class condition consistent with theexterior appearance of other similar facilities of comparable age and size inthe vicinity, including, when necessary, the exterior repainting of theBuilding. (b) SERVICE CONTRACTS. Lessee shall, at Lessee's sole expense,procure and maintain contracts, with copies to Lessor, in customary form andsubstance for, and with contractors specializing and experienced in themaintenance of the following equipment and improvements, if any, if and wheninstalled on the Premises: (i) HVAC equipment, (ii), (iii) fire extinguishing systems, including fire alarm and/or smoke detection, (iv) landscaping andirrigation systems, (v) roof covering and drains, (vi) driveways and parkinglots, (vii) clarifiers (viii) basic utility feed to the perimeter of theBuilding, and (ix) any other equipment, if reasonably required by Lessor. Page 4 of 15 (c) REPLACEMENT. Subject to Lessee's indemnification of Lessor asset forth in Paragraph 8.7 below, and without relieving Lessee of liabilityresulting from Lessee's failure to exercise and perform good maintenancepractices, if the Basic Elements described in Paragraph 7.1(b) cannot berepaired other than at a cost which is in excess of 50% of the cost of replacingsuch Basic Elements, then such Basic Elements shall be replaced by Lessor, andthe cost thereof shall be prorated between the Parties and Lessee shall only beobligated to pay, each month during the remainder of the term of this Lease, onthe date on which Base Rent is due, an amount equal to the product ofmultiplying the cost of such replacement by a fraction, the numerator of whichis one, and the denominator of which is the number of months of the useful lifeof such replacement as such useful life is specified pursuant to Federal incometax regulations or guidelines for depreciation thereof (including interest onthe unamortized balance as is then commercially reasonable in the judgment ofLessor's accountants), with Lessee reserving the right to prepay its obligationat any time. 7.2 LESSOR'S OBLIGATIONS. Subject to the provisions of Paragraphs 2.2(Condition), 2.3 (Compliance), 9 (Damage or Destruction) 14 (Condemnation), and67 (Maintenance by Lessor) it is intended by the Parties hereto that Lessor haveno obligation, in any manner whatsoever, to repair and maintain the Premises, orthe equipment therein, all of which obligations are intended to be that of theLessee. It is the intention of the Parties that the terms of this Lease governthe respective obligations of the Parties as to maintenance and repair of thePremises, and they expressly waive the benefit of any statute now or hereafterin effect to the extent it is inconsistent with the terms of this Lease. 7.3 UTILITY INSTALLATIONS; TRADE FIXTURES; ALTERATIONS. (a) DEFINITIONS; CONSENT REQUIRED. The term "UTILITYINSTALLATIONS" refers to all floor and window coverings, air lines, powerpanels, electrical distribution, security and fire protection systems,communication systems, lighting fixtures, HVAC equipment, plumbing, and fencingin or on the Premises. The term "TRADE FIXTURES" shall mean Lessee's machineryand equipment that can be removed without doing material damage to the Premises.The term "ALTERATIONS" shall mean any modification of the improvements, otherthan Utility Installations or Trade Fixtures, whether by addition or deletion."LESSEE OWNED ALTERATIONS AND/OR UTILITY INSTALLATIONS" are defined asAlterations and/or Utility Installations made by Lessee that are not yet ownedby Lessor pursuant to Paragraph 7.4(a). Lessee shall not make any Alterations orUtility Installations to the Premises without Lessor's prior written consent.Lessee may, however, make non-structural Utility Installations to the interiorof the Premises (excluding the roof) without such consent but upon notice toLessor, as long as they are not visible from the outside, do not involvepuncturing, relocating or removing the roof or any existing walls, and thecumulative cost thereof during this Lease as extended does not exceed $50,000 inthe aggregate or $10,000 in any one year. (b) CONSENT. Any Alterations or Utility Installations that Lesseeshall desire to make and which require the consent of the Lessor shall bepresented to Lessor in written form with detailed plans. Consent shall be deemedconditioned upon Lessee's: (i) acquiring all applicable governmental permits,(ii) furnishing Lessor with copies of both the permits and the plans andspecifications prior to commencement of the work, and (iii) compliance with allconditions of said permits and other Applicable Requirements in a prompt andexpeditious manner. Any Alterations or Utility Installations shall be performedin a workmanlike manner with good and sufficient materials. Lessee shallpromptly upon completion furnish Lessor with as-built plans and specifications.For work which costs an amount equal to the greater of one month's Base Rent, or$10,000. (c) INDEMNIFICATION. Lessee shall pay, when due, all claims forlabor or materials furnished or alleged to have been furnished to or for Lesseeat or for use on the Premises, which claims are or may be secured by anymechanic's or materialmen's lien against the Premises or any interest therein.Lessee shall give Lessor not less than ten (10) days' notice prior to thecommencement of any work in, on or about the Premises, and Lessor shall have theright to post notices of non-responsibility. If Lessee shall contest thevalidity of any such lien, claim or demand, then Lessee shall, at its soleexpense defend and protect itself, Lessor and the Premises against the same andshall pay and satisfy any such adverse judgment that may be rendered thereonbefore the enforcement thereof. If Lessor shall require, Lessee shall furnish asurety bond in an amount equal to one and one-half times the amount of suchcontested lien, claim or demand, indemnifying Lessor against liability for thesame. If Lessor elects to participate in any such action, Lessee shall payLessor's attorneys' fees and costs. 7.4 OWNERSHIP; REMOVAL; SURRENDER; AND RESTORATION. (a) OWNERSHIP. Subject to Lessor's right to require removal orelect ownership as hereinafter provided, all Alterations and UtilityInstallations made by Lessee shall be the property of Lessee, but considered apart of the Premises. Lessor may, at any time, elect in writing to be the ownerof all or any specified part of the Lessee Owned Alterations and UtilityInstallations. Unless otherwise instructed per Paragraph 7.4(b) hereof, allLessee Owned Alterations and Utility Installations shall, at the expiration ortermination of this Lease, become the property of Lessor and be surrendered byLessee with the Premises. (b) REMOVAL. By delivery to Lessee of written notice from Lessornot earlier than ninety (90) and not later than thirty (30) days prior to theend of the term of this Lease, Lessor may require that any or all Lessee OwnedAlterations or Utility Installations be removed by the expiration or terminationof this Lease. Lessor may require the removal at any time of all or any part ofany Lessee Owned Alterations or Utility Installations made without the requiredconsent. (c) SURRENDER/RESTORATION. Lessee shall surrender the Premises bythe Expiration Date or any earlier termination date, with all of theimprovements, parts and surfaces thereof broom clean and free of debris, and ingood operating order, condition and state of repair, ordinary wear and tearexcepted. "Ordinary wear and tear" shall not include any damage or deteriorationthat would have been prevented by good maintenance practice. Lessee shall repairany damage occasioned by the installation, maintenance or removal of TradeFixtures, Lessee Owned Alterations and/or Utility Installations, furnishings,and equipment as well as the removal of any storage tank installed by or forLessee, and the removal, replacement, or remediation of any soil, material orgroundwater contaminated by Lessee. Trade Fixtures shall remain the property ofLessee and shall be removed by Lessee. The failure by Lessee to timely vacatethe Premises pursuant to this Paragraph 7.4(c) without the express writtenconsent of Lessor shall constitute a holdover under the provisions of Paragraph26 below.8. INSURANCE; INDEMNITY. 8.1 PAYMENT FOR INSURANCE. Lessee shall pay for all insurancerequired under Paragraph 8 except to the extent of the cost attributable toliability insurance carried by Lessor under Paragraph 8.2(b) in excess of$2,000,000 per occurrence. Premiums for policy periods commencing prior to orextending beyond the Lease term shall be prorated to correspond to the Leaseterm. Payment shall be made by Lessee to Lessor within ten (10) days followingreceipt of an invoice. 8.2 LIABILITY INSURANCE. (a) CARRIED BY LESSEE. Lessee shall obtain and keep in force aCommercial General Liability Policy of Insurance protecting Lessee and Page 5 of 15Lessor against claims for bodily injury, personal injury and property damagebased upon or arising out of the ownership, use, occupancy or maintenance of thePremises and all areas appurtenant thereto. Such insurance shall be on anoccurrence basis providing single limit coverage in an amount not less than$2,000,000 per occurrence with an "ADDITIONAL INSURED -- MANAGERS OR LESSORS OFPREMISES ENDORSEMENT" and contain the "AMENDMENT OF THE POLLUTION EXCLUSIONENDORSEMENT" for damage caused by heat, smoke or fumes from a hostile fire. ThePolicy shall not contain any intra-insured exclusions as between insured personsor organizations, but shall include coverage for liability assumed under thisLease as an "insured contract" for the performance of Lessee's indemnityobligations under this Lease. The limits of said insurance shall not, however,limit the liability of Lessee nor relieve Lessee of any obligation hereunder.All insurance carried by Lessee shall be primary to and not contributory withany similar insurance carried by Lessor, whose insurance shall be consideredexcess insurance only. (b) CARRIED BY LESSOR. Lessor shall maintain liability insuranceas described in Paragraph 8.2(a), in addition to, and not in lieu of, theinsurance required to be maintained by Lessee. Lessee shall not be named as anadditional insured therein. 8.3 PROPERTY INSURANCE -- BUILDING, IMPROVEMENTS AND RENTAL VALUE. (a) BUILDING AND IMPROVEMENTS. The Insuring Party shall obtainand keep in force a policy or policies in the name of Lessor, with loss payableto Lessor, any ground lessor, and to any Lender(s) insuring loss or damage tothe Premises. The amount of such insurance shall be equal to the fullreplacement cost of the Premises, as the same shall exist from time to time, orthe amount required by any Lenders, but in no event more than the commerciallyreasonable and available insurable value thereof. If Lessor is the InsuringParty, however, Lessee Owned Alterations and Utility Installations, TradeFixtures, and Lessee's personal property shall be insured by Lessee underParagraph 8.4 rather than by Lessor. If the coverage is available andcommercially appropriate, such policy or policies shall insure against all risksof direct physical loss or damage (except the perils of flood and/orearthquake), including coverage for debris removal and the enforcement of anyApplicable Requirements requiring the upgrading, demolition, reconstruction orreplacement of any portion of the Premises as the result of a covered loss. Saidpolicy or policies shall also contain an agreed valuation provision in lieu ofany coinsurance clause, waiver of subrogation, and inflation guard protectioncausing an increase in the annual property insurance coverage amount by a factorof not less than the adjusted U.S. Department of Labor Consumer Price Index forAll Urban Consumers for the city nearest to where the Premises are located. Ifsuch insurance coverage has a deductible clause, the deductible amount shall notexceed $1,000 per occurrence, and Lessee shall be liable for such deductibleamount in the event of an Insured Loss. (b) RENTAL VALUE. The Insuring Party shall obtain and keep inforce a policy or policies in the name of Lessor, with loss payable to Lessorand any Lender, insuring the loss of the full Rent for one (1) year. Saidinsurance shall provide that in the event the Lease is terminated by reason ofan insured loss, the period of indemnity for such coverage shall be extendedbeyond the date of the completion of repairs or replacement of the Premises, toprovide for one full year's loss of Rent from the date of any such loss. Saidinsurance shall contain an agreed valuation provision in lieu of any coinsuranceclause, and the amount of coverage shall be adjusted annually to reflect theprojected Rent otherwise payable by Lessee, for the next twelve (12) monthperiod. Lessee shall be liable for any deductible amount in the event of suchloss. (c) ADJACENT PREMISES. If the Premises are part of a largerbuilding, or of a group of buildings owned by Lessor which are adjacent to thePremises, the Lessee shall pay for any increase in the premiums for the propertyinsurance of such building or buildings if said increase is caused by Lessee'sacts, omissions, use or occupancy of the Premises. 8.4 LESSEE'S PROPERTY/BUSINESS INTERRUPTION INSURANCE. (a) PROPERTY DAMAGE. Lessee shall obtain and maintain insurancecoverage on all of Lessee's personal property, Trade Fixtures, and Lessee OwnedAlterations and Utility Installations. Such insurance shall be full replacementcost coverage with a deductible of not to exceed $1,000 per occurrence. Theproceeds from any such insurance shall be used by Lessee for the replacement ofpersonal property, Trade Fixtures and Lessee Owned Alterations and UtilityInstallations. Lessee shall provide Lessor with written evidence that suchinsurance is in force. (b) BUSINESS INTERRUPTION. Lessee shall obtain and maintain lossof income and extra expense insurance in amounts as will reimburse Lessee fordirect or indirect loss of earnings attributable to all perils commonly insuredagainst by prudent lessees in the business of Lessee or attributable toprevention of access to the Premises as a result of such perils. (c) NO REPRESENTATION OF ADEQUATE COVERAGE. Lessor makes norepresentation that the limits or forms of coverage of insurance specifiedherein are adequate to cover Lessee's property, business operations orobligations under this Lease. 8.5 INSURANCE POLICIES. Insurance required herein shall be bycompanies duly licensed or admitted to transact business in the state where thePremises are located, and maintaining during the policy term a "GeneralPolicyholders Rating" of at least B+, V, as set forth in the most current issueof "Best's Insurance Guide", or such other rating as may be required by aLender. Lessee shall not do or permit to be done anything which invalidates therequired insurance policies. Lessee shall, prior to the Start Date, deliver toLessor certified copies of policies of such insurance or certificates evidencingthe existence and amounts of the required insurance. No such policy shall becancelable or subject to modification except after thirty (30) days priorwritten notice to Lessor. Lessee shall, at least thirty (30) days prior to theexpiration of such policies, furnish Lessor with evidence of renewals or"insurance binders" evidencing renewal thereof, or Lessor may order suchinsurance and charge the cost thereof to Lessee, which amount shall be payableby Lessee to Lessor upon demand. Such policies shall be for a term of at leastone year, or the length of the remaining term of this Lease, whichever is less.If either Party shall fail to procure and maintain the insurance required to becarried by it, the other Party may, but shall not be required to, procure andmaintain the same. 8.6 WAIVER OF SUBROGATION. Without affecting any other rights orremedies, Lessee and Lessor each hereby release and relieve the other, and waivetheir entire right to recover damages against the other, for loss of or damageto its property arising out of or incident to the perils required to be insuredagainst herein. The effect of such releases and waivers is not limited by theamount of insurance carried or required, or by any deductibles applicablehereto. The Parties agree to have their respective property damage insurancecarriers waive any right to subrogation that such companies may have againstLessor or Lessee, as the case may be, so long as the insurance is notinvalidated thereby. 8.7 INDEMNITY. Except for Lessor's gross negligence or willfulmisconduct, Lessee shall indemnify, protect, defend and hold harmless thePremises, Lessor and its agents, Lessor's master or ground lessor, partners andLenders, from and against any and all claims, loss of rents and/or damages,liens, judgments, penalties, attorneys' and consultants' fees, expenses and/orliabilities arising out of, involving, or in connection with, the use and/oroccupancy of the Premises by Lessee. If any action or proceeding is broughtagainst Lessor by reason of any of the foregoing matters, Lessee shall uponnotice defend the same at Lessee's expense by counsel reasonably satisfactory toLessor and Lessor shall cooperate with Lessee in such defense. Lessor need nothave first paid any such claim in order to be defended or indemnified.Notwithstanding anything to the contrary in this Lease, Lessor shall indemnify,protect, defend and hold harmless Lessee and Lessee's employees, officers,agents, directors, and shareholders, and the Page 6 of 15successors and assigns of each of the foregoing, against and from any andall claims, demands, losses, liabilities, damages, costs, and expenses(including, without limitation, attorneys' and consultants' fees and the costsand expenses of defense) arising or resulting from (i) Lessor's breach of anycovenant, representation or warranty under this Lease; or (ii) Lessor's orLessor's agents' or employees' active negligence or wilful misconduct. Themutual indemnity obligations of Lessor and Lessee under this Lease shall not,however, release the respective insurers of Lessor and Lessee from suchinsurers' obligations under any policies covering their respective insureds. 8.8 EXEMPTION OF LESSOR FROM LIABILITY. Lessor shall not be liablefor injury or damage to the person or goods, wares, merchandise or otherproperty of Lessee, Lessee's employees, contractors, invitees, customers, or anyother person in or about the Premises, whether such damage or injury is causedby or results from fire, steam, electricity, gas, water or rain, or from thebreakage, leakage, obstruction or other defects of pipes, fire sprinklers,wires, appliances, plumbing, HVAC or lighting fixtures, or from any other cause,whether the said injury or damage results from conditions arising upon thePremises or upon other portions of the Building of which the Premises are apart, or from other sources or places. Lessor shall not be liable for anydamages arising from any act or neglect of any other tenant of Lessor.Notwithstanding Lessor's negligence or breach of this Lease, Lessor shall underno circumstances be liable for injury to Lessee's business or for any loss ofincome or profit therefrom.9. DAMAGE OR DESTRUCTION. 9.1 DEFINITIONS. (a) "PREMISES PARTIAL DAMAGE" shall mean damage or destructionto the improvements on the Premises, other than Lessee Owned Alterations andUtility Installations, which can reasonably be repaired in six (6) months orless from the date of the damage or destruction. Lessor shall notify Lessee inwriting within thirty (30) days from the date of the damage or destruction as towhether or not the damage is Partial or Total. (b) "PREMISES TOTAL DESTRUCTION" shall mean damage ordestruction to the Premises, other than Lessee Owned Alterations and UtilityInstallations and Trade Fixtures, which cannot reasonably be repaired in six (6)months or less from the date of the damage or destruction. Lessor shall notifyLessee in writing within thirty (30) days from the date of the damage ordestruction as to whether or not the damage is Partial or Total. (c) "INSURED LOSS" shall mean damage or destruction toimprovements on the Premises, other than Lessee Owned Alterations and UtilityInstallations and Trade Fixtures, which was caused by an event required to becovered by the insurance described in Paragraph 8.3(a), irrespective of anydeductible amounts or coverage limits involved. (d) "REPLACEMENT COST" shall mean the cost to repair or rebuildthe improvements owned by Lessor at the time of the occurrence to theircondition existing immediately prior thereto, including demolition, debrisremoval and upgrading required by the operation of Applicable Requirements, andwithout deduction for depreciation. (e) "HAZARDOUS SUBSTANCE CONDITION" shall mean the occurrence ordiscovery of a condition involving the presence of, or a contamination by, aHazardous Substance as defined in Paragraph 6.2(a), in, on, or under thePremises. 9.2 PARTIAL DAMAGE -- INSURED LOSS. If a Premises Partial Damagethat is an Insured Loss occurs, then Lessor shall, at Lessor's expense, repairsuch damage (but not Lessee's Trade Fixtures or Lessee Owned Alterations andUtility Installations) as soon as reasonably possible and this Lease shallcontinue in full force and effect; provided, however, that Lessee shall, atLessor's election, make the repair of any damage or destruction the total costto repair of which is $10,000 or less, and, in such event, Lessor shall make anyapplicable insurance proceeds available to Lessee on a reasonable basis for thatpurpose. Notwithstanding the foregoing, if the required insurance was not inforce or the insurance proceeds are not sufficient to effect such repair, theInsuring Party shall promptly contribute the shortage in proceeds (except as tothe deductible which is Lessee's responsibility) as and when required tocomplete said repairs. In the event, however, such shortage was due to the factthat, by reason of the unique nature of the improvements, full replacement costinsurance coverage was not commercially reasonable and available, Lessor shallhave no obligation to pay for the shortage in insurance proceeds or to fullyrestore the unique aspects of the Premises unless Lessee provides Lessor withthe funds to cover same, or adequate assurance thereof, within ten (10) daysfollowing receipt of written notice of such shortage and request therefor. IfLessor receives said funds or adequate assurance thereof within said ten (10)day period, the party responsible for making the repairs shall complete them assoon as reasonably possible and this Lease shall remain in full force andeffect. If such funds or assurance are not received, Lessor may neverthelesselect by written notice to Lessee within ten (10) days thereafter to: (i) makesuch restoration and repair as is commercially reasonable with Lessor paying anyshortage in proceeds, in which case this Lease shall remain in full force andeffect, or have this Lease terminate thirty (30) days thereafter. Lessee shallnot be entitled to reimbursement of any funds contributed by Lessee to repairany such damage or destruction. Premises Partial Damage due to flood orearthquake shall be subject to Paragraph 9.3, notwithstanding that there may besome insurance coverage, but the net proceeds of any such insurance shall bemade available for the repairs if made by either Party. 9.3 PARTIAL DAMAGE -- UNINSURED LOSS. If a Premises Partial Damagethat is not an Insured Loss occurs, unless caused by a negligent or willful actof Lessee (in which event Lessee shall make the repairs at Lessee's expense),Lessor may either: (i) repair such damage as soon as reasonably possible atLessor's expense, in which event this Lease shall continue in full force andeffect, or (ii) terminate this Lease by giving written notice to Lessee withinthirty (30) days after receipt by Lessor of knowledge of the occurrence of suchdamage. Such termination shall be effective sixty (60) days following the dateof such notice. In the event Lessor elects to terminate this Lease, Lessee shallhave the right within ten (10) days after receipt of the termination notice togive written notice to Lessor of Lessee's commitment to pay for the repair ofsuch damage without reimbursement from Lessor. Lessee shall provide Lessor withsaid funds or satisfactory assurance thereof within thirty (30) days aftermaking such commitment. In such event this Lease shall continue in full forceand effect, and Lessor shall proceed to make such repairs as soon as reasonablypossible after the required funds are available. If Lessee does not make therequired commitment, this Lease shall terminate as of the date specified in thetermination notice. 9.4 TOTAL DESTRUCTION. Notwithstanding any other provision hereof,if a Premises Total Destruction occurs, this Lease shall terminate sixty (60)days following such Destruction. If the damage or destruction was caused by thegross negligence or willful misconduct of Lessee, Lessor shall have the right torecover Lessor's damages from Lessee, except as provided in Paragraph 8.6. 9.5 DAMAGE NEAR END OF TERM. If at any time during the last six (6)months of this Lease there is damage for which the cost to repair exceeds one(1) month's Base Rent, whether or not an Insured Loss, Lessor may terminate thisLease effective sixty (60) days following the date of occurrence of such damageby giving a written termination notice to Lessee within thirty (30) days afterthe date of occurrence of such damage. Notwithstanding the foregoing, if Lesseeat that time has an exercisable option to extend this Lease or to purchase thePremises, then Lessee may preserve this Lease by, (a) exercising such option and(b) providing Lessor with any shortage in insurance proceeds (or adequateassurance thereof) needed to make the repairs on or before the earlier of (i)the date which is ten days after Lessee's receipt of Lessor's written noticepurporting to terminate this Lease, or (ii) the day prior to the Initials ------- ------- Page 7 of 15date upon which such option expires. If Lessee duly exercises such option duringsuch period and provides Lessor with funds (or adequate assurance thereof) tocover any shortage in insurance proceeds, Lessor shall, at Lessor's commerciallyreasonable expense, repair such damage as soon as reasonably possible and thisLease shall continue in full force and effect. If Lessee fails to exercise suchoption and provide such funds or assurance during such period, then this Leaseshall terminate on the date specified in the termination notice and Lessee'soption shall be extinguished. 9.6 ABATEMENT OF RENT; LESSEE'S REMEDIES. (a) ABATEMENT. In the event of Premises Partial Damage orPremises Total Destruction or a Hazardous Substance Condition for which Lesseeis not responsible under this Lease, the Rent payable by Lessee for the periodrequired for the repair, remediation or restoration of such damage shall beabated in proportion to the degree to which Lessee's use of the Premises isimpaired, but not to exceed the proceeds received from the Rental Valueinsurance. All other obligations of Lessee hereunder shall be performed byLessee, and Lessor shall have no liability for any such damage, destruction,remediation, repair or restoration except as provided herein. (b) REMEDIES. If Lessor shall be obligated to repair or restorethe Premises and does not commence, in a substantial and meaningful way, suchrepair or restoration within ninety (90) days after such obligation shallaccrue, Lessee may, at any time prior to the commencement of such repair orrestoration, give written notice to Lessor and to any Lenders of which Lesseehas actual notice, of Lessee's election to terminate this Lease on a date notless than sixty (60) days following the giving of such notice. If Lessee givessuch notice and such repair or restoration is not commenced within thirty (30)days thereafter, this Lease shall terminate as of the date specified in saidnotice. If the repair or restoration is commenced within said thirty (30) days,this Lease shall continue in full force and effect. "COMMENCE" shall mean eitherthe unconditional authorization of the preparation of the required plans, or thebeginning of the actual work on the Premises, whichever first occurs. 9.7 TERMINATION -- ADVANCE PAYMENTS. Upon termination of this Leasepursuant to Paragraph 6.2(g) or Paragraph 9, an equitable adjustment shall bemade concerning advance Base Rent and any other advance payments made by Lesseeto Lessor. Lessor shall, in addition, return to Lessee so much of Lessee'sSecurity Deposit as has not been, or is not then required to be, used by Lessor. 9.8 WAIVE STATUTES. Lessor and Lessee agree that the terms of thisLease shall govern the effect of any damage to or destruction of the Premiseswith respect to the termination of this Lease and hereby waive the provisions ofany present or future statute to the extent inconsistent herewith.10. REAL PROPERTY TAXES. 10.1 DEFINITION OF "REAL PROPERTY TAXES." As used herein, the term"REAL PROPERTY TAXES" shall include any form of assessment; real estate,general, special, ordinary or extraordinary, or rental levy or tax (other thaninheritance, personal income or estate taxes); improvement bond; and/or licensefee imposed upon or levied against any legal or equitable interest of Lessor inthe Premises, Lessor's right to other income therefrom, and/or Lessor's businessof leasing, by any authority having the direct or indirect power to tax andwhere the funds are generated with reference to the Building address and wherethe proceeds so generated are to be applied by the city, county or other localtaxing authority of a jurisdiction within which the Premises are located. Theterm "REAL PROPERTY TAXES" shall also include any tax, fee, levy, assessment orcharge, or any increase therein, imposed by reason of events occurring duringthe term of this Lease, including but not limited to, a change in the ownershipof the Premises. 10.2 (a) PAYMENT OF TAXES. Lessee shall pay the Real Property Taxesapplicable to the Premises during the term of this Lease. Subject to Paragraph10.2(b), all such payments shall be made at least ten (10) days prior to anydelinquency date. Lessee shall promptly furnish Lessor with satisfactoryevidence that such taxes have been paid. If any such taxes shall cover anyperiod of time prior to or after the expiration or termination of this Lease,Lessee's share of such taxes shall be prorated to cover only that portion of thetax bill applicable to the period that this Lease is in effect, and Lessor shallreimburse Lessee for any overpayment. If Lessee shall fail to pay any requiredReal Property Taxes, Lessor shall have the right to pay the same, and Lesseeshall reimburse Lessor therefor upon demand. (b) ADVANCE PAYMENT. In the event Lessee incurs a late charge onany Rent payment, Lessor may, at Lessor's option, estimate the current RealProperty Taxes, and require that such taxes be paid in advance to Lessor byLessee, either: (i) in a lump sum amount equal to the installment due, at leasttwenty (20) days prior to the applicable delinquency date, or (ii) monthly inadvance with the payment of the Base Rent. If Lessor elects to require paymentmonthly in advance, the monthly payment shall be an amount equal to the amountof the estimated installment of taxes divided by the number of months remainingbefore the month in which said installment becomes delinquent. When the actualamount of the applicable tax bill is known, the amount of such equal monthlyadvance payments shall be adjusted as required to provide the funds needed topay the applicable taxes. If the amount collected by Lessor is insufficient topay such Real Property Taxes when due, Lessee shall pay Lessor, upon demand,such additional sums as are necessary to pay such obligations. All monies paidto Lessor under this Paragraph may be intermingled with other monies of Lessorand shall not bear interest. In the event of a Breach by Lessee in theperformance of its obligations under this Lease, then any balance of funds paidto Lessor under the provisions of this Paragraph may, at the option of Lessor,be treated as an additional Security Deposit. 10.3 JOINT ASSESSMENT. If the Premises are not separately assessed,Lessee's liability shall be an equitable proportion of the Real Property Taxesfor all of the land and improvements included within the tax parcel assessed,such proportion to be conclusively determined by Lessor from the respectivevaluations assigned in the assessor's work sheets or such other information asmay be reasonably available. 10.4 PERSONAL PROPERTY TAXES. Lessee shall pay, prior to delinquency,all taxes assessed against and levied upon Lessee Owned Alterations, UtilityInstallations, Trade Fixtures, furnishings, equipment and all personal propertyof Lessee. When possible, Lessee shall cause such property to be assessed andbilled separately from the real property of Lessor. If any of Lessee's saidpersonal property shall be assessed with Lessor's real property, Lessee shallpay Lessor the taxes attributable to Lessee's property within ten (10) daysafter receipt of a written statement.11. UTILITIES. Lessee shall pay for all water, gas, heat, light, power,telephone, trash disposal and other utilities and services supplied to thePremises, together with any taxes thereon. If any such services are notseparately metered to Lessee, Lessee shall pay a reasonable proportion, to bedetermined by Lessor, of all charges jointly metered. Notwithstanding anything to the contrary contained in Paragraph 11 of this Lease, in the event of an interruption of building utilities or essential services provided to the building, or if the Lessee's occupancy is otherwise prevented for a period of excess of five (5) days, Lessee's Rent shall be abated from the date of interruption to the extent covered by any Rental Loss insurance coverage maintained by Lessor.12. ASSIGNMENT AND SUBLETTING. 12.1 LESSOR'S CONSENT REQUIRED. (a) Lessee shall not voluntarily or by operation of law assign,transfer, mortgage or encumber (collectively, "ASSIGN OR ASSIGNMENT") or Page 8 of 15sublet all or any part of Lessee's interest in this Lease or in the Premiseswithout Lessor's prior written consent, which shall not be reasonable withheld. (b) A change in the control of Lessee shall constitute anassignment requiring consent. (c) The involvement of Lessee or its assets in any transaction,or series of transactions (by way of merger, sale, acquisition, financing,transfer, leveraged buy-out or otherwise), whether or not a formal assignment orhypothecation of this Lease or Lessee's assets occurs, which results or willresult in a reduction of the Net Worth of Lessee by an amount greater thantwenty-five percent (25%) of such Net Worth as it was represented at the time ofthe execution of this Lease or at the time of the most recent assignment towhich Lessor has consented, or as it exists immediately prior to saidtransaction or transactions constituting such reduction, whichever was or isgreater, shall be considered an assignment of this Lease to which Lessor maywithhold its consent. "NET WORTH OF LESSEE" shall mean the net worth of Lessee(excluding any guarantors) established under generally accepted accountingprinciples. (d) An assignment or subletting without consent shall, be a Default curable after notice per Paragraph 13.1(c). (e) Lessee's remedy for any breach of Paragraph 12.1 by Lessorshall be limited to compensatory damages and/or injunctive relief. 12.2 TERMS AND CONDITIONS APPLICABLE TO ASSIGNMENT AND SUBLETTING. (a) Regardless of Lessor's consent, any assignment or sublettingshall not: (i) be effective without the express written assumption by suchassignee or sublessee of the obligations of Lessee under this Lease; (ii)release Lessee of any obligations hereunder; or (iii) alter the primaryliability of Lessee for the payment of Rent or for the performance of any otherobligations to be performed by Lessee. (b) Lessor may accept Rent or performance of Lessee'sobligations from any person other than Lessee pending approval or disapproval ofan assignment. Neither a delay in the approval or disapproval of such assignmentnor the acceptance of Rent or performance shall constitute a waiver or estoppelof Lessor's right to exercise its remedies for Lessee's Default or Breach. (c) Lessor's consent to any assignment or subletting shall notconstitute a consent to any subsequent assignment or subletting. (d) In the event of any Default or Breach by Lessee, Lessor mayproceed directly against Lessee, any Guarantors or anyone else responsible forthe performance of Lessee's obligations under this Lease, including any assigneeor sublessee, without first exhausting Lessor's remedies against any otherperson or entity responsible therefore to Lessor, or any security held byLessor. (e) Each request for consent to an assignment or sublettingshall be in writing, accompanied by information relevant to Lessor'sdetermination as to the financial and operational responsibility andappropriateness of the proposed assignee or sublessee, including but not limitedto the intended use and/or required modification of the Premises, if any,together with a fee of $1,000 or ten percent (10%) of the current monthly BaseRent applicable to the portion of the Premises which is the subject of theproposed assignment or sublease, whichever is greater, as consideration forLessor's considering and processing said request. Lessee agrees to provideLessor with such other or additional information and/or documentation as may bereasonably requested. (f) Any assignee of, or sublessee under, this Lease shall, byreason of accepting such assignment or entering into such sublease, be deemed tohave assumed and agreed to conform and comply with each and every term,covenant, condition and obligation herein to be observed or performed by Lesseeduring the term of said assignment or sublease, other than such obligations asare contrary to or inconsistent with provisions of an assignment or sublease towhich Lessor has specifically consented to in writing. 12.3 ADDITIONAL TERMS AND CONDITIONS APPLICABLE TO SUBLETTING. Thefollowing terms and conditions shall apply to any subletting by Lessee of all orany part of the Premises and shall be deemed included in all subleases underthis Lease whether or not expressly incorporated therein: (a) Lessee hereby assigns and transfers to Lessor all ofLessee's interest in all Rent payable on any sublease, and Lessor may collectsuch Rent and apply same toward Lessee's obligations under this Lease; provided,however, that until a Breach shall occur in the performance of Lessee'sobligations, Lessee may collect said Rent. Lessor shall not, by reason of theforegoing or any assignment of such sublease, nor by reason of the collection ofRent, be deemed liable to the sublessee for any failure of Lessee to perform andcomply with any of Lessee's obligations to such sublessee. Lessee herebyirrevocably authorizes and directs any such sublessee, upon receipt of a writtennotice from Lessor stating that a Breach exists in the performance of Lessee'sobligations under this Lease, to pay to Lessor all Rent due and to become dueunder the sublease. Sublessee shall rely upon any such notice from Lessor andshall pay all Rents to Lessor without any obligation or right to inquire as towhether such Breach exists, notwithstanding any claim from Lessee to thecontrary. (b) In the event of a Breach by Lessee, Lessor may, at itsoption, require sublessee to attorn to Lessor, in which event Lessor shallundertake the obligations of the sublessor under such sublease from the time ofthe exercise of said option to the expiration of such sublease; provided,however, Lessor shall not be liable for any prepaid rents or security depositpaid by such sublessee to such sublessor or for any prior Defaults or Breachesof such sublessor. (c) Any matter requiring the consent of the sublessor under asublease shall also require the consent of Lessor. (d) No sublessee shall further assign or sublet all or any partof the Premises without Lessor's prior written consent. (e) Lessor shall deliver a copy of any notice of Default orBreach by Lessee to the sublessee, who shall have the right to cure the Defaultof Lessee within the grace period, if any, specified in such notice. Thesublessee shall have a right of reimbursement and offset from and against Lesseefor any such Defaults cured by the sublessee.13. DEFAULT; BREACH; REMEDIES. 13.1 DEFAULT; BREACH. A "DEFAULT" is defined as a failure by theLessee to comply with or perform any of the terms, covenants, conditions orrules under this Lease. A "BREACH" is defined as the occurrence of one or moreof the following Defaults, and the failure of Lessee to cure such Default withinany applicable grace period: (a) The abandonment of the Premises; or the vacating of thePremises without providing a commercially reasonable level of security, or wherethe coverage of the property insurance described in Paragraph 8.3 is jeopardizedas a result thereof, or without providing reasonable assurances to Page 9 of 15minimize potential vandalism. (b) The failure of Lessee to make any payment of Rent or anySecurity Deposit required to be made by Lessee hereunder, whether to Lessor orto a third party, when due, to provide reasonable evidence of insurance orsurety bond, or to fulfill any obligation under this Lease which endangers orthreatens life or property, where such failure continues for a period of ten(10) days following written notice to Lessee. (c) The failure by Lessee to provide (i) reasonable writtenevidence of compliance with Applicable Requirements, (ii) the service contracts,(iii) the rescission of an unauthorized assignment or subletting, (iv) a TenancyStatement, (v) a requested subordination, (vi) evidence concerning any guarantyand/or Guarantor, (vii) any document requested under Paragraph 42 (easements),or (viii) any other documentation or information which Lessor may reasonablyrequire of Lessee under the terms of this Lease, where any such failurecontinues for a period of ten (10) days following written notice to Lessee. (d) A Default by Lessee as to the terms, covenants, conditionsor provisions of this Lease, or of the rules adopted under Paragraph 40 hereof,other than those described in subparagraphs 13.1(a), (b) or (c), above, wheresuch Default continues for a period of thirty (30) days after written notice;provided, however, that if the nature of Lessee's Default is such that more thanthirty (30) days are reasonably required for its cure, then it shall not bedeemed to be a Breach if Lessee commences such cure within said thirty (30) dayperiod and thereafter diligently prosecutes such cure to completion. (e) The occurrence of any of the following events: (i) themaking of any general arrangement or assignment for the benefit of creditors;(ii) becoming a "DEBTOR" as defined in 11 U.S.C. Section 101 or any successorstatute thereto (unless, in the case of a petition filed against Lessee, thesame is dismissed within sixty (60) days); (iii) the appointment of a trustee orreceiver to take possession of substantially all of Lessee's assets located atthe Premises or of Lessee's interest in this Lease, where possession is notrestored to Lessee within thirty (30) days; or (iv) the attachment, execution orother judicial seizure of substantially all of Lessee's assets located at thePremises or of Lessee's interest in this Lease, where such seizure is notdischarged within thirty (30) days; provided, however, in the event that anyprovision of this subparagraph 13.1 (e) is contrary to any applicable law, suchprovision shall be of no force or effect, and not affect the validity of theremaining provisions. (f) The discovery that any financial statement of Lessee or ofany Guarantor given to Lessor was materially false. 13.2 REMEDIES. If Lessee fails to perform any of its affirmativeduties or obligations, within ten (10) days after written notice (or in case ofan emergency, without notice), Lessor may, at its option, perform such duty orobligation on Lessee's behalf, including but not limited to the obtaining ofreasonably required bonds, insurance policies, or governmental licenses, permitsor approvals. The costs and expenses of any such performance by Lessor shall bedue and payable by Lessee upon receipt of invoice therefor. If any check givento Lessor by Lessee shall not be honored by the bank upon which it is drawn,Lessor, at its option, may require all future payments to be made by Lessee tobe by cashier's check. In the event of a Breach, Lessor may, with or withoutfurther notice or demand, and without limiting Lessor in the exercise of anyright or remedy which Lessor may have by reason of such Breach: (a) Terminate Lessee's right to possession of the Premises byany lawful means, in which case this Lease shall terminate and Lessee shallimmediately surrender possession to Lessor. In such event Lessor shall beentitled to recover from Lessee: (i) the unpaid Rent which had been earned atthe time of termination; (ii) the worth at the time of award of the amount bywhich the unpaid rent which would have been earned after termination until thetime of award exceeds the amount of such rental loss that the Lessee provescould have been reasonably avoided; (iii) the worth at the time of award of theamount by which the unpaid rent for the balance of the term after the time ofaward exceeds the amount of such rental loss that the Lessee proves could bereasonably avoided; and (iv) any other amount necessary to compensate Lessor forall the detriment proximately caused by the Lessee's failure to perform itsobligations under this Lease or which in the ordinary course of things would belikely to result therefrom, including but not limited to the cost of recoveringpossession of the Premises, expenses of reletting, including necessaryrenovation and alteration of the Premises, reasonable attorneys' fees, and thatportion of any leasing commission paid by Lessor in connection with this Leaseapplicable to the unexpired term of this Lease. The worth at the time of awardof the amount referred to in provision (iii) of the immediately precedingsentence shall be computed by discounting such amount at the discount rate ofthe Federal Reserve Bank of the District within which the Premises are locatedat the time of award plus one percent (1%). Efforts by Lessor to mitigatedamages caused by Lessee's Breach of this Lease shall not waive Lessor's rightto recover damages under Paragraph 12. If termination of this Lease is obtainedthrough the provisional remedy of unlawful detainer, Lessor shall have the rightto recover in such proceeding any unpaid Rent and damages as are recoverabletherein, or Lessor may reserve the right to recover all or any part thereof in aseparate suit. If a notice and grace period required under Paragraph 13.1 wasnot previously given, a notice to pay rent or quit, or to perform or quit givento Lessee under the unlawful detainer statute shall also constitute the noticerequired by Paragraph 13.1. In such case, the applicable grace period requiredby Paragraph 13.1 and the unlawful detainer statute shall run concurrently, andthe failure of Lessee to cure the Default within the greater of the two suchgrace periods shall constitute both an unlawful detainer and a Breach of thisLease entitling Lessor to the remedies provided for in this Lease and/or by saidstatute. (b) Continue the Lease and Lessee's right to possession andrecover the Rent as it becomes due, in which event Lessee may sublet or assign,subject only to reasonable limitations. Acts of maintenance, efforts to relet,and/or the appointment of a receiver to protect the Lessor's interests, shallnot constitute a termination of the Lessee's right to possession. (c) Pursue any other remedy now or hereafter available under thelaws or judicial decisions of the state wherein the Premises are located. Theexpiration or termination of this Lease and/or the termination of Lessee's rightto possession shall not relieve Lessee from liability under any indemnityprovisions. Page 10 of 15 13.4 LATE CHARGES. Lessee hereby acknowledges that late payment byLessee of Rent will cause Lessor to incur costs not contemplated by this Lease,the exact amount of which will be extremely difficult to ascertain. Such costsinclude, but are not limited to, processing and accounting charges, and latecharges which may be imposed upon Lessor by any Lender. Accordingly, if any Rentshall not be received by Lessor within ten (10) days after such amount shall bedue, then, without any requirement for notice to Lessee, Lessee shall pay toLessor a one-time late charge equal to six percent (6%) of each such overdueamount. The Parties hereby agree that such late charge represents a fair andreasonable estimate of the costs Lessor will incur by reason of such latepayment. Acceptance of such late charge by Lessor shall in no event constitute awaiver of Lessee's Default or Breach with respect to such overdue amount, norprevent the exercise of any of the other rights and remedies granted hereunder. 13.5 INTEREST. Any monetary payment due Lessor hereunder, other thanlate charges, not received by Lessor, when due as to scheduled payments (such asBase Rent) or within thirty (30) days following the date on which it was due fornon-scheduled payment, shall bear interest from the date when due, as toscheduled payments, or the thirty-first (31st) day after it was due as tonon-scheduled payments. The interest ("Interest") charged shall be equal to theprime rate reported in the Wall Street Journal as published closest prior to thedate when due plus four percent (4%), but shall not exceed the maximum rateallowed by law. Interest is payable in addition to the potential late chargeprovided for in Paragraph 13.4. 13.6 BREACH BY LESSOR. (a) NOTICE OF BREACH. Lessor shall not be deemed in breach ofthis Lease unless Lessor fails within a reasonable time to perform an obligationrequired to be performed by Lessor. For purposes of this Paragraph, a reasonabletime shall in no event be less than thirty (30) days after receipt by Lessor,and any Lender whose name and address shall have been furnished Lessee inwriting for such purpose, of written notice specifying wherein such obligationof Lessor has not been performed; provided, however, that if the nature ofLessor's obligation is such that more than thirty (30) days are reasonablyrequired for its performance, then Lessor shall not be in breach if performanceis commenced within such thirty (30) day period and thereafter diligentlypursued to completion. (b) PERFORMANCE BY LESSEE ON BEHALF OF LESSOR. In the event thatneither Lessor nor Lender cures said breach within thirty (30) days afterreceipt of said notice, or if having commenced said cure they do not diligentlypursue it to completion, then Lessee may elect to cure said breach at Lessee'sexpense and offset from Rent an amount equal to the greater of one month's BaseRent or the Security Deposit, and to pay an excess of such expense underprotest, reserving Lessee's right to reimbursement from Lessor. Lessee shalldocument the cost of said cure and supply said documentation to Lessor.14. CONDEMNATION. If the Premises or any portion thereof are taken under thepower of eminent domain or sold under the threat of the exercise of said power(collectively "CONDEMNATION"), this Lease shall terminate as to the part takenas of the date the condemning authority takes title or possession, whicheverfirst occurs. If more than ten percent (10%) of any building portion of thePremises, or more than twenty-five percent (25%) of the land area portion of thePremises not occupied by any building, is taken by Condemnation, Lessee may, atLessee's option, to be exercised in writing within ten (10) days after Lessorshall have given Lessee written notice of such taking (or in the absence of suchnotice, within ten (10) days after the condemning authority shall have takenpossession) terminate this Lease as of the date the condemning authority takessuch possession. If Lessee does not terminate this Lease in accordance with theforegoing, this Lease shall remain in full force and effect as to the portion ofthe Premises remaining, except that the Base Rent shall be reduced in proportionto the reduction in utility of the Premises caused by such Condemnation.Condemnation awards and/or payments shall be the property of Lessor, whethersuch award shall be made as compensation for diminution in value of theleasehold, the value of the part taken, or for severance damages; provided,however, that Lessee shall be entitled to any compensation for Lessee'srelocation expenses, loss of business goodwill and/or Trade Fixtures, withoutregard to whether or not this Lease is terminated pursuant to the provisions ofthis Paragraph. All Alterations and Utility Installations made to the Premisesby Lessee, for purposes of Condemnation only, shall be considered the propertyof the Lessee and Lessee shall be entitled to any and all compensation which ispayable therefor. In the event that this Lease is not terminated by reason ofthe Condemnation, Lessor shall repair any damage to the Premises caused by suchCondemnation.15. 16. ESTOPPEL CERTIFICATES. (a) Each Party (as "RESPONDING PARTY") shall within ten (10)days after written notice from the other Party (the "REQUESTING PARTY") execute,acknowledge and deliver to the Requesting Party a statement in writing in formsimilar to the then most current "ESTOPPEL CERTIFICATE" form published by theAmerican Industrial Real Estate Association, plus such additional information,confirmation and/or statements as may be reasonably requested by the RequestingParty. (b) If the Responding Party shall fail to execute or deliver theEstoppel Certificate within such ten day period, the Requesting Party mayexecute an Estoppel Certificate stating that: (i) the Lease is in full force andeffect without modification except as may be represented by the Requesting Page 11 of 15Party, (ii) there are no uncured defaults in the Requesting Party's performance,and (iii) if Lessor is the Requesting Party, not more than one month's Rent hasbeen paid in advance. Prospective purchasers and encumbrancers may rely upon theRequesting Party's Estoppel Certificate, and the Responding Party shall beestopped from denying the truth of the facts contained in said Certificate. (c) If Lessor desires to finance, refinance, or sell thePremises, or any part thereof, Lessee and all Guarantors shall deliver to anypotential lender or purchaser designated by Lessor such financial statements asmay be reasonably required by such lender or purchaser, including, but notlimited to, Lessee's financial statements for the past three (3) years. All suchfinancial statements shall be received by Lessor and such lender or purchaser inconfidence and shall be used only for the purposes herein set forth.17. DEFINITION OF LESSOR. The term "LESSOR" as used herein shall mean theowner or owners at the time in question of the fee title to the Premises, or, ifthis is a sublease, of the Lessee's interest in the prior lease. In the event ofa transfer of Lessor's title or interest in the Premises or this Lease, Lessorshall deliver to the transferee or assignee (in cash or by credit) any unusedSecurity Deposit held by Lessor. Except as provided in Paragraph 15, upon suchtransfer or assignment and delivery of the Security Deposit, as aforesaid, theprior Lessor shall be relieved of all liability with respect to the obligationsand/or covenants under this Lease thereafter to be performed by the Lessor.Subject to the foregoing, the obligations and/or covenants in this Lease to beperformed by the Lessor shall be binding only upon the Lessor as hereinabovedefined. Notwithstanding the above, and subject to the provisions of Paragraph20 below, the original Lessor under this Lease, and all subsequent holders ofthe Lessor's interest in this Lease shall remain liable and responsible withregard to the potential duties and liabilities of Lessor pertaining to HazardousSubstances as outlined in Paragraph 6 above.18. SEVERABILITY. The invalidity of any provision of this Lease, asdetermined by a court of competent jurisdiction, shall in no way affect thevalidity of any other provision hereof.19. DAYS. Unless otherwise specifically indicated to the contrary, the word"days" as used in this Lease shall mean and refer to calendar days.20. LIMITATION ON LIABILITY. Subject to the provisions of Paragraph 17above, the obligations of Lessor under this Lease shall not constitute personalobligations of Lessor, the individual partners of Lessor or its or theirindividual partners, directors, officers or shareholders, and Lessee shall lookto the Premises, and to no other assets of Lessor, for the satisfaction of anyliability of Lessor with respect to this Lease, and shall not seek recourseagainst the individual partners of Lessor, or its or their individual partners,directors, officers or shareholders, or any of their personal assets for suchsatisfaction.21. TIME OF ESSENCE. Time is of the essence with respect to the performanceof all obligations to be performed or observed by the Parties under this Lease.22. NO PRIOR OR OTHER AGREEMENTS; BROKER DISCLAIMER. This Lease contains allagreements between the Parties with respect to any matter mentioned herein, andno other prior or contemporaneous agreement or understanding shall be effective.Lessor and Lessee each represents and warrants that it has made,and is relying solely upon, its own investigation as to the nature, quality,character and financial responsibility of the other Party to this Lease and asto the nature, quality and character of the Premises. 23. NOTICES. 23.1 NOTICE REQUIREMENTS. All notices required or permittedby this Lease shall be in writing and may be delivered in person (by hand or bycourier) or may be sent by regular, certified or registered mail or U.S. PostalService Express Mail, with postage prepaid, or by facsimile transmission, andshall be deemed sufficiently given if served in a manner specified in thisParagraph 23. The addresses noted adjacent to a Party's signature on this Leaseshall be that Party's address for delivery or mailing of notices. Either Partymay by written notice to the other specify a different address for notice,except that upon Lessee's taking possession of the Premises, the Premises shallconstitute Lessee's address for notice. A copy of all notices to Lessor shall beconcurrently transmitted to such party or parties at such addresses as Lessormay from time to time hereafter designate in writing. 23.2 DATE OF NOTICE. Any notice sent by registered orcertified mail, return receipt requested, shall be deemed given on the date ofdelivery shown on the receipt card, or if no delivery date is shown, thepostmark thereon. If sent by regular mail the notice shall be deemed givenforty-eight (48) hours after the same is addressed as required herein and mailedwith postage prepaid. Notices delivered by United States Express Mail orovernight courier that guarantee next day delivery shall be deemed giventwenty-four (24) hours after delivery of the same to the Postal Service orcourier. Notices transmitted by facsimile transmission or similar means shall bedeemed delivered upon telephone confirmation of receipt, provided a copy is alsodelivered via delivery or mail. If notice is received on a Saturday, Sunday orlegal holiday, it shall be deemed received on the next business day.24. WAIVERS. No waiver by Lessor of the Default or Breach of any term,covenant or condition hereof by Lessee, shall be deemed a waiver of any otherterm, covenant or condition hereof, or of any subsequent Default or Breach byLessee of the same or of any other term, covenant or condition hereof. Lessor'sconsent to, or approval of, any act shall not be deemed to render unnecessarythe obtaining of Lessor's consent to, or approval of, any subsequent or similaract by Lessee, or be construed as the basis of an estoppel to enforce theprovision or provisions of this Lease requiring such consent. The acceptance ofRent by Lessor shall not be a waiver of any Default or Breach by Lessee. Anypayment by Lessee may be accepted by Lessor on account of monies or damages dueLessor, notwithstanding any qualifying statements or conditions made by Lesseein connection therewith, which such statements and/or conditions shall be of noforce or effect whatsoever unless specifically agreed to in writing by Lessor ator before the time of deposit of such payment.26. NO RIGHT TO HOLDOVER. Lessee has no right to retain possession of thePremises or any part thereof beyond the expiration or termination of this Lease.In the event that Lessee holds over, then the Base Rent shall be increased toone hundred fifty percent (150%) of the Base Rent applicable during the monthimmediately preceding the expiration or termination. Nothing contained hereinshall be construed as consent by Lessor to any holding over by Lessee.27. CUMULATIVE REMEDIES. No remedy or election hereunder shall be deemedexclusive but shall, wherever possible, be cumulative with all other remedies atlaw or in equity.28. COVENANTS AND CONDITIONS; CONSTRUCTION OF AGREEMENT. All provisions ofthis Lease to be observed or performed by Lessee are both covenants andconditions. In construing this Lease, all headings and titles are for theconvenience of the Parties only and shall not be considered a part of thisLease. Whenever required by the context, the singular shall include the pluraland vice versa. This Lease shall not be construed as if prepared by one of theParties, but rather according to its fair meaning as a whole, as if both Partieshad prepared it.29. BINDING EFFECT; CHOICE OF LAW. This Lease shall be binding upon theparties, their personal representatives, successors and assigns and be Page 12 of 15governed by the laws of the State in which the Premises are located. Anylitigation between the Parties hereto concerning this Lease shall be initiatedin the county in which the Premises are located.30. SUBORDINATION; ATTORNMENT; NON-DISTURBANCE. 30.1 SUBORDINATION. This Lease and any Option granted hereby shall besubject and subordinate to any ground lease, mortgage, deed of trust, or otherhypothecation or security device (collectively, "SECURITY DEVICE"), now orhereafter placed upon the Premises, to any and all advances made on the securitythereof, and to all renewals, modifications, and extensions thereof. Lesseeagrees that the holders of any such Security Devices (in this Lease togetherreferred to as "Lessor's Lender") shall have no liability or obligation toperform any of the obligations of Lessor under this Lease. Any Lender may electto have this Lease and/or any Option granted hereby superior to the lien of itsSecurity Device by giving written notice thereof to Lessee, whereupon this Leaseand such Options shall be deemed prior to such Security Device, notwithstandingthe relative dates of the documentation or recordation thereof. 30.2 ATTORNMENT. Subject to the non-disturbance provisions ofParagraph 30.3, Lessee agrees to attorn to a Lender or any other party whoacquires ownership of the Premises by reason of a foreclosure of a SecurityDevice, and that in the event of such foreclosure, such new owner shall not: (i)be liable for any act or omission of any prior lessor or with respect to eventsoccurring prior to acquisition of ownership; (ii) be subject to any offsets ordefenses which Lessee might have against any prior lessor; or (iii) be bound byprepayment of more than one (1) month's rent. 30.3 NON-DISTURBANCE. With respect to Security Devices entered intoby Lessor after the execution of this Lease, Lessee's subordination of thisLease shall be subject to receiving a commercially reasonable non-disturbanceagreement (a "NON-DISTURBANCE AGREEMENT") from the Lender which Non-DisturbanceAgreement provides that Lessee's possession of the Premises, and this Lease,including any options to extend the term hereof, will not be disturbed so longas Lessee is not in Breach hereof and attorns to the record owner of thePremises. Further, within sixty (60) days after the execution of this Lease,Lessor shall use its commercially reasonable efforts to obtain a Non-DisturbanceAgreement from the holder of any pre-existing Security Device which is securedby the Premises. In the event that Lessor is unable to provide theNon-Disturbance Agreement within said sixty (60) days, then Lessee may, atLessee's option, directly contact Lessor's lender and attempt to negotiate forthe execution and delivery of a Non-Disturbance Agreement. 30.4 SELF-EXECUTING. The agreements contained in this Paragraph 30shall be effective without the execution of any further documents; provided,however, that, upon written request from Lessor or a Lender in connection with asale, financing or refinancing of the Premises, Lessee and Lessor shall executesuch further writings as may be reasonably required to separately document anysubordination, attornment and/or Non-Disturbance Agreement provided for herein.31. ATTORNEYS' FEES. If any Party or Broker brings an action or proceedinginvolving the Premises to enforce the terms hereof or to declare rightshereunder, the Prevailing Party (as hereafter defined) in any such proceeding,action, or appeal thereon, shall be entitled to reasonable attorneys' fees. Suchfees may be awarded in the same suit or recovered in a separate suit, whether ornot such action or proceeding is pursued to decision or judgment. The term,"PREVAILING PARTY" shall include, without limitation, a Party or Broker whosubstantially obtains or defeats the relief sought, as the case may be, whetherby compromise, settlement, judgment, or the abandonment by the other Party orBroker of its claim or defense. The attorneys' fees award shall not be computedin accordance with any court fee schedule, but shall be such as to fullyreimburse all attorneys' fees reasonably incurred. In addition, Lessor shall beentitled to attorneys' fees, costs and expenses incurred in the preparation andservice of notices of Default and consultations in connection therewith, whetheror not a legal action is subsequently commenced in connection with such Defaultor resulting Breach.32. LESSOR'S ACCESS; SHOWING PREMISES; REPAIRS. Lessor and Lessor's agentsshall have the right to enter the Premises at any time, in the case of anemergency, and otherwise at reasonable times for the purpose of showing the sameto prospective purchasers, lenders, or lessees, and making such alterations,repairs, improvements or additions to the Premises as Lessor may deem necessary.All such activities shall be without abatement of rent or liability to Lessee.Lessor may at any time place on the Premises any ordinary "FOR SALE" signs andLessor may during the last six (6) months of the term hereof place on thePremises any ordinary "FOR LEASE" signs. Lessee may at any time place on orabout the Premises any ordinary "FOR SUBLEASE" sign. In the event of an emergency, the determination of which shall require Lessor to be reasonable, Lessor shall use good faith efforts to provide Lessee with reasonable notice insuch situation. In the event of any entry by Lessor onto the Premises, Lessor shall use in good faith efforts not to interfere with the conduct of Lessee's business.33. AUCTIONS. Lessee shall not conduct, nor permit to be conducted, anyauction upon the Premises without Lessor's prior written consent. Lessor shallnot be obligated to exercise any standard of reasonableness in determiningwhether to permit an auction.34. SIGNS. Except for ordinary "For Sublease" signs, Lessee shall not placeany sign upon the Premises without Lessor's prior written consent, which shall not be unreasonably withheld. All signs must comply with all Applicable Requirements. See Addendum Section 68.35. TERMINATION; MERGER. Unless specifically stated otherwise in writing byLessor, the voluntary or other surrender of this Lease by Lessee, the mutualtermination or cancellation hereof, or a termination hereof by Lessor for Breachby Lessee, shall automatically terminate any sublease or lesser estate in thePremises; provided, however, that Lessor may elect to continue any one or allexisting subtenancies. Lessor's failure within ten (10) days following any suchevent to elect to the contrary by written notice to the holder of any suchlesser interest, shall constitute Lessor's election to have such eventconstitute the termination of such interest.36. CONSENTS. Except as otherwise provided herein, wherever in this Leasethe consent of a Party is required to an act by or for the other Party, suchconsent shall not be unreasonably withheld or delayed. Lessor's actualreasonable costs and expenses (including, but not limited to, architects',attorneys', engineers' and other consultants' fees) incurred in theconsideration of, or response to, a request by Lessee for any Lessor consent,including, but not limited to, consents to an assignment, a subletting or thepresence or use of a Hazardous Substance, shall be paid by Lessee upon receiptof an invoice and supporting documentation therefor. Lessor's consent to anyact, assignment or subletting shall not constitute an acknowledgment that noDefault or Breach by Lessee of this Lease exists, nor shall such consent bedeemed a waiver of any then existing Default or Breach, except as may beotherwise specifically stated in writing by Lessor at the time of such consent.The failure to specify herein any particular condition to Lessor's consent shallnot preclude the imposition by Lessor at the time of consent of such further orother conditions as are then reasonable with reference to the particular matterfor which consent is being given. In the event that either Party disagrees withany determination made by the other hereunder and reasonably requests thereasons for such determination, the determining party shall furnish its reasonsin writing and in reasonable detail within ten (10) business days following suchrequest. Page 13 of 1538. QUIET POSSESSION. Subject to payment by Lessee of the Rent andperformance of all of the covenants, conditions and provisions on Lessee's partto be observed and performed under this Lease, Lessee shall have quietpossession and quiet enjoyment of the Premises during the term hereof.39. OPTIONS. 39.1 DEFINITION. "OPTION" shall mean: (a) the right to extend theterm of or renew this Lease or to extend or renew any lease that Lessee has onother property of Lessor; (b) the right of first refusal or first offer to leaseeither the Premises or other property of Lessor; (c) the right to purchase orthe right of first refusal to purchase the Premises or other property of Lessor. 39.2 OPTIONS PERSONAL TO ORIGINAL LESSEE. Each Option granted toLessee in this Lease is personal to the original Lessee, and cannot be assignedor exercised by anyone other than said original Lessee and only while theoriginal Lessee is in full possession of the Premises and, if requested byLessor, with Lessee certifying that Lessee has no intention of thereafterassigning or subletting. 39.3 MULTIPLE OPTIONS. In the event that Lessee has any multipleOptions to extend or renew this Lease, a later Option cannot be exercised unlessthe prior Options have been validly exercised. 39.4 EFFECT OF DEFAULT ON OPTIONS. (a) Lessee shall have no right to exercise an Option: (i) duringthe period commencing with the giving of any notice of Default and continuinguntil said Default is cured, (ii) during the period of time any Rent is unpaid(without regard to whether notice thereof is given Lessee), (iii) during thetime Lessee is in Breach of this Lease, or (iv) in the event that Lessee hasbeen given three (3) or more notices of separate Default, whether or not theDefaults are cured, during the twelve (12) month period immediately precedingthe exercise of the Option. (b) The period of time within which an Option may be exercisedshall not be extended or enlarged by reason of Lessee's inability to exercise anOption because of the provisions of Paragraph 39.4(a). (c) An Option shall terminate and be of no further force oreffect, notwithstanding Lessee's due and timely exercise of the Option, if,after such exercise and prior to the commencement of the extended term, (i)Lessee fails to pay Rent for a period of thirty (30) days after such Rentbecomes due (without any necessity of Lessor to give notice thereof), (ii)Lessor gives to Lessee three (3) or more notices of separate Default during anytwelve (12) month period, whether or not the Defaults are cured, or (iii) ifLessee commits a Breach of this Lease.40. MULTIPLE BUILDINGS. If the Premises are a part of a group of buildingscontrolled by Lessor, Lessee agrees that it will observe all reasonable rulesand regulations which Lessor may make from time to time for the management,safety, and care of said properties, including the care and cleanliness of thegrounds and including the parking, loading and unloading of vehicles, and thatLessee will pay its fair share of common expenses incurred in connectiontherewith.41. SECURITY MEASURES. Lessee hereby acknowledges that the rental payable toLessor hereunder does not include the cost of guard service or other securitymeasures, and that Lessor shall have no obligation whatsoever to provide same.Lessee assumes all responsibility for the protection of the Premises, Lessee,its agents and invitees and their property from the acts of third parties.42. RESERVATIONS. Lessor reserves to itself the right, from time to time, togrant, without the consent or joinder of Lessee, such easements, rights anddedications that Lessor deems necessary, and to cause the recordation of parcelmaps and restrictions, so long as such easements, rights, dedications, maps andrestrictions do not unreasonably interfere with the use of the Premises byLessee. Lessee agrees to sign any documents reasonably requested by Lessor toeffectuate any such easement rights, dedication, map or restrictions.43. PERFORMANCE UNDER PROTEST. If at any time a dispute shall arise as toany amount or sum of money to be paid by one Party to the other under theprovisions hereof, the Party against whom the obligation to pay the money isasserted shall have the right to make payment "under protest" and such paymentshall not be regarded as a voluntary payment and there shall survive the righton the part of said Party to institute suit for recovery of such sum. If itshall be adjudged that there was no legal obligation on the part of said Partyto pay such sum or any part thereof, said Party shall be entitled to recoversuch sum or so much thereof as it was not legally required to pay.44. AUTHORITY. If either Party hereto is a corporation, trust, limitedliability company, partnership, or similar entity, each individual executingthis Lease on behalf of such entity represents and warrants that he or she isduly authorized to execute and deliver this Lease on its behalf. Each Partyshall, within thirty (30) days after request, deliver to the other Partysatisfactory evidence of such authority.45. CONFLICT. Any conflict between the printed provisions of this Lease andthe typewritten or handwritten provisions shall be controlled by the typewrittenor handwritten provisions.46. OFFER. Preparation of this Lease by either Party or their agent andsubmission of same to the other Party shall not be deemed an offer to lease tothe other Party. This Lease is not intended to be binding until executed anddelivered by all Parties hereto.47. AMENDMENTS. This Lease may be modified only in writing, signed by theParties in interest at the time of the modification. As long as they do notmaterially change Lessee's obligations hereunder, Lessee agrees to make suchreasonable non-monetary modifications to this Lease as may be reasonablyrequired by a Lender in connection with the obtaining of normal financing orrefinancing of the Premises.48. MULTIPLE PARTIES. If more than one person or entity is named herein aseither Lessor or Lessee, such multiple Parties shall have joint and severalresponsibility to comply with the terms of this Lease.49. MEDIATION AND ARBITRATION OF DISPUTES. An Addendum requiring theMediation and/or the Arbitration of all disputes between the Parties and/orBrokers arising out of this Lease [ ] IS [X] IS NOT attached to this Lease.50. See Addendum 50.LESSOR AND LESSEE HAVE CAREFULLY READ AND REVIEWED THIS LEASE AND EACH TERM ANDPROVISION CONTAINED HEREIN, AND BY THE EXECUTION OF THIS LEASE SHOW THEIRINFORMED AND VOLUNTARY CONSENT THERETO. THE PARTIES HEREBY AGREE THAT, AT THETIME THIS LEASE IS EXECUTED, THE TERMS OF THIS LEASE ARE COMMERCIALLY REASONABLEAND EFFECTUATE THE INTENT AND PURPOSE OF LESSOR AND LESSEE WITH RESPECT TO THEPREMISES. Page 14 of 15________________________________________________________________________________ATTENTION: NO REPRESENTATION OR RECOMMENDATION IS MADE BY THE AMERICANINDUSTRIAL REAL ESTATE ASSOCIATION OR BY ANY BROKER AS TO THE LEGAL SUFFICIENCY,LEGAL EFFECT, OR TAX CONSEQUENCES OF THIS LEASE OR THE TRANSACTION TO WHICH ITRELATES. THE PARTIES ARE URGED TO:1. SEEK ADVICE OF COUNSEL AS TO THE LEGAL AND TAX CONSEQUENCES OF THIS LEASE.2. RETAIN APPROPRIATE CONSULTANTS TO REVIEW AND INVESTIGATE THE CONDITION OF THE PREMISES. SAID INVESTIGATION SHOULD INCLUDE BUT NOT BE LIMITED TO: THEPOSSIBLE PRESENCE OF HAZARDOUS SUBSTANCES, THE ZONING OF THE PREMISES, THESTRUCTURAL INTEGRITY, THE CONDITION OF THE ROOF AND OPERATING SYSTEMS, AND THESUITABILITY OF THE PREMISES FOR LESSEE'S INTENDED USE.WARNING: IF THE PREMISES IS LOCATED IN A STATE OTHER THAN CALIFORNIA, CERTAINPROVISIONS OF THE LEASE MAY NEED TO BE REVISED TO COMPLY WITH THE LAWS OF THESTATE IN WHICH THE PREMISES IS LOCATED.________________________________________________________________________________The parties hereto have executed this Lease at the place and on the datesspecified above their respective signatures.Executed at: Manhattan Beach, Executed at: Manhattan Beach, California California ------------------------- ---------------------------on: on: ---------------------------------- ------------------------------------By LESSOR: By LESSEE:MANHATTAN CORNERS, LLC SKECHERS U.S.A., INC.------------------------------------- ---------------------------------------------------------------------------- ---------------------------------------By: /s/ Kenneth R. Ziegler By: /s/ Michael Greenberg ---------------------------------- ------------------------------------Name Printed: Kenneth R. Ziegler Name Printed: Michael Greenberg ------------------------ --------------------------Title: General Manager Title: President ------------------------------- ---------------------------------By: By: /s/ Michael Greenberg ---------------------------------- ------------------------------------Name Printed: Name Printed: Michael Greenberg ------------------------ --------------------------Title: Title: President ------------------------------- ---------------------------------Address: 1104 Highland Avenue Address: 228 Manhattan Beach Boulevard ----------------------------- ------------------------------- Suite K Suite 200 ----------------------------- ------------------------------- Manhattan Beach, CA 90266 Manhattan Beach, CA 90266 ----------------------------- -------------------------------Telephone: (310) 798-7192 Telephone: (310) 318-3100 --- -------------------- --- ----------------------Facsimile: ( ) Facsimile: ( ) --- -------------------- --- ----------------------Federal ID No. Federal ID No. ----------------------- -------------------------NOTE: These forms are often modified to meet the changing requirements of law and industry needs. Always write or call to make sure you are utilizing the most current form: AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION, 700 So. Flower Street, Suite 600, Los Angeles, California 90017. (213) 687-8777. Fax No. (213) 687-8616 Page 15 of 15 ADDENDUM TO STANDARD INDUSTRIAL/COMMERCIAL SINGLE-TENANT LEASE-NET By and Between MANHATTAN CORNERS, LLC ("LESSOR") and SKECHERS U.S.A., INC. ("LESSEE")This Addendum is attached to and made a part of the STANDARDINDUSTRIAL/COMMERCIAL SINGLE TENANT LEASE-NET dated April 28, 2000, by andbetween the above-named Lessor and Lessee (the "Lease"). In the event of aconflict between any provision(s) contained in the Lease and any provision(s)contained in this Addendum, the provisions of this Addendum shall control.50. PREMISES. Lessee acknowledges that it is familiar with the condition of thePremises, and, subject to the provisions of Sections 2.2 and 2.3, covenants andagrees to accept the Premises in its condition and state of repair "as is". ThisLease confers upon Lessee no right either with regard to the subsurface of theland situated below the Premises or with regard to airspace above the top of theroof of the Premises. Within thirty (30) days following the delivery ofpossession of the Premises to Lessee, Lessee, at its sole cost and expense, maycause Lessee's floor area to be measured by a licensed architect using B.O.M.A.standards. In the event that such calculation reflects a deviation from thesquare footage set forth herein, and Lessor does not dispute the calculation,the parties shall amend the Lease to reflect the recalculated floor area and toproportionally adjust the Base Rent to Three Dollars ($3.00) per square foot(subject to adjustments as provided herein). If Lessor disputes Lessee'srecalculation by a licensed architect, then Lessor's architect and Lessee'sarchitect shall appoint a third duly-licensed architect to measure the floorarea in dispute. If the third architect's recalculation does not agree witheither of the two prior calculations, then the floor area shall be determined tobe the average of the middle measurement and the measurement closest to it. Thecost of the third architect will be paid one-half (1/2) by Lessor and one-half(1/2) by Lessee.51. COMMENCEMENT DATE/EARLY POSSESSION. (a) COMMENCEMENT DATE. The term of this Lease shall commence on the date("Commencement Date") which is seven (7) days after the date on which Lessor hasdelivered the Premises to Lessee substantially complete in accordance with theterms and provisions of Lessor's approved plans and specifications and for whichLessor shall have received all necessary building inspection approvals. ThePremises shall be delivered to Lessee in "vanilla shell" condition, subject tothe following: (i) not less than one ton of HVAC per 350 square feet of floorarea; (ii) not less than 200 amp electrical panel with 42 breakers; and (iii)walls to be unpainted masonry or drywall over stud, taped, sanded and ready forpaint. Lessor agrees to give Lessee a rent credit for the cost of purchase andinstallation of floor covering and light fixtures equal to $7,500.00. Lessoragrees to proceed with the completion of construction in a diligent manner, andto keep Lessee reasonably informed of its progress. If Lessor's work has notbeen substantially completed prior to November 1, 2000, then Lessee shall beentitled to terminate this Lease upon ten (10) days written notice and theopportunity to cure to Lessor, and to receive a refund of any and all amountspreviously paid by Lessee to Lessor. Lessee shall have a period of thirty (30)days after receipt of possession to provide Lessor with a list ("punch-list") ofany defective or incomplete items with respect to Lessor's work. Lessor willcure any items of defective or incomplete construction on the punch-list in adiligent manner, and if Lessor fails to do so, then following ten (10) days'written notice and the opportunity to cure, Lessee shall be entitled to completethe punch-list items at Lessor's expense. (b) EARLY POSSESSION. Lessor will not unreasonably withhold consent to arequest by Lessee for entry upon the Premises for purposes of inspections ortests or completing Lessee's approved alterations and improvements to thePremises, provided that Lessee's activities do not interfere with Lessor'sconstruction activity. Any early possession by Lessee shall be subject to theprovisions of Section 3.2 of the 1Lease, and before being granted possession, Lessee shall furnish Lessor with aCertificate of Insurance as called for herein.52. INSURANCE. (a) INCREASES IN PREMIUMS. Lessee agrees that it will not keep, use,sell or offer for sale in or upon the Premises any article which may beprohibited by any insurance policy in force at any time during the term hereofcovering the Premises. If Lessee's occupancy or conduct of business in thePremises, whether or not Lessor has consented to the same, results in anyincrease in premiums for the insurance carried from time to time by Lessorhereunder, Lessee shall pay any such increase in premiums within ten (10) daysafter being billed therefor by Lessor. In determining whether increased premiumsare a result of Lessee's use or occupancy of the Premises, a schedule issued bythe organization computing the insurance rate on the Premises showing thevarious components of such rate shall be conclusive evidence of the severalitems and charges which make up the rate. Lessee shall promptly comply with allreasonable requirements of the insurance authority or of any insurer now orhereafter in effect relating to the Premises. (b) CANCELLATION. If any insurance policy carried by Lessor hereundershall be canceled or cancellation shall be threatened or the coverage thereunderreduced or threatened to be reduced in any way by reason of Lessee's use or occupation of any portion of the Premises, or by any assignee or sublessee ofLessee or by anyone permitted by Lessee to be upon the premises, and if Lesseefails to remedy the condition giving rise to such cancellation, threatenedcancellation or reduction of coverage within 48 hours after notice thereof,Lessor may, at its option either terminate this Lease or enter upon the Premisesand attempt to remedy such conditions and Lessee shall forthwith pay the costthereof to the Lessor as additional rent. Lessor shall not be liable for anydamage or injury caused to Lessee's personal property or any other propertylocated in the Premises as a result of such entry. Whether or not Lessor shallbe able to remedy such condition, it shall nonetheless constitute the event of aDefault by Lessee. Notwithstanding the foregoing, Lessor shall have noobligation to remedy such Default. (c) LIABILITY INSURANCE. The liability insurance policy limits andcoverages set forth in paragraph 8 of this Lease may be increased by Lessor fromtime to time in such amounts as Lessor shall reasonably determine.53. EXCESSIVE DAMAGE OR DESTRUCTION. If there is either "Premises TotalDestruction" as defined in paragraph 9.1 (b) or if Lessor determines that itcannot, with reasonable diligence, fully repair or restore any partial damage tothe Premises within two hundred seventy (270) days after the date of the damageor destruction, notwithstanding Lessee's exercise of any right to repair, Lessormay terminate this Lease. Lessor shall reasonable determine whether there isPremises Total Destruction or whether full repair or restoration can be madewithin the 270-day period, and Lessor's good faith determination shall bebinding upon Lessee. Lessor shall notify Lessee of its determination, inwriting, within forty-five (45) days after the date of the damage ordestruction. If Lessor determines that the Premises can be fully repaired orrestored within the 270-day period, or if it is determined that such repair orrestoration cannot be made within said period or there is Premises TotalDestruction but Lessor does not elect to terminate within forty-five (45) daysfrom the date of said determination, this Lease shall remain in full force andeffect and Lessor shall repair and restore the damage as soon as reasonablypossible, subject to the provisions of Section 9. Provided that Lessee was not acause of the destruction, in the event that there occurs Premises TotalDestruction, Lessee may terminate the Lease upon written notice to Lessor nolater than thirty (30) days after such Premises Total Destruction. 254. ASSIGNMENT AND SUBLETTING. (a) BONUS RENTAL. If for any assignment or sublease, Lessee receivesrent or other consideration, either initially or over the term of the assignmentor sublease, in excess of the Base Rent called for hereunder, or in the event ofthe sublease or a portion of the Premises, in excess of such Base Rent fairlyallocable to such portion (and actual out-of-pocket brokerage fees expended byLessee in obtaining such assignment or sublease), Lessee shall pay to Lessor,monthly as additional rent hereunder, fifty percent (50%) of the excess of eachsuch payment of rent or other consideration received by Lessee within ten(10) days after its receipt. For purposes of this paragraph 54, the term "rentor other consideration" shall include, without limitation, all monies or otherconsideration of any kind, if such sums are related to Lessee's interest in theLease or in the Premises, including but not limited to bonus money, key moneyand similar payments. (b) SCOPE. Unless Lessor requires an attornment in the event of asublease pursuant to paragraph 12.3(b), at Lessor's option, any sublease shallterminate upon termination of the Lease due to Lessee's Breach and suchsubtenant shall immediately vacate the Premises upon such termination. IfLessee's obligations under this Lease have been guaranteed by third parties,then at Lessor's option, a sublease, and Lessor's consent thereto, shall not beeffective unless and until said guarantors give their written consent to suchsublease and the terms thereof. Lessee immediately and irrevocably assigns toLessor, as security for Lessee's obligations under this Lease, all rent from anysubletting of all or part of the Premises as permitted by this Lease, andLessor, as assignee and as attorney-in-fact for Lessee, or a receiver for Lesseeappointed on Lessor's application, may collect such rent and apply it towardLessee's obligations under this Lease; provided that, until the occurrence of anact of a Default by Lessee, Lessee shall have the right to collect such rent;and provided further that no such collection shall be construed to constitute anovation or release of Lessee from the further performance of Lessee'sobligations hereunder.55. LIABILITY OF LESSOR. Neither Lessor, Lessor's members, managers, employees,agents, any persons or entities comprising Lessor, nor any successor in interestto Lessor (or to such persons or entities) shall have any personal liability forany failure by Lessor to perform any term, covenant or condition of this Lease.If Lessor shall fail to perform any covenant, term or condition of this Leaseupon Lessor's part to be performed, and if as a consequence of such defaultLessee shall recover a money judgment against Lessor, such judgment shall besatisfied only out of the proceeds of sale received upon execution of suchjudgment and levied thereon against the right, title and interest of Lessor inthe Building or out of the consideration received by Lessor from the sale orother disposition of all or any part of Lessor's right, title and interest inthe Building, subject, nevertheless, to the rights of Lessor's mortgagee, andneither Lessor nor any of the parties or entities comprising Lessor herein shallbe liable for any deficiency. The foregoing limitation of liability shall benoted in any judgment secured against Lessor and in the judgment index.56. TRIPLE NET. This Lease is a triple net (net, net, net) Lease. In addition toBase Rent, as additional rent, Lessee shall also be responsible for and shallpay the insurance, maintenance and repair costs, property taxes, utilities andother costs associated with the Building, all as more fully set forth in thisLease.57. PLATE GLASS INSURANCE. The property insurance required to be maintained byLessee pursuant to paragraph 8.4 of this Lease shall include all-risk coverageof all plate glass on the Premises, with a deductible amount of no more than$250.00 per incident or loss. Lessee, at its own risk, may self-insure for suchplate glass coverage.58. ADDITIONAL RENT/PAYMENTS DUE. In addition to the monthly Base Rent, Lesseeshall also pay as additional rent, without deduction or offset, all othercharges, fees, costs, taxes, impositions, expenses and other sums required to bepaid by Lessee under this Lease whether or not the same is designated asadditional rent. Unless otherwise set forth in this Lease, any and all amountsrequired to be paid by Lessee 3to Lessor, whether or not defined as additional rent, shall be due no later thanthe date that is ten (10) days following the date Lessor gives written notice toLessee of the amount due. In the event of nonpayment of any additional rent orother sums when due, Lessor shall have all of the rights and remedies providedhereunder or by law for the nonpayment of Base Rent.59. RENTAL ADJUSTMENT. (a) On each anniversary of the Commencement Date of this Lease (the"Adjustment Date"), the monthly Base Rent payable by Lessee to Lessor for eachof the succeeding twelve (12) months shall be increased, subject to subparagraph(e) below, by an amount equal to the increase, if any, of the Consumer PriceIndex of the Bureau of Labor Statistics of the U.S. Department of Labor for AllUrban Consumers-All Items, Los Angeles-Anaheim-Riverside, California (1982-1984= 100) (hereinafter referred to as "CPI") which occurred over the twelve (12)consecutive month period ending two (2) months prior to the respectiveAdjustment Date (the "CPI Period"). (b) The CPI increase, if applicable, shall be determined by multiplyingthe Base Rent amount for the month preceding the respective Adjustment Date by afraction the numerator of which shall be the CPI for the calendar month two (2)months prior to the Adjustment Date and the denominator of which shall be theCPI for the same calendar month of the immediately preceding calendar year. (c) In the event the compilation and/or publication of the CPI shall betransferred to any other governmental department or bureau or agency or shall bediscontinued, then such conversion factor, formula or table selected by Lessorin good faith as may be published by any other nationally recognized publisherof similar statistical information shall be used. (d) Lessor shall, as promptly as practical following publication of therelevant month's CPI each year, given notice to Lessee of the adjustment andincrease in the monthly Base Rent as determined by Lessor pursuant to theprovisions of this paragraph 59, and Lessor's computation thereof (absentmathematical error) shall be conclusive and binding. (e) Notwithstanding the above provisions of this paragraph 59, theminimum increase in Base Rent on each Adjustment Date will be three percent(3%), and the maximum increase will be seven percent (7%). (f) In the event that Lessee exercises its option to extend the term ofthe Lease, then the Base Rent during the first year of the Option Period will bedetermined according to the provisions of paragraph 66. Thereafter, eachsubsequent anniversary of the Commencement Date shall be an Adjustment Date, andthe Base Rent shall be increased according to the same provisions as set forthin subparagraphs (a) through (e) above.60. INTERRUPTION OF LESSEE'S BUSINESS. Lessor shall not be liable in any mannerfor the interruption of, or damage or injury to, Lessee or any of itssublessees, or its or their respective businesses on the Premises arising from,indirectly or directly relating to, or because of any construction, repair ormaintenance work by Lessor.61. NO BROKERS. Each party warrants and represents that there was no broker oragent representing it who was instrumental in consummating this Lease. Eachparty agrees to indemnify and hold the other party harmless against any claimsfor brokerage or other commissions arising by reason of a breach by theindemnifying party of this representation and warranty. 462. TRANSFER BY LESSOR. Lessor hereunder shall have the right to freely assignthis Lease without the consent of Lessee.63. NO PARTNERSHIP. Notwithstanding anything else to the contrary, Lessor shallnot be deemed to be a partner of Lessee or a joint venturer with Lessee.64. WAIVER OF COUNTERCLAIMS. Lessee shall not impose any counterclaim orcounterclaims in a summary proceeding or other action based on termination orholdover, it being the intent of the parties hereto that Lessee be strictlylimited in such instance to bringing a separate action in the court ofappropriate jurisdiction. The foregoing waiver is a material inducement toLessor making, executing and delivering this Lease and Lessee's waiver of itsright to counterclaim in any summary proceeding or other action based ontermination or holdover is done so knowingly, intelligently and voluntarily.65. WAIVER OF JURY TRIAL. Lessor and Lessee hereby waive trial by jury in anyaction, proceeding or counterclaim brought by either of the parties heretoagainst the other on, or in respect of, any matter whatsoever arising out of orin any way connected with this Lease, the relationship of Lessor and Lesseehereunder, Lessee's use or occupancy of the Premises and/or any claim of injuryor damage.66. OPTION TO EXTEND. Lessor hereby grants to Lessee the option to extend theterm of this Lease for one (1) additional five (5) year period (the "OptionTerm"), commencing when the initial term of the Lease expires, upon each and allof the following terms and conditions: (a) In order to exercise an option to extend, Lessee must give writtennotice by personal delivery or certified mail, return receipt requested, of suchelection to Lessor at least four (4) but not more than six (6) months prior tothe date that the option period would commence, time being of the essence. Ifproper notification of the exercise of an option is not given and/or received,such option shall automatically expire. (b) The provisions of paragraph 39, including those relating to Lessee'sDefault set forth in paragraph 39.4 of this Lease, are conditions of thisoption. (c) Except for the provisions of this Lease granting an option oroptions to extend the term, all of the terms and conditions of this Lease exceptwhere specifically modified by this option shall apply. (d) This option is personal to the original Lessee, and cannot beassigned or exercised by anyone other than said original Lessee and only whilethe original Lessee is in full possession of the Premises and without theintention of thereafter assigning or subletting. (e) On the date that the Option Term commences (the "Market Rental ValueAdjustment Date"), the Base Rent shall be adjusted to the "Market Rental Value"("MRV") of the Premises as follows: (i) In determining Market Rental Value, the parties will seek toestablish the fair market rental value for the Premises, without considerationof new tenant inducements, broker commissions, or construction allowances. (ii) Four (4) months prior to the Market Rental Value AdjustmentDate, the parties shall attempt to agree upon what the new MRV will be on theadjustment date. If agreement cannot be reached within thirty (30) days, thenLessor and Lessee shall immediately appoint a mutually acceptable appraiser orbroker to establish the new MRV within the next thirty (30) days. Any associatedcosts will be split equally between the parties. If the parties are unable toagree upon either the MRV or on a single appraiser, then 5Lessor and Lessee shall each immediately make a reasonable determination of theMRV and submit such determination, in writing, to arbitration in accordance withthe following provisions: a) Within fifteen (15) days thereafter, Lessor and Lesseeshall each select a licensed appraiser or real estate broker actively engaged inbusiness and with substantial experience in the Manhattan Beach commercialmarket ("Consultant") of their choice to act as an arbitrator. The twoarbitrators so appointed shall immediately select a third mutually acceptableConsultant to act as a third arbitrator. b) The three arbitrators shall within thirty (30) days ofthe appointment of the third arbitrator reach a decision as to what the actualMRV for the Premises is, and whether Lessor's or Lessee's submitted MRV is theclosest thereto. The decision of a majority of the arbitrators shall be bindingon the parties. The submitted MRV which is determined to be the closest to theactual MRV shall thereafter be used by the parties. c) If either of the parties fails to appoint an arbitratorwithin the specified fifteen (15) days, the arbitrator timely appointed by oneof them shall reach a decision on his/her own, and said decision shall bebinding on the parties. d) The entire cost of such arbitration shall be paid by theparty whose submitted MRV is not selected, i.e., the one that is NOT the closestto the actual MRV. (iii) Notwithstanding the foregoing, the new MRV shall not beless than the rent payable for the month immediately preceding the rentadjustment.67. Maintenance by Lessor. Except for damage caused by Lessee, its agents,employees or contractors (which shall be Lessee's sole responsibility), Lessorshall, at Lessor's sole expense, keep the exterior walls, (excludingstorefronts, windows, doors, plate glass, window casements, and glazing)foundations and structural components of the roof in good order, condition andrepair.68. Signage. Subject to Lessee's obtaining all necessary governmental approvalstherefor, Lessor will not unreasonably withhold its consent to Lessee'sinstallation and maintenance of all signage permitted by the City of ManhattanBeach on the Premises. All such signage shall be installed and maintained atLessee's sole cost and expense, and shall be designed, constructed and installedin a professional manner. Lessee shall have no right to place any signage uponthe roof of the Premises.69. General Rules of Construction. (a) This Lease may be executed in several counterparts and thecounterparts shall constitute one and the same instrument. (b) Lessor may act under this Lease by its attorney or agent. (c) Wherever a requirement is imposed on Lessee hereunder, Lessee shallbe required to perform such requirement at its sole cost and expense unless itis specifically otherwise provided herein. (d) (i) Wherever appropriate herein, the singular includes the pluraland the plural includes the singular (ii) whenever the word "including" is usedherein, it shall be deemed to mean "including, but not limited to"; (iii) thewords "re-enter" and "re-entry" as used herein shall not be restricted to theirtechnical legal meaning. (e) Anything in this Lease to the contrary notwithstanding: (i) anyprovision hereof which permits or requires a party to take any particular actionshall be deemed to permit or require, as the case may be, 6such party to cause such action to be taken; and (ii) any provision hereof whichrequires any party not to take any particular action shall be deemed to requiresuch party to prevent such action to be taken by any person or by operation oflaw.The parties hereto have executed this Addendum as of the date of execution ofthe Lease.By LESSOR: By LESSEE:MANHATTAN CORNERS, LLC SKECHERS U.S.A., INC.By: /s/ KENNETH R. ZIEGLER By: /s/ [SIGNATURE UNINTELLIGIBLE] ---------------------------- ------------------------------- KENNETH R. ZIEGLER, Managing Member Its: President ------------------------------- By: /s/ [SIGNATURE UNINTELLIGIBLE] ------------------------------- Its: President -------------------------------f.j.a.Manhattan Comers Sketchers Lease Addendum 7 EXHIBIT 10.28 [California Net Lease] LEASE AGREEMENT THIS LEASE AGREEMENT is made this 10th day of April, 2001, betweenProLogis California I LLC, a Delaware limited liability company ("Landlord"),and the Tenant named below.TENANT: Skechers U.S.A., Inc., a Delaware corporationTENANT'S REPRESENTATIVE, Paul GalliherADDRESS, AND PHONE NO.: 228 Manhattan Beach Blvd. Manhattan Beach, CA 90266PREMISES: That certain Building, containing approximately 763,228 rentable square feet, as determined by Landlord's architect, as shown on Exhibit A.PROJECT: Milliken Distribution Center #1BUILDING: Milliken Distribution Center #1 4100 E. Mission Blvd. Ontario, CA 91761TENANT'S PROPORTIONATESHARE OF PROJECT: 100.000%TENANT'S PROPORTIONATESHARE OF BUILDING: 100.000%LEASE TERM: Beginning on the Commencement Date and ending on the last day of the 120th full calendar month thereafter.COMMENCEMENT DATE: The day following the Rejection Date as defined in the Stipulation Regarding Rejection of Ontario Lease, Including Mutual Releases as described in Exhibit D attached hereto and pursuant to the provisions of Addendum 4INITIAL MONTHLY BASE RENT: See Addendum 1INITIAL ESTIMATED MONTHLY 1. Utilities: $0.00OPERATING EXPENSE PAYMENTS:(estimates only and subject 2. Common Area Charges: $5,343.00to adjustment to actual costsand expenses according to the 3. Taxes: $24,958.00provisions of this Lease) 4. Insurance: $2,900.00 5. Others: Mgmt Fee $3,816.00INITIAL ESTIMATED MONTHLY OPERATING EXPENSE PAYMENTS: $37,017.00INITIAL MONTHLY BASE RENT AND OPERATING EXPENSE PAYMENTS: $254,537.00SECURITY DEPOSIT: $250,000.00BROKER: CB Richard Ellis, Lee & AssociatesADDENDA: 1. Base Rent Adjustments 2. Construction (Allowance) 3. Two Renewal Options (Baseball Arbitration) 4. Miscellaneous ProvisionsEXHIBITS: A. Site Plan; B. Front Entrance Sign; C. Monument Sign; D. Name Sign; E. Stipulation Regarding Rejection of Ontario Lease, Including Mutual Releases 1. GRANTING CLAUSE. In consideration of the obligation of Tenant topay rent as herein provided and in consideration of the other terms, covenants,and conditions hereof, Landlord leases to Tenant, and Tenant takes fromLandlord, the Premises, to have and to hold for the Lease Term, subject to theterms, covenants and conditions of this Lease. 2. ACCEPTANCE OF PREMISES. Except as otherwise set forth in theLease, Tenant shall accept the Premises in its condition as of the CommencementDate, subject to all applicable laws, ordinances, regulations, covenants andrestrictions. Landlord has made no representation or warranty as to thesuitability of the Premises for the conduct of Tenant's business, and Tenantwaives any implied warranty that the Premises are suitable for Tenant's intendedpurposes. Except as otherwise set forth in the Lease, in no event shall Landlordhave any obligation for any defects in the Premises or any limitation on itsuse. The taking of possession of the Premises shall be conclusive evidence thatTenant accepts the Premises and that the Premises were in good condition at thetime possession was taken except for items that are Landlord's responsibilityunder the Lease and any punchlist items agreed to in writing by Landlord andTenant. Landlord, to its knowledge, represents and warrants that as of theCommencement Date (i) Landlord is unaware of any material defect or infirmityadversely affecting the Premises, (ii) Landlord is currently not the subject ofany bankruptcy or insolvency proceeding, (iii) to Landlord's knowledge withoutfurther inquiry, the Premises shall be in compliance with all Legal Requirements(hereinafter defined) in effect as of the Commencement Date of this Lease, (iv)Landlord has fee simple title to the Premisesand Landlord has full power, right and authority to execute and perform thisLease and all corporate action necessary to do so has been duly taken, and (v)the zoning for the Premises is designated "planned industrial" by the OntarioGeneral Plan under the Bridgestone/Firestone Industrial Park Specific Plan datedMarch, 1997, as revised May 14, 1997. Landlord warrants that the existing electrical, plumbing, firesprinkler, lighting, heating, ventilating and air conditioning systems ("HVAC"),loading doors, if any, and all other such building and mechanical systemsservicing the Premises, other than those constructed by Tenant, shall be in goodoperating condition on the Commencement Date, and that, subject to adverseweather conditions in which case the provisions of Paragraph 15 shall apply, thesurface of the roof and structural elements of the roof, bearing walls andfoundation of the Building shall be free of material defects on the CommencementDate. Landlord shall warrant the HVAC system for the first 90 days following theCommencement Date, and shall further warrant all other building and mechanicalsystems servicing the Premises for the first 30 days following the CommencementDate. Landlord shall be obligated for any and all repairs to such systems duringsuch warranty periods at no cost to Tenant. 3. USE. The Premises shall be used only for the purpose ofreceiving, storing, packaging, shipping and selling (but limited to wholesalesales) products, materials and merchandise made and/or distributed by Tenant andfor such other lawful purposes as may be incidental thereto; provided, however,with Landlord's prior written consent, Tenant may also use the Premises forlight manufacturing. Tenant shall not conduct or give notice of any auction,liquidation, or going out of business sale on the Premises, without Landlord'sprior written consent which shall not be unreasonably withheld or delayed.Tenant will use the Premises in a careful, safe and proper manner and will notcommit waste, overload the floor or structure of the Premises or subject thePremises to use that would damage the Premises. Tenant shall not permit anyobjectionable or unpleasant odors, smoke, dust, gas, noise, or vibrations toemanate from the Premises, or take any other action that would constitute anuisance or would disturb, unreasonably interfere with, or endanger Landlord orany tenants of the Project. For purposes of the preceding sentence, noise orvibrations from Tenant's material handling system shall not be considered"objectionable" by Landlord. Outside storage, including without limitation,storage of non-operable trucks and other non-operable vehicles, is prohibitedwithout Landlord's prior written consent; provided, however, that subject toapplicable Legal Requirements, Tenant shall be permitted to park trucks andtrailers used in Tenant's business operations on and from the Premises overnightat the truck docks of the Premises and Tenant's customers shall be permitted topark their vehicles overnight from time to time in the parking areas of thePremises, provided such customer's vehicles and such trucks and trailers are atall times in operable condition and there is no interference with the ingressand egress of the Project, and provided, further, that subject to applicableLegal Requirements, Tenant may store pallets, corrugated packaging supplies andother similar shipping and storage supplies outside of the Premises in a fencedlocation as mutually agreed to by Landlord and Tenant, so long as such storageis conducted in a neat and orderly fashion. Except as otherwise set forth in theLease, Tenant, at its sole expense, shall use and occupy the Premises incompliance with all laws, including, without limitation, the Americans WithDisabilities Act, orders, judgments, ordinances, regulations, codes, directives,permits, licenses, covenants and restrictions now or hereafter applicable to thePremises (collectively, "Legal Requirements"). Tenant shall, at its expense,make any alterations or modifications, within or without the Premises, that arerequired by Legal Requirements related to Tenant's specific use or occupation ofthe Premises. Tenant will not use or permit the Premises to be used for anypurpose or in any manner that would void Tenant's or Landlord's insurance,increase the insurance risk, or cause the disallowance of any sprinkler credits.If any increase in the cost of any insurance on the Premises or the Project iscaused by Tenant's use or occupation of the Premises, or because Tenant vacatesthe Premises, then Tenant shall pay the amount of such increase to Landlord. Anyoccupation of the Premises by Tenant prior to the Commencement Date shall besubject to all obligations of Tenant under this Lease. Notwithstanding anything contained herein to the contrary,Tenant's obligations hereunder shall relate only to the interior of the Premisesand any changes to the Premises, the Building, or the Project that relate solelyto the specific manner of use of the Premises by Tenant; and Landlord shall makeall other additions to or modifications of the Project required from time totime by Legal Requirements. The cost of such additions or modifications made byLandlord shall be included in Operating Expenses pursuant to Paragraph 6 of thisLease, except for those additions or modifications which are Landlord's soleresponsibility pursuant to the provisions of this Lease. Landlord represents that the improvements constructed orinstalled by Landlord pursuant to the Construction Addendum attached to thisLease shall comply in all material respects with all applicable covenants orrestrictions of record and all applicable laws, building codes, regulations andordinances in effect on the Commencement Date of this Lease. Notwithstanding anything contained herein to the contrary,Landlord shall make such modifications as may be required by order or directiveof applicable governmental authority in order to bring the Building intocompliance with applicable laws as of the Commencement Date without cost orexpense to Tenant and without including such cost or expense as an OperatingExpense. Any modifications made by Landlord that are required by applicable lawsor regulations that become effective after the Commencement Date shall beincluded in Operating Expenses pursuant to Paragraph 6 of this Lease, except forthose additions or modifications which are Landlord's sole responsibilitypursuant to the provisions of this Lease, or that are required as a result ofthe Tenant's use of the Premises shall be chargeable to Tenant at its sole costand expense pursuant to the provisions of this Lease. -2- 4. BASE RENT. Tenant shall pay Base Rent in the amount set forthabove. The first month's Base Rent and the first monthly installment ofestimated Operating Expenses (as hereafter defined) shall be due and payable onthe date hereof, and Tenant promises to pay to Landlord in advance, withoutdemand, deduction or set-off, monthly installments of Base Rent on or before thefirst day of each calendar month succeeding the Commencement Date. Payments ofBase Rent for any fractional calendar month shall be prorated. All paymentsrequired to be made by Tenant to Landlord hereunder shall be payable at suchaddress as Landlord may specify from time to time by written notice delivered inaccordance herewith. The obligation of Tenant to pay Base Rent and other sums toLandlord and the obligations of Landlord under this Lease are independentobligations. Tenant shall have no right at any time to abate, reduce, or set-offany rent due hereunder except as may be expressly provided in this Lease. IfTenant is delinquent in any monthly installment of Base Rent or of estimatedOperating Expenses for more than 10 days, Tenant shall pay to Landlord on demanda late charge equal to 5 percent of such delinquent sum. The provision for suchlate charge shall be in addition to all of Landlord's other rights and remedieshereunder or at law and shall not be construed as a penalty. 5. SECURITY DEPOSIT. The Security Deposit shall be due and payableon or before the Commencement Date of this Lease, and shall be held by Landlordas security for the performance of Tenant's obligations under this Lease. TheSecurity Deposit is not an advance rental deposit or a measure of Landlord'sdamages in case of Tenant's default. Upon each occurrence of an Event of Default(hereinafter defined), Landlord may use all or part of the Security Deposit topay delinquent payments due under this Lease, and the cost of any damage,injury, expense or liability caused by such Event of Default, without prejudiceto any other remedy provided herein or provided by law. Tenant shall payLandlord on demand the amount that will restore the Security Deposit to itsoriginal amount. Landlord's obligation respecting the Security Deposit is thatof a debtor, not a trustee. If the Security Deposit is in the form of a cash sumpayment, interest will accrue on the Security Deposit, for the benefit of theTenant, at an annual rate equal to the savings account rate in effect atNationsBank N.A. as of the Commencement Date and adjusted annually, and suchinterest shall be paid to Tenant on an annual basis. The Security Deposit shallbe the property of Landlord, but shall be paid to Tenant when Tenant'sobligations under this Lease have been completely fulfilled. Landlord shall bereleased from any obligation with respect to the Security Deposit upon transferof this Lease and the Premises to a person or entity assuming Landlord'sobligations under this Paragraph 5. 6. OPERATING EXPENSE PAYMENTS. During each month of the Lease Term,on the same date that Base Rent is due, Tenant shall pay Landlord an amountequal to 1/12 of the annual cost, as estimated by Landlord from time to time, ofTenant's Proportionate Share (hereinafter defined) of Operating Expenses for theProject. Payments thereof for any fractional calendar month shall be prorated.The term "Operating Expenses" means all costs and expenses incurred by Landlordwith respect to the ownership, maintenance, and operation of the Projectincluding, but not limited to costs of: Taxes (hereinafter defined) and feespayable to tax consultants and attorneys for consultation and contesting taxes;insurance; utilities; maintenance, repair and replacement of all portions of theProject, including without limitation, paving and parking areas, roads, roofs(including the roof membrane), alleys, and driveways, mowing, landscaping,exterior painting, utility lines, heating, ventilation and air conditioningsystems, lighting, electrical systems and other mechanical and building systems;amounts paid to contractors and subcontractors for work or services performed inconnection with any of the foregoing; charges or assessments of any associationto which the Project is subject; property management fees payable to a propertymanager, including any affiliate of Landlord calculated at $0.06 ps.f. perannum; security services, if any; trash collection, sweeping and removal; andadditions or alterations made by Landlord to the Project or the Building inorder to comply with Legal Requirements enacted after the Commencement Date(other than those expressly required herein to be made by Tenant or Landlord) orthat are appropriate to the continued operation of the Project or the Buildingas a bulk warehouse facility in the market area. The cost of additions oralterations or repairs that are required to be capitalized for federal incometax purposes shall be amortized on a straight line basis over a period equal tothe useful life thereof for federal income tax purposes. Operating Expenses donot include costs, expenses, depreciation or amortization for capital repairsand capital replacements required to be made by Landlord under Paragraph 10 ofthis Lease, debt service under mortgages or ground rent under ground leases,costs of restoration to the extent of net insurance proceeds received byLandlord with respect thereto, leasing commissions, or the costs of renovatingspace for tenants. Further, Operating Expenses shall not mean or include: (i)costs incurred in connection with the construction or remodeling of the Projector any other improvements now or hereafter located thereon, correction ofdefects in design or construction; (ii) interest, principal, or other paymentson account of any indebtedness that is secured by any encumbrance on any part ofthe Project, or rental or other payments under any ground lease, or any paymentsin the nature of returns on or of equity of any kind; (iii) costs of selling,syndicating, financing, mortgaging or hypothecating any part of or interest inthe Project; (iv) taxes on the income of Landlord or Landlord's franchise taxes(unless any of said taxes are hereafter instituted by applicable taxingauthorities in substitution for ad valorem real property taxes); (v)depreciation; (vi) Landlord's overhead costs, including equipment, supplies,accounting and legal fees, rent and other occupancy costs or any other costsassociated with the operation or internal organization and function of Landlordas a business entity (but this provision does not prevent the payment of amanagement fee to Landlord as provided in this Paragraph 6); (vii) fees or othercosts for professional services provided by space planners, architects,engineers, and other similar professional consultants, real estate commissions,and marketing and advertising expenses; (viii) costs of defending or prosecutinglitigation with any party, unless a favorable judgment would reduce or avoid anincrease in Operating Expenses, or unless the litigation is to enforcecompliance with Rules and Regulations of the Project, or other standards orrequirements for the general benefit of the tenants in the Project; (ix) costsincurred as a result of Landlord's violation or breach of this Lease or of anyother lease, contract, law or ordinance, including fines and penalties; (x) latecharges, interest or penalties of any kind for late or other improper payment ofany public or private obligation, including ad valorem taxes; (xi) costs ofremoving Hazardous Materials or of correcting any other conditions in order -3-to comply with any environmental law or ordinance (but this exclusion shall notconstitute a release by Landlord of Tenant for any such costs for which Tenantis liable pursuant to Paragraph 30 of this Lease); (xii) costs for whichLandlord is reimbursed from any other source; (xiii) costs related to anybuilding or land not included in the Project, including any allocation of costsincurred on a shared basis, such as centralized accounting costs, unless theallocation is made on a reasonable and consistent basis that fairly reflects theshare of costs actually attributable to the Project; (xiv) the part of any costsor other sum paid to any affiliate of Landlord that may exceed the fair marketprice or cost generally payable for substantially similar goods or services inthe area of the Project; (xv) bad debt expenses; (xvi) costs arising fromLandlord's charitable or political contributions, if any; and (xvii) the cost ofLandlord's compliance with the provisions of Paragraphs 2, 3, 10 and 15 hereof,or any other costs which are charged to Landlord and not to be borne by Tenantunder the terms of the Lease. Notwithstanding anything contained herein to the contrary, theproperty management fees payable to a property manager, including any affiliateof Landlord as set forth in this Paragraph 6 shall not exceed $0.06 p.s.f. perannum throughout the initial Lease Term. Landlord shall provide Tenant within 90 days following the finalday of the calendar year Landlord's itemized year-end common area maintenancereconciliation reports which reference and include all applicable OperatingExpenses for such year. Upon Tenant's written request (which request shall belimited to once in a calendar year), Landlord shall provide photocopies ofinvoices, bills and other verification to substantiate such costs. If Tenant'stotal payments of Operating Expenses for any year are less than Tenant'sProportionate Share of actual Operating Expenses for such year, then Tenantshall pay the difference to Landlord within 30 days after demand, and if more,then Landlord shall retain such excess and credit it against Tenant's nextpayments. For purposes of calculating Tenant's Proportionate Share of OperatingExpenses, a year shall mean a calendar year except the first year, which shallbegin on the Commencement Date, and the last year, which shall end on theexpiration of this Lease. With respect to Operating Expenses which Landlordallocates to the entire Project, Tenant's "Proportionate Share" shall be thepercentage set forth on the first page of this Lease as Tenant's ProportionateShare of the Project as reasonably adjusted by Landlord in the future forchanges in the physical size of the Premises or the Project; and, with respectto Operating Expenses which Landlord allocates only to the Building, Tenant's"Proportionate Share" shall be the percentage set forth on the first page ofthis Lease as Tenant's Proportionate Share of the Building as reasonablyadjusted by Landlord in the future for changes in the physical size of thePremises or the Building. Landlord may equitably increase Tenant's ProportionateShare for any item of expense or cost reimbursable by Tenant that relates to arepair, replacement, or service that benefits only the Premises or only aportion of the Project or Building that includes the Premises or that varieswith occupancy or use. The estimated Operating Expenses for the Premises setforth on the first page of this Lease are only estimates, and Landlord makes noguaranty or warranty that such estimates will be accurate. 7. UTILITIES. Tenant shall pay for all water, gas, electricity,heat, light, power, telephone, sewer, sprinkler services, refuse and trashcollection, and other utilities and services used on the Premises, allmaintenance charges for utilities, and any storm sewer charges or other similarcharges for utilities imposed by any governmental entity or utility provider,together with any taxes, penalties, surcharges or the like pertaining toTenant's use of the Premises. All utilities shall be separately metered orcharged directly to Tenant by the provider. No interruption or failure ofutilities shall result in the termination of this Lease or the abatement ofrent. 8. TAXES. Landlord shall pay all taxes, assessments and governmentalcharges (collectively referred to as "Taxes") that accrue against the Projectduring the Lease Term, which shall be included as part of the Operating Expensescharged to Tenant. Landlord may contest by appropriate legal proceedings theamount, validity, or application of any Taxes or liens thereof. If Landlordfails to contest the real estate taxes, Tenant shall have the right to requestLandlord to contest such taxes, and Landlord shall so contest, at Tenant's solecost and expense (including, without limitation, Landlord's reasonableattorneys' fees and reasonable fees payable to tax consultants and attorneys forconsultation and contesting taxes) , if, in Landlord's reasonable judgment, suchcontest is warranted; provided, however, Tenant's request of such contesting ofTaxes shall be limited to one request in a calendar year. Landlord shallcooperate in the institution and prosecution of any such proceedings ofcontesting taxes and will execute any documents reasonably required therefor.All reductions, refunds, or rebates of Taxes paid or payable by Tenant shallbelong to Tenant whether as a consequence of a Tenant proceeding or otherwise.All capital levies or other taxes assessed or imposed on Landlord upon the rentspayable to Landlord under this Lease and any franchise tax, any excise,transaction, sales or privilege tax, assessment, levy or charge measured by orbased, in whole or in part, upon such rents from the Premises and/or the Projector any portion thereof shall be paid by Tenant to Landlord monthly in estimatedinstallments or upon demand, at the option of Landlord, as additional rent;provided, however, in no event shall Tenant be liable for any net income taxesimposed on Landlord unless such net income taxes are in substitution for anyTaxes payable hereunder. If any such tax or excise is levied or assesseddirectly against Tenant, then Tenant shall be responsible for and shall pay thesame at such times and in such manner as the taxing authority shall require.Tenant shall be liable for all taxes levied or assessed against any personalproperty or fixtures placed in the Premises, whether levied or assessed againstLandlord or Tenant. 9. INSURANCE. Landlord shall maintain all risk property insurancecovering the full replacement cost of the Building. Landlord may, but is notobligated to, maintain such other insurance and additional coverages as it maydeem necessary, including, but not limited to, commercial liability insuranceand rent loss insurance. All such insurance shall be included as part of theOperating Expenses charged to Tenant. The Project or Building may be included ina blanket policy (in which case the cost of such insurance allocable to theProject or Building will be determined by Landlord based upon the insurer's costcalculations). Tenant shall also reimburse Landlord for any -4-increased premiums or additional insurance which Landlord reasonably deemsnecessary as a result of Tenant's use of the Premises. Tenant, at its expense, shall maintain during the Lease Term: allrisk property insurance covering the full replacement cost of all property andimprovements installed or placed in the Premises by Tenant at Tenant's expense;worker's compensation insurance with no less than the minimum limits required bylaw; employer's liability insurance with such limits as required by law; andcommercial liability insurance, with a minimum limit of $1,000,000 peroccurrence and a minimum umbrella limit of $1,000,000, for a total minimumcombined general liability and umbrella limit of $2,000,000 (together with suchadditional umbrella coverage as Landlord may reasonably require) for propertydamage, personal injuries, or deaths of persons occurring in or about thePremises. Landlord may from time to time require reasonable increases in anysuch limits. The commercial liability policies shall name Landlord as anadditional insured, insure on an occurrence and not a claims-made basis, beissued by insurance companies which are reasonably acceptable to Landlord, notbe cancelable unless 30 days' prior written notice shall have been given toLandlord, contain a hostile fire endorsement and a contractual liabilityendorsement and provide primary coverage to Landlord (any policy issued toLandlord providing duplicate or similar coverage shall be deemed excess overTenant's policies). Such policies or certificates thereof shall be delivered toLandlord by Tenant upon commencement of the Lease Term and upon each renewal ofsaid insurance. The all risk property insurance obtained by Landlord and Tenantshall include a waiver of subrogation by the insurers and all rights based uponan assignment from its insured, against Landlord or Tenant, their officers,directors, employees, managers, agents, invitees and contractors, in connectionwith any loss or damage thereby insured against. Neither party nor its officers,directors, employees, managers, agents, invitees or contractors shall be liableto the other for loss or damage caused by any risk coverable by all riskproperty insurance, and each party waives any claims against the other party,and its officers, directors, employees, managers, agents, invitees andcontractors for such loss or damage. The failure of a party to insure itsproperty shall not void this waiver. Landlord and its agents, employees andcontractors shall not be liable for, and Tenant hereby waives all claims againstsuch parties for, business interruption and losses occasioned thereby sustainedby Tenant or any person claiming through Tenant resulting from any accident oroccurrence in or upon the Premises or the Project from any cause whatsoever,including without limitation, damage caused in whole or in part, directly orindirectly, by the negligence of Landlord or its agents, employees orcontractors. Tenant and its subtenants, assignees, invitees, employees,contractors and agents shall not be liable for, and Landlord hereby waives allclaims against Tenant and its subtenants, assignees, invitees, employees,contractors and agents for damage to property sustained by Landlord or anyperson claiming through Landlord resulting from any accident or occurrence in orupon the Premises or in or about the Project from any cause whatsoever,including, without limitation, damage caused in whole or in part, directly orindirectly, by the negligence of Tenant or its subtenants, assignees, invitees,employees, contractors or agents; provided, however, such waiver shall onlyapply to claims in excess of the commercially reasonable deductible underLandlord's insurance policy. 10. LANDLORD'S REPAIRS. Landlord shall maintain, at its expense, thestructural components of the roof, foundation, footings, floor and exteriorwalls of the Building in good repair, reasonable wear and tear and uninsuredlosses and damages caused by Tenant, its agents and contractors excluded. Theterm "walls" as used in this Paragraph 10 shall not include windows, glass orplate glass, doors or overhead doors, special store fronts, dock bumpers, dockplates or levelers, or office entries. Tenant shall promptly give Landlordwritten notice of any repair required by Landlord pursuant to this Paragraph 10,after which Landlord shall have a reasonable opportunity to repair. In the event of an emergency, Tenant shall have the right to makesuch temporary, emergency repairs (and only such temporary, emergency repairs)to the roof, foundation or exterior walls of the Project as may be reasonablynecessary to prevent material damage to Tenant's property at the Premises and/orpersonal injury to Tenant's employees at the Premises (provided Tenant firstattempts to notify Landlord telephonically of such emergency and notifiesLandlord of such circumstances in writing as soon as practicable thereafter). Insuch event, Landlord shall reimburse Tenant for the reasonable, out-of-pocketcosts actually incurred by Tenant in making such repairs. If Landlord fails toreimburse Tenant for the reasonable, out-of-pocket costs incurred by Tenant inmaking such repairs, up to but not to exceed $25,000.00 with respect to suchemergency, within 30 days after demand therefor, accompanied by supportingevidence of the costs incurred by Tenant, then Tenant may bring an action fordamages against Landlord to recover such costs, together with interest thereofat the rate provided for in Paragraph 37(j) of the Lease, and reasonableattorney's fees incurred by Tenant in bringing such action for damages. In noevent, however, shall Tenant have a right to terminate the Lease. 11. TENANT'S REPAIRS. Landlord, at Tenant's expense as provided inParagraph 6, shall maintain in good repair and condition the parking areas andother common areas of the Building, including, but not limited to driveways,alleys, landscape and grounds surrounding the Premises. Subject to Landlord'sobligations as set forth in this Lease and subject to Paragraphs 9 and 15,Tenant, at its expense, shall repair, replace and maintain in good condition allportions of the Premises and all areas, improvements and systems exclusivelyserving the Premises including, without limitation, dock and loading areas,truck doors, plumbing, water and sewer lines up to points of common connection,fire sprinklers and fire protection systems, entries, doors, ceilings, windows,interior walls, and the interior side of demising walls, and heating,ventilation and air conditioning systems. Such repair and replacements includecapital expenditures and repairs whose benefit may extend beyond the Term.Heating, ventilation and air conditioning systems and fire sprinklers and fireprotection systems serving the Premises shall be maintained at Tenant's expensepursuant to maintenance service contracts entered into by Tenant. The scope ofservices and -5-contractors under such maintenance contracts shall be reasonably approved byLandlord. If Tenant fails to perform any repair or replacement for which it isresponsible, Landlord may perform such work and be reimbursed by Tenant within10 days after demand therefor. Subject to Paragraphs 9 and 15, Tenant shall bearthe full cost of any repair or replacement to any part of the Building orProject that results from damage caused by Tenant, its agents, contractors, orinvitees and any repair that benefits only the Premises. 12. TENANT-MADE ALTERATIONS AND TRADE FIXTURES. Any alterations,additions, or improvements made by or on behalf of Tenant to the Premises("Tenant-Made Alterations") in excess of $50,000 shall be subject to Landlord'sprior written consent, which shall not be unreasonably withheld provided thatsuch alteration does not materially affect the structure or the roof of theBuilding, or modify the utility systems of the Project. Tenant shall cause, atits expense, all Tenant-Made Alterations to comply with insurance requirementsand with Legal Requirements and shall construct at its expense any alteration ormodification required by Legal Requirements as a result of any Tenant-MadeAlterations. All Tenant-Made Alterations shall be constructed in a good andworkmanlike manner by contractors reasonably acceptable to Landlord and onlygood grades of materials shall be used. All plans and specifications for anyTenant-Made Alterations shall be submitted to Landlord for its approval.Landlord may monitor construction of the Tenant-Made Alterations. Tenant shallreimburse Landlord for its reasonable costs in reviewing plans andspecifications and in monitoring construction. Landlord's right to review plansand specifications and to monitor construction shall be solely for its ownbenefit, and Landlord shall have no duty to see that such plans andspecifications or construction comply with applicable laws, codes, rules andregulations. Tenant shall provide Landlord with the identities and mailingaddresses of all persons performing work or supplying materials, prior tobeginning such construction, and Landlord may post on and about the Premisesnotices of non-responsibility pursuant to applicable law. Tenant shall furnishsecurity or make other arrangements reasonably satisfactory to Landlord toassure payment for the completion of all work free and clear of liens and shallprovide certificates of insurance for worker's compensation and other coveragein amounts and from an insurance company satisfactory to Landlord protectingLandlord against liability for personal injury or property damage duringconstruction. Upon completion of any Tenant-Made Alterations, Tenant shalldeliver to Landlord sworn statements setting forth the names of all contractorsand subcontractors who did work on the Tenant-Made Alterations and final lienwaivers from all such contractors and subcontractors. Upon surrender of thePremises, all Tenant-Made Alterations and any leasehold improvements constructedby Landlord or Tenant shall remain on the Premises as Landlord's property,except to the extent Landlord requires removal at Tenant's expense of any suchitems or Landlord and Tenant have otherwise agreed in writing in connection withLandlord's consent to any Tenant-Made Alterations. Upon Tenant's writtenrequest, Landlord shall provide Tenant, at the time of Tenant's request forapproval of Tenant-Made Alterations, a list of which Tenant-Made AlterationsLandlord will require Tenant to remove upon surrender of the Premises. Tenantshall repair any damage caused by such removal. Tenant, at its own cost and expense and without Landlord's priorapproval, may erect such shelves, bins, machinery and trade fixtures(collectively "Trade Fixtures") in the ordinary course of its business providedthat such items do not alter the basic character of the Premises, do notoverload or damage the Premises, and may be removed without injury to thePremises, and the construction, erection, and installation thereof complies withall Legal Requirements and with Landlord's requirements set forth above. Tenantshall remove its Trade Fixtures and shall repair any damage caused by suchremoval. 13. SIGNS. Tenant shall not make any changes to the exterior of thePremises, install any exterior lights, decorations, balloons, flags, pennants,banners, or painting, or erect or install any signs, windows or door lettering,placards, decorations, or advertising media of any type which can be viewed fromthe exterior of the Premises, without Landlord's prior written consent, whichconsent shall not be unreasonably withheld or delayed. Upon surrender orvacation of the Premises, Tenant shall have removed all signs and repair, paint,and/or replace the building facia surface to which its signs are attached.Tenant shall obtain all applicable governmental permits and approvals for signand exterior treatments. All signs, decorations, advertising media, blinds,draperies and other window treatment or bars or other security installationsvisible from outside the Premises shall be subject to Landlord's approval andconform in all respects to Landlord's requirements. Notwithstanding anythingcontained herein to the contrary, Tenant, at Tenant's sole cost and expense, mayplace a new monument sign, in substantially similar form as described on theattached Exhibit C, in front of the Building along the Mission Boulevardfrontage within the boundaries of the Project, as more fully described on theattached Exhibit A. Further, Tenant, at Tenant's sole cost and expense, mayplace its company logo sign, in substantially similar form as described on theattached Exhibit B, above the two (2) main entrances of the Premises, as morefully described on the attached Exhibit A. Further, Tenant, at Tenant's solecost and expense, may place a "name sign", in substantially similar form asdescribed on the attached Exhibit D, at the three (3) locations where thecurrent eToys signage is currently displayed, as more fully described on theattached Exhibit A. Further, Landlord hereby agrees that Tenant, at Tenant'ssole cost and expense, may repaint the existing green accents on the Building tothe color of blue which is consistent with Tenant's branding. Such repaintingshall be performed in a good and workmanlike manner using first class gradematerials and paint, and shall not increase the width of such accents on theBuilding or adversely impact the overall appearance of the Building. 14. PARKING. Tenant shall be allocated the parking areas of theBuilding as more fully described on the attached Exhibit A. Landlord shall notbe responsible for enforcing Tenant's parking rights against any third parties. 15. RESTORATION. If at any time during the Lease Term the Premisesare damaged by a fire or other casualty, Landlord shall notify Tenant within 30days after such damage as to the amount of time Landlord reasonably estimates itwill take to restore the Premises. If the restoration time is estimated toexceed 4 months and such damage -6-materially interferes with Tenant's use of the Premises, Tenant may elect toterminate this Lease upon notice to Landlord given no later than 30 days afterLandlord's notice. If Tenant elects not to terminate this Lease or if Landlordestimates that restoration will take 4 months or less, then, Landlord shallpromptly restore the Premises excluding the improvements installed by Tenant orby Landlord and paid by Tenant, subject to delays arising from Force Majeureevents. Tenant at Tenant's expense shall promptly perform, subject to delaysarising from the collection of insurance proceeds, or from Force Majeure events,all repairs or restoration not required to be done by Landlord and shallpromptly re-enter the Premises and commence doing business in accordance withthis Lease. Notwithstanding the foregoing, either party may terminate this Leaseif the Premises are damaged during the last 9 months of the Lease Term andTenant has not exercised its option to renew, as applicable, (as hereinafterdescribed in Addendum 3), and Landlord reasonably estimates that it will takemore than one month to repair such damage. Base Rent and Operating Expensesshall be abated for the period of repair and restoration in the proportion whichthe area of the Premises, if any, which is not usable by Tenant bears to thetotal area of the Premises. Such abatement shall be the sole remedy of Tenant,and except as provided herein, Tenant waives any right to terminate the Lease byreason of damage or casualty loss. 16. CONDEMNATION. If any part of the Premises or the Project shouldbe taken for any public or quasi-public use under governmental law, ordinance,or regulation, or by right of eminent domain, or by private purchase in lieuthereof (a "Taking" or "Taken"), and the Taking would prevent or materiallyinterfere with Tenant's use of the Premises or in Landlord's judgment wouldmaterially interfere with or impair its ownership or operation of the Project,then upon written notice by Landlord this Lease shall terminate and Base Rentshall be apportioned as of said date. If part of the Premises shall be Taken,and this Lease is not terminated as provided above, the Base Rent payablehereunder during the unexpired Lease Term shall be reduced to such extent as maybe fair and reasonable under the circumstances. Tenant shall have the right, tothe extent that same shall not diminish Landlord's award, to make a separateclaim against the condemning authority (but not Landlord) for such compensationas may be separately awarded or recoverable by Tenant. 17. ASSIGNMENT AND SUBLETTING. Without Landlord's prior writtenconsent, which Landlord shall not unreasonably withhold or delay, Tenant shallnot assign this Lease or sublease the Premises or any part thereof or mortgage,pledge, or hypothecate its leasehold interest or grant any concession or licensewithin the Premises and any attempt to do any of the foregoing shall be void andof no effect. For purposes of this paragraph, a transfer of the ownershipinterests controlling Tenant shall be deemed an assignment of this Lease unlesssuch ownership interests are publicly traded or unless such transfers do notresult in a loss of such control. Notwithstanding the above, Tenant may assignor sublet the Premises, or any part thereof, to any entity controlling Tenant,controlled by Tenant or under common control with Tenant (a "Tenant Affiliate"),without the prior written consent of Landlord. Tenant shall reimburse Landlordfor all of Landlord's reasonable out-of-pocket expenses in connection with anyassignment or sublease. It shall be reasonable for the Landlord to withhold its consentto any assignment or sublease in any of the following instances: (i) an Event ofDefault has occurred and is continuing that would not be cured upon the proposedsublease or assignment; (ii) the assignee or sublessee does not have a net worthcalculated according to generally accepted accounting principles at least equalto $100 million immediately prior to such assignment or sublease; (iii) theintended use of the Premises by the assignee or sublessee is not reasonablysatisfactory to Landlord; (iv) the identity or business reputation of theassignee or sublessee will, in the good faith judgment of Landlord, tend todamage the goodwill or reputation of the Project; (v) in the case of a sublease,the subtenant has not acknowledged that the Lease controls over any inconsistentprovision in the sublease; or (vi) the proposed assignee or sublessee is agovernmental agency. Tenant and Landlord acknowledge that each of the foregoingcriteria are reasonable as of the date of execution of this Lease. The foregoingcriteria shall not exclude any other reasonable basis for Landlord to refuse itsconsent to such assignment or sublease. Any approved assignment or subleaseshall be expressly subject to the terms and conditions of this Lease. Tenantshall provide to Landlord all information concerning the assignee or sublesseeas Landlord may request. Notwithstanding anything contained herein to the contrary,Landlord hereby consents to the entering into of that certain Sublease Agreementdated March 30, 2001 ("eToys Sublease") between Tenant, as sublessor, and eToys,Inc., as subtenant ("Subtenant"), upon the express understandings and conditionsthat (a) Landlord neither approves nor disapproves the terms, conditions andagreements contained in the eToys Sublease (all of which shall be subordinateand subject at all times to the terms, covenants and conditions of this Lease)and assumes no liability or obligation of any kind whatsoever on account ofanything contained in the eToys Sublease; (b) by consenting to the eToysSublease, Landlord shall not be deemed to have waived any rights under thisLease nor shall Landlord be deemed to have waived Tenant's obligations to obtainany required consents under this Lease (other than consent to the eToys Subleaseitself); (c) Notwithstanding anything in the eToys Sublease to the contrary,Tenant shall be and continue to remain liable for the payment of rent and thefull and prompt performance of all of the obligations of Tenant under and as setforth in this Lease; (d) Nothing contained in the eToys Sublease shall be takenor construed to in any way modify, alter, waive or affect any of the terms,covenants or conditions contained in this Lease, or be deemed to grant Subtenantany privity of contract with Landlord, or require Landlord to accept anypayments from Subtenant on behalf of Tenant; (e) The eToys Sublease shall bedeemed and agreed to be a sublease only and not an assignment and there shall beno further subletting or assignment of all or any portion of the Premises underthis Lease (including the premises demised by the foregoing eToys Sublease)except in accordance with the terms and conditions of this Lease; and (f) IfLandlord terminates this Lease as a result of a default by Tenant thereunder,the eToys Sublease shall automatically terminate concurrently therewith. -7- Notwithstanding any assignment or subletting, Tenant and anyguarantor or surety of Tenant's obligations under this Lease shall at all timesremain fully responsible and liable for the payment of the rent and forcompliance with all of Tenant's other obligations under this Lease (regardlessof whether Landlord's approval has been obtained for any such assignments orsublettings). In the event that the rent due and payable by a sublessee orassignee (or a combination of the rental payable under such sublease orassignment plus any bonus or other consideration therefor or incident thereto)exceeds the rental payable under this Lease, then Tenant shall be bound andobligated to pay Landlord as additional rent hereunder 50% of all such excessrental and other excess consideration within 10 days following receipt thereofby Tenant, except as the same applies to the eToys Sublease, in which caseTenant shall not be obligated to Landlord for the payment of such excess rentalor other excess consideration. If this Lease be assigned or if the Premises be subleased(whether in whole or in part) or in the event of the mortgage, pledge, orhypothecation of Tenant's leasehold interest or grant of any concession orlicense within the Premises or if the Premises be occupied in whole or in partby anyone other than Tenant, then upon a default by Tenant hereunder Landlordmay collect rent from the assignee, sublessee, mortgagee, pledgee, party to whomthe leasehold interest was hypothecated, concessionee or licensee or otheroccupant and, except to the extent set forth in the preceding paragraph, applythe amount collected to the next rent payable hereunder; and all such rentalscollected by Tenant shall be held in trust for Landlord and immediatelyforwarded to Landlord. No such transaction or collection of rent or applicationthereof by Landlord, however, shall be deemed a waiver of these provisions or arelease of Tenant from the further performance by Tenant of its covenants,duties, or obligations hereunder. 18. INDEMNIFICATION. Except for the negligence of Landlord, itsagents, employees or contractors, and to the extent permitted by law, Tenantagrees to indemnify, defend and hold harmless Landlord, and Landlord's agents,employees and contractors, from and against any and all losses, liabilities,damages, costs and expenses (including attorneys' fees) resulting from claims bythird parties for injuries to any person and damage to or theft ormisappropriation or loss of property occurring in or about the Project andarising from the use and occupancy of the Premises or from any activity, work,or thing done, permitted or suffered by Tenant in or about the Premises or dueto any other act or omission of Tenant, its subtenants, assignees, invitees,employees, contractors and agents. The furnishing of insurance requiredhereunder shall not be deemed to limit Tenant's obligations under this Paragraph18. Further, the foregoing provisions of this Paragraph 18 shall not be deemedto limit the mutual waiver of subrogation between Landlord and Tenant as setforth in Paragraph 9 of this Lease in connection with any loss or damage causedby any risk coverable by all risk property insurance, whereby Landlord andTenant waive any claims against each other, and its officers, directors,employees, managers, agents, invitees and contractors for such loss or damagecoverable by all risk property insurance. 19. INSPECTION AND ACCESS. Landlord and its agents, representatives,and contractors may enter the Premises at any reasonable time to inspect thePremises and to make such repairs as may be required or permitted pursuant tothis Lease and for any other business purpose. Landlord and Landlord'srepresentatives may enter the Premises during business hours for the purpose ofshowing the Premises to prospective purchasers and, during the last year of theLease Term, to prospective tenants. Landlord may erect a suitable sign on thePremises stating the Premises are available to let or that the Project isavailable for sale. Landlord may grant easements, make public dedications,designate common areas and create restrictions on or about the Premises,provided that no such easement, dedication, designation or restrictionmaterially interferes with Tenant's use or occupancy of the Premises. AtLandlord's request, Tenant shall execute such instruments as may be necessaryfor such easements, dedications or restrictions. 20. QUIET ENJOYMENT. If Tenant shall perform all of the covenants andagreements herein required to be performed by Tenant, Tenant shall, subject tothe terms of this Lease, at all times during the Lease Term, have peaceful andquiet enjoyment of the Premises against any person claiming by, through or underLandlord. 21. SURRENDER. Upon termination of the Lease Term or earliertermination of Tenant's right of possession, Tenant shall surrender the Premisesto Landlord in the same condition as received, broom clean, ordinary wear andtear and casualty loss and condemnation covered by Paragraphs 15 and 16 andTenant's removal or non-removal of Tenant-Made Alterations pursuant to theprovisions of Paragraph 12 excepted. Any Trade Fixtures, Tenant-Made Alterationsand property not so removed by Tenant as permitted or required herein shall bedeemed abandoned and may be stored, removed, and disposed of by Landlord atTenant's expense, and Tenant waives all claims against Landlord for any damagesresulting from Landlord's retention and disposition of such property. Allobligations of Tenant hereunder not fully performed as of the termination of theLease Term shall survive the termination of the Lease Term, including withoutlimitation, indemnity obligations, payment obligations with respect to OperatingExpenses and obligations concerning the condition and repair of the Premises. 22. HOLDING OVER. If Tenant retains possession of the Premises afterthe termination of the Lease Term, unless otherwise agreed in writing, suchpossession shall be subject to immediate termination by Landlord at any time,and all of the other terms and provisions of this Lease (excluding any expansionor renewal option or other similar right or option) shall be applicable duringsuch holdover period, except that Tenant shall pay Landlord from time to time,upon demand, as Base Rent for the holdover period, an amount equal to double theBase Rent in effect on the termination date, computed on a monthly basis foreach month or part thereof during such holding over. All other payments shallcontinue under the terms of this Lease. In addition, Tenant shall be liable forall damages incurred by Landlord as a result of such holding over. No holdingover by Tenant, whether with or without consent of Landlord, -8-shall operate to extend this Lease except as otherwise expressly provided, andthis Paragraph 22 shall not be construed as consent for Tenant to retainpossession of the Premises. 23. EVENTS OF DEFAULT. Each of the following events shall be an eventof default ("Event of Default") by Tenant under this Lease: (i) Tenant shall fail to pay any installment of Base Rent or any other payment required herein when due, and such failure shall continue for a period of 10 days from the date such payment was due. (ii) Tenant or any guarantor or surety of Tenant's obligations hereunder shall (A) make a general assignment for the benefit of creditors; (B) commence any case, proceeding or other action seeking to have an order for relief entered on its behalf as a debtor or to adjudicate it a bankrupt or insolvent, or seeking reorganization, arrangement, adjustment, liquidation, dissolution or composition of it or its debts or seeking appointment of a receiver, trustee, custodian or other similar official for it or for all or of any substantial part of its property (collectively a "proceeding for relief"); (C) become the subject of any proceeding for relief which is not dismissed within 60 days of its filing or entry; or (D) die or suffer a legal disability (if Tenant, guarantor, or surety is an individual) or be dissolved or otherwise fail to maintain its legal existence (if Tenant, guarantor or surety is a corporation, partnership or other entity). (iii) Any insurance required to be maintained by Tenant pursuant to this Lease shall be cancelled or terminated or shall expire or shall be reduced or materially changed, except, in each case, as permitted in this Lease. (iv) Tenant shall not occupy or shall vacate the Premises or shall fail to continuously operate its business at the Premises for the permitted use set forth herein, whether or not Tenant is in monetary or other default under this Lease. (v) Tenant shall attempt or there shall occur any assignment, subleasing or other transfer of Tenant's interest in or with respect to this Lease except as otherwise permitted in this Lease. (vi) Tenant shall fail to discharge any lien placed upon the Premises in violation of this Lease within 30 days after any such lien or encumbrance is filed against the Premises. (vii) Tenant shall fail to comply with any provision of this Lease other than those specifically referred to in this Paragraph 23, and except as otherwise expressly provided herein, such default shall continue for more than 30 days after Landlord shall have given Tenant written notice of such default. 24. LANDLORD'S REMEDIES. Upon each occurrence of an Event of Defaultand so long as such Event of Default shall be continuing, Landlord may at anytime thereafter at its election: terminate this Lease or Tenant's right ofpossession, (but Tenant shall remain liable as hereinafter provided) and/orpursue any other remedies at law or in equity. Upon the termination of thisLease or termination of Tenant's right of possession, it shall be lawful forLandlord, without formal demand or notice of any kind, to re-enter the Premisesby summary dispossession proceedings or any other action or proceedingauthorized by law and to remove Tenant and all persons and property therefrom.If Landlord re-enters the Premises, Landlord shall have the right to keep inplace and use, or remove and store, all of the furniture, fixtures and equipmentat the Premises. Except as otherwise provided in the next paragraph, if Tenantbreaches this Lease and abandons the Premises prior to the end of the termhereof, or if Tenant's right to possession is terminated by Landlord because ofan Event of Default by Tenant under this Lease, this Lease shall terminate. Uponsuch termination, Landlord may recover from Tenant the following, as provided inSection 1951.2 of the Civil Code of California: (i) the worth at the time ofaward of the unpaid Base Rent and other charges under this Lease that had beenearned at the time of termination; (ii) the worth at the time of award of theamount by which the reasonable value of the unpaid Base Rent and other chargesunder this Lease which would have been earned after termination until the timeof award exceeds the amount of such rental loss that Tenant proves could havebeen reasonably avoided; (iii) the worth at the time of the award by which thereasonable value of the unpaid Base Rent and other charges under this Lease forthe balance of the term of this Lease after the time of award exceeds the amountof such rental loss that Tenant proves could have been reasonably avoided; and(iv) any other amount necessary to compensate Landlord for all the detrimentproximately caused by Tenant's failure to perform its obligations under thisLease or that in the ordinary course of things would be likely to resulttherefrom. As used herein, the following terms are defined: (a) the "worth atthe time of award" of the amounts referred to in Sections (i) and (ii) iscomputed by allowing interest at the lesser of 18 percent per annum or themaximum lawful rate. The "worth at the time of award" of the amount referred toin Section (iii) is computed by discounting such amount at the discount rate ofthe Federal Reserve Bank of San Francisco at the time of award plus one percent;(b) the "time of award" as used in clauses (i), (ii), and (iii) above is thedate on which judgment is entered by a court of competent jurisdiction; (c) The"reasonable value" of the amount referred to in clause (ii) above is computed bydetermining the mathematical product of (1) the "reasonable annual rental value"(as defined herein) and (2) the number of years, including fractional partsthereof, between the date of termination and the time of award. The "reasonablevalue" of the amount referred to in clause (iii) is computed by determining themathematical product of (1) the annual Base Rent and other charges under thisLease and (2) the number of years including fractional parts thereof remainingin the balance of the term of this Lease after the time of award. -9- Even though Tenant has breached this Lease and abandoned thePremises, this Lease shall continue in effect for so long as Landlord does notterminate Tenant's right to possession, and Landlord may enforce all its rightsand remedies under this Lease, including the right to recover rent as it becomesdue. This remedy is intended to be the remedy described in California Civil CodeSection 1951.4 and the following provision from such Civil Code Section ishereby repeated: "The Lessor has the remedy described in California Civil CodeSection 1951.4 (lessor may continue lease in effect after lessee's breach andabandonment and recover rent as it becomes due, if lessee has right to sublet orassign, subject only to reasonable limitations)." Any such payments due Landlordshall be made upon demand therefor from time to time and Tenant agrees thatLandlord may file suit to recover any sums falling due from time to time.Notwithstanding any such reletting without termination, Landlord may at any timethereafter elect in writing to terminate this Lease for such previous breach. Exercise by Landlord of any one or more remedies hereundergranted or otherwise available shall not be deemed to be an acceptance ofsurrender of the Premises and/or a termination of this Lease by Landlord,whether by agreement or by operation of law, it being understood that suchsurrender and/or termination can be effected only by the written agreement ofLandlord and Tenant. Any law, usage, or custom to the contrary notwithstanding,Landlord shall have the right at all times to enforce the provisions of thisLease in strict accordance with the terms hereof; and the failure of Landlord atany time to enforce its rights under this Lease strictly in accordance with sameshall not be construed as having created a custom in any way or manner contraryto the specific terms, provisions, and covenants of this Lease or as havingmodified the same. Tenant and Landlord further agree that forbearance or waiverby Landlord to enforce its rights pursuant to this Lease or at law or in equity,shall not be a waiver of Landlord's right to enforce one or more of its rightsin connection with any subsequent default. A receipt by Landlord of rent orother payment with knowledge of the breach of any covenant hereof shall not bedeemed a waiver of such breach, and no waiver by Landlord of any provision ofthis Lease shall be deemed to have been made unless expressed in writing andsigned by Landlord. To the greatest extent permitted by law, Tenant waives theservice of notice of Landlord's intention to re-enter as provided for in anystatute, or to institute legal proceedings to that end, and also waives allright of redemption in case Tenant shall be dispossessed by a judgment or bywarrant of any court or judge. The terms "enter," "re-enter," "entry" or"re-entry," as used in this Lease, are not restricted to their technical legalmeanings. Any reletting of the Premises shall be on such terms and conditions asLandlord in its sole discretion may determine (including without limitation aterm different than the remaining Lease Term, rental concessions, alterationsand repair of the Premises, lease of less than the entire Premises to any tenantand leasing any or all other portions of the Project before reletting thePremises). Landlord shall not be liable, nor shall Tenant's obligationshereunder be diminished because of, Landlord's failure to relet the Premises orcollect rent due in respect of such reletting. 25. TENANT'S REMEDIES/LIMITATION OF LIABILITY. Landlord shall not bein default hereunder unless Landlord fails to perform any of its obligationshereunder within 30 days after written notice from Tenant specifying suchfailure (unless such performance will, due to the nature of the obligation,require a period of time in excess of 30 days, then after such period of time asis reasonably necessary). All obligations of Landlord hereunder shall beconstrued as covenants, not conditions; and, except as may be otherwiseexpressly provided in this Lease, Tenant may not terminate this Lease for breachof Landlord's obligations hereunder. All obligations of Landlord under thisLease will be binding upon Landlord only during the period of its ownership ofthe Premises and not thereafter. The term "Landlord" in this Lease shall meanonly the owner, for the time being of the Premises, and in the event of thetransfer by such owner of its interest in the Premises, such owner shallthereupon be released and discharged from all obligations of Landlord thereafteraccruing, it being understood that Landlord shall not be released from anyobligations accruing prior to such transfer unless such obligations have beenassumed in writing by Landlord's successor, but such obligations shall bebinding during the Lease Term upon each new owner for the duration of suchowner's ownership. Any liability of Landlord under this Lease shall be limitedsolely to its interest in the Project, and in no event shall any personalliability be asserted against Landlord in connection with this Lease nor shallany recourse be had to any other property or assets of Landlord. 26. Intentionally deleted. 27. SUBORDINATION. This Lease and Tenant's interest and rightshereunder are and shall be subject and subordinate at all times to the lien ofany mortgage, now existing or hereafter created on or against the Project or thePremises, and all amendments, restatements, renewals, modifications,consolidations, refinancing, assignments and extensions thereof, without thenecessity of any further instrument or act on the part of Tenant. Tenant agrees,at the election of the holder of any such mortgage, to attorn to any suchholder. Tenant agrees upon demand to execute, acknowledge and deliver suchinstruments, confirming such subordination and such instruments of attornment asshall be requested by any such holder. Tenant hereby appoints Landlord attorneyin fact for Tenant irrevocably (such power of attorney being coupled with aninterest) to execute, acknowledge and deliver any such instrument andinstruments for and in the name of the Tenant and to cause any such instrumentto be recorded. Notwithstanding the foregoing, any such holder may at any timesubordinate its mortgage to this Lease, without Tenant's consent, by notice inwriting to Tenant, and thereupon this Lease shall be deemed prior to suchmortgage without regard to their respective dates of execution, delivery orrecording and in that event such holder shall have the same rights with respectto this Lease as though this Lease had been executed prior to the execution,delivery and recording of such mortgage and had been assigned to such holder.The term "mortgage" whenever used in this Lease shall be deemed to include deedsof trust, security assignments and any other encumbrances, and any reference tothe "holder" of a mortgage shall be deemed to include the beneficiary under adeed of trust. Tenant shall not be obligated to subordinate the Lease or itsinterest therein to any mortgage, deed of -10-trust or ground lease on the Project unless concurrently with such subordinationthe holder of such mortgage or deed of trust or the ground lessor under suchground lease agrees not to disturb Tenant's possession of the Premises under theterms of the Lease in the event such holder or ground lessor acquires title tothe Premises through foreclosure, deed in lieu of foreclosure or otherwise.Landlord shall use commercially reasonable and good faith efforts to obtain anon-disturbance agreement from any such holder or ground lessor existing as ofthe Commencement Date for the benefit of Tenant. 28. MECHANIC'S LIENS. Tenant has no express or implied authority tocreate or place any lien or encumbrance of any kind upon, or in any manner tobind the interest of Landlord or Tenant in, the Premises or to charge therentals payable hereunder for any claim in favor of any person dealing withTenant, including those who may furnish materials or perform labor for anyconstruction or repairs. Tenant covenants and agrees that it will pay or causeto be paid all sums legally due and payable by it on account of any laborperformed or materials furnished in connection with any work performed on thePremises and that it will save and hold Landlord harmless from all loss, cost orexpense based on or arising out of asserted claims or liens against theleasehold estate or against the interest of Landlord in the Premises or underthis Lease. Tenant shall give Landlord immediate written notice of the placingof any lien or encumbrance against the Premises and cause such lien orencumbrance to be discharged within 30 days of the filing or recording thereof;provided, however, Tenant may contest such liens or encumbrances as long as suchcontest prevents foreclosure of the lien or encumbrance and Tenant causes suchlien or encumbrance to be bonded or insured over in a manner satisfactory toLandlord within such 30 day period. 29. ESTOPPEL CERTIFICATES. Tenant agrees, from time to time, within10 days after request of Landlord, to execute and deliver to Landlord, orLandlord's designee, any estoppel certificate requested by Landlord, statingthat this Lease is in full force and effect, the date to which rent has beenpaid, that Landlord is not in default hereunder (or specifying in detail thenature of Landlord's default), the termination date of this Lease and such othermatters pertaining to this Lease as may be requested by Landlord. Tenant'sobligation to furnish each estoppel certificate in a timely fashion is amaterial inducement for Landlord's execution of this Lease. No cure or graceperiod provided in this Lease shall apply to Tenant's obligations to timelydeliver an estoppel certificate. Tenant hereby irrevocably appoints Landlord asits attorney in fact to execute on its behalf and in its name any such estoppelcertificate if Tenant fails to execute and deliver the estoppel certificatewithin 10 days after Landlord's written request thereof. 30. ENVIRONMENTAL REQUIREMENTS. Except for Hazardous Materialcontained in products used by Tenant in de minimis quantities for ordinarycleaning and office purposes and equipment maintenance, Tenant shall not permitor cause any party to bring any Hazardous Material upon the Premises ortransport, store, use, generate, manufacture or release any Hazardous Materialin or about the Premises without Landlord's prior written consent. Tenant, atits sole cost and expense, shall operate its business in the Premises in strictcompliance with all Environmental Requirements and shall remediate in a mannersatisfactory to Landlord any Hazardous Materials released on or from the Projectby Tenant, its agents, employees, contractors, subtenants or invitees. Tenantshall complete and certify to disclosure statements as requested by Landlordfrom time to time relating to Tenant's transportation, storage, use, generation,manufacture or release of Hazardous Materials on the Premises. The term"Environmental Requirements" means all applicable present and future statutes,regulations, ordinances, rules, codes, judgments, orders or other similarenactments of any governmental authority or agency regulating or relating tohealth, safety, or environmental conditions on, under, or about the Premises orthe environment, including without limitation, the following: the ComprehensiveEnvironmental Response, Compensation and Liability Act; the ResourceConservation and Recovery Act; and all state and local counterparts thereto, andany regulations or policies promulgated or issued thereunder. The term"Hazardous Materials" means and includes any substance, material, waste,pollutant, or contaminant listed or defined as hazardous or toxic, under anyEnvironmental Requirements, asbestos and petroleum, including crude oil or anyfraction thereof, natural gas liquids, liquified natural gas, or synthetic gasusable for fuel (or mixtures of natural gas and such synthetic gas). As definedin Environmental Requirements, Tenant is and shall be deemed to be the"operator" of Tenant's "facility" and the "owner" of all Hazardous Materialsbrought on the Premises by Tenant, its agents, employees, contractors orinvitees, and the wastes, by-products, or residues generated, resulting, orproduced therefrom. Tenant shall indemnify, defend, and hold Landlord harmless fromand against any and all losses (including, without limitation, diminution invalue of the Premises or the Project and loss of rental income from theProject), claims, demands, actions, suits, damages (including, withoutlimitation, punitive damages), expenses (including, without limitation,remediation, removal, repair, corrective action, or cleanup expenses), and costs(including, without limitation, actual attorneys' fees, consultant fees orexpert fees and including, without limitation, removal or management of anyasbestos brought into the property by Tenant, its agents, employees,contractors, subtenants, assignees or invitees or disturbed by Tenant, itsagents, employees, contractors, subtenants, assignees or invitees in breach ofthe requirements of this Paragraph 30, regardless of whether such removal ormanagement is required by law) which are brought or recoverable against, orsuffered or incurred by Landlord as a result of any release of HazardousMaterials for which Tenant is obligated to remediate as provided above or anyother breach of the requirements under this Paragraph 30 by Tenant, its agents,employees, contractors, subtenants, assignees or invitees, regardless of whetherTenant had knowledge of such noncompliance. The obligations of Tenant under thisParagraph 30 shall survive any termination of this Lease. Landlord shall have access to, and a right to perform inspectionsand tests of, the Premises to determine Tenant's compliance with EnvironmentalRequirements, its obligations under this Paragraph 30, or the environmentalcondition of the Premises. Access shall be granted to Landlord upon Landlord'sprior notice to Tenant and at such times so as to minimize, so far as may bereasonable under the circumstances, any disturbance to Tenant's -11-operations. Such inspections and tests shall be conducted at Landlord's expense,unless such inspections or tests reveal that Tenant has not complied with anyEnvironmental Requirement, in which case Tenant shall reimburse Landlord for thereasonable cost of such inspection and tests. Landlord's receipt of orsatisfaction with any environmental assessment in no way waives any rights thatLandlord holds against Tenant. Landlord represents and warrants that except for informationcontained in the Phase I Environmental Assessment Report dated June 19, 2000 andprepared by ATC Associates Inc., Landlord, to Landlord's knowledge withoutfurther inquiry, is unaware of any environmental conditions affecting thePremises. Notwithstanding anything to the contrary in this Paragraph 30,Tenant shall have no liability of any kind to Landlord as to Hazardous Materialson the Premises caused or permitted by (i) Landlord, its agents, employees,contractors or invitees; or (ii) any other tenants in the Project or theiragents, employees, contractors, subtenants, assignees or invitees; or (iii) anyother person or entity located outside of the Premises or the Project. Landlord shall indemnify, defend and save Tenant harmless fromany claims, fines, penalties, liabilities, losses, damages, costs and expenses(including reasonable attorney's fees, expert witness fees and other costs ofdefense) which arise from any environmental condition existing prior to theCommencement Date adversely affecting the Premises and in violation ofEnvironmental Requirements. 31. RULES AND REGULATIONS. Tenant shall, at all times during theLease Term and any extension thereof, comply with all reasonable rules andregulations at any time or from time to time established by Landlord coveringuse of the Premises and the Project. The current rules and regulations areattached hereto. In the event of any conflict between said rules and regulationsand other provisions of this Lease, the other terms and provisions of this Leaseshall control. Landlord shall not have any liability or obligation for thebreach of any rules or regulations by other tenants in the Project. 32. SECURITY SERVICE. Tenant acknowledges and agrees that, whileLandlord may patrol the Project, Landlord is not providing any security serviceswith respect to the Premises and that Landlord shall not be liable to Tenantfor, and Tenant waives any claim against Landlord with respect to, any loss bytheft or any other damage suffered or incurred by Tenant in connection with anyunauthorized entry into the Premises or any other breach of security withrespect to the Premises. 33. FORCE MAJEURE. Except for monetary obligations, neither Landlordnor Tenant shall be held responsible for delays in the performance of itsobligations hereunder when caused by strikes, lockouts, labor disputes, acts ofGod, inability to obtain labor or materials or reasonable substitutes therefor,governmental restrictions, governmental regulations, governmental controls,delay in issuance of permits, enemy or hostile governmental action, civilcommotion, fire or other casualty, and other causes beyond the reasonablecontrol of Landlord or Tenant ("Force Majeure"). 34. ENTIRE AGREEMENT. This Lease constitutes the complete agreementof Landlord and Tenant with respect to the subject matter hereof. Norepresentations, inducements, promises or agreements, oral or written, have beenmade by Landlord or Tenant, or anyone acting on behalf of Landlord or Tenant,which are not contained herein, and any prior agreements, promises,negotiations, or representations are superseded by this Lease. This Lease maynot be amended except by an instrument in writing signed by both parties hereto. 35. SEVERABILITY. If any clause or provision of this Lease isillegal, invalid or unenforceable under present or future laws, then and in thatevent, it is the intention of the parties hereto that the remainder of thisLease shall not be affected thereby. It is also the intention of the parties tothis Lease that in lieu of each clause or provision of this Lease that isillegal, invalid or unenforceable, there be added, as a part of this Lease, aclause or provision as similar in terms to such illegal, invalid orunenforceable clause or provision as may be possible and be legal, valid andenforceable. 36. BROKERS. Tenant represents and warrants that it has dealt with nobroker, agent or other person in connection with this transaction and that nobroker, agent or other person brought about this transaction, other than thebroker, if any, set forth on the first page of this Lease, and Tenant agrees toindemnify and hold Landlord harmless from and against any claims by any otherbroker, agent or other person claiming a commission or other form ofcompensation by virtue of having dealt with Tenant with regard to this leasingtransaction. Landlord hereby acknowledges and agrees that the broker referencedon Page One of this Lease shall be entitled to a leasing commission fromLandlord by virtue of this Lease, which leasing commission shall be deemedearned and shall be paid by Landlord to said broker in accordance with, andsubject to the terms of, a separate written agreement. 37. MISCELLANEOUS. (a) Any payments or charges due from Tenant toLandlord hereunder shall be considered rent for all purposes of this Lease. (b) If and when included within the term "Tenant," as used in thisinstrument, there is more than one person, firm or corporation, each shall bejointly and severally liable for the obligations of Tenant. -12- (c) All notices required or permitted to be given under this Leaseshall be in writing and shall be sent by registered or certified mail, returnreceipt requested, or by a reputable national overnight courier service, postageprepaid, or by hand delivery addressed to the parties at their addresses below,and with a copy sent to Landlord at 14100 East 35th Place, Aurora, Colorado80011. Either party may by notice given aforesaid change its address for allsubsequent notices. Except where otherwise expressly provided to the contrary,notice shall be deemed given upon delivery. (d) Except as otherwise expressly provided in this Lease or asotherwise required by law, Landlord's right to withhold any consent or approvalshall not be unreasonably withheld or delayed. (e) Intentionally deleted. (f) Neither this Lease nor a memorandum of lease shall be filed by oron behalf of Tenant in any public record. Landlord may prepare and file, andupon request by Landlord Tenant will execute, a memorandum of lease. (g) The normal rule of construction to the effect that anyambiguities are to be resolved against the drafting party shall not be employedin the interpretation of this Lease or any exhibits or amendments hereto. (h) The submission by Landlord to Tenant of this Lease shall have nobinding force or effect, shall not constitute an option for the leasing of thePremises, nor confer any right or impose any obligations upon either party untilexecution of this Lease by both parties. (i) Words of any gender used in this Lease shall be held andconstrued to include any other gender, and words in the singular number shall beheld to include the plural, unless the context otherwise requires. The captionsinserted in this Lease are for convenience only and in no way define, limit orotherwise describe the scope or intent of this Lease, or any provision hereof,or in any way affect the interpretation of this Lease. (j) Any amount not paid by Tenant within 10 days after its due datein accordance with the terms of this Lease shall bear interest from such duedate until paid in full at the lesser of the highest rate permitted byapplicable law or 12 percent per year. It is expressly the intent of Landlordand Tenant at all times to comply with applicable law governing the maximum rateor amount of any interest payable on or in connection with this Lease. Ifapplicable law is ever judicially interpreted so as to render usurious anyinterest called for under this Lease, or contracted for, charged, taken ,reserved, or received with respect to this Lease, then it is Landlord's andTenant's express intent that all excess amounts theretofore collected byLandlord be credited on the applicable obligation (or, if the obligation hasbeen or would thereby be paid in full, refunded to Tenant), and the provisionsof this Lease immediately shall be deemed reformed and the amounts thereaftercollectible hereunder reduced, without the necessity of the execution of any newdocument, so as to comply with the applicable law, but so as to permit therecovery of the fullest amount otherwise called for hereunder. (k) Construction and interpretation of this Lease shall be governedby the laws of the state in which the Project is located, excluding anyprinciples of conflicts of laws. (l) Time is of the essence as to the performance of Tenant'sobligations under this Lease. (m) All exhibits and addenda attached hereto are hereby incorporatedinto this Lease and made a part hereof. In the event of any conflict betweensuch exhibits or addenda and the terms of this Lease, such exhibits or addendashall control. 38. LANDLORD'S LIEN/SUBORDINATION. Provided Tenant is not in defaultunder the Lease, Landlord, at the request of Tenant, agrees to subordinateLandlord's lien, if any, arising under the Lease against Tenant's property orany of Tenant's leased or financed property located on the Premises and agreesthat Tenant's property or its leased or financed property shall not become partof the Premises or encumbered by a lien by Landlord regardless of the manner inwhich the leased or financed property may be attached or affixed to thePremises. Such subordination shall be required only if the lender or lessorshall be a bank or other financial institution or the vendor of Tenant'sequipment or a financing entity related to such vendor and shall be subject tosuch conditions as Landlord may reasonably require. Tenant shall reimburseLandlord for all reasonable out-of-pocket expenses incurred by Landlord innegotiating and executing such agreement with Tenant's lender. 39. LIMITATION OF LIABILITY OF TRUSTEES, SHAREHOLDERS, AND OFFICERSOF PROLOGIS TRUST. Any obligation or liability whatsoever of ProLogis Trust, aMaryland real estate investment trust, which may arise at any time under thisLease or any obligation or liability which may be incurred by it pursuant to anyother instrument, transaction, or undertaking contemplated hereby shall not bepersonally binding upon, nor shall resort for the enforcement thereof be had tothe property of, its trustees, directors, shareholders, officers, employees oragents, regardless of whether such obligation or liability is in the nature ofcontract, tort, or otherwise. 40. LIMITATION OF LIABILITY OF DIRECTORS, SHAREHOLDERS, AND OFFICERSOF SKECHERS U.S.A., INC. Any obligation or liability whatsoever of SkechersU.S.A., Inc., a Delaware corporation, which may arise at any time under thisLease or any obligation or liability which may be incurred by it pursuant to anyother instrument, -13-transaction, or undertaking contemplated hereby shall not be personally bindingupon, nor shall resort for the enforcement thereof be had to the property of,its directors, shareholders, officers, employees or agents, regardless ofwhether such obligation or liability is in the nature of contract, tort, orotherwise. -14- IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease as ofthe day and year first above written.TENANT: LANDLORD:SKECHERS U.S.A., INC PROLOGIS CALIFORNIA I LLC BY: PROLOGIS TRUST, ITS MANAGING MEMBERBy: /s/ DAVID WEINBERG By: /s/ NED K. ANDERSON --------------------------------- ------------------------------------Name: David Weinberg Name: Ned K. Anderson ------------------------------- Title: Managing DirectorTitle: CFO ------------------------------ Address:By: /s/ PHILIP G. PACCIONE 47775 Fremont Blvd. --------------------------------- Fremont, CA 94538Name: Philip G. Paccione -------------------------------Title: V.P. and Corporate SecretaryAddress:228 Manhattan Beach Blvd.Manhattan Beach, CA 90266 -15- Rules and Regulations1. The sidewalk, entries, and driveways of the Project shall not be obstructed by Tenant, or its agents, or used by them for any purpose other than ingress and egress to and from the Premises.2. Tenant shall not place any objects, including antennas, outdoor furniture, etc., in the parking areas, landscaped areas or other areas outside of its Premises, or on the roof of the Project.3. Except for seeing-eye dogs, no animals shall be allowed in the offices, halls, or corridors in the Project.4. Tenant shall not disturb the occupants of the Project or adjoining buildings by the use of any radio or musical instrument or by the making of loud or improper noises.5. Except as otherwise set forth in the Lease, if Tenant desires telegraphic, telephonic or other electric connections in the Premises, no boring or cutting of wires will be permitted without Landlord's prior consent, which shall not be unreasonably withheld or delayed. Any such installation or connection shall be made at Tenant's expense.6. Tenant shall not install or operate any steam or gas engine or boiler, or other mechanical apparatus (except for Tenant's material handling system) in the Premises, except as specifically approved in the Lease. The use of oil, gas or inflammable liquids for heating, lighting or any other purpose is expressly prohibited. Explosives or other articles deemed extra hazardous shall not be brought into the Project.7. Parking any type of recreational vehicles is specifically prohibited on or about the Project. Except for the overnight parking of operative vehicles and except as permitted in the Lease, no vehicle of any type shall be stored in the parking areas at any time. In the event that a vehicle is disabled, it shall be removed within 48 hours. There shall be no "For Sale" or other advertising signs on or about any parked vehicle. All vehicles shall be parked in the designated parking areas in conformity with all signs and other markings. All parking will be open parking, and no reserved parking, numbering or lettering of individual spaces will be permitted except as specified by Landlord.8. Tenant shall maintain the Premises free from rodents, insects and other pests.9. Landlord reserves the right to exclude or expel from the Project any person who, in the judgment of Landlord, is intoxicated or under the influence of liquor or drugs or who shall in any manner do any act in violation of the Rules and Regulations of the Project.10. Tenant shall not cause any unnecessary labor by reason of Tenant's carelessness or indifference in the preservation of good order and cleanliness. Landlord shall not be responsible to Tenant for any loss of property on the Premises, however occurring, or for any damage done to the effects of Tenant by the janitors or any other employee or person.11. Tenant shall give Landlord prompt notice of any defects in the water, lawn sprinkler, sewage, gas pipes, electrical lights and fixtures, heating apparatus, or any other service equipment affecting the Premises.12. Except as otherwise set forth in the Lease, Tenant shall not permit storage outside the Premises, including without limitation, outside storage of trucks and other vehicles, or dumping of waste or refuse or permit any harmful materials to be placed in any drainage system or sanitary system in or about the Premises.13. All moveable trash receptacles provided by the trash disposal firm for the Premises must be kept in the trash enclosure areas, if any, provided for that purpose.14. No auction, public or private, will be permitted on the Premises or the Project without Landlord's prior written consent, which consent shall not be unreasonably withheld or delayed.15. No awnings shall be placed over the windows in the Premises except with the prior written consent of Landlord.16. The Premises shall not be used for lodging, sleeping or cooking (except for microwave usage) or for any immoral or illegal purposes or for any purpose other than that specified in the Lease. No gaming devices shall be operated in the Premises.17. Tenant shall ascertain from Landlord the maximum amount of electrical current which can safely be used in the Premises, taking into account the capacity of the electrical wiring in the Project and the Premises and the needs of other tenants, and shall not use more than such safe capacity. Landlord's consent to the installation of electric equipment shall not relieve Tenant from the obligation not to use more electricity than such safe capacity.18. Tenant assumes full responsibility for protecting the Premises from theft, robbery and pilferage.19. Tenant shall not install or operate on the Premises any machinery or mechanical devices of a nature not related to Tenant's use of the Premises as permitted under the Lease. -16- ADDENDUM 1 BASE RENT ADJUSTMENTS ATTACHED TO AND A PART OF THE LEASE AGREEMENT DATED 4/10, 2001, BETWEEN PROLOGIS CALIFORNIA I LLC and SKECHERS U.S.A., INC. Base Rent shall equal the following amounts for the respective periodsset forth below: Period Monthly Base Rent ------ ----------------- Month 1 through Month 60 $217,520.00 Month 61 through Month 90 $236,601.00 Month 91 through Month 120 $251,865.00 -17- ADDENDUM 2 CONSTRUCTION (ALLOWANCE) ATTACHED TO AND A PART OF THE LEASE AGREEMENT DATED 4/10, 2001, BETWEEN PROLOGIS CALIFORNIA I LLC and SKECHERS U.S.A., INC. (a) Landlord agrees to furnish or perform those items ofconstruction and those improvements (the "Initial Improvements") specifiedbelow: Dock equipment packages including levelers, seals, shelters, bumpers, lighting and foil insulation (provided such insulation is installed in such a manner that it is held back from the purlin hangers in a manner approved by Landlord) and general purpose electrical wiring and distribution which shall be mutually agreed upon between Landlord and Tenant.Landlord shall pay for the Initial Improvements up to a maximum amount of$650,000.00, and Tenant shall pay for the cost of the Initial Improvements inexcess of such amount. If the cost of the Initial Improvements is estimated toexceed such amount, such estimated overage shall be paid by Tenant beforeLandlord begins construction and a final adjusting payment based upon the actualcosts of the Initial Improvements shall be made when the Initial Improvementsare complete.Landlord will competitively bid all Initial Improvements and will disclose suchbids to Tenant on an "open book" basis. (b) If Tenant shall desire any changes, Tenant shall so adviseLandlord in writing and Landlord shall determine whether such changes can bemade in a reasonable and feasible manner. Any and all costs of reviewing anyrequested changes, and any and all costs of making any changes to the InitialImprovements which Tenant may request and which Landlord may agree to shall beat Tenant's sole cost and expense and shall be paid to Landlord upon demand andbefore execution of the change order. (c) Landlord shall proceed with and complete the constructionof the Initial Improvements in a good and workmanlike manner. As soon as suchimprovements have been Substantially Completed, which such date shall be nolater than 120 days following mutual agreement between the parties of the plansand specifications for the Initial Improvements, unless otherwise agreed to bythe parties, Landlord shall notify Tenant in writing of the date that theInitial Improvements were Substantially Completed. The Initial Improvementsshall be deemed substantially completed ("Substantially Completed") when, in theopinion of the construction manager (whether an employee or agent of Landlord ora third party construction manager) ("Construction Manager"), the Premises aresubstantially completed except for punch list items which do not prevent in anymaterial way the use of the Premises for the purposes for which they wereintended. In the event Tenant, its employees, agents, or contractors causeconstruction of such improvements to be delayed, the date of SubstantialCompletion shall be deemed to be the date that, in the opinion of theConstruction Manager, Substantial Completion would have occurred if such delayshad not taken place. Without limiting the foregoing, Tenant shall be solelyresponsible for delays caused by Tenant's request for any changes in the plans,Tenant's request for long lead items or Tenant's interference with theconstruction of the Initial Improvements. After the Initial Improvements areSubstantially Completed, Tenant shall, upon demand, execute and deliver toLandlord a letter of acceptance of delivery of the Premises. In the event of anydispute as to the Initial Improvements, the certificate of the ConstructionManager shall be conclusive absent manifest error. (d) The failure of Tenant to take possession of or to occupythe Premises through no fault of Landlord shall not serve to relieve Tenant ofobligations arising on the Commencement Date or delay the payment of rent byTenant. Subject to applicable ordinances and building codes governing Tenant'sright to occupy or perform in the Premises, Tenant shall be allowed to installits tenant improvements, machinery, equipment, fixtures, or other property onthe Premises during the final stages of completion of construction provided thatTenant does not thereby interfere with the completion of construction or causeany labor dispute as a result of such installations, and provided further thatTenant does hereby agree to indemnify, defend, and hold Landlord harmless fromany loss or damage to such property, and all liability, loss, or damage arisingfrom any injury to the Project or the property of Landlord, its contractors,subcontractors, or materialmen, and any death or personal injury to any personor persons arising out of such installations, unless any such loss, damage,liability, death, or personal injury was caused by Landlord's negligence. Anysuch occupancy or performance in the Premises shall be in accordance with theprovisions governing Tenant-Made Alterations and Trade Fixtures in the Lease,and shall be subject to Tenant providing to Landlord satisfactory evidence ofinsurance for personal injury and property damage related to such installationsand satisfactory payment arrangements with respect to installations permittedhereunder. Delay in putting Tenant in possession of the Premises shall not serveto extend the term of this Lease or to make Landlord liable for any damagesarising therefrom. (e) Except for incomplete punch list items which are not of amaterial nature, Tenant upon Substantial Completion of the Initial Improvementsshall have and hold the Premises as the same shall then be without -18-any liability or obligation on the part of Landlord for making any furtheralterations or improvements of any kind in or about the Premises. -19- ADDENDUM 3 TWO RENEWAL OPTIONS (BASEBALL ARBITRATION) ATTACHED TO AND A PART OF THE LEASE AGREEMENT DATED 4/10, 2001, BETWEEN PROLOGIS CALIFORNIA I LLC and SKECHERS U.S.A., INC. (a) Provided that as of the time of the giving of the First ExtensionNotice (as hereafter defined) and the Commencement Date of the First ExtensionTerm (as hereafter defined), (x) Tenant is the Tenant originally named herein(or a Tenant Affiliate or a permitted assignee), (y) Tenant (or a TenantAffiliate or a permitted assignee) actually occupies all of the Premisesinitially demised under this Lease and any space added to the Premises, and (z)no Event of Default exists or would exist but for the passage of time or thegiving of notice, or both; then Tenant shall have the right to extend the LeaseTerm for an additional term of 5 years (such additional term is hereinaftercalled the "First Extension Term") commencing on the day following theexpiration of the Lease Term (hereinafter referred to as the "Commencement Dateof the First Extension Term"). Tenant shall give Landlord notice (hereinaftercalled the "First Extension Notice") of its election to extend the term of theLease Term at least 9 months, but not more than 12 months, prior to thescheduled expiration date of the Lease Term. (b) Provided that as of the time of the giving of the SecondExtension Notice (as hereafter defined) and the Commencement Date of the SecondExtension Term (as hereafter defined), (x) Tenant is the Tenant originally namedherein (or a Tenant Affiliate or a permitted assignee), (y) Tenant (or a TenantAffiliate or a permitted assignee) actually occupies all of the Premisesinitially demised under this Lease and any space added to the Premises, and (z)no Event of Default exists or would exist but for the passage of time or thegiving of notice, or both and provided Tenant has exercised its option for theFirst Extension Term; then Tenant shall have the right to extend the Lease Termfor an additional term of 5 years (such additional term is hereinafter calledthe "Second Extension Term") commencing on the day following the expiration ofthe First Extension Term (hereinafter referred to as the "Commencement Date ofthe Second Extension Term"). Tenant shall give Landlord notice (hereinaftercalled the "Second Extension Notice") of its election to extend the term of theLease Term at least 9 months, but not more than 12 months, prior to thescheduled expiration date of the First Extension Term. (c) The Base Rent payable by Tenant to Landlord during the FirstExtension Term shall be the greater of: (i) the Base Rent in effect on the expiration of the Lease Term, and (ii) the Fair Market Rent, as defined and determined pursuant to Paragraphs (e), (f), and (g) below. (d) The Base Rent payable by Tenant to Landlord during the SecondExtension Term shall be the greater of: (i) the Base Rent in effect on the expiration of the First Extension Term, and (ii) the Fair Market Rent, as defined and determined pursuant to Paragraphs (e), (f), and (g) below. (e) The term "Fair Market Rent" shall mean the Base Rent, expressedas an annual rent per square foot of floor area, which Landlord would havereceived from leasing the Premises for the First Extension Term or the SecondExtension Term, as applicable, to an unaffiliated person which is not then atenant in the Project, assuming that such space were to be delivered in "as-is"condition, and taking into account the rental which such other tenant would mostlikely have paid for such premises, provided that Fair Market Rent shall not inany event be less than the Base Rent for the Premises as of the expiration ofthe Lease Term or the First Extension Term, as applicable. Fair Market Rentshall not be further reduced by reason of any costs or expenses saved byLandlord by reason of Landlord's not having to find a new tenant for thePremises (including without limitation brokerage commissions, cost ofimprovements necessary to prepare the space for such tenant's occupancy, rentconcession, or lost rental income during any vacancy period). Fair Market Rentmeans only the rent component defined as Base Rent in the Lease and does notinclude reimbursements and payments by Tenant to Landlord with respect toOperating Expenses and other items payable or reimbursable by Tenant under theLease. In addition to its obligation to pay Base Rent (as determined herein),Tenant shall continue to pay and reimburse Landlord as set forth in the Leasewith respect to such Operating Expenses and other items with respect to thePremises during the First Extension Term or the Second Extension Term, asapplicable. The arbitration process described below shall be limited to thedetermination of the Base Rent and shall not affect or otherwise reduce ormodify the Tenant's obligation to pay or reimburse Landlord for such operatingexpenses and other reimbursable items. (f) Landlord shall notify Tenant of its determination of the FairMarket Rent (which shall be made in Landlord's sole discretion and shall in anyevent be not less than the Base Rent in effect as of the expiration of the LeaseTerm or the First Extension Term, as applicable) for the First Extension Term orthe Second Extension Term, as applicable, and Tenant shall advise Landlord ofany objection within 10 days of receipt of Landlord's notice. Failure to respondwithin -20-the 10-day period shall constitute Tenant's acceptance of such Fair Market Rent.If Tenant objects, Landlord and Tenant shall commence negotiations to attempt toagree upon the Fair Market Rent within 30 days of Landlord's receipt of Tenant'snotice. If the parties cannot agree, each acting in good faith but without anyobligation to agree, then the Lease Term shall not be extended and shallterminate on its scheduled termination date and Tenant shall have no furtherright hereunder or any remedy by reason of the parties' failure to agree unlessTenant or Landlord invokes the arbitration procedure provided below to determinethe Fair Market Rent. (g) Arbitration to determine the Fair Market Rent shall be inaccordance with the Real Estate Valuation Arbitration Rules of the AmericanArbitration Association. Unless otherwise required by state law, arbitrationshall be conducted in the metropolitan area where the Project is located by asingle arbitrator unaffiliated with either party. Either party may elect toarbitrate by sending written notice to the other party and the Regional Officeof the American Arbitration Association within 5 days after the 30-daynegotiating period provided in Paragraph (f), invoking the binding arbitrationprovisions of this paragraph. Landlord and Tenant shall each submit to thearbitrator their respective proposal of Fair Market Rent. The arbitrator mustchoose between the Landlord's proposal and the Tenant's proposal and may notcompromise between the two or select some other amount. Notwithstanding anyother provision herein, the Fair Market Rent determined by the arbitrator shallnot be less than, and the arbitrator shall have no authority to determine a FairMarket Rent less than, the Base Rent in effect as of the scheduled expiration ofthe Lease Term or the First Extension Term, as applicable. The decision of thearbitrator shall be final, binding and non-appealable. The cost of thearbitration shall be paid by Landlord if the Fair Market Rent is that proposedby Landlord, and by Tenant if the Fair Market Rent is that proposed by Tenant;and shall be borne equally otherwise. If the arbitrator has not determined theFair Market Rent as of the end of the Lease Term or the First Extension Term, asapplicable, Tenant shall pay 105 percent of the Base Rent in effect under theLease as of the end of the Lease Term or the First Extension Term, asapplicable, until the Fair Market Rent is determined as provided herein. Uponsuch determination, Landlord and Tenant shall make the appropriate adjustmentsto the payments between them. (h) The parties consent to the jurisdiction of any appropriate courtto enforce the arbitration provisions of this Addendum and to enter judgmentupon the decision of the arbitrator. (i) Except for the Base Rent as determined above, Tenant's occupancyof the Premises during the First Extension Term or the Second Extension Term, asapplicable, shall be on the same terms and conditions as are in effectimmediately prior to the expiration of the initial Lease Term or the FirstExtension Term, as applicable; provided, however, Tenant shall have no furtherright to extend the Lease Term pursuant to this addendum or to any allowances,credits or abatements or options to expand, contract, renew or extend the Lease. (j) If Tenant does not send the First Extension Notice or the SecondExtension Notice, as applicable, within the period set forth in Paragraphs (a)and (b), Tenant's right to extend the Lease Term shall automatically terminate.Time is of the essence as to the giving of the First Extension Notice and theSecond Extension Notice, as applicable, and the notice of Tenant's objectionunder Paragraph (f). (k) Landlord shall have no obligation to refurbish or otherwiseimprove the Premises for the First Extension Term or the Second Extension Term,as applicable, but in no event shall Landlord be relieved of its continuingrepair, maintenance and other obligations under the Lease. Subject to theforegoing, the Premises shall be tendered on the Commencement Date of the FirstExtension Term and the Second Extension Term, as applicable, in "as-is"condition. (l) If the Lease is extended for the First Extension Term or theSecond Extension Term, as applicable, then Landlord shall prepare and Tenantshall execute an amendment to the Lease confirming the extension of the LeaseTerm and the other provisions applicable thereto. (m) If Tenant exercises its right to extend the term of the Lease forthe First Extension Term or the Second Extension Term, as applicable, pursuantto this Addendum, the term "Lease Term" as used in the Lease, shall be construedto include, when practicable, the First Extension Term and the Second ExtensionTerm except as provided in (i) above. -21- ADDENDUM 4 MISCELLANEOUS PROVISIONS ATTACHED TO AND A PART OF THE LEASE AGREEMENT DATED 4/10, 2001, BETWEEN PROLOGIS CALIFORNIA I LLC and SKECHERS U.S.A., INC. 1. COMMENCEMENT DATE LEASE CONTINGENCY. The Commencement Date ofthis Lease shall be the day following the Rejection Date as defined in theStipulation Regarding Rejection of Ontario Lease, Including Mutual Releasesattached hereto as Exhibit E. If, however, the Rejection Date does not occur onor before May 30, 2001, then this Lease shall automatically terminate and theparties shall be released and discharged from all liability and responsibilityhereunder. Landlord shall have no obligation to contract for or fund the TenantImprovement Allowance referenced in Addendum 2 until this contingency expires oris waived by Landlord and Tenant. 2. FIRST RIGHT OF OPPORTUNITY FOR SINGLE ASSET BUILDING SALE. Ifduring the Term of the Lease Landlord desires to market the Building for Sale asa single asset sale, Landlord grants Tenant, provided that Tenant is not indefault under the Lease, a First Right of Opportunity to negotiate with Landlordfor purchase of the Building. If Landlord and Tenant, following good faithnegotiations, are unable to agree to terms within ten (10) business days afterLandlord's written notice to Tenant, Landlord shall be free to market theBuilding to third parties without any further obligation to Tenant. This Rightof First Opportunity expressly excludes any sale or conveyance in whole or inpart of Landlord's interest in the Building if such sale or conveyance ofinterest is part of or connected in any way with a portfolio sale or conveyance.Such a portfolio sale or conveyance includes i) any transaction involving theBuilding and any other asset where Landlord (or any other entity with whichProLogis Trust or the New York Common Retirement Fund) has an ownership interestor ii) any conveyance to a third party with whom Landlord or ProLogis Trust hasan ongoing business relationship. 3. LANDLORD'S RECAPTURE RIGHT. If during the Term of the LeaseLandlord deems it necessary to relocate its existing Ontario branch office,Landlord shall have the right upon 30 days prior written notice to Tenant torecapture a portion of the Premises located at the southwest corner of theBuilding and consisting of approximately 2,000 s.f. as more fully described onthe attached Exhibit A ("Landlord's Office Space"), for purposes of generaloffice use, to be used by Landlord as a branch office for its normal businessoperations. Landlord shall cause the utilities with respect to Landlord's OfficeSpace to be separately metered (except for water and sewer which shall bejointly metered) and Landlord and Tenant shall pay their respectiveProportionate Share of such charges. Landlord shall, at its sole cost andexpense, be responsible for any build-out of Landlord's Office Space. Upon theeffective date of such recapture of Landlord's Office Space, the monthly BaseRent and Operating Expenses payable by Tenant to Landlord and Tenant'sProportionate Share of the Project and the Building shall be adjustedaccordingly in the proportion that Landlord's Office Space bears to the totalsquare footage of the Premises. -22- EXHIBIT A SITE PLAN ATTACHED TO AND A PART OF THE LEASE AGREEMENT DATED 4/10, 2001, BETWEEN PROLOGIS CALIFORNIA I LLC and SKECHERS U.S.A., INC. [ILLUSTRATION] EXHIBIT B FRONT ENTRANCE SIGN ATTACHED TO AND A PART OF THE LEASE AGREEMENT DATED 4/10, 2001, BETWEEN PROLOGIS CALIFORNIA I LLC and SKECHERS U.S.A., INC. [ILLUSTRATION] EXHIBIT C MONUMENT SIGN ATTACHED TO AND A PART OF THE LEASE AGREEMENT DATED 4/10, 2001, BETWEEN PROLOGIS CALIFORNIA I LLC and SKECHERS U.S.A., INC. [ILLUSTRATION] EXHIBIT D NAME SIGN ATTACHED TO AND A PART OF THE LEASE AGREEMENT DATED 4/10, 2001, BETWEEN PROLOGIS CALIFORNIA I LLC and SKECHERS U.S.A., INC. [ILLUSTRATION] EXHIBIT E STIPULATION REGARDING REJECTION OF ONTARIO LEASE, INCLUDING MUTUAL RELEASES ATTACHED TO AND A PART OF THE LEASE AGREEMENT DATED 4/10, 2001, BETWEEN PROLOGIS CALIFORNIA I LLC and SKECHERS U.S.A., INC. STIPULATION REGARDING REJECTION OF ONTARIO LEASE, INCLUDING MUTUAL RELEASES ProLogis California I LLC, as successor to ProLogis Development ServicesIncorporated (collectively, "ProLogis"), eToys, Inc. ("Inc.") and eToysDistribution L.L.C. ("eToys" collectively with Inc., the "Debtors") hereby enterinto this Stipulation Regarding Rejection of Ontario Lease, Including MutualReleases (the "Agreement") with reference to the following: I. RECITALS A. ProLogis, as landlord, and eToys, as tenant, are parties to thatcertain Lease Agreement (the "Ontario Lease") dated as of February 28, 2000,pursuant to which eToys leases premises commonly known as ProLogis Park,Milliken Avenue, Ontario, California (the "Premises"). The Premises consist ofan entire building, containing approximately 763,228 rentable square feet,together with certain surrounding land, parking areas, and improvements. B. The Ontario Lease is for a term of 60 months, which commenced onJune 9, 2000, and requires eToys to make monthly payments of base rent,operating expenses, and amortized improvements totaling approximately $258,840. C. To secure payment of all sums due under the Ontario Lease,ProLogis required, and received from eToys, a security deposit of $2,029,090,which ProLogis continues to possess. Additionally, eToys, Inc., guaranteed theobligations of eToys under the Ontario Lease. D. The Debtors filed voluntary petitions for relief under chapter 11of title 11 of the United States Code (the "Bankruptcy Code") on March 7, 2001(the "Petition Date"), thereby commencing their respective bankruptcy cases(collectively, the "Bankruptcy Cases"). E. Since the Petition Date, the Debtors have continued to operatetheir respective businesses as debtors in possession. However, the Debtors haveconcluded that it is not possible to reorganize their business and haveundertaken to liquidate their assets as quickly as possible. F. The Debtors have attempted to sell the Ontario Lease, but theirefforts have not been successful; the monthly payments due under the OntarioLease are slightly higher than current fair market rates. The Debtors thereforedesire to reject the Ontario Lease pursuant to Bankruptcy Code section 365. G. ProLogis and the Debtors understand that Skechers USA, Inc.("Skechers") desires to enter into a new lease with ProLogis, pursuant to whichSkechers would lease the Premises for a term greater than the remaining term ofthe Ontario Lease (the "Skechers Lease"). ProLogis has advised the Debtors that,in order to induce Skechers to enter into the Skechers Lease, ProLogis will haveto incur new tenant improvement costs and leasing commission costs in anaggregate amount greater than $1.5 million. In addition to such expenditures,ProLogis is incurring additional damages as a result of eToys' rejection of theOntario Lease: (i) eToys currently owes ProLogis $10,953.64 on account ofunderpayments of operating expenses during the year 2000, and (ii) ProLogis willcollect approximately $170,000 less rent under the Skechers Lease during thenext 50 months than it would have collected under the Ontario Lease. Thus,ProLogis will sustain total mitigation costs and rejection damages ofapproximately $1,700,000, not including related attorneys' fees and costs. H. The Debtors and ProLogis desire to settle all claims relating tothe Ontario Lease, expedite rejection of the Ontario Lease, and increase thelikelihood that Skechers will enter into the Skechers Lease. I. Certain personal property of the Debtors is located at thePremises. The Debtors and ProLogis understand that Skechers is prepared to enterinto the Skechers Lease as of the first calendar day after the Rejection Date,as defined below, and to sublease a portion of the Premises to the Debtors for aterm sufficient for them to liquidate or otherwise remove such personal propertyfrom the Premises. 2 II. STIPULATION WHEREFORE, based upon the foregoing Recitals for other good and valuableconsideration, the receipt of which is hereby acknowledged, ProLogis and theDebtors hereby covenant and agree as follows: 2.1. Rejection of Ontario Lease. The Ontario Lease shall be rejectedeffective on the first business day after ten days after the date on which anorder is entered in the Bankruptcy Cases (the "Rejection Date"); provided thatsuch order has not been appealed. 2.2. Delivery of Premises. The Debtors shall remove all of theirpersonal property, including all inventory, furniture, fixtures, and equipment,except such personal property as Skechers consents to have remain in or on thePremises for any period after the commencement of the Skechers Lease ("permittedpersonal property"), before the Rejection Date, and shall deliver the Premises,vacant (except for permitted personal property) and broom-clean, in the samecondition as received from ProLogis, ordinary wear and tear excepted, toProLogis on the Rejection Date. 2.3. Partial Repayment of Security Deposit. Within five business daysafter the Debtors' performance of their obligations under the precedingparagraph 2.2, and only after they have performed such obligations, ProLogisshall remit payment to the Debtors' bankruptcy counsel of the sum of $1 millionless an amount equal to all rent and other amounts payable under the OntarioLease (at the rate of $8,628.01 per diem), for the period from April 1, 2001through the later of (a) the Rejection Date and (b) the date the Debtors performtheir obligation under the preceding paragraph 2.2. 2.4. Retention of Security Deposit in Satisfaction of Claims. ProLogisshall retain the security deposit received from eToys, net of the paymentremitted to Debtors' counsel pursuant to the preceding paragraph 2.3, togetherwith all interest accrued thereon (approximately $15,000), 3in full satisfaction of all claims of ProLogis with respect to the Ontario Leaseagainst either of the Debtors. 2.5. Mutual Releases. Upon the performance by the Debtors of theirobligations under paragraph 2.2 of this Agreement and the performance byProLogis of its obligations under paragraph 2.3 of this Agreement, the releasesgranted in Article III of this Agreement shall be effective and Inc.'s guarantyof the Ontario Lease (the "Guaranty") shall be terminated. III. RELEASE AND DISCHARGE OF GUARANTY AND ALL RELATED CLAIMS 3.1. Release by ProLogis. ProLogis hereby releases and discharges eachof the Debtors and their present and former representatives, assigns,shareholders, agents, officers, directors, employees, professionals, andsubsidiaries, shareholders and affiliates (collectively, the eToys Parties"),from, and waives and relinquishes any and all Claims (as defined below), whichit, or any person or entity claiming from, through or under it, ever had, nowhas, or hereafter can, shall, or may have against the eToys Parties in any way,manner, or fashion related to (i) the Ontario Lease or the Guaranty as eithermay have been modified, amended, or supplemented, (ii) any agreements enteredinto in connection therewith, and (iii) the Bankruptcy Cases. 3.2. Release by the Debtors. Each of Inc. and eToys hereby releasesand discharges ProLogis and its predecessors, and each of their present andformer representatives, assigns, subsidiaries, partnerships, affiliates,shareholders, agents, officers, directors, employees, and professionals, andeach of them (the "ProLogis Parties"), from, and waives and relinquishes, anyand all Claims (as defined below), which it, or any person or entity claimingfrom, through or under it, ever had, now has, or hereafter can, shall, or mayhave against the ProLogis Parties in any way, manner, or fashion related to (i)the Ontario Lease or the Guaranty as either may have 4been modified, amended, or supplemented (ii) any agreements entered into inconnection therewith, and (iii) the Bankruptcy Cases. 3.3. "Claim" Defined. As used in this Agreement, the term "Claim"means any and all rights, claims, counterclaims, demands, debts, liabilities,obligations, actions, omissions, causes of action, setoffs, suits, sums ofmoney, accounts, defenses, reckonings, covenants, contracts (whether express orimplied, oral or written, or otherwise) and all breach thereof, complaints,objections, controversies, agreements, promises, understandings, breaches ofduty or any relationship, malfeasance, nonfeasance, compensation, damages(including actual, consequential, and punitive damages), penalties, costs,losses, expenses or circumstances of every type, kind, nature, description orcharacter and irrespective of how, why, or by reason of whatever facts whetherheretofore existing or hereafter arising, or which could, might, or may bedeemed to exist, whether known or unknown, suspected or unsuspected, contingentor fixed, liquidated or unliquidated, matured or unmatured, in law, equity,bankruptcy or otherwise, each as though fully set forth herein at length,whether or not the same arises out of contract, tort, fraud, misrepresentation,duress, breach of duty, or violation of laws or regulations. 3.4. California Civil Code Section 1542. EACH PARTY HERETO EXPRESSLYUNDERSTANDS that Section 1542 of the Civil Code of the State of Californiaprovides as follows: A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THECREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTINGTHE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENTWITH THE DEBTOR. 3.5. Waiver. EACH PARTY TO THIS AGREEMENT HEREBY AGREES THAT THEPROVISIONS OF SECTION 1542 of the Civil Code of the State of California and allsimilar federal or state laws, rights, rules, or principles, legal or equitable,which may be applicable hereto ARE HEREBY KNOWINGLY AND VOLUNTARILY WAIVED ANDRELINQUISHED BY EACH PARTY TO THIS AGREEMENT to the full extent that such 5rights and benefits may be waived, and each party to this Agreement herebyagrees and acknowledges that this waiver and relinquishment is an essential termof this Agreement, without which the consideration provided to it would not havebeen given. 3.6. Subsequently Discovered Claims. In connection with the waiver andrelinquishment of the Claims and rights as set forth in this Agreement, eachparty to this Agreement acknowledges that it is aware that it may hereafterdiscover Claims presently unknown or unsuspected, or facts in addition to ordifferent from those which it now knows or believes to be true. Nevertheless, itis the intent of each party in executing this Agreement fully, finally, andforever to settle and release all such matters, and all Claims relative thereto,which exist, may exist, or might have existed (whether or not previously orcurrently asserted in any action) which are the subject of the releases grantedby each party under this Agreement. IV. CONDITIONS TO EFFECTIVENESS This Agreement shall be effective only upon the satisfaction of each ofthe following conditions: 4.1. Entry of a final order in the Debtors' respective BankruptcyCases approving, authorizing, and directing the Debtors to enter into thisAgreement, which order shall not have been appealed. 4.2. Execution and delivery by Skechers to ProLogis, and acceptance byProLogis of the Skechers Lease in a form acceptable to ProLogis in its solediscretion. 4.3. Occurrence of the Rejection Date on or before May 10, 2001. V. REPRESENTATIONS AND WARRANTIES The parties hereby represent, warrant, and agree with one another asfollows: 5.1. Representation by Counsel. Each party acknowledges that it hasbeen represented by counsel of its choice throughout the negotiations whichpreceded the execution of the 6Agreement, and in connection with the preparation and execution of thisAgreement, each party acknowledges that it has executed this Agreementvoluntarily, without coercion or duress of any kind, and on the advice of itsindependent counsel. 5.2. No Reliance. Neither party, nor any person acting on its behalf,has made any statement or representation to the other party regarding any factrelied upon in entering into this Agreement, and the parties do not rely uponany statement, representation, or promise of the other party or other personacting on behalf of the other party in making the settlement provided forherein, except as expressly stated in this Agreement. 5.3. Independent Investigation. Each party has made such investigationof the facts pertaining to this Agreement, and of all the matters pertainingthereto, as it deemed necessary. 5.4. Comprehension. Each party has read this Agreement and understandits contents. 5.5. Construction. Each party has cooperated in the drafting andpreparation of this Agreement. Hence, this Agreement shall not be construedagainst any party. 5.6. No Transfer of Claims. Each party warrants and represents thatthere has been no assignment, sale, or transfer, by operation of law orotherwise, of any Claim to be released by the release contained herein. Theparties agree to indemnify, defend, and hold harmless each other party from anyclaim, liability, or expense which may be incurred as a result of the assertionof any such Claim by any other person by reason of such assignment, sale, ortransfer. 5.7. Authority. Each party has taken all appropriate corporate actionto authorize execution of this Agreement and grant the releases containedherein, and the peon executing this Agreement on behalf of each respective partyhas full authority to do so. VI. MISCELLANEOUS 6.1. Complete Agreement. This Agreement represents the completeagreement among the parties, and supersedes all prior and contemporaneousagreements, understandings, and 7representations, if any. This Agreement may only be amended or modified by awritten agreement executed by all of the parties. 6.2. Attorneys' Fees and Expenses. In any litigation or otherproceeding arising out of or relating to this Agreement, the prevailing party orparties shall recover all attorneys' fees and other expenses and costs incurredin connection with the litigation or other proceeding. 6.3. Governing Law. This Agreement shall be governed by thesubstantive laws of the State of California (without regard to any doctrine ofconflict of laws). 6.4. Headings. The headings of the articles and sections of thisAgreement have been inserted for convenience of reference only and shall notmodify, define, or limit any of the terms or provisions hereof. 6.5. Successors and Assigns. This Agreement shall be binding upon andinure to the benefit of the parties hereto, and their respective successors andassigns. 6.6. No Third Party Beneficiaries. The provisions of this Agreementare for the benefit of the parties hereto and the released parties identified inArticle III hereof, and not for any other person, and may not enforced or reliedupon by any person other than the parties and the parties released under ArticleIII hereof. 6.7. Severability. If any provision of this Agreement is declared by acourt of competent jurisdiction to be illegal, unenforceable, or void, thatprovision shall be modified so as to be enforceable and as nearly as possible toreflect the original intention of the applicable parties, it being agreed andunderstood by the parties hereto that (a) this Agreement and all the provisionshereof shall be enforceable in accordance with their respective terms to thefullest extent permitted by law; and (b) the remainder of this Agreement shallremain in full force and effect. 8PROLOGIS CALIFORNIA I LLC, as ETOYS, INC.successor to PROLOGIS DEVELOPMENTSERVICES INCORPORATED By: --------------------------------- Name:By: Title: ---------------------------------Name:Title: ETOYS DISTRIBUTION L.L.C. By: --------------------------------- Name: Title:Approved as to form and content:MAYER, BROWN & PLATTKIMBERLY S. WINICKBy: --------------------------------- Kimberly S. WinickAttorneys for ProLogis California I LLC,as successor to ProLogis DevelopmentServices IncorporatedIRELL & MANELLAHOWARD J. STEINBERGBy: --------------------------------- Howard J. SteinbergAttorneys for eToys, Inc. and eToys Distribution L.L.C. 9 Exhibit 21.1 Subsidiaries of the Registrant Name of Subsidiary State/Country of Incorporation/Organization ------------------ ------------------------------------------- Skechers By Mail, Inc. Delaware Skechers U.S.A., Inc. II Delaware Skechers U.S.A. Ltd. England Skechers U.S.A. SAS France Skechers U.S.A. Deutschland GmbH Germany Skechers S.a.r.l. Switzerland Skechers International Switzerland Skechers International II Switzerland Skechers U.S.A., Inc., Taiwan Branch Taiwan Skechers Collection LLC California Skechers Sport LLC California Duncan Investments, LLC California Yale Investments, LLC Delaware  Exhibit 23.1 Independent Accountants' ConsentWe consent to incorporation by reference in the registration statement (No.333-71114) on Form S-8 of Skechers U.S.A., Inc. of our report dated February 13,2002, relating to the consolidated balance sheets of Skechers U.S.A., Inc. andsubsidiaries as of December 31, 2000, and 2001, and the related consolidatedstatements of earnings, stockholders' equity and comprehensive income, and cashflow for each of the years in the three-year period ended December 31, 2001, andthe related financial statement schedule, which report appears in the December31, 2001 annual report on Form 10-K of Skechers U.S.A., Inc.Los Angeles, CaliforniaMarch 29, 2002 

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