Back to GetFilings.com

Table of Contents

Index to Financial Statements

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

FOR THE FISCAL YEAR ENDED: DECEMBER 31, 2002

OR

FOR THE TRANSITION PERIOD FROM _________ TO _________.

COMMISSION FILE NUMBER: 0-20418

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and  (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

Indicate by check mark whether the registrant is an accelerated filer as defined in the Securities and Exchange Act Rule 12b-2. Yes o No x

The aggregate market value of the voting stock of the registrant held by non-affiliates of the registrant, based upon closing sales price of the Common Stock on the NASDAQ Stock Market on June 28, 2002 was approximately $37 million. The number of shares of the registrant's Common Stock outstanding as of March 31, 2003 was 10,298,392.

DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Registrant’s proxy statement for its 2003 Annual Meeting of Stockholders, to be held at a future date, are incorporated by reference into Part III of this report.

Table of Contents

Index to Financial Statements

KENNEDY-WILSON, INC.

INDEX TO ANNUAL REPORT ON FORM 10-K

2

Table of Contents

Index to Financial Statements

ITEM 1.  BUSINESS

OVERVIEW

We are an integrated, national real estate services and investment Company.  Founded in 1977, we were later incorporated in Delaware and became a public Company in 1992.  We deliver a complementary array of real estate services.  Headquartered in Beverly Hills, we have over 530 employees in offices in the U.S.  We initially gained recognition through our real estate auction services.  Over time, we diversified our business so that we now provide:

In addition to these real estate related services, we invest primarily through joint venture investments in commercial and residential real estate and discounted loan portfolios. Our clients include large financial institutions, major corporations, pension funds, real estate developers, insurance companies and governmental entities.

Our previously wholly-owned, consolidated subsidiary, Kennedy-Wilson Japan (KWJ), has had a presence in Japan for ten years through which we have developed significant relationships with Japanese companies and financial institutions. In February 2002, the Company completed an initial public offering of the shares of KWJ, which consisted of 4,500 newly issued shares and 2,500 shares sold by the Company at a price of approximately $3,319 per share, for total gross cash consideration of approximately $23 million. In September 2002, a secondary public stock offering of KWJ was completed and consisted of 4,900 shares at a price of $1,700 per share, and the private sale of 2,000 shares of the stock, for total gross cash consideration of approximately $11.7 million. Effective with the completion of the secondary offering, the Company retained ownership of 37% of KWJ’s shares and KWJ became an unconsolidated subsidiary in the Company’s financial statements and is accounted for as an equity method investment.

OUR BUSINESS OPERATIONS

FUND MANAGEMENT

KWI Fund Management Group is a vertically integrated real estate services and fund management firm.  This group organizes and manages closed-end commingled

3

Table of Contents

Index to Financial Statements

real estate investment funds that invest in high-quality office, industrial, retail and multifamily income property located in selected markets in the U.S.  We serve as the general partner of the funds and co-invest with our pension fund clients as limited partners.  We earn fees for services provided to the fund including fees for acquisition, asset management, property management, leasing, and disposition services.

KWI Fund I, formed in August 2000, is a $146 million fund comprised of $68 million in equity, which is 5% owned by the Company, and capitalized with limited partners’ capital and $78 million in debt.  Through the end of 2002 KWI Fund I has acquired 11 office properties and one multifamily property, totaling approximately 1,745,000 square feet.  The properties are located in Los Angeles, Santa Monica, Houston, Austin, Dallas and Atlanta. 

Future funds are expected to be in the $100 million equity range with $250 million in assets.  The funds are expected to have the following principal investment objectives:

PROPERTY MANAGEMENT AND LEASING

We are a nationwide commercial and residential property management and leasing Company.  We provide a full range of services relating to property management, including:

We have managers in ten regional offices -- Beverly Hills, New York, Dallas, Austin, Houston, San Francisco, Seattle, Walnut Creek, Minneapolis and Chicago -- supervising nearly 530 employees who assist in managing more than 200 office and industrial buildings, and multi-unit residential complexes in 22 different states.  We have approximately 53 million gross square feet of real estate under management.

As part of our strategy for providing our property management clients with the best services possible, we apply the same approach in managing our

4

Table of Contents

Index to Financial Statements

clients’ properties as we do in managing our own, where our primary objective is to maximize the return on investment.  To this end, we work with each client to ascertain their goals and expectations and to design strategic plans for leasing and improving each property in a way that increases the client’s returns.  We also strive to maximize our clients’ returns by reducing property operating expenses through the discounts and lower prices that we generally obtain for vendor services and supplies.

REAL ESTATE BROKERAGE

Through our offices in Beverly Hills and New York, we provide specialized brokerage services for both commercial and residential real estate.  We market and sell on behalf of our clients and ourselves:

We specialize in marketing institutional properties through privately negotiated and sealed bid sales.  We develop and implement cost-effective marketing campaigns ranging from local to worldwide in scope.  Each marketing campaign is tailored to the client’s objectives and the property’s characteristics, including time parameters, sensitivity to publicity, and cash flow needs.  We also investigate and analyze, among other things, the physical condition of the property, its cash flow and tenant characteristics, market rents and market dynamics within submarkets, and comparable transactions.

We also market properties directly to various investors with whom we maintain ongoing business relationships.  We believe that through these efforts, we create a sales environment intended to enable our clients to obtain the highest possible prices for their properties.  We obtain our commercial brokerage engagements primarily through our existing relationships with over 100 institutional and corporate owners of real estate primarily located in the U.S. and Japan.

We also design marketing programs to sell single-family home developments and condominium projects using conventional sales and auction-marketing programs.  We also design and implement sealed bid marketing programs for exclusive estates and land for residential development.  Most of the residential properties that we have brokered are located in California.  Our clients include builders, developers, private sellers and financial institutions.

On a national basis, we provide our clients with auction marketing services to sell both commercial and residential real estate.  Auctions provide a seller an opportunity to concentrate the marketing efforts and sell its holdings on one established date.  By doing so, the seller can increase liquidity and avoid long-term carrying costs and the risk of a drop in market value.  For these reasons, we believe that the net proceeds to the seller following an auction sale of multiple units often exceeds what the net proceeds would have been had the units been sold individually through conventional brokerage arrangements.

5

Table of Contents

Index to Financial Statements

REAL ESTATE INVESTMENTS

We invest in commercial and residential real estate primarily through joint ventures with institutional joint venture partners, who typically contribute the majority of the capital.  The investment platforms typically target specific property types.  We have joint venture funds for multiple investments with certain institutional partners.  These funds enable us to leverage our capital and diversify the risks associated with owning properties.  In addition, we earn fees for services provided to the joint venture, including due diligence, acquisition, asset management, leasing, property management and disposition services. Profit from fees earned by the Company from entities in which the Company retains an ownership interest are deferred to the extent of the Company's ownership percentage in amounts capitalized by the joint venture.

We purchase properties that are subperforming in a manner which we believe can be rectified with our expertise or financial resources.  For example, a developer of a residential real estate project may find it difficult or impossible to finish the project because it cannot properly market the finished product or has insufficient cash flow.  In such a situation, we can purchase the project at a discounted price then apply our marketing expertise and draw on our financial resources to finish the project and sell it as a whole or to individual buyers for a profit.  With regard to commercial properties, we acquire subperforming buildings, make the improvements necessary to attract tenants, lease to new tenants and then sell the buildings.

One of our strengths is our ability to quickly identify and acquire desirable real estate assets in privately negotiated transactions.  We do so by capitalizing on the institutional knowledge we have developed through our brokerage, property management, and investment business and by conducting quick and thorough investigations and analyses of the properties, their financial condition and what we believe to be their financial potential.  We have extensive experience in identifying and analyzing the factors that impact property values in the regions in which we do business, such as new construction, the marketability of certain neighborhoods, leasing trends and the types of businesses seeking various types of commercial space.  Our due diligence is conducted by our experienced in house team.

Most of the real estate in which we and our joint venture investment platform have invested is located in California and Texas.  The current cycle of the U.S. real estate market presents value-added investment potential.  Our brokerage and property management operations are the source of many of our real estate acquisitions.  These operations provide us with unique investment opportunities in the form of close relationships with our institutional clients that have substantial real estate investments.  For example, a financial institution client that has acquired a property through a foreclosure may desire to sell it in less time than it would take for a conventional brokerage sale.   We are often able to meet the needs of these types of clients by purchasing their properties quickly and discretely for one of our joint venture funds.

NOTES RECEIVABLE INVESTMENTS

In 2001, we began acquiring discounted loan portfolios that were performing and were secured primarily by real estate.  These assets are accounted for under the interest method, which provides that the accretable discount be recorded as interest income over the life of the loans.

Through 1999 our note pool portfolio acquisitions consisted primarily of pools of assets that contained

6

Table of Contents

Index to Financial Statements

bankruptcy claims, judgments, credit guarantees, and other residual claims arising from defaulted credit transactions.  These assets were typically purchased from financial institutions. Our strategy to collect the asset balances consists of negotiating a cash payoff, restructuring the asset to a performing note or foreclosing and selling any related collateral.  Our last acquisition of these types of assets was in 1999.  Most of these notes have been settled, with the majority being paid off in less than two years. 

KENNEDY-WILSON JAPAN

The Company has had a presence in Japan for over ten years through its formerly wholly-owned subsidiary, Kennedy-Wilson Japan (KWJ). The operations in Japan include investment in real estate, the acquistion of pools of discounted Japanese notes and asset management and brokerages services. The notes are typically secured by real estate and personal property. The investment strategy is to acquire the notes on a privately negotiated basis from Japanese financial institutions. KWJ's investments are typically acquired in joint venture funds with institutional investors who contribute the majority of the capital. As noted above, subsequent to the secondary public stock offering of KWJ in September 2002, KWJ became an unconsolidated subsidiary in the Company's financial statements and is accounted for as an equity method investment.

GOVERNMENT REGULATIONS

Our brokerage and property management operations are subject to various federal, state and local regulations.  We must have an officer licensed as a real estate broker or we must associate with a broker licensed by each state within the U.S. in which we provide brokerage or property management services.  Each of our employees that performs certain brokerage functions in any particular state must be a licensed real estate salesperson in that state and he or she must work under the supervision of a broker licensed by that state.  We are in compliance with all material licensing requirements and regulations in states and countries in which

7

Table of Contents

Index to Financial Statements

licenses are required and in which we are engaged in brokerage and property management activities.

In various states, governmental entities license individual auctioneers and/or administer various regulations governing their activities and may require that auctioneers post bonds.  We are in compliance with all material licensing and bonding requirements in all states in which auctioning licenses and bonds are required and in which we are engaged in material auction activities.

COMPETITION

Because of our unique combination of businesses, we compete with brokerage and property management companies as well as companies that invest in real estate and distressed notes.  The brokerage and property management businesses are both highly fragmented and competitive.  We compete with real estate brokerage companies on the basis of our relationship with property owners, quality of service, and commissions charged.  We compete with property management and leasing firms also on the basis of our relationship with clients, the range and quality of services provided, and fees and commissions charged.  Our investment operations compete to varying degrees with real estate investment partnerships and other investment companies.  We compete with these other investors on the basis of our relationship with the sellers and the amounts that we pay for the investments acquired.

EMPLOYEES

We have approximately 530 employees in the U.S.  Our compensation policies are designed to attract, retain and motivate employees that are an integral part of our profitability.  Our employees typically receive a base salary and performance based incentives including bonuses based primarily on the cash flow of their operational units.  As a result, employees are encouraged to meet individual goals as well as to contribute their expertise and efforts on behalf of their group.  In addition to promoting the generation of revenues, our compensation structure also encourages our employees to control costs.

AVAILABLE INFORMATION

The Company is subject to the informational requirements of the Securities Exchange Act of 1934 that require the Company to file, most often electronically, reports, proxy and information statements, and other information with the Securities and Exchange Commission (SEC). The public may read and copy the Company's filings at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. The public can obtain information on the operation of the Public Reference Room by calling 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov.

ITEM 2.  PROPERTIES

Our executive and administrative offices are located at 9601 Wilshire Boulevard, Suite 220, Beverly Hills, California.  We also lease space for our regional and branch offices and sublease space to third parties.  These facilities, including our Beverly Hills headquarters, comprise a total of approximately 104,000 square feet of leased space, with an annual aggregate base rental of approximately $2.5 million.  Each of these leases is scheduled to expire within the next five years.  We believe that we will be able to renew any expiring lease or obtain suitable office space to replace such leased facility, as necessary, without any material increase in our rental costs. 

As described above, we also buy and sell real estate, primarily through joint venture investments, in the ordinary course of our business.

8

Table of Contents

Index to Financial Statements

ITEM 3.  LEGAL PROCEEDINGS

We are involved in various legal proceedings generally incidental to our business.  These matters are generally covered by insurance.  While the ultimate disposition of these proceedings is not known, based upon current available information, we believe that the outcomes will not have a material adverse effect on our financial position or results of operations.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of our stockholders during the fourth quarter of 2002.

9

Table of Contents

Index to Financial Statements

PART II

ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our Company’s Common Stock trades on The NASDAQ National Market under the symbol “KWIC”.  The following table sets forth the high and low closing prices of our Common Stock as reported on the NASDAQ National Market.

As of March 24, 2003, there were approximately 1,200 holders of our Common Stock.

EQUITY COMPENSATION PLAN TABLE

10

Table of Contents

Index to Financial Statements

ITEM 6.  SELECTED FINANCIAL DATA

The following table sets forth selected financial data as of and for each of the five fiscal years ended December 31, 2002.  The data set forth below should be read in conjunction with the Consolidated Financial Statements and related Notes to Consolidated Financial Statements appearing elsewhere herein and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

	Year ended December 31,
		2002			Restated* 2001				Restated* 2000				Restated* 1999				Restated* 1998
	(in thousands, except share data)
STATEMENTS OF OPERATIONS DATA:
Total revenue	$	44,662			$	60,508			$	91,535			$	88,191			$	50,156
Total operating expenses		48,643				59,263				85,283				71,480				36,312
Equity in joint venture income		8,709				5,592				6,236				2,049				612
Equity in income of Kennedy-Wilson Japan		907				-				-				-				-
Income from operations		5,635				6,837				12,488				18,760				14,456
Non-operating items, minority interest and income taxes		530				(4,297	)			(7,349	)			(13,834	)			(9,197	)
Net income		6,165				2,540				5,139				4,926				5,259
Basic net income per share	$	0.66			$	0.29			$	0.57			$	0.60			$	0.84
Basic weighted average shares		9,338				8,701				9,018				8,219				6,254
Diluted net income per share	$	0.64			$	0.29			$	0.54			$	0.51			$	0.77
Diluted weighted average shares		9,584				8,888				10,128				10,015				6,801

 

	Year ended December 31,
		2002			Restated* 2001				Restated* 2000				Restated* 1999				Restated* 1998
	(in thousands)
BALANCE SHEET DATA:
Total assets	$	129,075			$	128,856			$	131,459			$	133,493			$	204,278
Long term debt		24,741				25,541				55,653				27,901				136,130
Total liabilities		66,377				77,296				82,804				87,829				181,837
Total stockholders’ equity		62,698				51,560				48,655				45,664				22,441

* See Note 25 to the Consolidated Financial Statements.

11

Table of Contents

Index to Financial Statements

ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The accompanying management’s discussion and analysis of financial condition and results of operations gives effect to the restatement of the Consolidated Financial Statements for the years ended 2001 and 2000 as described in Note 25 to the Consolidated Financial Statements.

OVERVIEW

We are an integrated real estate services and investment Company with headquarters in Beverly Hills, California.  Through our subsidiaries, we provide a complementary array of real estate services, including fund management, property management and leasing, real estate brokerage services including auction marketing, and asset management.  We also invest in commercial and residential real estate and discounted loan portfolios. Our investments in real estate are made primarily through joint venture funds. 

In 2002 the Company completed two public stock offerings and two private sales of shares of its formerly wholly-owned subsidiary, Kennedy-Wilson Japan.  The sale of stock reduced the Company’s ownership in the Japan subsidiary to 37%.  This change in ownership necessitated a change in the accounting treatment for Kennedy-Wilson Japan from a consolidated entity to an equity investment beginning in the fourth quarter of 2002.  Instead of including the various components of Kennedy-Wilson Japan’s revenue and expenses in the individual revenue and expense categories on the income statement, the Company’s 37% of the net income of the Japan subsidiary is shown as a single separate line item. Likewise, on the balance sheet the Comnpany’s investment in Kennedy-Wilson Japan is shown as a single separate line item.

Our current real estate investment strategy favors joint venture investments, however, in the future, we may still acquire and sell commercial real estate on a wholly owned basis.  We are no longer involved in single-family residential development and sales but are investing, through joint venture partnerships, in multi-family apartment projects.  We also invest in discounted loan portfolios secured primarily by real estate, on our own account and through joint venture partnerships.  The discounted asset portfolios acquired prior to 2001 consisted primarily of claims, judgements and guarantees.

COMPARISON OF YEARS ENDED DECEMBER 31, 2002 AND 2001

Our revenues in 2002 and 2001 were $44.7 million and $60.5 million, respectively.  Total operating expenses in 2002 and 2001 were  $48.6 million and $59.3 million, respectively.  Our net income for the same periods was $6.2 million and $2.5 million, respectively.

REVENUE

In 2002 property management and leasing generated revenue of $27.1 million (including related party fees of $5.4 million), representing 60.7% of our total revenue, compared to approximately $33.4 million (including approximately $5.4 million in related party fees) and 55.2% in 2001.  Property management and leasing revenue includes asset management, construction management, leasing services, engineering and other services to property operators.  Because the Japan subsidiary is now being accounted for as an equity investment, their property management revenue is not included in this category after September 2002.  Property management revenue in the U.S. declined

12

Table of Contents

Index to Financial Statements

due in part to the decrease in the total square footage of properties under management.  Lower interest rates and favorable loan terms, have resulted in an increased number of building sale transactions including some of the buildings managed by the Company.  Leasing commission revenue, construction development fees and engineering services have similarly declined due to the decrease in economic activity. The overall downturn of the economy has led to a decline in the occupancy rates in many markets resulting in fewer number of leasing transactions completed, and the terms of new leases and renewals are often at lower rates and for shorter terms than current leases, thus reducing leasing commissions.  The Company has a business development plan in each of the regional property management divisions to aggressively seek out new third party business, as well as investment opportunities which we expect to benefit the Company’s real estate operating platform of property management, leasing, engineering and construction management services.

Brokerage commission revenues in 2002 increased 5.0% to $13.5 million (including approximately $7.7 million in related party fees), representing 30.2% of total revenues compared to brokerage commission revenues in 2001 of $12.8 million (including related party fees of approximately $4.5 million).  Brokerage commissions are reported net of outside broker’s commission expense but not commissions paid to employees which are recorded as marketing and commission expense.  Brokerage commissions in Japan prior to the deconsolidation increased 23.0%, in part, due to an increased number and size of transactions which has resulted from Japanese financial institutions being motivated to liquidate assets.  Because the Japan subsidiary is now being accounted for as an equity investment, commissions earned in Japan are not included in this category after September 2002.  Brokerage commissions in the U.S. decreased 14.6% due to the decrease in the number and size of sales transactions.  While we have brokered sales throughout the US, we have a significant concentration in Southern California and Texas.  A downturn in one or both of these markets could have an adverse effect on our brokerage business.  As part of our business plan, the Company plans to expand our brokerage activity in the Northeast region of the U.S. In connection with our brokerage activities we provide property valuations, development and implementation of marketing plans, sealed bid auctions and open bid auctions.

There were no gains on sales of residential real estate in 2002 compared to approximately $11 million in 2001.  During 2002, the Company sold two small pieces of land resulting in a loss of approximately $200,000, which was offset by a gain of approximately $200,000 from the former Japan subsidiary. The Company has chosen to exit the development and sales of single family residential real estate projects as a business component in favor of investing, with joint venture partners, in multi-family apartment projects in selected areas of the country.  The sales of residential real estate completed during 2001 included 44 homes in a 109-home development in the Palm Springs area. 

There was no gain on sale of commercial real estate in 2002 compared to $281,000 in 2001 representing the sale of a parcel of land located in Hawaii.  Currently, the Company does not own any real estate on a wholly owned basis, although in the future, in addition to investing in commercial real estate through joint venture partnerships, we may still choose to acquire selected commercial real estate properties for our own account.  

13

Table of Contents

Index to Financial Statements

Interest and other income totaled approximately $4.1 million or 9.2% of total revenues compared to approximately $3.0 million in 2001. Interest and other income includes accretion of discounts on acquired loan portfolios, interest on corporate notes receivable that are held as a result of investment sales, interest on cash investments and other miscellaneous sources of revenue. The accretion of discounts on loan portfolios are accounted for under the interest method, which provides that the accretable discount be recorded as interest income over the life of the loans. In 2002 and 2001, $3.4 million and $1.4 million, respectively, was recorded as interest income earned from loan portfolios accounted for under the interest method previously discussed. The portion of the interest and other income from loan portfolios and other sources earned in Japan during 2002 and 2001 was $2.2 million and $983,000, respectively. Interest earned on a large note relating to the sale of land in Hawaii earned $353,000 of interest in 2002 and $407,000 in 2001. During 2002, the land collateralizing this note was foreclosed upon and sold to a new joint venture investment entity in which the Company maintains a 50% ownership interest. No gain was recognized on this transaction.

OPERATING EXPENSES

As discussed above, the Company’s formerly wholly-owned subsidiary, Kennedy-Wilson Japan, was consolidated through September 2002. Subsequent to September 2002, the investment is accounted for on the equity method. Therefore, operating expenses for 2002 include nine months of consolidated activity for Kennedy-Wilson Japan compared to a full year of activity included in 2001.

Operating expenses in 2002 were $48.6 million, representing a decrease of 17.9% from  $59.3 million in 2001.  Most of the decrease represents the $11.1 million cost associated with the sales of residential real estate in 2001 compared to $220,000 in 2002.  As discussed above, the Company has exited the single-family residential real estate development business.

Commissions and marketing expenses decreased to $5.5 million in 2002 from $6.9 million in 2001.  The expense represents 41.0% of the commission revenue in 2002 down from 53.9% of the commission revenue in 2001.  The reduction in the percentage of commission expense to commission revenue represents a reduction in brokerage commissions earned by the property management division of the Company which typically pays out approximately 50% to 60% of the gross commission to brokers and employees as commission expense.

Cost of residential real estate sold was $220,000 in 2002, a 98.0% decrease from $11.1 million in 2001.  The expense in 2002 relates to the sale of real estate by the former Japan subsidiary. As previously discussed, the Company has exited the residential real estate development business.

Compensation and related expenses were $26.0 million in 2002, down 1.2% from $26.3 million in 2001.  The decrease was primarily a result of cost reduction initiatives, staff reductions and the impact of not consolidating Kennedy-Wilson Japan during the fourth quarter of 2002 versus a full year in 2001.  The total number of employees, excluding the Japan subsidiary was approximately 530 at December 31, 2002 compared to 593 at December 31, 2001.

14

Table of Contents

Index to Financial Statements

General and administrative expenses were $10.7 million in 2002, representing a 4.0% decrease from 2001 expenses of $11.2 million.  General and administrative expenses in the U.S. increased by 1.5%, offset by a decrease in the Japan subsidiary of 26.7% through September 2002.

Depreciation and amortization expense decreased to $3.6 million in 2002, a 4.4% decrease from $3.8 million in 2001. In the US, the reduction results from the elimination of goodwill amortization in accordance with SFAS 142, offset by depreciation of capitalized costs relating to the consolidation of our technology-based real estate auction brokerage and related services business that was previously reported under the equity method of accounting. Depreciation and amortization for the Japan subsidiary through September 2002 increased due to depreciation related to several properties acquired during 2002 for their own account.

Non-cash write-down of investment was approximately $1.5 million for 2002, compared to no write-down in 2001.  During 2002, management concluded that the cost basis of a real estate investment was not probable of recovery.  Based on the analysis performed by management, the basis of the real estate investment was reduced by approximately $1.5 million, resulting in a cost basis of the associated asset of zero.

Non-recurring, non-cash Japan IPO expense relating to the discounted stock issued to employees of the Japan subsidiary is associated with the gain on sale of stock of subsidiary of $12.9 million classified in non-operating income.

Equity in joint venture income totaled $8.7 million in 2002 compared to $5.6 million realized in 2001.  The revenue from joint venture investments includes income from the operation and sale of numerous real estate investments in the US which are owned primarily in joint venture funds with institutional investor partners. Additionally, as previously discussed, income earned on note pool assets owned in joint venture partnerships is also included in this operating income category.  During 2002, five commercial buildings, and two apartment projects were sold to either third parties or joint ventures in which the Company retained an ownership interest. The Company recorded equity in income of approximately $5.3 million from these sales after deferral of income in the amount of $339,000 related to the Company’s percentage ownership in the acquiring joint venture investment entity.  During 2001, two apartment projects were sold and the Company's equity in this income was approximately $1.0 million.  Our current investment portfolio and our plans for future investments focus on commercial buildings and on multiple family residences.  Under the Company’s investment strategy, we typically contribute a fully funded initial capital contribution and/or property previously owned by the Company.

Equity in income of Kennedy-Wilson Japan was $907,000 in 2002. This represents the equity in the income of the Company’s formerly consolidated subsidiary, Kennedy-Wilson Japan, subsequent to the September 2002 deconsolidation of the entity.

NON-OPERATING ITEMS

Gain on sale of stock of subsidiary was approximately $12.9 million for 2002 compared to no gain in 2001.  The gain resulted from the sale of shares owned in our Japan subsidiary as part of the successful initial public offering, the secondary offering of the subsidiary’s shares in Japan, and the private sales of shares owned by the Company. The initial public offering consisted of 4,500 newly issued shares and 2,500 shares sold by the Company at a price of approximately $3,319 per share, for total gross cash consideration of approximately $23 million. The secondary public stock offering consisted of 4,900 shares of its Japan subsidiary at a price of $1,700 per share, and the private sale of 2,000 shares of the stock of the subsidiary, for total gross cash consideration of approximately $11.7 million. The Company retained ownership of 37% of the subsidiary’s shares after the transactions. Effective with the completion of the secondary offering, Kennedy-Wilson Japan became an unconsolidated subsidiary in the Company’s financial statements and is accounted for as an equity method investment.

Interest expense was $2.6 million in 2002 a decrease of 7.3% compared to approximately $2.8 million in 2001 due, in part, to the reduced average interest rates on variable rate loans.  Additionally, in both 2002 and 2001, interest expense was reduced by approximately $2.3 million of interest capitalized on several qualifying real estate investments.  These investments were undergoing construction or entitlement activities in preparation for their planned principal operations.

15

Table of Contents

Index to Financial Statements

The valuation adjustment for the change in the fair value of warrants issued in connection with the issuance of $15 million of 12% senior unsecured notes resulted in income of $209,000 for 2002 compared to an expense of $158,000 in 2001. The Company issued the warrants to the purchasers of the notes for the purchase of 597,888 shares of the common stock of the Company at an exercise price of $6.25 per share. The warrants expire June 22, 2008. The warrants contain a put provision that requires the Company, at the option of the note holders, to repurchase the common shares issued upon exercise of the warrants, at the prevailing market price, during years four through six of the warrant term. The fair value of the warrants was estimated using a combination of the Black-Scholes Option Pricing Model and Monte Carlo Simulation. A liability was recorded for the fair value of the warrants, which is adjusted quarterly to record the warrants at their estimated fair value while they are outstanding, with the change in value recorded as valuation adjustment - warrants. As a result of the partial repayment of $5 million of the notes in 2002, warrants for the purchase of 199,296 shares of common stock were cancelled and the liability for the value of the warrants was reduced by $222,000. The estimated fair value of the warrants was $283,000 and $714,000 at December 31, 2002 and 2001, respectively, and is included in accrued expenses and other liabilities.

Write-down of technology investments in 2002 was $3.2 million compared to no write-down in 2001.  Management concluded that the cost basis of two e-commerce investments were not probable of recovery.  Based on the analysis performed by management, the basis of the e-commerce investments was reduced by $3.2 million resulting in the cost basis of one of the associated assets being written down to $1 million and the cost basis of the other associated asset being written down to zero. Because the Company is not in the business of investing in Internet start-up companies, the write-down of the technology investments is classified as non-operating, as will any income or loss in future periods.

Gain on extinguishment of debt was $750,000 for 2002 compared to no gain in 2001.  The gain on extinguishment of debt related to the conversion of the convertible subordinated debentures in the amount of $3,977,000 and the issuance of subordinated debentures in the amount of $2,773,000 to retire the $7,500,000 of convertible subordinated debt. Under recently adopted accounting pronouncements (SFAS 145), such gain is not considered an extraordinary item.

The provision for income taxes was approximately $3.4 million for 2002 compared to $1.3 million in 2001 as a result of the change in income before provision for income taxes. The effective tax rate in 2002 was 36% compared to 35% in 2001.

COMPARISON OF YEARS ENDED DECEMBER 31, 2001 AND 2000

Total revenues for 2001 were $60.5 million, which represents a 33.9% decrease from $91.5 million in 2000.  Earnings before taxes for 2001 were $3.9 million, compared to $9.0 million in 2000. Net income for 2001 was approximately $2.5 million compared to approximately $5.1 million in 2000. 

REVENUE

In 2001 our property management and leasing operations generated $33.4 million (including approximately $5.4 million in related party fees) of revenues, representing 55.2% of our total revenue and a 14.7% decrease from property management revenue of approximately $39.1 million (including related party fees of approximately $1.0 million) in 2000.  The decline in revenue corresponds to a decline in total square footage under management due to the sale of several of the buildings managed by the Company.  Leasing commissions also declined due to the sale of the buildings and a general decline in the local economic conditions, particularly in the southwestern region of the country.  Property management and leasing revenue includes asset management, construction management, and engineering services.

Brokerage commission revenues in 2001 were $12.8 million (including approximately $4.5 million in related party fees), representing 21.2% of total revenues and a 13.5% decrease from brokerage commission revenues in

16

Table of Contents

Index to Financial Statements

2000 of $14.8 million (including approximately $3.4 million in related party fees).  During 2001, both the number and the size of brokerage transactions declined from the brokerage sales in 2000.  During the year 2000 we completed four large sales transactions with commissions averaging approximately $1.2 million.  During 2001 there were no such transactions.  Our brokerage services include sales and leasing for commercial, industrial, retail and apartment properties.

Sales of residential real estate were $11.0 million in 2001, representing 18.2% of total revenues, compared to $30.2 million in 2000.  The sales completed during 2001 included 44 homes in a 109-home development in the Palm Springs area.  The sales completed during the 2000 included the bulk sale of 53 condominium units in a 136-unit building located in Los Angeles, 48 homes in a 109-home development in the Palm Springs area and two single family homes in Los Angeles.  The sales of residential real estate for both years reflect our strategy to sell upon completion of planned improvements, rather than holding for speculation.

The gain on sale of commercial real estate in 2001 was $281,000 compared to no sales during 2000.  During 2001, we sold a parcel of land located in Hawaii.

Interest and other income for 2001 totaled approximately $3.0 million, or 5.0% of total revenue, compared to approximately $7.4 million in 2000. Interest and other income includes gains on loan portfolios, interest on corporate notes receivable that are held as a result of investment sales, interest on cash investments and other miscellaneous sources of revenue. The gains on loan portfolios are accounted for under the interest method, which provides that the accretable discount be recorded as interest income over the life of the loans. In 2001 and 2000, interest income earned from loan portfolios accounted for under the interest method was $1.4 million and $4.4 million, respectively. The higher income in 2000 relates to the cash settlement of several large loans. Additionally, in 2001, interest earned on a large note relating to the sale of land in Hawaii was approximately $407,000. During 2000, interest earned on a note relating to the sale of the Company's 25% interest in a joint venture investment that owned two commercial buildings was $276,000.

OPERATING EXPENSES

Operating expenses in 2001 were $59.3 million, compared to $85.3 million in 2000.  The largest decrease represents the lower cost of goods sold associated with the sales of residential real estate discussed above.  Commissions and marketing expenses decreased approximately $1.0 million, compensation and general and administrative cost combined decreased by approximately $9.0 million and depreciation and amortization expense decreased by approximately $550,000.

Brokerage commissions and marketing expenses decreased to $6.9 million in 2001 from $7.9 million in 2000.  Commission and marketing expense for 2001

17

Table of Contents

Index to Financial Statements

was 53.9% of commission revenue and in 2000 commission and marketing expense was 53.0% of commission revenue.  Commission revenue is recorded net of third party broker payments and the commission expense is the portion of the commission paid to employees of the Company.

Cost of residential real estate sold was $11.1 million in 2001, a 58.3% decrease from $26.6 million in 2000.  This increase correlates with the decreased revenues from the sales of real estate discussed above.

Compensation and related expenses were $26.3 million in 2001, a 13.6% decrease from $30.4 million in 2000.  The decrease was primarily a result of cost reduction initiatives and staff reductions during the year that reduced the total number of employees to 620 in 2001 from 820 in 2000.

General and administrative expenses were $11.2 million in 2001, representing a 30.5% decrease from 2000 expenses of $16.1 million.  Again, the decrease was due primarily to the continuing aggressive cost reduction initiatives throughout the year.

Depreciation and amortization expense decreased to $3.8 million in 2001, a 12.7% decrease from $4.4 million in 2000.  The decrease was due to the sale of a 50% interest in a commercial office building during 2001.

Equity in income of investments in joint ventures totaled $5.6 million in 2001, compared to $6.2 million realized in 2000.  The revenue from joint venture investments includes income from the operation, sale, and fees earned on numerous investments in the U.S. and Japan, which are owned primarily in joint venture funds with institutional partners.  Income earned on investments in Japan was $4.0 million and $1.9 million respectively.  Revenue from joint venture investment funds in Japan included continued settlement of the non-performing note pools and incentive fees earned on both the note pools and real estate assets acquired through the joint ventures. During 2001 a large commercial office building in Tokyo was sold and the Company realized incentive fees and gain from the sale.  Also during 2001, the Company sold four commercial office buildings in the greater Los Angeles area and one apartment project located in Azusa, California.  During 2000, the Company realized profit from the sale of two apartment projects located in the greater Los Angeles area.

NON-OPERATING ITEMS

Interest expense was approximately $2.8 million in 2001 a decrease of 20.1% compared to $3.5 million in 2000 due, in part, to declining interest rates.  Additionally, in 2001 interest expense was reduced by approximately $2.3 million of interest capitalized on several qualifying real estate investments compared with $2.0 million of interest capitalized in 2000.  These investments were in real estate buildings or land parcels, which were undergoing construction or entitlement activities in preparation for their planned principal operations.

The provision for income taxes was approximately $1.3 million in 2001, compared to approximately $3.8 million in 2000.  The income tax provision decreased proportionate to the decrease in pre-tax earnings.

18

Table of Contents

Index to Financial Statements

LIQUIDITY AND CAPITAL RESOURCES

Our liquidity and capital resources requirements include expenditures for joint venture fund investments, real estate held for sale, discounted loan portfolios and working capital needs.  Historically, we have not required significant capital resources to support our brokerage and property management operations.  We finance our operations with internally generated funds and borrowings under our revolving lines of credit.  Our investments in real estate are typically financed by mortgage loans secured primarily by that real estate.  These mortgage loans are generally nonrecourse in that, in the event of default, recourse will be limited to the mortgaged property serving as collateral.  In some cases, the Company guarantees a portion of the loan related to a joint venture investment, usually until some condition, such as completion of construction or leasing or certain net operating income criteria, has been met. The Company does not expect these guarantees to materially affect liquidity or capital resources.

During 2002, we entered into three credit agreements.  The first agreement is an unsecured revolving credit facility for $30 million with US Bank and East-West Bank for use in acquisitions and working capital purposes.  This facility replaces the loans from East-West Bank and United California Bank in the total amount of $28 million.  We also entered into a loan agreement with Pacific Western National Bank in the amount of $5 million.  This borrowing was used to repay a portion of the 12% senior notes and carry a much more favorable rate of interest of prime plus 1%.  Additional borrowings for a similar purpose are expected in 2003.  Lastly, the Company entered into a revolving loan agreement for $30 million with Foothill Capital Corporation for use in the expansion of our loan portfolio acquisition business.

Cash provided by operating activities was about $3.5 million in 2002, compared to approximately $5.2 million used in operating activities in 2001.  The change resulted from the increase in net income, including the increase in equity income, offset by the decrease in accounts receivable and other assets and an increase in accrued expenses and other liabilities.  Cash used in operating activities was about $5.2 million in 2001, compared to approximately $8.3 million in 2000.  The change resulted from an increase in the collection of accounts receivable, offset by a decline in net income.

Cash used in investing activities was about $11.8 million in 2002, compared to $11.1 million provided by investing activities in 2001.  The change resulted primarily from the reduction in cash held by Kennedy-Wilson Japan at deconsolidation, as discussed above, and contributions to joint ventures, offset by the proceeds from the sale of a portion of the Company's investment in Kennedy-Wilson Japan and a reduction in proceeds from sale of real estate. Cash provided by investing activities was about $11.1 million in 2001, compared to approximately $6.9 million in 2000.  The change resulted primarily from a decline in the purchase of real estate held for sale, offset by a decline in the settlement of notes receivable.

Cash provided by financing activities was about $8.8 million in 2002, compared to $9,000 used in financing activities in 2001.  The change resulted primarily by the increase in borrowings under notes payable, offset by the decrease in borrowings of mortgages notes payable.  Cash used in financing activities was $9,000 in 2001, compared to cash provided by financing activities of approximately $1.4 million in 2000.  The change resulted from the issuance of $15 million of senior unsecured notes, offset by the repayment of $9 million of subordinated debt in 2000 and the repurchase of common stock.

19

Table of Contents

Index to Financial Statements

To the extent that we engage in additional strategic investments, including real estate, note portfolio, or acquisitions of other property management companies, we may need to obtain third party financing which could include bank financing or the public sale or private placement of debt or equity securities.  We believe that existing cash, plus capital generated from property management and leasing, brokerage, sales of real estate owned, collections from notes receivable, as well as our current lines of credit, will provide us with sufficient capital requirements for the foreseeable future.

Under our current joint venture strategy, we generally contribute property, expertise, and typically a fully funded initial cash contribution (without commitment to additional funding by the Company).  Capital required for additional improvements and supporting operations during lease-up and stabilization periods is generally obtained at the time of acquisition via debt financing or third party investors.  Accordingly, the Company generally does not have significant capital commitments with unconsolidated entities.  Infrequently, there may be some circumstances when the Company, usually with the other members of the joint venture entity, may be required to contribute additional capital for a limited period of time. The Company believes that it has the capital resources, generated from our business activities and our borrowing capacity, to finance any such capital requirements, and does not believe that any additional capital contributions to joint ventures will materially affect liquidity.

Our need, if any, to raise additional funds to meet our capital requirements will depend on many factors, including the success and pace of the implementation of our strategy for growth.  We regularly monitor capital raising alternatives to be able to take advantage of other available avenues to support our working capital and investment needs, including strategic partnerships and other alliances, bank borrowings, and the sale of equity or debt securities.  The Company expects to meet the repayment obligations of notes payable and borrowings under lines of credit from cash generated by our business activities, including the sale of assets and the refinancing of debt. We intend to retain earnings to finance our growth and, therefore, do not anticipate paying dividends.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

At December 31, 2002, the Company’s contractual cash obligations, including debt, lines of credit, capital lease obligations and operating leases include the following:

CRITICAL ACCOUNTING POLICIES

Management’s discussion and analysis of financial condition and results of operations is based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The Company bases its estimates on historical experience and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies affect its significant judgments and estimates used in the preparation of its consolidated financial statements.

Revenue Recognition

The Company’s real estate services revenues are generally recorded when the related services are performed or at closing in the case of real estate sales. Property management fees are recognized over time as earned based upon the terms of the management agreement.

Leasing commission revenues are accounted for in accordance with the provisions of SAB 101. Accordingly, leasing commissions that are payable upon tenant occupancy, payment of rent or other events beyond the Company’s control are now recognized upon the occurrence of such events. In accordance with EITF 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, the Company records brokerage commission revenues and expenses on a gross basis. Of the criteria listed in the EITF, the Company is the primary obligor in the transaction, does not have inventory risk, performs all, or part, of the service, has credit risk, and has wide latitude in establishing the price of services rendered and discretion in selection of agents and determination of service specifications. Due to these factors, gross reporting is appropriate.

Residential real estate sales revenue and gains on sale of commercial property are recognized at the close of escrow when title to the real property passes to the buyer. The Company follows the requirements for profit recognition as set forth by Statement of Financial Accounting Standards No. 66, Accounting for Sales of Real Estate. The Company presents sales of commercial real estate on a net gain on sale basis due to the fact that these properties are typically held for two to three years and generate rental income and operating expenses during the holding period. Residential real estate is accounted for as inventory because these properties are generally held for less than one year and do not generate income during the holding period. Accordingly, gross revenue and cost of sales are presented separately on the statements of income.

Revenues on notes receivable are recognized as follows: The Company accounts for performing discounted loan portfolios that it began acquiring in 2001 on an effective interest basis under the provisions of Practice Bulletin 6. Through 1999, the Company acquired pools of claims, judgements, and other defaulted credit transactions. Revenues on these assets are accounted for as follows: Cash payments on defaulted notes are applied to the cost basis until fully recovered before any revenue is recognized. When claims and judgements purchased are subsequently structured into performing collateralized notes, the difference between the cost basis of the asset and the fair value of the resulting note is accreted into interest and other income over the life of the note.

Valuation of Investments

The Company reviews each of its investments in joint ventures on a periodic basis for evidence of impairment. Impairment losses are recognized whenever events or changes in circumstances indicate declines in value of an investment below carrying value and the related undiscounted cash flows are not sufficient to recover the asset’s carrying amount. In 2002, the Company recorded impairment losses of approximately $3.2 million on remaining technology investments and approximately $1.5 million on a real estate investment based on this evaluation.

Valuation of Intangibles

The Company’s intangible assets substantially consist of property management contracts which are amortized on a straight-line basis over seven years, and goodwill representing costs paid in excess of net assets of acquired businesses. Through December 31, 2001, the Company used an undiscounted cash flow methodology to determine whether underlying operating cash flows were sufficient to recover the carrying amount of goodwill. Beginning January 1, 2002, goodwill is no longer amortized, but is evaluated annually for impairment based on a reporting unit fair value approach as required by SFAS 142. In determining fair value of a reporting unit, the Company relies on the application of generally accepted valuation approaches. During the year ended December 31, 2002, no impairment was indicated by application of the valuation analysis.

IMPACT OF INFLATION AND CHANGING PRICES

Inflation has not had a significant impact on the results of operations of the Company in recent years and is not anticipated to have a significant impact in the foreseeable future. The Company’s exposure to market risk from changing prices consists primarily of fluctuations in rental rates of commercial and residential properties, market interest rates on residential mortgages and debt obligations and real estate property values. The revenues associated with the commercial services businesses are impacted by fluctuations in interest rates, lease rates, real property values and the availability of space and competition in the market place. Commercial service revenues are derived from a broad range of services that are primarily transaction driven and are therefore volatile in nature and highly competitive. The revenues of the property management operations with respect to rental properties are highly dependent upon the aggregate rents of the properties managed, which are affected by rental rates and building occupancy rates. Rental rate increases are dependent upon market conditions and the competitive environments in the respective locations of the properties. Employee compensation is the principal cost element of property management. Economic trends in 2002 were characterized by general slowdowns in commercial leasing volume in the U.S.

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the FASB issued Statement of Financial Accounting Standards No. 141, Business Combinations (“SFAS 141”). SFAS 141 prospectively prohibits the pooling of interest method of accounting for business combinations initiated after June 30, 2001. The Company’s adoption of SFAS 141 did not have a material impact on the Company’s financial position or results of operations.

Also in July 2001, the FASB issued Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). SFAS 142, which is effective January 1, 2002, includes requirements to test goodwill and indefinite lived intangible assets for impairment rather than amortize them. In testing for impairment in accordance with SFAS 142, goodwill was assigned to the reporting units based upon the amount of goodwill generated at the time of acquisition of the businesses by the reporting unit. An earnings multiple appropriate to the respective reporting unit was applied to the cash basis net operating income of the reporting unit. This process enables a fair approximation of the entity’s value, which is then compared to the net book value of the reporting unit. As a result of the evaluation performed of its goodwill as described above, the Company has determined that there was no goodwill impairment as of the transition date or December 31, 2002.

The effects on earnings and earnings per share of excluding such goodwill amortization from 2001 and 2000 are as follows:

 

	For the year ended December 31,
		2002			2001			2000
Net income, as reported	$	6,165,000		$	2,540,000		$	5,139,000
Goodwill amortization, net of tax effect		—			577,000			472,000
Net income, excluding goodwill amortization	$	6,165,000		$	3,117,000		$	5,611,000
Basic earnings per share Earnings per share as reported	$	0.66		$	0.29		$	0.57
Earnings per share, excluding goodwill amortization	$	0.66		$	0.36		$	0.62
Diluted earnings per share Earnings per share as reported	$	0.64		$	0.29		$	0.54
Earnings per share, excluding goodwill amortization	$	0.64		$	0.35		$	0.58

In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”). SFAS 144 supercedes SFAS 121, Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed Of and applies to all long-lived assets, including discontinued operations. SFAS 144 establishes a single accounting model for the impairment or disposal of long-lived assets, including discontinued operations. Additionally, SFAS 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS 144 was effective for fiscal years beginning after December 15, 2001. None of the real estate sold in 2002, which was vacant land, had significant operating income and, therefore, is not reported as discontinued operations. The Company’s adoption of SFAS 144 did not have a material impact on the Company’s financial position or results of operations.

In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections (“SFAS 145”). The provisions of SFAS 145 relating to the early extinguishment of debt are effective for fiscal years beginning after May 15, 2002. The Company's adoption of these provisions, effective April 1, 2002, resulted in the Company recording a non-operating gain on extinguishment of debt in 2002 in the amount of $750,000 as a component of income.

In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS 146”). SFAS 146, which is effective for exit or disposal activities initiated after December 31, 2002, requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The Company does not expect the adoption of this standard to have a material impact on the Company’s consolidated financial statements.

In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34 (“FIN 45”). FIN 45 requires that upon issuance of a guarantee, the entity must recognize a liability for the fair value of the obligation it assumes under that guarantee. FIN 45 requires disclosure about each guarantee even if the likelihood of the guarantor’s having to make any payments under the guarantee is remote. The provisions for initial recognition and measurement are effective on a prospective basis for guarantees that are issued or modified after December 31, 2002 and the disclosure provisions of FIN 45 are effective for our December 31, 2002 financial statements. We do not expect adopting the recognition provisions of FIN 45 will have an impact on the Company. See Note 2 to the Consolidated Financial Statements.

In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure (“SFAS 148”). SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS 148 requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclosure requirements of SFAS 148 are effective for fiscal years ended after December 15, 2002. The interim disclosure requirements of Statement 148 are effective for interim periods ending after December 15, 2002. The adoption of the provisions of Statement 148 did not have a material impact on the Company's consolidated financial statements. The Company has elected not to adopt the fair value basis of accounting, however, the Company has modified its disclosures as required.

In December 2002, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB 51 (“FIN 46”). The primary objectives of FIN 46 are to provide guidance on the identification of entities for which control is achieved through means other than through voting right (variable interest entities, or VIEs) and how to determine when and which business enterprise should consolidate the VIE (the primary beneficiary). The provisions of FIN 46 are effective immediately for VIES created after January 31, 2003 and no later than July 1, 2003 for VIEs created before February 1, 2003. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest make additional disclosure in Financial Statements issued after January 31, 2003. We expect a certain previously unconsolidated special purpose entity to be consolidated under the provisions of this interpretation. The special purpose entity which is expected to be consolidated under the provisions of FIN 46 comprises $1,502,000 of the Company’s total $48,452,000 investments in joint ventures as of December 31, 2002. This investment is engaged in the development, operation and ultimate disposition of four office and industrial properties located in San Antonio, Texas. The Company’s maximum exposure to loss as a result of its involvement is limited to its capital investment.

20

Table of Contents

Index to Financial Statements

FORWARD-LOOKING STATEMENTS

Certain statements contained in this document may constitute “forward-looking statements” within the meaning of the federal securities laws.  Forward-looking statements are statements containing a projection of revenues, income, earnings, capital expenditures, dividends, capital structure or other financial terms or our plans and objectives for future operations.

The forward-looking statements in this document are based on our management’s beliefs, assumptions, and expectations of our future economic performance, taking into account the information currently available to them.  These statements are not statements of historical fact.  Forward-looking statements involve risks and uncertainties that may cause our actual results, performance or financial condition to be materially different from the expectations of future results, performance or financial condition we express or imply in any forward-looking statements.  Some of the important factors that could cause our actual results, performance or financial condition to differ materially from our expectations are:

When used in our documents or oral presentations, the words “plan”, “believe”, “anticipate”, “estimate”, “expect”, “objective”, “projection”, “forecast”, “goal”, or similar words, are intended to identify forward-looking statements.  We qualify any and all such forward-looking statements entirely by these cautionary factors.

21

Table of Contents

Index to Financial Statements

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The table below represents contractual balances of our financial instruments at the expected maturity dates as well as the fair value at December 31, 2002.  The expected maturity categories take into consideration actual amortization of principal and do not take into consideration reinvestment of cash.  The weighted average interest rate for the various assets and liabilities presented are actual as of December 31, 2002.  (See Consolidated Financial Statements – Note 2 - Fair Value of Financial Instruments)  Management closely monitors the fluctuation in interest rates, and if rates were to increase significantly, the Company believes that it would be able either to hedge the change in the interest rate or to refinance the loans with fixed interest rate debt.  All instruments included in this analysis are non-trading.

22

Table of Contents

Index to Financial Statements

The Company has an investment in Kennedy-Wilson Japan (KWJ) in the amount of $13,286,000 which represents a 37% ownership interest in KWJ, which is publicly traded in Japan. This investment is subject to fluctuations in the foreign exchange rates between the U.S. dollar and Japanese yen. The Company believes that at the current trading values, the fair value of its investment in KWJ significantly exceeds the Company's carrying value. Accordingly, while exchange rate fluctuations may result in sources of other comprehensive income or loss, the likelihood that such fluctuations would reduce the value below the Company's carrying value is remote.

23

Table of Contents

Index to Financial Statements

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

Index to Financial Statements

24

Table of Contents

Index to Financial Statements

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and Stockholders
Kennedy-Wilson, Inc.;

We have audited the accompanying consolidated balance sheet of Kennedy-Wilson, Inc. and subsidiaries (the "Company") as of December 31, 2002, and the related consolidated statement of income, changes in stockholders' equity and comprehensive income, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements of certain unconsolidated investee companies (the Investees). The Company's investment in the Investees at December 31, 2002, was $17,629,000, and its equity in earnings of the Investees was $2,498,000 for the year ended December 31, 2002. Additionally, one of the unconsolidated Investees was consolidated by the Company through September 20, 2002 and generated revenues of $12,493,000 during the period from January 1 through September 20, 2002. The financial statements of the Investees were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for the investees, is based solely on the reports of the other auditors.

We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, based on our audit and the reports of the other auditors, the 2002 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kennedy-Wilson, Inc. as of December 31, 2002 and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

25

Table of Contents

Index to Financial Statements

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and Stockholders
Kennedy-Wilson, Inc.
Beverly Hills, California

We have audited the accompanying consolidated balance sheet of Kennedy-Wilson, Inc. and subsidiaries (the “Company”) as of December 31, 2001, and the related consolidated statements of income, changes in stockholders’ equity and comprehensive income, and cash flows for each of the two years in the period ended December 31, 2001.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America.  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Kennedy-Wilson, Inc. and subsidiaries at December 31, 2001, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note  25, the accompanying consolidated financial statements for 2001 and 2000 have been restated.

DELOITTE & TOUCHE LLP
Los Angeles, California
March 22, 2002, except for Note 25, as to which the date is April 14, 2003

26

Table of Contents

Index to Financial Statements

Kennedy-Wilson, Inc. and Subsidiaries
Consolidated Balance Sheets

See accompanying notes to consolidated financial statements.

27

Table of Contents

Index to Financial Statements

Kennedy-Wilson, Inc. and Subsidiaries
Consolidated Statements of Income