kswiss_10k-123112.htm

PART I

Item 1. Business

Company History and General Strategy

K•Swiss Inc. designs, develops and markets an array of footwear, apparel and accessories for athletic, high performance sports and fitness activities and casual wear under the K•Swiss brand. Since July 2008, we also design, develop and market footwear for adventurers for all terrains under the Palladium brand. Revenues by brand for the years ended December 31, 2012, 2011 and 2010 are as follows (in thousands):

	2012		2011		2010
K•Swiss brand	$	171,068	$	224,769	$	185,513
Palladium brand		51,783		43,588		31,253
Total revenue	$	222,851	$	268,357	$	216,766

K•Swiss was founded in 1966 by two Swiss brothers, who introduced one of the first leather tennis shoes in the United States. The shoe, the K•Swiss “Classic,” has remained relatively unchanged from its original design, and accounts for a significant portion of our sales. The Classic has evolved from a high-performance shoe into a casual, lifestyle shoe. In our marketing, we have consistently emphasized our commitment to produce products of high quality and enduring style and we plan to continue to emphasize the high quality and classic design of our products as we introduce new models of athletic footwear.

On December 30, 1986, K•Swiss was purchased by an investment group led by our current Chairman of the Board and President, Steven Nichols. Thereafter we recruited experienced management and reduced manufacturing costs by increasing offshore production and entering into new, lower cost purchasing arrangements. Our products are manufactured to our specifications by overseas suppliers predominately in Asia, including the People’s Republic of China (“China”), Thailand, Vietnam and Indonesia. In June 1991 and September 1992, we established operations in Taiwan and Europe, respectively, to broaden our distribution on a global scale.

In July 2008, we purchased a 57% equity interest in Palladium for a total purchase price of €5,350,000, or $8,448,000 (including a loan of €3,650,000, or $5,764,000). In June 2009, we purchased the remaining 43% equity interest in Palladium for €5,000,000, or $7,034,000, plus a variable future purchase price, i.e. the Contingent Purchase Price (“CPP”), the terms of which were amended in May 2010. In May 2010, we revised the terms of the remaining future purchase price to be equal to the net present value of €3,000,000 plus up to €500,000 based on an amount calculated in accordance with a formula driven by Palladium’s EBITDA for the twelve months ended December 31, 2012. In July 2012, we revised the terms of the remaining future purchase price to be equal to the net present value of €1,500,000 plus up to €500,000 based on an amount calculated in accordance with a formula driven by Palladium’s EBITDA for the twelve months ended December 31, 2012 and made a payment of €1,443,000 or $1,776,000. The €500,000 CPP was determined each quarter based on the current quarter’s projection of Palladium’s EBITDA for the twelve months ended December 31 of the current year. Excluding the initial recognition of the CPP, any change in CPP was based on the change in net present value of the €1,500,000 and the current quarter’s EBITDA projection, and was recognized as interest income or interest expense during the current quarter. The fair value of the CPP at December 31, 2012 was €2,000,000, or $2,644,000, and is payable in 2013.

In July 2010, we entered into a Membership Interest Purchase Agreement with Form Athletics, LLC (“Form Athletics”) and its Members to purchase Form Athletics for $1,600,000 in cash and additional cash consideration to certain Members of Form Athletics in an amount equal to Form Athletics’ EBITDA for the twelve months ended December 31, 2012 (“Form CPP”). During 2011, we decided to no longer pursue operating in this line of business and recognized impairment losses of $3,689,000 on the Form Athletics goodwill and trademark and reversed the Form CPP liability of $2,110,000. Operations of the Form Athletics brand have been accounted for and presented as a discontinued operation in the accompanying financial information.

On January 16, 2013, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with E-Land World Limited, a corporation organized under the laws of the Republic of Korea (“Parent” or “E-Land”), Ian Acquisition Sub, Inc., a Delaware corporation and an indirect wholly-owned subsidiary of Parent (“Merger Sub”), pursuant to which Merger Sub will be merged with and into the Company, with the Company surviving as an indirect wholly-owned subsidiary of Parent (the “Merger”). Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each outstanding share of the Company’s Class A Common Stock and Class B Common Stock will be converted into the right to receive $4.75 in cash, without interest. Consummation of the Merger is subject to approval of the Merger by 80% of the Company’s voting power, and other customary closing conditions, including expiration or termination of the Hart-Scott-Rodino regulatory waiting period, expiration or termination of the relevant waiting period under the Korean Monopoly Regulation and Fair Trade Act (or approval of the business combination report filed thereunder by the Korean Fair Trade Commission), and the absence of any court order or other legal restraint prohibiting the Merger. The Merger is expected to close in the second quarter of 2013.

The discussion during the remainder of this Item 1 presents key information on our two brands separately. The discussion relating to distribution, futures orders, trademarks and patents, and employees is presented on a Company-wide basis.

K•Swiss Inc. is a corporation that was organized under the laws of the State of Delaware on April 16, 1990. The Company is successor in interest to K•Swiss Inc., a Massachusetts corporation, which in turn was successor in interest to K•Swiss Inc., a California corporation. Unless the context otherwise indicates, the terms “we,” “us,” “K•Swiss” and the “Company” as used herein refers to K•Swiss Inc. and its wholly-owned subsidiaries.

K•Swiss Brand

The following discussion relates solely to the K•Swiss brand.

Products

Footwear

Our primary product is footwear. Our footwear products are classified into two product categories: lifestyle and performance.

Our lifestyle category emphasizes the Classic and its derivatives. The lifestyle category evolved from a shoe called the Classic, which was originally developed in 1966 as a high-performance tennis shoe. Since that time, the Classic has become a popular casual shoe. The upper of the Classic includes only three separate pieces of leather, which allows for a relatively simple manufacturing process and yields a product with few seams. This simple construction improves the shoe’s comfort, fit and durability. We have from time to time incorporated certain technical advances in materials and construction, but the Classic has remained relatively unchanged in style since 1966, and continues to be the Company’s single most important product. In 2000, we successfully launched the Classic Luxury Edition and in 2009, we re-mastered and re-launched the original Classic, which is currently sold in the market today. In the third quarter of 2012, we introduced the Clean Classic, which is a sleeker version of the Classic without stripes and D-rings.

Our performance category emphasizes performance running, as well as tennis and training. In 2008, we entered the performance running segment with an emphasis on performance innovation. In 2009, we entered into a three year agreement to be the Official Run Course Sponsor (for footwear and apparel) of certain Ironman events which expired on December 31, 2012. In 2010 and 2011, we were the Presenting Sponsor of the Los Angeles Marathon.

Within each product category we have certain styles designated as core products. Our core products offer style continuity and often include on-going improvement. We believe our core product program is a critical factor in attempting to achieve our goal of becoming the “retailers’ most profitable vendor.” The core program tends to minimize retailers’ markdowns and maximizes the effectiveness of marketing expenditures because of longer product life cycles.

Revenues, by product category, for the years ended December 31, 2012, 2011 and 2010, are as follows (dollar amounts in thousands). Most styles within the lifestyle and performance categories are offered in men’s (approximately 65% of 2012 revenues), women’s (approximately 25% of 2012 revenues) and children’s (approximately 10% of 2012 revenues). There were no customers that accounted for more than 10% of total revenues during 2012. See Note M to our Consolidated Financial Statements.

	2012				2011				2010
K•Swiss Brand Category	$		%		$		%		$		%
Lifestyle	$	89,333	55	%	$	92,168	43	%	$	102,911	58	%
Performance		61,604	38			105,183	49			59,674	34
Other (1)		11,996	7			15,978	8			13,831	8
Total	$	162,933	100	%	$	213,329	100	%	$	176,416	100	%

Domestic (2, 3)	$	65,947	40	%	$	109,487	51	%	$	86,730	49	%
Foreign (2, 3)	$	96,986	60	%	$	103,842	49	%	$	89,686	51	%

(1)	Other consists of apparel and accessories.

(2)	For purposes of this table, revenues do not include other domestic income and fees earned on sales by foreign licensees and distributors.

(3)	Included in “Total.”

Apparel and Accessories

We market a limited line of K•Swiss branded apparel and accessories. The products are designed with the same classic strategies used in the footwear line. Classic styling allows us to appeal to a variety of markets, from consumers wanting performance apparel and accessories to the casual sportstyle consumers.

K•Swiss introduced apparel in 1999, with a new 7.0 collection of high tech tennis apparel to complement our performance 7.0 collection of footwear. Our tennis collection continues to offer world-class performance apparel (skirts, shorts, tops, polos, dresses and warm-ups) for both men and women. Regionally, we also offer a collection of running performance items, as well as casual athletic items, consisting of jackets, sweaters, sweatshirts, track jackets, tee shirts, caps, socks and bags.

The apparel line is distributed through better specialty stores, resorts and fitness centers worldwide. The tennis apparel line is sold primarily through tennis specialty and tennis pro shops. We also outfit professional and celebrity figures which offers us global branding exposure.

Sales

We sell our products through our sales executives and independent sales representatives primarily to a limited number of specialty athletic footwear stores, pro shops, sporting good stores and department stores and also through a number of foreign distributors. See “Risk Factors: Our financial success is limited to the success of our customers” and “Risk Factors: The loss of a significant customer, or a significant reduction in our sales to such a customer, could adversely affect our sales and results of operations.” We also sell our products through our website and retail locations which are becoming increasingly important sales channels to us particularly in light of our limited distribution. The following table sets forth revenue by sales channels, as a percentage of product revenues, for the years ended December 31, 2012, 2011 and 2010:

	2012			2011			2010
Wholesale		72	%		77	%		76	%
Distributor		16			13			14
Retail		9			7			7
Web		3			3			3
Total		100	%		100	%		100	%

We believe the athletic and casual footwear industry experiences seasonal fluctuations, due to increased sales during certain selling seasons, including Easter, back-to-school and the year-end holiday season. We present full-line offerings for the Easter season for delivery during the first and second quarters and back-to-school season for delivery during the third quarter, but only limited offerings for the year-end holiday season. See “Risk Factors: Our business is affected by seasonality, which could result in fluctuations in our operating results.”

Financial information relating to domestic and international operations is presented as part of Item 8 of this report. See Note N to our Consolidated Financial Statements.

Marketing

Advertising and Promotion

We have an integrated advertising plan with broadcast, print, cinema, outdoor, retail and online initiatives. Traditional media such as television, print and outdoor is still an important part of our media plan but online and social media activities are becoming increasingly more important to our advertising strategy given the changing media landscape and consumer preferences.

The K•Swiss website (www.kswiss.com) was created in 1999 to provide consumers an opportunity to purchase our footwear, apparel and accessories online at prices competitive with our retailers and have the product shipped directly to them. Our website reflects the premium sport positioning of K•Swiss and leverages the assets of our advertising campaigns.

We offer a “futures” program, under which retailers are offered discounts on orders scheduled for delivery more than five months after the order is made. There is no guarantee that such orders will not be canceled prior to acceptance by the customer. See “Futures Orders” and “Risk Factors: Our current futures orders may not be indicative of future sales.” This program is similar to programs offered by other athletic shoe companies. The futures program has a positive effect on inventory costs, planning and production scheduling. See “Distribution.” In addition, we engage in certain sales programs from time to time that provide for extended payment terms on initial orders of new styles.

Domestic Marketing

Domestically, our marketing uses a variety of traditional media, including television, cinema, out-of-home advertising and sports, music and general interest/fashion magazines, as well as non-traditional media, including the internet and social media networks, public relations, sports marketing, endorsements, in-store merchandising, product seeding and sponsorship.

Our footwear products are sold domestically through 39 independent regional sales representatives and 8 Company-employed sales managers. The independent sales representatives are paid on a commission basis, and are prohibited by contract from representing other brands of athletic footwear and related products. These sales personnel sold to approximately 3,000, 2,900 and 2,400 separate accounts as of December 31, 2012, 2011 and 2010, respectively.

We maintain a customer service department consisting of 10 persons at our Westlake Village, California facility. The customer service department accepts orders for our products, handles inquiries and notifies retailers of the status of their orders. We have made a substantial investment in computer equipment for general customer support and service, as well as for distribution. See “Distribution.”

International Marketing

In 1991, we established a sales management team in Asia which provides certain regional marketing materials and print and television advertising to our distributors. We have distributors in certain Pacific Rim countries and other international markets. Distributors of our products are generally contractually obligated to spend specific amounts on advertising and promotion of our products. We control the nature and content of these promotions. Certain distributors operate retail stores that sell exclusively K•Swiss branded product. In addition, we operate our own retail stores in Taiwan, Hong Kong and Japan that sell exclusively K•Swiss branded product.

To expand the sales and marketing of our products into Europe, we opened our own office in the Netherlands in 1992. Our product is sold through Company-employed sales managers, independent sales representatives and distributors. Our European marketing uses a variety of media distribution including print media, social and online media, in-store merchandising, catalog placement and local publicity events and sponsorships.

Internationally, at December 31, 2012, K•Swiss had the exclusive right to market our products in 118 countries through 7 international subsidiaries and 30 distributors.

Product Design and Development

We maintain offices in California, Taiwan and the Netherlands that include a staff of individuals responsible for the product direction for each regional market. All design activities occur in our Corporate Office in Westlake Village, California. Additionally, individuals located in our Taiwan, China, Thailand, Vietnam and Indonesia offices are responsible for the execution of the design and detailed development of new styles for all global regions. The staff receives guidance from our management team in California, who meet regularly to review sales, consumer and market trends.

Manufacturing

In 2012, approximately 32%, 25%, 22% and 21% of our footwear products were manufactured in China, Thailand, Vietnam and Indonesia, respectively. In April 2010 one of our contract manufacturers, which was one of only three manufacturers utilized by us at that time in our global supply chain, ceased its operations. While we were able to secure production capacity in new facilities during 2010, we experienced production delays throughout the remainder of 2010 and through a portion of 2011, as these facilities gained expertise in producing our product. Although we have no long-term manufacturing agreements and compete with other athletic shoe companies for production facilities (including companies that are much larger than us), we believe our relationships with our footwear producers are satisfactory and that we have the ability to develop, over time, alternative sources for our footwear. Our operations, however, could be materially and adversely affected if a substantial delay occurred in locating and obtaining alternative producers. Starting in 2011, we began to experience the inflationary pressures of our contract manufacturing in Asia, especially in China, with increases in, among other things, labor, raw materials and freight/transportation. As a result of the increases in these product costs, we raised selling prices approximately 6% in the United States for all orders received after May 15, 2011, which mainly affected shipments after November 30, 2011. See “Risk Factors: Fluctuations in the price, availability and quality of raw materials could cause delay and increase costs,” “Risk Factors: Because we rely on independent manufacturers to produce our products, our sales and profitability may be adversely affected if our independent manufacturers fail to meet pricing, product quality and timeliness requirements or terminate their operations or if we are unable to obtain some components used in our products from limited supply sources or experience supply chain disruptions” and “Risk Factors: Because a large portion of our imported products are manufactured in China, our profitability may be adversely affected if the United States government takes action against China for its concern over the level of intellectual property rights protection and enforcements available in China.”

All manufacturing of footwear is performed in accordance with detailed specifications furnished by us and is subject to quality control standards, and we retain the right to reject products that do not meet our specifications. The bulk of all raw materials used in such production are purchased by manufacturers at our direction. Our inspectors at the manufacturing facilities test and inspect footwear products prior to shipment from those facilities.

During 2012, our apparel and accessory products were manufactured in China, El Salvador, Hong Kong, Indonesia, Philippines, Singapore, Taiwan, the United States and Vietnam by certain manufacturers selected by us.

Our manufacturing operations and international sales are subject to the customary risks of doing business abroad, including compliance with applicable foreign laws and regulations, fluctuations in currency exchange rates, disruptions or delays in cross-border shipments, changing economic conditions, transportation costs, political instability, and the elimination, adjustment or imposition by any of the countries in which we manufacture our products of new export and import duties, quotas, tariffs, safeguard measures, anti-dumping duties, trade restrictions, restrictions on the transfer of funds and other changes and restrictions. We cannot predict the likelihood or frequency of any of such events occurring. If any of these or other factors make the conduct of business in a particular country undesirable or impractical, our business could be adversely affected.

Our use of common elements in raw materials, lasts and dies gives us flexibility to duplicate sourcing in various countries in order to reduce the risk that we may not be able to obtain products from a particular country.

Our footwear products entering the United States are subject to customs duties which range from 8.5% to 10.0% of factory cost on footwear made principally of leather, to duties on synthetic and textile footwear ranging from 6.0% to 20.0% plus, for certain styles, $0.90 per pair. Our footwear products, manufactured in China, entering the European Union are subject to customs duties at 8.0% of landed cost on footwear with uppers made principally of leather and a duty rate of 16.8% for synthetic upper footwear. Our footwear products, manufactured in Thailand, entering the European Union are subject to customs duties which range from 3.5% to 4.5% of landed cost on footwear with uppers made principally of leather and a duty rate of 11.9% for synthetic upper footwear. Currently, approximately 67% of our footwear volume is derived from sales of leather footwear and approximately 33% of our footwear volume is derived from sales of synthetic and textile footwear.

Competition

The athletic footwear industry is highly competitive. There are several marketers of footwear larger than us, including Nike and adidas. Each of these companies has substantially greater financial, distribution and marketing resources as well as greater brand awareness than us.

In the past, we have increased our emphasis on product lines beyond our Classic model as we have introduced products in such highly competitive categories as court, boating, outdoor and children’s shoes and we entered the higher end priced running category in 2008. See “K•Swiss Products – Footwear.” There can be no assurance that we will penetrate these or other new markets or maintain the market share we have established to date.

The principal elements of competition in the athletic footwear market include brand awareness, product quality, design, pricing, fashion appeal, marketing, distribution, performance and brand positioning. Our products compete primarily on the basis of technological innovations, quality, style and brand awareness among consumers. While we believe that our competitive strategy has resulted in increased brand awareness and market share, there can be no assurance that we will be able to retain or increase our market share or respond to changing consumer preferences.

Palladium Brand

The following discussion relates solely to the Palladium brand.

Products – Footwear

Palladium was founded in 1920 to make tires for the fledgling aviation industry. Tires were made by layering canvas bands underneath vulcanized rubber. Palladium’s expertise was so advanced that soon the majority of Europe’s aircraft were using Palladium tires. Because the end of World War II brought a significant decline in the demand for tires, Palladium began to produce footwear that was as hard wearing as their tires. In 1947, the legendary Pampa boot was born. The French Foreign Legion adopted the Pampa boot for its functionality, comfort and durability over the harsh desert conditions of North Africa, and throughout the rugged terrain of the Atlas Mountains. Combining over 60 years of authenticity with modern manufacturing, premium materials and cutting edge styling, Palladium boots are still based on the original classic boot, the Pampa.

The Palladium footwear line is classified into three categories, Palladium Original, Palladium Sport and PLDM. The Original category contains our core product line, featuring the same rubber molded rugged outsole across the range. Uppers are made with cotton canvas and leathers. While the outsole stayed constant across the range, we use various uppers of different heights to create choices for consumers. The primary styles are the Pampa Oxford, Pampa High, Pampa Baggy and Pampa Tactical. We concentrate on unique material treatments, such as enzyme washing our canvas for a vintage, worn-in look and feel. For leather, we use premium re-tanned leathers with unique finishes and textures. We also create performance products in this category, such as waterproof boots, using waterproof leather and stitching, sealed seams and gusseted tongues for protection from rain. We also provide boots for warmth, using wool and thermal linings. We believe that being known for performance functionality is key to longevity, and aim to be “a functional brand that is fashionable” by blending performance and style.

Our Sport category, introduced in Spring 2010, features the same styles but uses athletic colors and materials. Colors are more vibrant and influenced by popular sports team colors, and athletic textiles, leathers and meshes are used. One of the main collections within the Sport category is the “Blanc” collection, featuring a white rubber outsole, relating the boot to the sneaker world where white outsoles are well accepted. In Spring 2013, we plan to introduce the “Monochrome” collection to the Sport category, which again uses athletic colors but has matching color on the upper and the outsole, for a monochromatic effect.

PLDM is a sub-brand of Palladium, comprised of footwear outside of the Pampa family for men, women and children. It represents the legacy business that existed when we purchased Palladium SAS in 2008. PLDM creates comfort footwear in the sportswear space, targeted at a fashionable city dwelling consumer. Using rich leathers and modern materials, PLDM has original design influences from heritage Palladium and is available in various styles, heights, boots, shoes and flats. The design team is located in Lyon, France. PLDM product is manufactured in Portugal, Vietnam and Indonesia and is primarily distributed in Europe.

Revenues, by product category, for the years ended December 31, 2012, 2011 and 2010, are as follows (dollar amounts in thousands). There were no customers that accounted for more than 10% of total revenues during 2012. See Note M to our Consolidated Financial Statements.

	2012					2011					2010
Palladium Brand Category			$		%			$		%			$		%
Original	$	27,705		54	%	$	21,270		49	%	$	9,392		30	%
Sport		3,200		6			0		0			0		0
PLDM		20,604		40			21,996		51			21,670		70
Total	$	51,509		100	%	$	43,266		100	%	$	31,062		100	%

Domestic (1, 2)	$	8,820		17	%	$	5,761		13	%	$	4,253		14	%
Foreign (1, 2)	$	42,689		83	%	$	37,505		87	%	$	26,809		86	%

(1)	For purposes of this table, revenues do not include other domestic income and fees earned on sales by foreign licensees and distributors.

(2)	Included in “Total.”

Sales

Wholesale

We sell our products through sales executives primarily to a limited number of department stores, specialty boutiques, independent retailers, national chains and also through a number of foreign distributors. We also sell through online retailers which are becoming increasingly important, due to our limited distribution. We offer our products in two primary seasons, “spring/summer” and “fall/winter” with multiple deliveries within those seasons.

Retail

In addition to our wholesale business, at December 31, 2012, we own and operate 8 Palladium retail stores. We have 2 stores in London, 1 in Amsterdam, 2 in Hong Kong and 3 in the United States. In addition, we have 10 leased departments in Taiwan that we operate. All of these stores are stand-alone Palladium stores, selling only Palladium products. They have an industrial, concrete look and feel to match our city exploring brand position, and the design is centered around the “rubble bin,” a wooden crate branded with Palladium, that contains a layer of concrete rubble that the display shoes sit on top of. Certain international distributors have contracted to open Palladium stores in the next five years. Palladium’s own website (www.palladiumboots.com) contains a web store, which has been in operation since 2009, and sells Palladium products direct to consumers, shipping globally.

The following table sets forth revenue by sales channels, as a percentage of product revenues, for the years ended December 31, 2012, 2011 and 2010:

	2012			2011			2010
Wholesale		78	%		86	%		92	%
Distributor		10			5			4
Retail		9			6			2
Web		3			3			2
Total		100	%		100	%		100	%

Marketing

Advertising and Promotion

Palladium’s tagline is “Engineered for City Terrain,” with our brand positioned as being for city exploring. Our boots are ideal for concrete city terrain. Our brand communication and marketing serve to further establish that position with a consistent concrete, industrial look and feel to our brand materials and point-of-sale displays. For our primary campaigns, we explore cities around the world and create short documentary-style films, which serve as our advertising vehicles. In each film, an explorer wears Palladium boots and explores concrete city environments, and visits abandoned, forgotten or hidden places to uncover a unique side of the city, finding interesting and often newsworthy stories. These films have been shared hundreds of thousands of times by viewers via social media such as Twitter and Facebook, and have garnered major publicity from media outlets such as CNN, Huffington Post, the Wall Street Journal and GQ Magazine. In 2010, we brought in international celebrity Johnny Knoxville to lead our exploration of Detroit, showing the resurgence of a struggling city by a youth movement who has taken over abandoned buildings to create new creative spaces. In 2011, we ventured to Tokyo, Japan, with celebrity and music producer Pharrell Williams and explored subterranean Tokyo and saw a side to the city that even locals may not have seen. Our films are promoted via multiple elements of the marketing mix, including print advertising, online advertising, in-store marketing and public relations. Our company website, www.palladiumboots.com, serves as a hub for all of our video content, and provides consumers the opportunity to purchase our entire product line.

We also offer a “futures” program; under which retailers are offered discounts on orders scheduled for delivery more than five months after the order is made. See “K•Swiss Brand – Marketing – Advertising and Promotion.”

Domestic Marketing

Domestically, our marketing consists of in-store displays, print advertising, online advertising, outdoor advertising, social media and product seeding. The global “exploration campaigns” are executed domestically.

Our products are sold domestically through 8 Company-employed sales representatives and 1 person dedicated to customer service at our Westlake Village, California facility.

International Marketing

Palladium’s global campaigns and marketing strategy are executed in local regions, working via two international hubs, in Hong Kong for Asia and Amsterdam for Europe. Palladium teams in those regions disseminate marketing information to their local markets and ensure consistent execution of the global strategy. Product imagery, point of sale display design, advertising campaigns, brand communication and image are all standardized globally. Distributors of our products are generally contractually obligated to spend specific amounts on advertising and promotion of our products.

Certain distributors operate retail stores that exclusively sell Palladium products. Internationally, as of December 31, 2012, Palladium had the exclusive right to market our products in 90 countries through 6 international subsidiaries and 21 distributors.

Distribution

We purchase footwear from independent manufacturers located in Asia. The time required to fill new orders placed by us with our manufacturers is approximately five months. Such footwear is generally shipped in ocean containers and delivered to our facilities.

We maintain 309,000 square feet of warehouse space at a leased facility in Mira Loma, California. See “Item 2. Properties.” In some cases, large customers may receive containers of footwear directly from the manufacturer. We ship by package express or truck from California, depending upon the size of order, customer location and availability of inventory. Distribution to European customers and certain other European distributors is based out of a public distribution facility in the Netherlands. Distribution to our customers and retail locations in Taiwan and Hong Kong are based out of public distribution facilities in Taipei, Taiwan and Kwai Chung, Hong Kong, respectively. We generally arrange shipment of other international orders directly from our independent manufacturers.

We maintain an open-stock inventory on certain products which permits us to ship to retailers on an “at-once” basis in response to orders placed by mail, fax, toll-free telephone call or electronically. We have made a significant investment in computer equipment that provides on-line capability to determine open-stock availability for shipment. Additionally, products can be ordered under our “futures” program. See “K•Swiss Brand – Marketing – Advertising and Promotion.”

Futures Orders

Futures orders as of any date, represents orders scheduled to be shipped within the next six months. Futures orders do not include orders scheduled to be shipped on or prior to that date. At December 31, 2012 and 2011, total futures orders with start ship dates from January through June 2013 and 2012 were approximately $76,471,000 and $73,138,000, respectively, representing an increase of 4.6% at December 31, 2012. The 4.6% increase in total futures orders is comprised of a 1.0% increase in the first quarter 2013 futures orders and a 14.9% increase in the second quarter 2013 futures orders. At December 31, 2012 and 2011, domestic futures orders with start ship dates from January through June 2013 and 2012 were approximately $22,158,000 and $21,879,000, respectively, representing an increase of 1.3% at December 31, 2012. At December 31, 2012 and 2011, international futures orders with start ship dates from January through June 2013 and 2012 were approximately $54,313,000 and $51,259,000, respectively, representing an increase of 6.0% at December 31, 2012.

The mix of “futures” and “at-once” orders can vary significantly from quarter to quarter and year to year and therefore “futures” are not necessarily indicative of revenues for subsequent periods. Orders may be canceled by customers without financial penalty.

Trademarks and Patents

We utilize trademarks on all our products and believe our products are more marketable on a long-term basis when identified with distinctive markings. The K•SWISS and PALLADIUM trademarks are registered in the United States and many other countries. Our Shield Emblem, the Five-Stripe Design, and the Palladium Round Logo trademarks are also registered in the United States and certain foreign countries. In a very few countries, the Five-Stripe Design trademark is not registered because local trademark officials consider it to be ornamental. We selectively seek to register the names of our shoes, logos and the names given to certain of our technical and performance innovations, including the names ULTRA-NATURAL and SHOCK SPRING. We have obtained patents in the United States and selected foreign countries for certain inventions incorporated into our products. We work constantly to secure and improve protection for our trademarks and other intellectual property. We vigorously defend our trademarks and patent rights against infringement worldwide and employ independent security consultants to assist in such protection. To date, we are not aware of any significant trademark counterfeiting problems regarding our products. However, see “Risk Factors: Because a large portion of our imported products are manufactured in China, our profitability may be adversely affected if the United States government takes action against China for its concern over the level of intellectual property rights protection and enforcements available in China” and “Risk Factors: Our competitive position could be harmed if we are unable to protect our intellectual property rights. Counterfeiting of our brands can divert sales and damage our brand image.”

Employees

At December 31, 2012, we employed a total of 542 persons, comprised of 174 persons in the United States, 233 persons in China, Hong Kong, Japan, Taiwan, Vietnam and Indonesia, 128 persons in France, Germany, the Netherlands and the United Kingdom and 7 persons in Canada.

Available Information

K•Swiss’ internet address is www.kswiss.com. We make available free of charge on or through our internet website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”) as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (“S.E.C.”). Materials K•Swiss files with or furnishes to the S.E.C. may be read and copied at the S.E.C.’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. This information may also be obtained by calling the S.E.C. at 1-800-SEC-0330. The S.E.C. also maintains an internet website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the S.E.C. at www.sec.gov. The Company will provide a copy of any of the foregoing documents to stockholders upon request.

Item 1A. Risk Factors

The Company operates in a changing environment that involves numerous known and unknown risks and uncertainties that could materially adversely affect our operations. The risks described below highlight some of the factors that have affected, and in the future could affect our operations. Additional risks we do not yet know of or that we currently think are immaterial may also affect our business operations. If any of the events or circumstances described in the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected.

Risk Related to the Company’s Business

The market for athletic footwear is intensely competitive and if we fail to compete effectively, we could lose our market position and our business could be harmed.

The athletic footwear industry is intensely competitive, especially with respect to product offerings, technologies, marketing expenditures (including expenditures for advertising and endorsements), pricing, cost of production and customer service. Certain of our competitors have substantially greater financial, distribution and marketing resources as well as greater brand awareness than us. Their greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and production and more quickly develop new products. Further, a major marketing or promotional success or technological innovation by one of our competitors could adversely impact our competitive position. In addition, the availability of overseas manufacturing opportunities and capacity more readily allows for the introduction of competitors with new products. In countries where the athletic footwear market is mature, it may be difficult for us to maintain or increase our market share as doing so may require us to overcome or dislodge the competitive position of one or more of our competitors, a task which may be difficult to accomplish. Our results of operations and market position may be adversely impacted by our competitors and the competitive pressures in the athletic footwear industry.

We believe our ability to compete effectively depends on a number of factors, including anticipating and responding to changing consumer preferences, demographics and demands in a timely manner, maintaining brand reputation and authenticity, performance and product reliability, developing high quality products that appeal to consumers, appropriately pricing our products, providing strong and effective marketing support, ensuring product availability, providing quality customer service, adopting new technologies, maintaining and effectively assessing our distribution channels, and anticipating and responding to actions by our competitors, as well as many other factors beyond our control. Because many of these factors are not within our control, we may not be able to compete successfully in the future. Increased competition may result in price reductions, reduced profit margins, loss of market share, and an inability to generate cash flows that are sufficient to maintain or expand our development and marketing of new products, each of which would adversely affect our business.

The athletic footwear business is subject to consumer preferences and unanticipated shifts in consumer preferences could adversely affect our sales and results of operations.

The athletic footwear industry is subject to rapid changes in consumer preferences. Consumer demand for athletic footwear and apparel is heavily influenced by brand image. Our initiatives to strengthen our brand image, which include conducting market research, introducing new and innovative products and initiating focused advertising campaigns, may not be successful. Our current products have declined in popularity over the past years and new products we introduce may not achieve adequate consumer acceptance for us to recover development, manufacturing, marketing and other costs. Our failure to anticipate, identify and react to shifts in consumer preferences and maintain a strong brand image could have an adverse effect on our sales and results of operations. Also, if our customers purchase our products and do not have success in selling our products at retail, they may request a return or price adjustment to assist them in marking down the selling price to make the products more attractive to retail consumers.

If we continue to incur significant losses and are unable to access sufficient working capital from our operations or through external financings, our liquidity will be impaired.

We have incurred substantial net losses in each of the last three fiscal years. As reflected in our financial statements, we have experienced net losses of $34,779,000, $70,471,000 and $68,212,000 for the years ended December 31, 2012, 2011 and 2010, respectively. As a result, the total amount of our cash and cash equivalents, restricted cash and cash equivalents and restricted investments available for sale, and investments available for sale declined from $193,142,000 at December 31, 2009 to $42,911,000 at December 31, 2012. The negative cash flow we have sustained has reduced our working capital and continued negative cash flow would materially and negatively affect our ability to fund our operations. While we have taken and continue to take actions intended to improve our results, including implementing a major cost reduction program in which we reduced compensation costs, advertising and promotion costs and inventories, the availability of necessary working capital is subject to many factors beyond our control. Such factors include, among others, our ability to obtain additional financing, our ability to increase revenues and to reduce our losses from operations, economic conditions, market acceptance of our products, the intensity of competition in our markets and the level of demand for our products. In an effort to increase the amount of credit available to us, in April 2012 we replaced our credit facility with a $35,000,000 asset-based facility. If we are unable to reduce our operating losses and significantly reduce our inventories, our liquidity would be impaired.

Restrictions imposed by the terms of our credit facility may limit our operating and financial flexibility.

On April 25, 2012, we entered into a new revolving credit facility (“Credit Facility”) with Wells Fargo Bank, National Association and Wells Fargo Capital Finance, LLC (collectively as “Wells Fargo”). The Credit Facility, among other things, largely prevents us from incurring any additional indebtedness, limits capital expenditures and restricts dividends and stock repurchases. The Credit Facility also provides for financial covenants, which include a minimum monthly EBITDA for each month through November 30, 2013 and a fixed charge coverage ratio for each twelve month fiscal period commencing for the fiscal period ending on December 31, 2013 which applies when the excess availability has fallen below a certain level. In addition, our ability to access the Credit Facility will be affected by the amount and value of our assets which are used to determine the borrowing base under the Credit Facility. The borrowing base is reduced by availability limits and reserves established by Wells Fargo pursuant to the terms of the Credit Facility. As a result of the foregoing, our operation and financial flexibility may be limited, which may prevent us from engaging in transactions that might further our growth strategy or otherwise be considered beneficial to us.

The Credit Facility contains events of default that include failure to pay principal or interest when due, failure to comply with the covenants set forth in the Credit Facility, bankruptcy events, cross-defaults and judgments involving an aggregate amount of $1,000,000 or more and the occurrence of a change of control, in each case subject to the grace periods, qualifications and thresholds specified in the Credit Facility. If the indebtedness under the Credit Facility were to be accelerated, we cannot be certain that we will have sufficient funds available to pay such indebtedness or that we will have the ability to refinance the accelerated indebtedness on terms favorable to us or at all. Any such acceleration could also result in a foreclosure on all or substantially all of our assets, which would have a negative impact on the value of our common stock and jeopardize our ability to continue as a going concern.

Purchasing patterns are influenced by consumers’ disposable income, which is affected by economic conditions.

Consumer purchasing patterns are influenced by consumers’ disposable income. Consequently, the success of our operations may depend to a significant extent upon a number of factors affecting disposable income, including general economic conditions, level of employment, salaries and wage rates, consumer confidence, consumer perception of economic conditions, interest rates and taxation. Many of these factors are outside of our control and may have a negative impact on our sales and margins.

The consumer environment has been particularly challenging over the last several years and especially so in Europe, where our operations are significant, due to the risk surrounding the current European debt crisis and stability of the Euro and European Union. Disruptions in the overall economy and financial markets could further reduce consumer income, liquidity, credit and confidence in the economy and result in further reductions in consumer spending. Further deterioration of the consumer spending environment and increases in the unemployment rate may result in reduced demand for our products, which would be harmful to our financial position and results of operations.

If we fail to accurately forecast consumer demand, we may experience difficulties in handling customer orders or in liquidating excess inventories and our sales and brand image may be adversely affected.

The athletic footwear industry has relatively long lead times for the design and production of products. Consequently, we must commit to production tooling, and in some cases to production, in advance of orders based on our forecasts of consumer demand. The uncertainty surrounding today’s economy makes it increasingly difficult for us to accurately forecast product demand trends. If we fail to forecast consumer demand accurately, we may under-produce or over-produce our products. If we under-produce our products, we may experience inventory shortages which might delay shipments to customers, negatively impact retailer and distributor relationships, negatively impact our sales results and diminish brand awareness. Conversely, if we over-produce our products based on an aggressive forecast of consumer demand, this may result in inventory write-downs, the sale of excess inventory at discounted prices and retailers may not be able to sell the product and may seek to return the unsold quantities and cancel future orders. These outcomes could have an adverse effect on our sales and brand image.

Our current futures orders may not be indicative of future sales.

Our “futures” program allows our customers to order our products five months or more prior to delivery of product. Our current futures orders position may not be indicative of future sales. The mix of “futures” and “at-once” orders can vary significantly from quarter to quarter and year to year and therefore “futures” are not necessarily indicative of revenues for subsequent periods. Orders may be cancelled by customers without financial penalty. Customers may also reject nonconforming goods. If we experience adverse developments in customer cancellations, product returns or bad debts of customers, such developments could have a material adverse impact on our business, financial condition or results of operations.

Fluctuations in the price, availability and quality of raw materials could cause delay and increase costs.

Fluctuations in the price, availability and quality of the fabrics, leather or other raw materials used by us in our manufactured products and in the price of materials used to manufacture our footwear could have a material adverse effect on our cost of sales or our ability to meet our customers’ demands. The price and availability of such raw materials may fluctuate significantly, depending on many factors, including natural resources, such as oil and electricity, increased freight costs, increased labor costs and weather conditions. In the future, we may not be able to pass all or a portion of such higher raw materials prices on to our customers.

The loss of a significant customer, or a significant reduction in our sales to such a customer, could adversely affect our sales and results of operations.

While no customer accounted for more than 10% of our total revenues in 2012, we do have significant customers. The loss of any of these customers, or a significant reduction in our sales to any of these customers, could adversely affect our sales and results of operations. In addition, if any such customer becomes insolvent or otherwise fails to pay its debts, it could have an adverse affect on our results of operations.

Consolidation of customers or concentration of customer market share among a few customers may increase and concentrate our credit risk, and impair our ability to sell our products.

The athletic and casual footwear and apparel retail markets in some countries where we sell our products are dominated by a few large footwear and apparel retailers with many stores. These retailers have increased their market share and may continue to do so in the future by expanding through acquisitions and construction of additional stores. Such consolidation concentrates our credit risk with a relatively small number of retailers, and, if any of these retailers were to experience a shortage of liquidity, it would increase the risk that their outstanding payables to us may not be paid. In addition, increasing market share concentration among one or a few retailers in a particular country or region increases the risk that if any one of them substantially reduces their purchases of our products, we may be unable to find a sufficient number of other retail outlets for our products to sustain the same level of revenues.

Our financial success is limited to the success of our customers.

Our financial success is directly related to the success of our customers and the willingness and financial resources of our customers to continue to buy our products. We do not have long-term contracts with any of our customers. Sales to our customers are generally on an order-by-order basis and are subject to rights of cancellation and rescheduling by our customers. If any of these customers experience a significant downturn in their business, insolvency, difficulty in obtaining financing in the capital and credit markets to purchase our products or fail to remain committed to our products or brands, then these customers may defer, reduce, cancel or discontinue purchases from us and/or fail to meet their payment obligations to us. Such conditions could decrease our revenues, or cause higher accounts receivables, reduced cash flows, greater expense associated with collection efforts or increased bad debt expense, any or all of which could have a material adverse effect on our business, results of operations and financial condition.

If we decrease the price that we charge for our products, we will earn lower gross margins and our revenues and profitability will be adversely affected.

The prices we are able to charge for our products depend on the type of product offered, the consumer and retailer response to the product and the prices charged by our competitors. To the extent that we are forced to lower our prices, our gross margins will be lower and our revenues and profitability would be adversely affected.

Our business is subject to economic conditions in our major markets. Consequently, adverse changes in economic conditions could have a negative effect on our business.

Our business is subject to economic conditions that may fluctuate in the major markets in which we operate. Factors that could cause economic conditions to fluctuate include, without limitation, recession, inflation, higher interest borrowing rates, higher levels of unemployment, higher consumer debt levels, general weakness in retail markets and changes in consumer purchasing power and preferences.

If global economic and financial market conditions continue to remain uncertain and/or weak for an extended period of time, any of the following factors, among others, could have a material adverse effect on our financial condition and results of operations:

slower consumer spending may result in reduced demand for our products, reduced orders from customers for our products, order cancellations, lower revenues, increased inventories, and lower gross margins;

continued volatility in the global markets and fluctuations in exchange rates for foreign currencies and contracts in foreign currencies could negatively impact our reported financial results and condition;

continued volatility in the prices for commodities and raw materials we use in our products could have a material adverse effect on our costs, gross margins, and ultimately our profitability;

if our customers experience declining revenues, or experience difficulty obtaining financing in the capital and credit markets to purchase our products, this could result in reduced orders for our products, order cancellations, inability of customers to timely meet their payment obligations to us, extended payment terms, higher accounts receivable, reduced cash flows, greater expense associated with collection efforts and increased bad debt expense;

a severe financial difficulty experienced by our customers may cause them to become insolvent or cease business operations, which could reduce the availability of our products to consumers; and

any difficulty or inability on the part of manufacturers of our products or other participants in our supply chain in obtaining sufficient financing to purchase raw materials or to finance general working capital needs may result in delays or non-delivery of shipments of our products.

Our international sales and manufacturing operations are subject to the risks of doing business abroad.

We operate offices and sell products in numerous countries outside the United States. Our revenue earned from international markets represents approximately 66%, 56% and 57% of our revenues for the years ended December 31, 2012, 2011 and 2010, respectively. Additionally, all of our footwear products are manufactured abroad and we have suppliers located in China, Thailand, Vietnam and Indonesia. Our athletic footwear sales and manufacturing operations are subject to the risks of doing business abroad. These risks include:

fluctuations in currency exchange rates;

political instability;

limitations on conversion of foreign currencies into U.S. Dollars;

restrictions on dividend payments and other payments by our foreign subsidiaries and other restrictions on transfers of funds to or from foreign countries;

export and import duties, tariffs, regulations, quotas and other restrictions on free trade, particularly as these regulations may affect our operations in China; and

investment regulation and other restrictions by foreign governments.

If these risks limit or prevent us from selling or manufacturing products in any significant international market, prevent us from acquiring products from our foreign suppliers or significantly increase the cost of our products, our operations could be seriously disrupted until alternative suppliers are found or alternative markets are developed. Although we enter into certain forward currency exchange contracts to hedge the risk of exchange rate fluctuations, these steps may not fully protect us against this risk and we may incur losses.

The potential imposition of additional duties, quotas, tariffs and other trade restrictions could have an adverse impact on our sales and profitability.

All of the products we manufacture overseas and import into the United States, the European Union and other countries are subject to shipment inspections, audits and customs duties collected by customs authorities. Customs information submitted by the Company is routinely subject to review by customs authorities. Further, additional U.S. or foreign inspections, audits, customs duties, quotas, tariffs, anti-dumping duties, safeguard measures, cargo restrictions to prevent terrorism or other trade restrictions may be imposed on the importation of our products in the future. The imposition of such restrictions in foreign countries where we operate, as well as in countries where our third party distributors and licensees operate, could result in increases in the costs of our products generally and could, as a result, adversely affect our sales and profitability.

Our business depends in part on a strong brand image.

Our brand names are one of our most important and valuable assets. Adverse publicity relating to our products, advertising, customer service or employees could tarnish our reputation and reduce the value of our brands. If our brands are damaged or consumers lose confidence in our brands, demand for our products could decrease and our financial results could be adversely affected. Further, we may be required to expend additional resources to rebuild our reputation and restore the value of our brands.

Our financial position, cash flow or results may be adversely affected by the threat of terrorism and related political instability and economic uncertainty.

The threat of potential terrorist attacks on the United States and throughout the world and political instability has created an atmosphere of economic uncertainty in the United States and in foreign markets. Our results may be impacted by the macroeconomic effects of those events. Also, a disruption in our supply chain as a result of terrorist attacks or the threat thereof may significantly affect our business and its prospects. In addition, such events may also result in heightened domestic security and higher costs for importing and exporting shipments of components and finished goods. Any of these occurrences may have a material adverse effect on our financial position, cash flow or results in any reporting period.

Because we rely on independent manufacturers to produce our products, our sales and profitability may be adversely affected if our independent manufacturers fail to meet pricing, product quality and timeliness requirements or terminate their operations or if we are unable to obtain some components used in our products from limited supply sources or experience supply chain disruptions.

We depend upon independent manufacturers to manufacture our products in a timely and cost-efficient manner while maintaining specified quality standards. We also compete with other larger companies for production capacity of independent manufacturers that produce our products. We rely heavily on manufacturing facilities located in Asia. In 2012, approximately 32%, 25%, 22% and 21% of our K•Swiss brand footwear manufacturing occurred in China, Thailand, Vietnam and Indonesia, respectively. We also rely upon the availability of sufficient production capacity at our manufacturers. Timely delivery of product may be impacted by factors such as weather conditions, disruption of the transportation systems or shipping lines used by our suppliers, or uncontrollable factors such as natural disasters, epidemic diseases, terrorism and war. It is essential that our manufacturers deliver our products in a timely manner and in accordance with our quality standards because our orders may be cancelled by customers if agreed-upon delivery windows are not met or products are not of agreed-upon quality. Inflationary pressures, including increased labor costs, that are experienced by our independent contract manufacturers, may result in increased costs to us. A failure by one or more of our manufacturers to meet established criteria for pricing, product quality or timely delivery or the termination of operations by any one of our manufacturers could adversely impact our sales and profitability.

Because a large portion of our imported products are manufactured in China, our profitability may be adversely affected if the United States government takes action against China for its concern over the level of intellectual property rights protection and enforcements available in China.

We rely heavily on manufacturing facilities located in China. The United States government has expressed serious concern over the level of intellectual property rights protection and enforcement available in China and the United States Trade Representative has in turn included China on its Priority Watch List. If the United States government takes action against China for its failure to adequately protect intellectual property rights, the result of that action could, among other things, include the imposition of trade sanctions that could affect the ability of the Company to continue to import products from China, which in turn could affect the costs of products purchased and sold by the Company and lead to a decline in the Company’s profitability.

Our competitive position could be harmed if we are unable to protect our intellectual property rights. Counterfeiting of our brands can divert sales and damage our brand image.

We believe that our trademarks, patents and proprietary technologies and designs are of great value. From time to time third parties have challenged, and may, in the future, try to challenge our ownership or the validity of our intellectual property. A successful challenge to any of our significant intellectual property rights could adversely affect our business and ability to generate revenue.

Our brands and designs are constantly at risk for counterfeiting and infringement of our intellectual property rights, especially in China where a large portion of our imported products are manufactured, and we find counterfeit products and products that infringe on our intellectual property rights in our markets as well as domain names that use our trade names or trademarks without our consent. We have not always been successful, particularly in some foreign countries, in combating counterfeit products and stopping infringements or other misappropriation of our intellectual property rights. Counterfeit and infringing products can cause us to lose significant sales and can also harm the integrity of our brands by associating our trademarks or designs with lesser quality or defective goods. Additionally, the scope of protection of our proprietary intellectual property rights can vary significantly from country to country, and can be quite narrow in some countries because of local law or practices. This is especially the case in China where the United States government has elevated China to its Priority Watch List, as discussed above. We may need to resort to litigation in the future to enforce our intellectual property rights. This litigation could result in substantial costs and may require the devotion of substantial resources.

We rely on our warehouses and if there is a natural disaster or other serious disruption at any of these facilities, we may be unable to deliver product effectively to our customers.

We rely on warehouses in Mira Loma, California; Rotterdam, the Netherlands; Taipei, Taiwan; and Kwai Chung, Hong Kong. We also rely on the timely performance of services provided by third parties (i.e. Netherlands public distribution facility, freight delivery carriers) at these facilities. Any natural disaster or other serious disruption at any of these facilities due to fire, earthquake, flood, terrorist attack or any other natural or manmade cause could damage a portion of our inventory or impair our ability to use our warehouse as a docking location for product. Any of these occurrences could impair our ability to adequately supply our customers and negatively impact our operating results.

We depend on independent distributors to sell our products in certain international markets.

We sell our products in certain international markets mainly through independent distributors. If a distributor fails to meet annual sales goals, it may be difficult and costly to locate an acceptable substitute distributor. If a change in our distributors becomes necessary, we may experience increased costs, as well as a substantial disruption and loss of sales.

Our business is affected by seasonality, which could result in fluctuations in our operating results.

We believe the athletic and casual footwear industry experiences seasonal fluctuations, due to increased sales during certain selling seasons, including Easter, back-to-school and the year-end holiday season. We too experience moderate fluctuations in aggregate sales volume during the year. The mix of our product sales may also vary considerably from time to time as a result of changes in seasonal and geographic demand for particular types of footwear and apparel. As a result, we may not be able to accurately predict our quarterly sales. This seasonality, along with other factors that are beyond our control, including the other risk factors described in this report, could adversely affect our business and cause our results of operations to fluctuate.

We may be subject to periodic litigation and other regulatory proceedings and may be affected by changes in government regulations.

From time to time we may be a party to lawsuits and regulatory actions relating to our business, including with respect to the intellectual property rights of others. Due to the inherent uncertainties of litigation and regulatory proceedings, we cannot accurately predict the ultimate outcome of any such proceedings. An unfavorable outcome could have a material adverse impact on our business, financial condition and results of operations. In addition, regardless of the outcome of any litigation or regulatory proceedings, such proceedings could result in substantial costs and may require that we devote substantial resources to defend the Company. Further, changes in government regulations both in the United States and in the countries in which we operate could have adverse affects on our business and subject us to additional regulatory actions.

Our net income may be adversely affected by an increase in our effective tax rate.

At any point in time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with tax authorities may affect tax positions taken by us. Additionally, our effective tax rate in a given financial statement period may be materially impacted by changes in the geographic mix or level of earnings. We have not recorded United States income tax expense on earnings of selected foreign subsidiary companies as these are intended to be permanently invested, thus reducing our overall income tax expense. The amount of earnings designated as permanently invested is based upon our expectations of the future cash needs of our subsidiaries. Income tax considerations are also a factor in determining the amount of earnings to be permanently invested. Because the declaration involves our future plans and expectations of future events, the possibility exists that amounts declared as permanently invested may ultimately be repatriated. This would result in additional income tax expense in the year we determined that amounts were no longer permanently invested which in turn would adversely affect our results of operations.

We depend on attracting and retaining qualified personnel, whose loss would adversely impact our business.

Our success is largely dependent upon the efforts of Steven Nichols, our President, Chief Executive Officer and Chairman of the Board, and certain other key executives. Although we have entered into an employment agreement with Mr. Nichols that expires in December 2015, the loss of his and/or other key executive’s services would have a material adverse effect on our business and prospects. Our success also depends to a significant degree upon the continued services of our personnel. Accordingly, our continued success will depend on our ability to attract, retain and motivate qualified management, marketing, technical and sales personnel. These people are in high demand and often have competing employment opportunities. The labor market for skilled employees is highly competitive due to limited supply, and we may lose key employees or be forced to increase their compensation. Employee turnover could significantly increase our training and other related employee costs. The loss of the services of any key personnel or our inability to attract additional personnel could have a material adverse effect on our ability to manage our business.

A limited number of our stockholders can exert significant influence over the Company.

At December 31, 2012, the Company’s President, Chief Executive Officer and Chairman of the Board, Steven Nichols, held approximately 92.7% of the voting power of our Class B Common Stock and approximately 69.1% of total voting power. This voting power permits Mr. Nichols to exert significant influence over the outcome of stockholder votes, including votes concerning the election of a certain class of directors, by-law amendments, possible mergers, corporate control contests and other significant corporate transactions.

We depend on our computer and communications systems.

We extensively utilize computer and communications systems to operate our Internet business and manage our internal operations including without limitation, demand and supply planning, and inventory control. Despite our preventative efforts, our information technology systems and websites are vulnerable from time to time to damage or interruption from, among other things, power loss, telecommunications failure, failure of our computer system or other interruption caused by weather, natural disasters or similar events, any of which could disrupt our operations and result in lost sales. In addition, hackers and computer viruses have disrupted operations at many major companies. We may be vulnerable to similar acts of sabotage. Any breach of our systems may result in the loss of valuable business data, our customers’ or employees’ personal information or a disruption of our business, which could give rise to unwanted media attention, damage our customer relationships and reputation and result in lost sales, fines or lawsuits. In addition, we must comply with increasingly complex regulatory standards enacted to protect business and personal data. An inability to maintain compliance with these regulatory standards could subject us to legal risks.

We rely on our management information systems to operate our business and to track our operating results. Our management information systems will require maintenance, modification and refinement as our business needs change. If we experience a significant system failure or if we are unable to maintain and modify our management information systems to respond to changes in our business needs, then our ability to properly run our business could be adversely affected.

We may face transitional challenges with acquisitions of other businesses.

In years past, the Company has from time to time pursued acquisitions of other businesses and may pursue such acquisitions in the future, subject to the restrictions in the Merger Agreement. The Company cannot provide assurance that it will be able to successfully integrate the operations of any newly-acquired businesses into the Company’s operations. Acquisitions involve numerous risks, including risks inherent in entering new markets in which the Company may not have prior experience, potential loss of significant customers or key personnel of the acquired business; managing geographically-remote operations, and potential diversion of management’s attention from other aspects of the Company’s business operations. Acquisitions may also result in incurrence of debt, dilutive issuances of the Company’s equity securities and write-offs of goodwill and substantial amortization expenses of other intangible assets. The failure to integrate newly acquired businesses could have an adverse effect on the Company’s business, results of operations and financial position.

Failure of our contractors or our licensees’ contractors to comply with our code of conduct, local laws, and other standards could harm our business.

We work with contractors outside of the United States to manufacture our products, and we also have license agreements that permit unaffiliated parties to manufacture or contract to manufacture products using our trademarks. We impose, and require our licensees to impose, on those contractors a code of conduct and other environmental, health, and safety standards for the benefit of workers. We also require these contractors to comply with applicable standards for product safety. However, from time to time contractors may not comply with such standards or applicable local law or our licensees may not require their contractors to comply with such standards or applicable local law. Significant or continuing noncompliance with such standards and laws by one or more contractors could harm our reputation or result in a product recall and, as a result, could have an adverse effect on our sales and financial condition.

Risks Related to Our Announced Merger

As discussed in “Item 1. Business”, we have entered into a Merger Agreement, dated as of January 16, 2013, with E-Land and Merger Sub, which contemplates the Merger of Merger Sub with and into the Company, with the Company surviving the Merger as an indirect wholly-owned subsidiary of E-Land. In relation to the Merger, we are subject to certain risks, including, without limitation, those set forth below.

Due to the proposed Merger and the related diversion of our management’s attention from the operation of our business, our business and results of operations may be adversely affected.

As a result of the proposed Merger, our management and board of directors have devoted and will continue to devote a significant amount of time and attention to the proposed Merger. In addition, we have incurred and will continue to incur associated expenses related to the proposed Merger which could prove to be significant. Our business and our operating and financial results may be materially adversely impacted by the diversion of management’s time and attention and the expenses associated with the proposed Merger.

The proposed Merger will not be completed if all of the conditions to the Merger are not satisfied or waived.

Completion of the Merger is subject to the satisfaction or waiver of various conditions, including the approval of our stockholders and the receipt of certain antitrust approvals. There can be no assurance that all of the conditions will be satisfied or waived within the anticipated timeframe, or at all, and there can be no assurance as to whether, or when, the Merger will be completed. If the Merger is not effected on or before June 26, 2013, either E-Land or the Company may terminate the Merger Agreement as long as it was not the primary cause of, or the primary factor that resulted in, the failure of the Merger to be completed.

The Merger Agreement contains provisions that could discourage or make it difficult for a third party to acquire us prior to the completion of the proposed Merger.

The Merger Agreement contains provisions that restrict our ability to entertain a third-party proposal to acquire us. These provisions include the general prohibition on our soliciting or engaging in discussions or negotiations regarding any alternative acquisition proposal, subject to certain exceptions, and the requirement that we pay a termination fee of up to $5.2 million if the Merger Agreement is terminated in specified circumstances.

These provisions might discourage an otherwise-interested third party from considering or proposing to acquire us, even one that may be deemed of greater value than the proposed Merger to our stockholders. Furthermore, even if a third party elects to propose an acquisition, the concept of a termination fee may result in that third party offering a lower value to our stockholders than such third party might otherwise have offered.

Failure to complete the proposed Merger could negatively impact our business, financial condition, results of operations or stock price.

The completion of the proposed Merger is subject to a number of conditions and there can be no assurance that the conditions to the completion of the proposed Merger will be satisfied or that the proposed Merger will otherwise occur. If the proposed Merger is not completed, we will be subject to several risks, including:

our employees may experience uncertainty about their future roles with us, which might adversely affect our ability to retain and hire key personnel and other employees;

customers and other parties with which we maintain business relationships may experience uncertainty about our future and seek alternative relationships with other parties or seek to alter their business relationships with us;

we may be required to pay a termination fee of up to $5.2 million or up to $1.0 million of the reasonable out-of-pocket costs incurred by E-Land in connection with the Merger Agreement and the transactions contemplated thereby if the Merger Agreement is terminated under certain circumstances which would negatively affect our financial results and liquidity;

we expect to incur transaction costs in connection with the proposed Merger regardless of whether the proposed Merger is completed, which costs could prove to be significant;

we would not realize any of the anticipated benefits of having completed the proposed Merger; and

under the Merger Agreement, we are subject to certain restrictions on the conduct of our business prior to completing the proposed Merger, which restrictions could adversely affect our ability to realize certain of our business strategies regardless of whether the Merger is consummated.

Several lawsuits have been filed against the Company, E-Land, Merger Sub, our directors and certain of our officers challenging the proposed Merger, and an adverse ruling may prevent the proposed Merger from being completed or adversely affect the Company’s financial results and liquidity.

The Company, E-Land, Merger Sub, and the members of the Board and certain of our officers have been named as defendants in several lawsuits brought by purported stockholders of the Company challenging the proposed Merger and seeking, among other things, injunctive relief to enjoin the defendants from completing the proposed Merger on the agreed-upon terms.

One of the conditions to the closing of the Merger is that no injunction or other legal restraint or prohibition shall be in effect that prohibits or makes illegal the consummation of the Merger. Therefore, if a settlement or other resolution is not reached in the lawsuits referenced above and the plaintiffs secure injunctive or other relief prohibiting, delaying or otherwise adversely affecting the Company’s ability to complete the Merger, then such injunctive or other relief may prevent the proposed Merger from becoming effective within the expected timeframe or at all. In addition, an adverse judgment for monetary damages could have a material adverse effect on the financial results, operations and liquidity of the Company.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

In 1998, we moved into our headquarters facility in Westlake Village, California. This facility, which is owned by us, is approximately 50,000 square feet. We occupy approximately eighty-five percent of this facility and lease approximately fifteen percent of this facility.

We lease a 309,000 square foot distribution facility in Mira Loma, California. We use this facility as our main distribution center. The effective monthly commitment for this facility is approximately $117,000. In July 2008, we exercised an option under the lease to extend the term of the lease until January 2015.

We also lease office space of approximately 14,000 square feet in Haarlem, the Netherlands, which is our primary European headquarters. The effective monthly commitment for this office space is approximately $26,000. During 2010, we extended the lease until March 2016, and at that time it can be renewed for an additional five years. In addition, we contract with a third party public distribution facility in Rotterdam, the Netherlands, to manage our inventory destined to European customers.

Distribution to our customers and retail locations in Taiwan and Hong Kong are based out of the public distribution facilities in Taipei, Taiwan and Kwai Chung, Hong Kong, respectively.

Item 3. Legal Proceedings

Litigation Related to the Merger

On January 22, 2013 a putative class action lawsuit was filed by David Raul as custodian for Malka Raul Utma NY, individually and on behalf of all similarly situated stockholders, in the Court of Chancery of the State of Delaware, C.A. No. 8239-CS, against K•Swiss, the members of the Company’s Board of Directors, and Merger Sub challenging the proposed Merger. The lawsuit asserts claims for breach of fiduciary duty against the K•Swiss directors and aiding and abetting breach of fiduciary duty against K•Swiss and Merger Sub. The lawsuit seeks to enjoin the proposed Merger, rescission or rescissory damages if the proposed Merger is consummated, an accounting, costs, attorneys’ and expert fees, and any other relief the court may deem proper.

On January 23, 2013 a putative class action lawsuit was filed by Mark Weiderman, individually and on behalf of all similarly situated stockholders, in the Superior Court of the State of California, County of Ventura, Case No. 56-2013-00430951-CU-BC-VTA, against K•Swiss, the members of the Company’s Board of Directors, and E-Land challenging the proposed Merger. The lawsuit asserts claims for breach of fiduciary duty against the K•Swiss directors and aiding and abetting breach of fiduciary duty against K•Swiss and E-Land. The lawsuit seeks to enjoin the defendants from consummating the proposed Merger, an injunction directing the K•Swiss directors to exercise their fiduciary duties to obtain a transaction which is in the best interest of K•Swiss’s stockholders, rescission of the proposed Merger to the extent it is implemented, costs, attorneys’ and expert fees and costs, and other equitable and/or injunctive relief the court may deem proper.

On January 25, 2013 a putative class action lawsuit was filed by Timothy Coyne, individually and on behalf of all similarly situated stockholders, in the Superior Court of the State of California, County of Los Angeles, Case No. BC499935, against K•Swiss, the members of the Company’s Board of Directors, E-Land and Merger Sub challenging the proposed Merger. The lawsuit asserts claims for breach of fiduciary duty against the K•Swiss directors and aiding and abetting breach of fiduciary duty against E-Land and Merger Sub. The lawsuit seeks to enjoin the defendants from consummating the proposed Merger and initiating any defensive measures that would inhibit their ability to maximize value for K•Swiss stockholders, rescission or rescissory damages if the Merger is consummated, an accounting, costs, attorneys’ and expert fees, pre-judgment and post-judgment interest, and any other relief the court deems proper.

Other

The Company is, from time to time, a party to litigation which arises in the normal course of our business operations. We do not believe that we are presently a party to litigation which will have a material adverse effect on our business or operations.

Item 4. Mine Safety Disclosures

Not applicable.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

K•Swiss Inc.’s Class A Common Stock began trading June 4, 1990 on the National Market System maintained by the National Association of Securities Dealers (now the Nasdaq Global Select Market) upon completion of our initial public offering. Per share high and low sales prices (in dollars) for the quarterly periods during 2012 and 2011 as reported by Nasdaq were as follows:

	March 31,		June 30,		September 30,		December 31,
2012
Low	$	2.84	$	2.66	$	2.59	$	2.20
High		4.59		4.38		3.87		3.55

2011
Low	$	8.75	$	9.33	$	4.20	$	2.47
High		13.04		12.48		11.79		4.99

The Class A Common Stock is listed on the Nasdaq Global Select Market under the symbol KSWS.

The number of stockholders of record of the Class A Common Stock on February 15, 2013 was 109. However, based on available information, we believe that the total number of Class A Common stockholders, including beneficial stockholders, is approximately 3,385.

There is currently no established public trading market for our Class B Common Stock. The number of stockholders of record of the Class B Common Stock on February 15, 2013 was 9.

Stock Price Performance Graph

The Stock Price Performance Graph below represents a comparison of the five year total return of K•Swiss Inc. Class A Common Stock, the NASDAQ Composite Index and the Morningstar Footwear and Accessories Group. The graph assumes $100 was invested on December 31, 2007 and dividends are reinvested for all years ending December 31.

Dividend Policy

On March 3, 2009, the Board of Directors suspended the payment of dividends for the foreseeable future to preserve liquidity and enhance the strength of the Company’s balance sheet. Accordingly, the Company did not pay any dividends during 2012 or 2011.

The Company’s Credit Facility with Wells Fargo also limits the Company’s ability to pay dividends. Pursuant to the terms of the Credit Facility, the Company may pay a dividend provided that (i) no Event of Default (as defined in the Credit Facility) has occurred and is continuing or would result from the payment of the dividend, (ii) the aggregate dividend amount does not exceed $3,000,000 per fiscal year, (iii) there will be Excess Availability (as defined in the Credit Facility) equal to or greater than $10,000,000 immediately after payment of the dividend, (iv) the Company remains in compliance with the financial covenants in the Credit Facility, after giving effect to the payment of the dividend, and (v) the Fixed Charge Coverage Ratio (as defined in the Credit Facility) for the most recent twelve month period ended prior to paying a dividend is greater than or equal to 1.0:1.0.

The Company is also restricted from paying any dividends pursuant to the terms of the Merger Agreement with E-Land and Merger Sub. Pursuant to the Merger Agreement, between January 16, 2013 and the effective time of the Merger, neither the Company nor any of its subsidiaries may declare, set aside, make or pay any dividend or other distribution, payable in cash, stock, property or otherwise, with respect to any of its capital stock (except for any dividend or distribution by a subsidiary of the Company to the Company or to other subsidiaries).

Purchases of Equity Securities by the Issuer

In November 2009, the Board of Directors approved a new stock repurchase program to purchase through December 31, 2014 up to $70,000,000 of the Company’s Class A Common Stock.

During the fourth quarter of 2012, the Company did not repurchase any shares of K•Swiss Class A Common Stock. $70,000,000 remains available for repurchase under the Company’s repurchase program.

Item 6. Selected Financial Data

The selected consolidated financial data presented below for each of the five years in the period ended December 31, 2012 have been derived from audited financial statements which for the most recent three years appear elsewhere herein. The data presented below should be read in conjunction with such financial statements, including the related notes thereto and the other information included herein.

	Year ended December 31,
	2012			2011			2010			2009			2008
	(in thousands, except per share data)
Income Statement Data
Revenues	$	222,851		$	268,357		$	216,766		$	240,729		$	327,405
Cost of goods sold		145,726			175,735			131,774			154,558			195,385
Gross profit		77,125			92,622			84,992			86,171			132,020
Selling, general and administrative expenses		107,895			153,626			141,039			118,303			139,899
Impairment of intangibles and goodwill		0			2,986			0			4,830			0
Operating loss		(30,770	)		(63,990	)		(56,047	)		(36,962	)		(7,879	)
Other income/(expense)		0			3,000			(3,320	)		(1,249	)		30,000
Interest (expense)/income, net		(812	)		219			435			1,050			8,216
(Loss)/Earnings before income taxes and discontinued operations		(31,582	)		(60,771	)		(58,932	)		(37,161	)		30,337
Income tax expense/(benefit)		3,197			3,751			7,932			(9,663	)		5,882
(Loss)/Earnings from continuing operations		(34,779	)		(64,522	)		(66,864	)		(27,498	)		24,455
Loss from discontinued operations, less applicable income taxes (1)		0			(5,949	)		(1,348	)		(464	)		(3,570	)
Net (Loss)/Earnings	$	(34,779	)	$	(70,471	)	$	(68,212	)	$	(27,962	)	$	20,885

(Loss)/Earnings per share
Basic:
(Loss)/Earnings from continuing operations	$	(0.98	)	$	(1.81	)	$	(1.90	)	$	(0.79	)	$	0.70
Loss from discontinued operations		(0.00	)		(0.17	)		(0.04	)		(0.01	)		(0.10	)
Net (Loss)/Earnings	$	(0.98	)	$	(1.98	)	$	(1.94	)	$	(0.80	)	$	0.60
Diluted:
(Loss)/Earnings from continuing operations	$	(0.98	)	$	(1.81	)	$	(1.90	)	$	(0.79	)	$	0.69
Loss from discontinued operations		(0.00	)		(0.17	)		(0.04	)		(0.01	)		(0.10	)
Net (Loss)/Earnings	$	(0.98	)	$	(1.98	)	$	(1.94	)	$	(0.80	)	$	0.59

Dividends declared per common share	$	0.00		$	0.00		$	0.00		$	0.00		$	2.20

Weighted average number of shares outstanding
Basic		35,603			35,510			35,218			34,962			34,785
Diluted (2)		35,603			35,510			35,218			34,962			35,407

Balance Sheet Data (at end of period)
Current assets	$	140,928		$	180,886		$	235,186		$	287,986		$	332,776
Current liabilities		36,203			41,939			32,948			28,335			52,139
Total assets		176,723			219,611			288,165			344,150			394,290
Total debt (3)		1,443			10,114			970			4,207			5,376
Stockholders’ equity		131,614			165,969			234,913			301,783			324,762

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(1)

On April 30, 2009, the Company sold certain Royal Elastics assets. In the third quarter of 2011, the Company decided to no longer pursue operating the Form Athletics line of business. Operations of the Royal Elastics and Form Athletics brands have been accounted for and presented as a discounted operation.

(2)	Includes common stock and dilutive potential common stock (options).

(3)	Includes all interest-bearing debt, but excludes outstanding letters of credit ($378,000, $280,000, $2,362,000, $700,000 and $1,399,000 as of December 31, 2012, 2011, 2010, 2009 and 2008, respectively).

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Note Regarding Forward-Looking Statements and Analyst Reports

“Forward-looking statements,” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), include certain written and oral statements made, or incorporated by reference, by us or our representatives in this report, other reports, filings with the Securities and Exchange Commission (the “S.E.C.”), press releases, conferences, or otherwise. Such forward-looking statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance, or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will likely result,” or any variations of such words with similar meaning. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed or forecasted in any such forward-looking statements. Investors should carefully review the risk factors set forth in the reports and documents we file with the S.E.C., including Forms 10-Q, 10-K and 8-K. Some of the other risks and uncertainties that should be considered include, but are not limited to, the following: international, national and local general economic and market conditions; concerns relating to our liquidity, including our ability to reduce operating losses and significantly reduce inventory levels; the size and growth of the overall athletic footwear and apparel markets; the size of our competitors; intense competition among designers, marketers, distributors and sellers of athletic footwear, athletic apparel and boots for consumers and endorsers; market acceptance of all our product offerings; popularity of particular designs, categories of products and sports; seasonal and geographic demand for our products; the size, timing and mix of purchases of our products; performance and reliability of products; difficulties in anticipating or forecasting changes in consumer preferences, demographics and demand for our product, and various market factors described above; the amount of consumer disposable income; the availability of credit facilities for our customers and/or the stability of credit markets; fluctuations and difficulty in forecasting operating results, including, without limitation, the fact that advance “futures” orders may not be indicative of future revenues due to the changing mix of futures and at-once orders; potential cancellation of future orders; our ability to continue, manage or forecast our growth and inventories; new product development and timely commercialization; fluctuations in the price, availability and quality of raw materials; the loss of, or reduction in, sales to a significant customer or distributor; the success, willingness to purchase and financial resources of our customers; pressure to decrease the prices of our products; the ability to secure and protect trademarks, patents, and other intellectual property; inadvertent and nonwillful infringement on others’ trademarks, patents and other intellectual property; difficulties in implementing, operating, maintaining and protecting our increasingly complex information systems and controls including, without limitation, the systems related to demand and supply planning, and inventory control; difficulties in maintaining SAP information management software; interruptions in data and communication systems; changes in our effective tax rates as a result of changes in tax laws or changes in our geographic mix of sales and level of earnings; potential earthquake disruption due to the location of our warehouse and headquarters; potential disruption in supply chain due to various factors including but not limited to natural disasters, epidemic diseases or customer purchasing habits; the continued operation and ability of our manufacturers to satisfy our production requirements; our ability to secure sufficient manufacturing capacity, or the loss of, or reduction in, manufacturing capacity from significant suppliers; responsiveness of customer service; adverse publicity; concentration of credit risk to a few customers; business disruptions; increased costs of freight and transportation to meet delivery deadlines; increased material and/or labor costs; the effects of terrorist actions on business activities, customer orders and cancellations, and the United States and international governments’ responses to these terrorist actions; changes in business strategy or development plans; general risks associated with doing business outside the United States, including, without limitation, exchange rate fluctuations, import duties, tariffs, quotas and political and economic instability; changes in government regulations; liability and other claims asserted against us; the ability to attract and retain qualified personnel; a limited number of our stockholders can exert significant influence over the Company; transitional challenges of integrating newly acquired companies into our business; the conditions to the closing of the Merger may not be satisfied or waived; the Merger may involve unexpected costs, liabilities or delays; the Company’s business may suffer as a result of the uncertainty surrounding the Merger; the outcome of any legal proceeding relating to the Merger; the occurrence of any event, change or other circumstances that could give rise to the termination of the Merger Agreement; the risks that the pending Merger disrupts current plans and operations and the potential difficulties in employee retention as a result of the proposed Merger; other risks to consummation of the Merger, including the risk that the Merger will not be consummated within the expected time period or at all; and other factors referenced or incorporated by reference in this report and other reports.

K•Swiss Inc. (the “Company,” “K•Swiss,” “we,” “us,” and “our”) operates in a very competitive and rapidly changing environment. New risk factors can arise and it is not possible for management to predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

Investors should also be aware that while we communicate, from time to time, with securities analysts, it is against our policy to disclose to them any material non-public information or other confidential commercial information. Accordingly, investors should not assume that we agree with any statement or report issued by any analyst irrespective of the content of the statement or report. Furthermore, we have a policy against issuing or confirming financial forecasts or projections issued by others. Thus, to the extent that reports issued by securities analysts or others contain any projections, forecasts or opinions, such reports are not our responsibility.

Overview

The Company designs, develops and markets an array of footwear, apparel and accessories for athletic, high performance sports and fitness activities and casual wear under the K•Swiss brand. Since July 2008, the Company also designs, develops and markets footwear for adventurers for all terrains under the Palladium brand. Sales of the Palladium brand were approximately 23.2% of total revenues in 2012. The categories of footwear we sell are explained in more detail in Part I, Item 1, under the subheadings, “K•Swiss Brand – Products – Footwear” and “Palladium Brand – Products – Footwear.” We market our products through Company employed sales managers and independent regional sales representatives primarily to a limited number of specialty athletic footwear stores, pro shops, sporting good stores, specialty boutiques, independent retailers, national chains and department stores and also through a number of foreign distributors. We also sell our products through our website and retail locations, which are becoming increasingly important sales channels to us particularly in light of our limited distribution.

As a result of current economic conditions and their impact on the retail environment, business conditions may remain difficult for the foreseeable future. These conditions combined with the weak demand for the Company’s product during the past few years could put additional pressure on the Company’s ability to maintain margins. Further, such conditions have had and may continue to have a material adverse effect on the Company’s stock price. During the latter part of 2011 we experienced a significant decline in our market capitalization as a result of a decline in our stock price and determined that due to such decline goodwill was impaired. As such, we recognized an impairment charge of $2,986,000 related to the K•Swiss brand for 2011.

In 2012, approximately 32%, 25%, 22% and 21% of our K•Swiss brand footwear products were manufactured in China, Thailand, Vietnam and Indonesia, respectively. In April 2010 one of our contract manufacturers, which was one of only three manufacturers utilized by us at that time in our global supply chain, ceased its operations. While we were able to secure production capacity in new facilities during 2010, we experienced production delays throughout the remainder of 2010 and through a portion of 2011, as these facilities gained expertise in producing our product. Although we have no long-term manufacturing agreements, we believe that our current relationships with our producers are satisfactory and that we have the ability to develop alternative sources for our footwear. Our operations could, however, be materially and adversely affected if a substantial delay occurred in locating and obtaining alternative producers. Starting in 2011, we began to experience the inflationary pressures of our contract manufacturing in Asia, especially in China, with increases in, among other things, labor, raw materials and freight/transportation. As a result of the increase in these product costs, we raised selling prices approximately 6% in the United States for all orders received after May 15, 2011, which mainly affected shipments after November 30, 2011.

Because we record revenues when title passes and the risks and rewards of ownership have passed to our customer, our revenues may fluctuate in cases when our customers delay accepting shipment of products. Our total revenues decreased 17.0% in 2012 from 2011, due to a decrease in the volume of footwear sold, offset by an increase in the average underlying wholesale price per pair. Our overall gross profit margins, as a percentage of revenues, were 34.6% and 34.5% in 2012 and 2011, respectively. This increase in gross profit margin was the result of a higher level of international revenue as a percentage of revenues, which generally yield a higher selling price, brand mix resulting from a higher level of Palladium product sold at higher margins, a higher level of retail revenues which yield higher selling prices, and decreases in reserves against guaranteed minimum royalties, provision for unused molds and inventories, offset by an increase in the level of sales of closeout product as a percentage of revenues. Our overall selling, general and administrative expenses decreased to $107,895,000 in 2012 from $153,626,000 in 2011 as a result of decreases in advertising, compensation and warehousing expenses.

Other income for 2011 consisted of a $3,000,000 settlement agreement between us and one of our international distributors relating to the termination of this distributor’s contracts. The contracts with this distributor were terminated as a result of this distributor not performing in accordance with its contracts, and there was no litigation.

At December 31, 2012, our total futures orders with start ship dates from January through June 2013 were $76,471,000, an increase of 4.6% from the comparable period of the prior year. Of this amount, domestic futures orders were $22,158,000, an increase of 1.3%, and international futures orders were $54,313,000, an increase of 6.0%.

The net loss for 2012 was $34,779,000, or $0.98 per share (diluted loss per share), compared to the net loss for 2011 of $70,471,000, or $1.98 per share (diluted loss per share).

In 2012, we experienced net cash used in operating activities from continuing operations of $572,000, net cash provided by investing activities of $22,727,000 mainly due to proceeds from the maturity or sale of investments available for sale and restricted investments available for sale, offset by the change in restricted cash and cash equivalents, and net cash used in financing activities of $8,654,000 primarily due to paying off our previous line of credit.

Our working capital decreased $34,222,000 to $104,725,000 at December 31, 2012 from $138,947,000 at December 31, 2011. With our new asset-based line of credit, we believe our present sources of capital are sufficient to sustain our anticipated capital needs for the next twelve months.

At December 31, 2012 and 2011, we had debt outstanding of $1,443,000 and $10,114,000, excluding outstanding letters of credit of $378,000 and $280,000 at December 31, 2012 and 2011, respectively.

Subsequent Event

On January 16, 2013, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with E-Land World Limited, a corporation organized under the laws of the Republic of Korea (“Parent”), Ian Acquisition Sub, Inc., a Delaware corporation and an indirect wholly-owned subsidiary of Parent (“Merger Sub”), pursuant to which Merger Sub will be merged with and into the Company, with the Company surviving as an indirect wholly-owned subsidiary of Parent (the “Merger”). Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each outstanding share of the Company’s Class A Common Stock and Class B Common Stock will be converted into the right to receive $4.75 in cash, without interest. Consummation of the Merger is subject to approval of the Merger by 80% of the Company’s voting power, and other customary closing conditions, including expiration or termination of the Hart-Scott-Rodino regulatory waiting period, expiration or termination of the relevant waiting period under the Korean Monopoly Regulation and Fair Trade Act (or approval of the business combination report filed thereunder by the Korean Fair Trade Commission), and the absence of any court order or other legal restraint prohibiting the Merger. The Merger is expected to close in the second quarter of 2013.

Critical Accounting Policies

Our significant accounting policies are described in Note A to our Consolidated Financial Statements included in Item 8 of this Form 10-K. Our discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.

On an on-going basis, we evaluate our estimates, including those related to the carrying value of inventories, realizability of outstanding accounts receivable, intangible assets, sales returns and allowances, and the provision for income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. In the past, actual results have not been materially different from our estimates. However, results may differ from these estimates under different assumptions or conditions.

We have identified the following as critical accounting policies, based on the significant judgments and estimates used in determining the amounts reported in our Consolidated Financial Statements:

Revenue Recognition

We record revenues when title passes and the risks and rewards of ownership have passed to the customer, based on the terms of sale. Title passes generally upon shipment.

In some instances, we ship product directly from our supplier to our customer. In these cases, we recognize revenue when the product is delivered to our customer according to the terms of the order. Our revenues may fluctuate in cases when our customers delay accepting shipment of product for periods up to several weeks.

As part of our revenue recognition policy, we record estimated sales returns and allowances as reductions to revenues. We base our estimates on historical rates of returns and allowances and specific identification of outstanding returns not yet received from customers. However, actual returns and allowances in any future period are inherently uncertain and thus may differ from our estimates. If actual or expected future returns and allowances were significantly greater or lower than the reserves we had established, we would record a reduction or increase to net revenues in the period in which we made such determination.

Accounts Receivable

We make ongoing estimates relating to the collectibility of our accounts receivable and maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We estimate potential losses based on our knowledge of the financial condition of certain customers and historical level of credit losses, as well as an assessment of the overall retail conditions. Historically, losses have been within our expectations. If the financial condition of our customers were to change, adjustments may be required to these estimates. Furthermore, we provide for estimated losses resulting from differences that arise from the gross carrying value of our receivables and the amounts which customers estimate are owed to us. The settlement or resolution of these differences could result in future changes to these estimates. Our allowance for bad debts as a percentage of accounts receivable has remained relatively constant over the past three years despite the weak economy due to our increased scrutiny of customer relationships.

Inventory Reserves

We also make ongoing estimates relating to the market value of inventories, based upon our assumptions about future demand and market conditions. If we estimate that the market value of our inventory is less than the cost of the inventory recorded on our books, we record a reserve equal to the difference between the cost of the inventory and the estimated market value. This reserve is recorded as a charge to cost of sales. If changes in market conditions result in reductions in the estimated market value of our inventory below our previous estimate, we would increase our reserve in the period in which we made such a determination and record the additional charge to cost of sales.

Income Taxes

We account for income taxes under an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. We evaluate uncertain tax positions and recognize the benefit/exposure of those positions if they meet the more-likely-than-not threshold. Any tax position recognized is an adjustment to the effective tax rate. Also, at any point in time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with tax authorities may affect tax positions taken. Additionally, our effective tax rate in a given financial statement period may be materially impacted by changes in the geographic mix or level of earnings.

We have not recorded United States income tax expense on earnings of selected foreign subsidiary companies as these are intended to be permanently invested, thus reducing our overall income tax expense. The amount of earnings designated as permanently invested is based upon our expectations of the future cash needs of our subsidiaries. Income tax considerations are also a factor in determining the amount of earnings to be permanently invested. Because the declaration involves our future plans and expectations of future events, the possibility exists that amounts declared as permanently invested may ultimately be repatriated. This would result in additional income tax expense in the year we determine that such amounts were no longer permanently invested.

On a quarterly basis, we estimate what our effective tax rate will be for the full calendar year by estimating pre-tax income, excluding significant or infrequently occurring items, and tax expense for the remaining quarterly periods of the year. The estimated annual effective tax rate is then applied to year-to-date pre-tax income to determine the estimated year-to-date and quarterly tax expense. The income tax effects of infrequent or unusual items are recognized in the quarterly period in which they occur. As the year progresses, we continually refine our estimate based upon actual events and earnings. This continual estimation process periodically results in a change to our expected annual effective tax rate. When this occurs, we adjust the income tax provision during the quarter in which the change in estimate occurs so that the year-to-date income tax provision equals the estimated annual rate. Our effective tax rate fluctuates mainly due to our geographic mix of earnings. In addition, starting January 1, 2005, provision has not been made for United States income taxes on earnings of selected international subsidiary companies as these are intended to be permanently invested.

We evaluate the future realization of our deferred tax assets quarterly. We review each material tax jurisdiction for which a deferred tax asset has been recorded. Our analysis includes a review of past results, future income, the tax life of net operating loss carryforwards and tax credits. We assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more-likely-than-not” standard. In making such judgments, significant weight is given to evidence that can be objectively verified. All evidence is evaluated in forming a conclusion whether a valuation allowance, if any, needs to be recorded. A cumulative loss in recent years is significant negative evidence in considering whether deferred tax assets are realizable.

We account for the uncertainty in income tax positions and use a minimum recognition threshold that a tax position must meet before recognition in the financial statements. The evaluation of a tax position is a two-step process. The first step is a recognition process to determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, it is presumed that the position will be examined by the appropriate taxing authority that has full knowledge of all relevant information. The second step is a measurement process whereby a tax position that meets the more-likely-than-not recognition threshold is calculated to determine the amount of benefit/expense to recognize in the financial statements. The tax position is measured at the largest amount of benefit/expense that is greater than 50% likely of being realized upon ultimate settlement. Any tax position recognized would be an adjustment to the effective tax rate. We recognize interest expense and penalties on income tax liabilities in income tax expense on our Consolidated Statement of Earnings/Loss. We recognize our uncertain tax positions in either accrued income taxes, if determined to be short-term, or other liabilities if determined to be long-term, on our Consolidated Balance Sheet.

Intangible Assets

Indefinite-lived intangible assets are evaluated for impairment at least annually, and more often when events indicate that an impairment exists. Intangible assets with finite lives are amortized over their useful lives.

Events or changes in circumstances that may trigger impairment reviews include among other factors, significant changes in business climate, operating results, planned investments, or an expectation that the carrying amount may not be recoverable. The test for impairment involves the use of estimates relating to the fair values of intangible assets with indefinite lives.

We review intangible assets related to trademarks for impairment, by determining fair value using a “relief from royalty payments” methodology. This approach involves two steps: (i) estimating reasonable royalty rates for each trademark and (ii) applying these royalty rates to a net sales stream and discounting the resulting cash flows to determine fair value. If the fair value is less than the carrying value then impairment is recognized.

Determining the fair value of intangible assets is highly subjective and requires the use of estimates and assumptions. We use estimates including estimated future revenues, royalty rates and discount rates, among other factors. We also consider the following factors:

the asset’s ability to continue to generate income from operations and positive cash flow in future periods;

changes in consumer demand or acceptance of our brands and products; and

other considerations that could affect fair value or otherwise indicate potential impairment.

In addition, facts and circumstances could change, including further deterioration of general economic conditions, customers reducing orders in response to such conditions and increased competition. These and/or other factors could result in changes to the calculation of the fair value which could result in future impairment of the remaining intangible assets. Changes in any one or more of these estimates and assumptions could produce different financial results.

Other Contingencies

In the ordinary course of business, we are involved in legal proceedings involving contractual and employment relationships, product liability claims, trademark rights and a variety of other matters. We record contingent liabilities resulting from claims against us, including related legal costs, when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. We disclose contingent liabilities when there is a reasonable possibility that the ultimate loss will exceed the recorded liability. Estimating probable losses requires analysis of multiple factors, in some cases including judgment about the potential actions of third party claimants and courts. Therefore, actual losses in any future period are inherently uncertain. Currently, we do not believe that any of our pending legal proceedings or claims will have a material impact on our financial position or results of operations. However, if actual or estimated probable future losses exceed our recorded liability for such claims, we would record additional charges during the period in which the actual loss or change in estimate occurred.

In addition, we and our directors and certain executive officers are party to certain claims relating to the proposed Merger. See “Item 3—Legal Proceedings—Litigation Related to the Merger,” which is incorporated herein by reference.

Form Athletics

On July 23, 2010, we entered into a Membership Interest Purchase Agreement with Form Athletics, LLC (“Form Athletics”) and its Members to purchase Form Athletics for $1,600,000 in cash and additional cash consideration to certain Members of Form Athletics in an amount equal to Form Athletic’s EBITDA for the twelve months ended December 31, 2012 (“Form CPP”). Form Athletics was established in January 2010 to design, develop and distribute apparel for mixed martial arts under the Form Athletics brand worldwide. The acquisition of Form Athletics was recorded as a 100% purchase. The purchase of Form Athletics was part of an overall strategy to enter the action sports market, however during 2011, we decided to no longer pursue operating in this line of business and recognized impairment losses of $3,689,000 on the Form Athletics goodwill and trademark and reversed the Form CPP liability of $2,110,000. Operations of Form Athletics have been accounted for and presented as a discontinued operation in the accompanying Consolidated Financial Statements. For additional information see Note P to our Consolidated Financial Statements.

Results of Operations

The following table sets forth, for the periods indicated, the percentage of certain items in the Consolidated Statements of Earnings/Loss relative to revenues.

	Year ended December 31,
	2012			2011			2010
Revenues		100.0	%		100.0	%		100.0	%
Cost of goods sold		65.4			65.5			60.8
Gross profit		34.6			34.5			39.2
Selling, general and administrative expenses		48.4			57.3			65.1
Impairment of intangibles		0.0			1.1			0.0
Other income/(expense)		0.0			1.1			(1.5	)
Interest (expense)/income, net		(0.4	)		0.1			0.2
Loss before income taxes and discontinued operations		(14.2	)		(22.7	)		(27.2	)
Income tax expense		1.4			1.4			3.7
Loss from discontinued operations, less applicable income taxes		0.0			(2.2	)		(0.6	)
Net Loss		(15.6	)%		(26.3	)%		(31.5	)%

2012 Compared to 2011

Revenue

Total revenues decreased 17.0% to $222,851,000 in 2012 from $268,357,000 in 2011. This decrease was attributable to a decrease in the volume of footwear sold, offset by an increase in the average underlying wholesale price per pair. The volume of footwear sold decreased 18.7% to 6,566,000 pair in 2012 from 8,074,000 pair in 2011. The average wholesale price per pair was $30.81 in 2012 and $29.79 in 2011, an increase of 3.4%.

Domestic revenues decreased 35.0% to $75,872,000 in 2012 from $116,781,000 in 2011. International revenues decreased 3.0% to $146,979,000 in 2012 from $151,576,000 in 2011. International revenue is derived from both product revenues and from licensing and other fees on sales by foreign licensees and distributors. International product revenues decreased 1.2% in 2012 to $139,675,000 from $141,347,000 in 2011. Licensing and other fees earned by the Company on sales by foreign licensees and distributors were $7,304,000 for 2012 and $10,229,000 for 2011, a decrease of 28.6%, mainly due to a lower level of sales by one of our significant licensees in 2012. International revenues, as a percentage of total revenues, increased to 66.0% in 2012 from 56.5% in 2011. The breakdown of revenues (dollar amounts in thousands) is as follows:

	2012		2011		% Change
Domestic
K•Swiss brand	$	66,859	$	110,848		(39.7	)%
Palladium brand		9,013		5,933		51.9
Total domestic	$	75,872	$	116,781		(35.0	)%

International
K•Swiss brand	$	104,209	$	113,921		(8.5	)%
Palladium brand		42,770		37,655		13.6
Total international	$	146,979	$	151,576		(3.0	)%

Total revenues	$	222,851	$	268,357		(17.0	%)

K•Swiss brand revenues decreased 23.9% to $171,068,000 in 2012 (39.1% derived from domestic revenues) from $224,769,000 in 2011 (49.3% derived from domestic revenues). Such decline was driven by the decrease in domestic K•Swiss brand revenue, which decreased 39.7% for 2012 primarily as a result of a decrease in our performance category footwear revenues of 41.4% during 2012 as compared to 2011. The decline in revenue from our performance category footwear sold was driven by a decrease in running product of 40.5%. In addition, the decline in K•Swiss brand revenues was the result of a decrease in the volume of footwear sold, offset by an increase in the average underlying wholesale price per pair. The volume of footwear sold decreased 25.0% to 5,330,000 pair in 2012 from 7,105,000 pair in 2011. The average wholesale price per pair was $28.32 in 2012 and $27.78 in 2011, an increase of 1.9%, which resulted from the geographic mix of revenues, as international revenues increased as a percentage of revenues, which generally yield a higher selling price, and a higher level of retail revenues as a percentage of revenues, which yield higher selling prices, offset by the product mix of revenues, including a lower percentage of performance product sold in 2012, which generally sell at a higher price than lifestyle product, and from an increase in percentage of revenues of closeout product in 2012.

Palladium brand revenues increased 18.8% to $51,783,000 in 2012 (17.4% derived from domestic revenues) compared to $43,588,000 in 2011 (13.6% derived from domestic revenues). The increase in Palladium brand revenues in 2012 was due to the increase in revenues in a majority of our selling regions as a result of continuing marketing and selling efforts of Palladium product in these regions beginning in the second half of 2009. The volume of footwear sold increased 27.6% to 1,236,000 pair in 2012 from 969,000 pair in 2011, due to an increase in revenues in a majority of our selling regions, as discussed above. The average underlying wholesale price per pair was $41.57 in 2012 and $44.57 in 2011, a decrease of 6.7%. This decrease was attributable primarily to the product mix of revenues, the geographic mix of revenues as international revenues, which generally yield higher selling prices, decreased as a percentage of revenues, and an increase of closeout product as a percentage of revenues, offset by a higher level of retail revenues, which yield higher selling prices.

We believe the athletic and casual footwear industry experiences seasonal fluctuations, due to increased sales during certain selling seasons, including Easter, back-to-school and the year-end holiday season. We present full-line offerings for the Easter season for delivery during the first and second quarters and back-to-school season for delivery during the third quarter, but only limited offerings for the year-end holiday season.

At December 31, 2012, domestic and international futures orders with start ship dates from January through June 2013 were approximately $22,158,000 and $54,313,000, respectively, 1.3% higher and 6.0% higher, respectively, than such orders were at December 31, 2011 for start ship dates of the comparable period of the prior year. These orders are not necessarily indicative of revenues for subsequent periods because: (1) the mix of “future” and “at-once” orders can vary significantly from quarter to quarter and year to year and (2) the rate of customer order cancellations can also vary from quarter to quarter and year to year.

Gross Profit Margin

Overall gross profit margin, as a percentage of revenues, was 34.6% in 2012 and 34.5% in 2011. K•Swiss brand gross profit margin, as a percentage of revenues, was 32.4% in 2012, a decrease from 32.6% in 2011. This decrease in gross profit margin was a result of an increase in the level of sales of closeout product as a percentage of revenues, offset by a higher level of international revenues as a percentage of revenues which generally yield a higher selling price, a higher level of retail revenues as a percentage of revenues, which yield higher selling prices, and decreases in reserves against guaranteed minimum royalties, inventory reserves and provision for unused molds,.

Palladium brand gross profit margin, as a percentage of revenues, was 41.5% in 2012, a decrease from 42.8% in 2011. The decrease in gross margin was a result of the geographic mix of revenues as a result of a decrease in the level of international revenues as a percentage of revenues which generally yield a higher selling price, an increase in closeout product as a percentage of revenues, and an increase in inventory reserves, offset by a higher level of retail revenues as a percentage of revenues, which yield higher selling prices, and a decrease in the provision for unused molds.

Our gross margins may not be comparable to some of our competitors as we recognize warehousing costs within selling, general and administrative expenses. These warehousing costs were $13,871,000 and $16,511,000 for 2012 and 2011, respectively.

Selling, General and Administrative Expenses

Overall selling, general and administrative expenses decreased 29.8% to $107,895,000 (48.4% of revenues) in 2012 from $153,626,000 (57.3% of revenues) in 2011. The decrease in selling, general and administrative expenses during 2012 was the result of decreases in advertising, compensation and warehousing expenses. Advertising expenses decreased 53.6% for 2012 due to an effort to reduce advertising spending to industry averages of approximately 10% of revenues. Compensation expenses, which includes commissions, bonus/incentive related expenses and employee recruiting and relocation expenses, decreased 18.6% in 2012 as a result of a reduction in salary related expenses from the prior year in the United States and Europe of approximately 20%, a decrease in commission expenses due to a decrease in sales and a decrease in interest expense related to the Company’s deferred compensation plan which was terminated in October 2011. Other warehousing expenses, which do not include compensation expenses, decreased 15.1% during 2012 mainly as a result of decreased revenues. Corporate expenses of $12,132,000 and $13,856,000 for 2012 and 2011, respectively, are included in selling, general and administrative expenses and include expenses such as salaries and related expenses for executive management and support departments such as accounting and treasury, information technology and legal which benefit the entire Company. This decrease in corporate expenses was primarily due to decreases in compensation and data processing expenses. The decrease in compensation costs resulted primarily from a reduction of salary related expenses and the interest on the deferred compensation plan, offset by an increase in stock option compensation expense. The decrease in data processing expenses was a result of decreases in on-going maintenance expense for the Company’s SAP computer software system.

Impairment on Goodwill

Goodwill impairment of $2,986,000 was recognized on the K•Swiss brand in 2011. During the latter part of 2011 we experienced a significant decline in our market capitalization due to a decline in our stock price. As such, the implied fair value of goodwill was less than the carrying amount of goodwill and it was determined that goodwill was fully impaired.

Other Income, Interest and Taxes

Net interest expense was $812,000 (0.4% of revenues) for 2012 and net interest income was $219,000 (0.1% of revenues) for 2011. The change in net interest expense for 2012 was due to the change in the fair value of Palladium Contingent Purchase Price (“CPP”), a decrease in interest income earned on cash, restricted cash, restricted investments available for sale and investments available for sale as a result of lower average balances and interest rates and an increase in amortization of loan origination fees, offset by a decrease in interest expense on debt. For 2012 and 2011, interest expense of $681,000 and $50,000, respectively, was recognized for the change in the net present value of the CPP.

Income tax expense was $3,197,000 for 2012 and $3,751,000 for 2011. We did not recognize any income tax benefit from options exercised during 2012 or 2011 as a result of our net loss in each of these years.

We evaluate our deferred tax assets, including net operating losses and tax credits, to determine if a valuation allowance is required. We assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more-likely-than-not” standard. In making such judgments, significant weight is given to evidence that can be objectively verified. A cumulative loss in recent years is significant negative evidence in considering whether deferred tax assets are realizable.

At December 31, 2012 our valuation allowance was $61,637,000. At December 31, 2012, we had a net deferred tax asset after valuation allowance of $2,308,000 which consisted of U.S. foreign tax credits of $35,000 for the eventual carryback of foreign tax credits to the 2006 tax year as we believe it is more-likely-than-not that it will be utilized and foreign net operating losses of $2,273,000 which is related to the pre-acquisition losses of Palladium, a French company, which has an unlimited carryforward period and therefore we believe it is more-likely-than-not that the loss carryforward will be utilized. The ultimate realization of this loss carryforward is dependent upon the generation of future taxable income in France during the periods in which those temporary differences become deductible. This assessment could change in future periods if we do not achieve taxable income in France or projections of future taxable income decline. Changes in existing tax laws could also affect actual tax results and the valuation of deferred tax assets over time. The accounting for deferred taxes is based upon an estimate of future operating results. Differences between the anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated results of operations or financial position. If an increase in the valuation allowance in future periods is required, this would result in an increase in our income tax expense and could materially impact the effective income tax rate in the period recorded.

At December 31, 2012, gross uncertain tax positions and the related interest, which are shown as other liabilities on the Consolidated Balance Sheet, were $7,827,000 and $1,484,000, respectively, all of which would affect the income tax rate if reversed. Income tax expense related to uncertain tax positions for the years ended December 31 was as follows (in thousands):

	2012		2011
Income tax expense related to uncertain tax positions	$	715	$	810
Interest expense related to uncertain tax positions		212		228
Total income tax expense related to uncertain tax positions	$	927	$	1,038

The federal income tax returns for 2006 through 2009 are currently under various stages of audit by the Internal Revenue Service (“IRS”). We received a Notice of Proposed Adjustment from the IRS for tax years 2006 and 2007 of $7,114,000 (which includes $1,186,000 in penalties). Interest will be assessed, and at this time it is estimated at approximately $1,879,000. This issue, which relates to intercompany transfer pricing, has been sent to the IRS Appeal’s office for further consideration. We do not believe that an additional tax accrual is required at this time.

In January 2012, we received a Notice of Proposed Adjustment for the 2008 tax year, also regarding intercompany transfer pricing. The 2008 proposed adjustment is $251,000. Interest will be assessed, and at this time it is estimated at approximately $40,000. This issue has been sent to the IRS Appeal’s office for further consideration. This will not create any additional financial statement impact due to the available U.S. tax losses that may be carried back from the 2010 tax year to the 2008 tax year.

Also in January 2012, we received a Notice of Proposed Adjustment for the 2009 tax year of $496,000 related to the gain on sale of certain Royal Elastics assets. Interest will not be assessed as the adjustment will reduce our net operating loss for 2009. We have agreed to this adjustment. The IRS did not propose an adjustment to our 2009 intercompany transfer pricing even though our intercompany transfer pricing methodology has been the same during the 2006 to 2009 period.

We do not agree with the 2006 through 2008 adjustments and plan to vigorously defend our position. The amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year. Our material tax jurisdiction is the United States.

The net loss for 2012 was $34,779,000, or $0.98 per share (diluted loss per share) compared to the net loss for 2011 of $70,471,000, or $1.98 per share (diluted loss per share).

2011 Compared to 2010

Revenue

Total revenues increased 23.8% to $268,357,000 in 2011 from $216,766,000 in 2010. This increase was attributable to an increase in the volume of footwear sold and an increase in the average underlying wholesale price per pair. The volume of footwear sold increased 19.9% to 8,074,000 pair in 2011 from 6,732,000 pair in 2010. The average wholesale price per pair was $29.79 in 2011 and $28.76 in 2010, an increase of 3.6%.

Domestic revenues increased 26.7% to $116,781,000 in 2011 from $92,178,000 in 2010. International revenues increased 21.7% to $151,576,000 in 2011 from $124,588,000 in 2010. International product revenues increased 21.3% in 2011 to $141,347,000 from $116,496,000 in 2010. Licensing and other fees earned by the Company on sales by foreign licensees and distributors were $10,229,000 for 2011 and $8,092,000 for 2010, an increase of 26.4%. International revenues, as a percentage of total revenues, decreased to 56.5% in 2011 from 57.5% in 2010. The breakdown of revenues (dollar amounts in thousands) is as follows:

	2011		2010		% Change
Domestic
K•Swiss brand	$	110,848	$	87,804		26.2	%
Palladium brand		5,933		4,374		35.6
Total domestic	$	116,781	$	92,178		26.7	%

International
K•Swiss brand	$	113,921	$	97,709		16.6	%
Palladium brand		37,655		26,879		40.1
Total international	$	151,576	$	124,588		21.7	%

Total revenues	$	268,357	$	216,766		23.8	%

K•Swiss brand revenues increased 21.2% to $224,769,000 in 2011 (49.3% derived from domestic revenues) from $185,513,000 in 2010 (47.3% derived from domestic revenues). This increase was the result of increases in the volume of footwear sold and in the average underlying wholesale price per pair. The volume of footwear sold increased 19.5% to 7,105,000 pair in 2011 from 5,947,000 pair in 2010. The average wholesale price per pair was $27.78 in 2011 and $27.34 in 2010, an increase of 1.6%, which resulted from the product mix of revenues, including a higher percentage of performance product sold in 2011, which generally sell at a higher price than lifestyle product, offset by an increase in percentage of revenues of closeout product in 2011. We believe the increased revenues were a result of higher than industry standard advertising levels as a percentage of revenues.

Palladium brand revenues increased 39.5% to $43,588,000 in 2011 (13.6% derived from domestic revenues) compared to $31,253,000 in 2010 (14.0% derived from domestic revenues). The increase in Palladium brand revenues in 2011 was due to the increase in revenues in all regions, including France, for reasons discussed above. The volume of footwear sold increased 23.4% to 969,000 pair in 2011 from 785,000 pair in 2010, due to an increase in revenues in all regions, as discussed above. The average underlying wholesale price per pair was $44.57 in 2011 and $39.57 in 2010, an increase of 12.6%, resulting from the geographic mix of revenues, increase in certain selling prices and decrease in percentage of revenues of closeout product in France, which sell at a lower price.

Gross Profit Margin

Overall gross profit margin, as a percentage of revenues, was 34.5% in 2011, a decrease from 39.2% in 2010. K•Swiss brand gross profit margin, as a percentage of revenues, was 32.6% in 2011, a decrease from 38.0% in 2010. This decrease was largely the result of an increase in inventory reserves, greater discounts given to customers due to production delays by our factories, an increase in product costs (discussed further below), an increase in sales of closeout product which has a lower gross profit margin, an increase in reserves against guaranteed minimum royalties and an increase in the provision for unused molds. Starting in 2011, we began to experience the inflationary pressures of our contract manufacturing in Asia, especially China, with increases in, among other things, labor, raw materials and freight/transportation. As a result of the increase in these product costs, we raised selling prices approximately 6% in the United States for all orders received after May 15, 2011, which mainly affected future order shipments after November 30, 2011.

Palladium brand gross profit margin, as a percentage of revenues, was 42.8% in 2011, an increase from 40.6% in 2010. This increase was a result of the geographic mix of revenues, increase in certain selling prices, decrease in sales of closeout product in France, offset by increases in product costs, inventory reserves and provision for unused molds.

Warehousing costs were $16,511,000 and $13,610,000 for 2011 and 2010, respectively.

Selling, General and Administrative Expenses

Overall selling, general and administrative expenses increased 8.9% to $153,626,000 (57.3% of revenues) in 2011 from $141,039,000 (65.1% of revenues) in 2010. The increase in selling, general and administrative expenses during 2011 was the result of increases in compensation, warehousing and advertising expenses. Compensation expenses increased 12.8% for 2011 as a result of an increase in average headcount from the prior year, severance related expenses and reserve of an employee receivable. During 2011, average headcount increased as a result of an increase in headcount for the Palladium brand on a worldwide basis and increases in headcount especially in Asia, where we expanded our retail operations and also our manufacturing to regions outside of China. This increase was offset by approximately a 20% reduction in United States and European headcount as a result of cost reduction programs which led to an increase in severance related expenses from the prior year. Other warehousing expenses, which do not include compensation expenses, increased 27.8% during 2011 as a result of increases in freight and transportation costs to customers, rent and storage expenses and third party handling fees as a result of increases in inventories, sales, the number of customers and the volume of shipments to customers. Advertising expenses increased 4.4% for 2011 mainly as a result of strategic efforts to drive revenue in domestic and international markets for the Palladium brand. Corporate expenses of $13,856,000 and $15,261,000 for 2011 and 2010, respectively, are included in selling, general and administrative expenses. This decrease was primarily due to decreases in legal and data processing expenses. The decrease in legal expenses was a result of decreases in expenses incurred to defend the Company’s trademarks. The decrease in data processing expenses was a result of decreases in on-going maintenance expense for the Company’s SAP computer software system.

Impairment on Goodwill

Goodwill impairment of $2,986,000 was recognized on the K•Swiss brand for 2011, as discussed above.

Other Income, Interest and Taxes

As discussed above, other income for 2011 consisted of a $3,000,000 settlement agreement between us and one of our international distributors relating to the termination of this distributor’s contracts. Other expense for 2010 consisted of the recognition of $3,320,000, which represented the net present value of the estimated CPP for Palladium, as discussed below.

On May 1, 2010, we entered into Amendment No. 2 to the Share Purchase and Shareholders’ Rights Agreement with Palladium to revise the terms of the remaining future purchase price for Palladium payable in 2013. Pursuant to Amendment No. 2, the fair value of the future purchase price for Palladium, i.e. the CPP, will be equal to the net present value of €3,000,000 plus up to €500,000 based on an amount calculated in accordance with a formula driven by Palladium’s EBITDA for the twelve months ended December 31, 2012. For 2010 we recognized the initial fair value of the CPP of $3,320,000 as other expense in the Consolidated Statement of Earnings/Loss, which represents the net present value of €3,000,000.

Net interest income was $219,000 (0.1% of revenues) and $435,000 (0.2% of revenues) for 2011 and 2010, respectively. The decrease in net interest income for 2011 was due to lower average balances on cash and investments available for sale and an increase in interest expense on debt, offset by the change in fair value of the Palladium CPP and slightly higher interest rates earned on cash, restricted cash and restricted investments available for sale and investments available for sale. For 2011 and 2010, interest expense of $50,000 and $369,000, respectively, was recognized for the change in the net present value of the CPP.

Income tax expense was $3,751,000 for 2011 and $7,932,000 for 2010. We did not recognize any income tax benefit from options exercised during 2011 or 2010 as a result of our net loss in each of these years.

Income tax expense related to uncertain tax positions for the years ended December 31 was as follows (in thousands):

	2011		2010
Income tax expense related to uncertain tax positions	$	810	$	137
Interest expense related to uncertain tax positions		228		141
Total income tax expense related to uncertain tax positions	$	1,038	$	278

The net loss for 2011 was $70,471,000, or $1.98 per share (diluted loss per share) compared to the net loss for 2010 of $68,212,000, or $1.94 per share (diluted loss per share).

Liquidity and Capital Resources

We experienced net cash used in operating activities from continuing operations of $572,000, $85,817,000 and $45,017,000 for 2012, 2011 and 2010, respectively. The decrease in net cash used in operating activities from continuing operations for 2012 was due to the differences in the amounts of changes in inventories, accounts receivables and accounts payable and accrued liabilities and the decrease in net loss from continuing operations, offset by the differences in prepaid expenses and other assets and CPP. The increase in cash used in operating activities from continuing operations during 2011 was due to differences in the amounts of changes in accounts payable and accrued liabilities, income taxes receivable, accounts receivable, deferred income taxes, inventories and CPP, offset by differences in the amounts of changes in prepaid expenses and other assets, impairment of goodwill and the decrease in net loss from continuing operations. The changes in inventory during 2012 and 2011 were due to the timing of sales to customers and purchases from suppliers and starting in 2012, a focus on improving our inventory management. In addition, during 2011 there was an overall increase in inventory to support strategic initiatives, including performance product, investing in the growth of the Palladium brand and growth in international futures orders. It is possible that our continued plans to reduce inventory levels will be less than fully successful, and that such an outcome would result in a change in the inventory reserve in the near-term. The changes in accounts payable and accrued liabilities during 2012 and 2011 were due to the timing of payments to suppliers. The changes in accounts receivable during 2012 and 2011 were due to the timing of sales to customers and receipts from customers. The changes in prepaid expenses and other assets during 2012 and 2011 were due to changes in endorsements, premiums or discounts on investments available for sale and restricted investments available for sale, forward contracts and prepaid payments to vendors and for 2012, loan origination fees, and for 2011, prepaid royalties and the liquidation of the investment underlying the deferred compensation plan liability. The change in impairment of goodwill was due to the recognition of impairment of the K•Swiss brand during 2011. The changes in income taxes receivable during 2010 was due to the recognition of a receivable in 2009 which was fully collected in 2010. The change in the deferred income taxes in 2011 was mainly due to the recognition of a tax valuation allowance and timing of items recognized for income tax purposes. During 2012 and 2011, the change in CPP is related to the change in fair value of the Palladium CPP liability, however the change in 2012 is primarily due to the payment of $1,776,000 in July 2012 as a result of amendment No. 3 to the Share Purchase and Shareholders’ Rights Agreement which revised the terms of the remaining future purchase price for Palladium. During 2010, we recognized the initial recording and subsequent valuation of the Palladium CPP. For additional details, see Note O to our Consolidated Financial Statements.

We experienced net cash provided by investing activities of $22,727,000 and $60,119,000 during 2012 and 2011, respectively, and net cash used in investing activities of $40,401,000 during 2010. For 2012, the restrictions on a significant amount of cash were released as a result of entering into a new loan facility in April 2012. The change in cash inflows from investment activities during 2012 was mainly due to the changes in proceeds from the maturity or sale of investments and restricted investments available for sale, offset by the change in restricted cash and cash equivalents and the change in purchase of investments and restricted investments available for sale. The change in net cash from investing activities during 2011 was mainly due to changes in purchases of investments available for sale and restricted investments available for sale and proceeds from the maturity or sale of investments available for sale, offset by the change in restricted cash and cash equivalents. The changes in restricted cash and cash equivalents, purchase of investments available for sale and restricted investments available for sale and proceeds from the maturity or sale of investments available for sale and restricted investments available for sale are partially due to the Company’s strategy to shift to higher yielding liquid investments or liquidation of investments into cash for operating activities.

We experienced net cash outflows from our financing activities of $8,654,000 and $1,989,000 during 2012 and 2010, respectively and net cash inflows from our financing activities of $10,117,000 during 2011. The change in cash used in financing activities during 2012 was mainly due to a decrease in borrowings on our bank lines of credit and capital leases and an increase in repayments on our bank lines of credit, long-term debt and capital leases. During 2012, as a result of entering into a new loan facility in April 2012, we paid off our previous bank line of credit. The change in cash from financing activities during 2011 was mainly due to an increase in net borrowings on our bank lines of credit and capital leases, primarily to support inventory growth for strategic initiatives and growth in futures orders in Europe, as we borrowed funds in Euros which reduced our overall exposure to foreign exchange rate fluctuations.

Our bank lines of credit, long-term debt, long-term capital leases and outstanding letters of credit at December 31 were as follows (dollars and Euros in thousands):

	2012		2011
Bank Lines of Credit – Secured Variable Rate Lines of Credit with Financial Institutions:
Credit Facility of $35,000 at an interest rate of 4.50% at December 31, 2012, due April 23, 2016 (1)	$	0	$	0
Bank line of credit of $21,000 at an interest rate of 2.69% at December 31, 2011, due July 1, 2013 (2)		0		9,716
Facility of €4,000, or approximately $5,288, at December 31, 2012, at an interest rate of 0.84%, due December 31, 2012 and approximately $5,182, at December 31, 2011, at an interest rate of 2.13%, due December 31, 2012 (3) (4)		998		0
Facilities of €1,200, or approximately $1,587, at December 31, 2012, at interest rates ranging from 1.39% to 2.57%, due December 31, 2012 and facilities of €1,000, or approximately $1,296, at December 31, 2011, at interest rates ranging from 2.56% to 3.12%, due December 31, 2011 (3) (5)		0		0
Total bank lines of credit		998		9,716
Secured Fixed Rate Term Loans with Financial Institutions of €800, or approximately $1,058, at December 31, 2012, at an interest rate of 5.42%, due February 2013 and €1,320, or approximately $1,710, at December 31, 2011, with interest rates ranging from 5.42% to 5.84%, due between February 2012 and February 2013 (3)		151		394
Accrued interest		1		4
Total long-term debt		152		398
Capital leases for information systems, with interest rates ranging from 2.01% to 11.58%, due between June 2014 and December 2016		293		0
Total bank lines of credit, long-term debt and long-term capital leases	$	1,443	$	10,114
Outstanding letters of credit, not included above	$	378	$	280

(1)	Secured by all assets of K•Swiss Inc., K•Swiss Sales Corp. and K•Swiss Direct Inc. The amount available to borrow on this line of credit at December 31, 2012 was $16,234. See further discussion below.

(2)	Fully secured by cash (or our restricted cash and cash equivalents and restricted investments available for sale, see Note B to our Consolidated Financial Statements). This facility was fully paid off on April 25, 2012. See further discussion below.

(3)	These lines of credit are secured by Palladium’s assets including accounts receivable and/or intellectual property rights (i.e. trademarks), as well as Palladium common stock.

(4)	A new facility of €9,000 was entered into as of January 2, 2013. This facility continues indefinitely with three months notice. This is secured by Palladium accounts receivables.

(5)

These lines of credit are renewable every six months. Subsequent to December 31, 2012 and 2011, these lines of credit were renewed until June 30, 2013 and 2012, respectively, and the maximum facility amount available between January 1 through June 30, 2013 is €1,200 (or approximately $1,587) and the maximum facility amount available between January 1 through June 30, 2012 was €1,000 (or approximately $1,296).

On April 25, 2012, the Company and two of its subsidiaries, K•Swiss Sales Corp. and K•Swiss Direct Inc. (collectively with the Company, the “Borrowers”) entered into a Credit Agreement (the “Credit Facility”) with Wells Fargo Bank, National Association and Wells Fargo Capital Finance, LLC (collectively as “Wells Fargo” or the “Lenders”). The Credit Facility consists of revolving loans of up to $35,000,000 (subject to the limitations described below) available in U.S. Dollars, Euro and Pound Sterling, and up to $5,000,000 of which may be drawn in the form of letters of credit. The Credit Facility matures April 23, 2016.

Loans made under the Credit Facility bear interest at:

(1)

the greatest of (i) the Federal Funds Rate plus 0.5%, (ii) the LIBOR Rate plus 1%, and (iii) Wells Fargo’s prime rate (the “Base Rate”); or

(2)

the rate per annum appearing on Bloomberg L.P.’s Page BBAM1/Official BBA USD Dollar Libor Fixings two Business Days prior to the commencement of the requested Interest Period, for a term and in an amount comparable to the interest period and the amount requested (the “LIBOR Rate”); or

(3)

for loans made in Euros or Pound Sterling, the LIBOR Rate

plus, in each case, the “Applicable Margin.”

If the average use of the Credit Facility is less than 50% of the Maximum Revolver Amount (as defined below) during the previous fiscal quarter, the Applicable Margin is 1.25% for Base Rate loans, 2.25% for U.S. Dollar LIBOR Rate loans, and 3.00% for loans made in Euros or Pound Sterling. If the average use of the Credit Facility is more than 50% of the Maximum Revolver Amount, the Applicable Margin is 1.50% for Base Rate loans, 2.50% for U.S. Dollar LIBOR Rate loans, and 3.25% for loans made in Euros or Pound Sterling.

The “Maximum Revolver Amount” is $35,000,000; provided that the amount of revolving loans and letters of credit under the Credit Facility may not exceed (a) 85% of Eligible Accounts (as defined in the Credit Facility) plus the lesser of (i) 85% of Eligible Accounts that are Extended Pay Accounts (as defined in the Credit Facility) and (ii) $1,500,000 (minus any dilution reserve), plus (b) the lesser of (i) $20,000,000 or (ii) an amount equal to (x) the lesser of (1) 65% of Eligible Inventory or (2) 85% of Net Recovery Percentage (each as defined in the Credit Facility), minus (y) a reserve of $3,500,000 and any other reserves established by Wells Fargo in its permitted discretion.

The financial covenants contained in the Credit Facility are as follows (in each case, with respect to the Company and its subsidiaries on a consolidated basis):

We must achieve Minimum EBITDA specified in the Credit Facility for each month through November 30, 2013.

We must maintain a Fixed Charge Coverage Ratio for each twelve month fiscal period, commencing for the fiscal period ending on December 31, 2013, of not less than 1.0:1.0.

We must limit Capital Expenditures for each fiscal year to $2,400,000, except with the Lender’s consent.

These financial covenants apply on the date that Excess Availability (as defined in the Credit Facility) has fallen below 20% of the Maximum Revolver Amount and ends on the date that Excess Availability has been greater than 20% of the Maximum Revolver Amount for any period of thirty consecutive days thereafter.

Our obligations under the Credit Facility are guaranteed by four of the Company’s other domestic subsidiaries (the “Guarantors”) pursuant to a Guaranty and Security Agreement, dated April 25, 2012 (the “Guaranty and Security Agreement”). Pursuant to the Guaranty and Security Agreement, the Borrowers and the Guarantors pledged substantially all of their respective assets as collateral security for the loans to be made pursuant to the Credit Facility. The foreign subsidiaries of the Borrowers did not guaranty the Credit Facility or pledge any of their directly-owned assets. We also granted a security interest in our real property to the Lenders, consisting of a deed of trust securing our corporate headquarters building.

The Credit Facility contains other certain affirmative and negative covenants, as well as event of default provisions. The affirmative covenants include certain reporting requirements, maintenance of properties, payment of taxes and insurance, compliance with laws, environmental compliance, and other provisions customary in such agreements. Negative covenants limit or restrict, among other things, dividends, secured and unsecured indebtedness, mergers and fundamental changes, asset sales, investments and acquisitions, liens and encumbrances, transactions with affiliates, redemption distributions to former employees, officers or directors, and other matters customarily restricted in such agreements.

Wells Fargo and its affiliates are permitted to make loans to, issue letters of credit, accept deposits, provide Bank Products (as defined in the Credit Facility) to, acquire equity interests in, and generally engage in any kind of banking, trust, financial advisory, underwriting, or other business with us.

At December 31, 2012, the Company was in compliance with its covenants under the Credit Facility.

On April 25, 2012, we drew down approximately $9,924,000 under the Credit Facility to repay in full all indebtedness outstanding under our previous line of credit with Bank of America and to pay fees and expenses related to the Credit Facility. We intend to utilize the Credit Facility for working capital, to issue letters of credit in connection with purchases of inventory and other general corporate purposes.

In accordance with these financing arrangements with the financial institutions, Palladium must meet minimum working capital requirements and is restricted as to the amount of dividends it can pay. At December 31, 2012, Palladium was in compliance with these debt covenants.

See Note G to our Consolidated Financial Statements for further discussion.

We anticipate future cash needs for repayments required pursuant to borrowings under our lines of credit facilities, term loans and capital leases. In addition, additional funds will be required by our operations if operating results continue to be weak. No other material capital commitments exist at December 31, 2012. With our new asset-based line of credit, we believe our present sources of capital are sufficient to sustain our anticipated capital needs for the next twelve months. However, the negative cash flow we have sustained has reduced our working capital and continued negative cash flow would materially and negatively affect our ability to fund our operations. While we have taken and continue to take actions intended to improve our results including implementing a major cost reduction program in which we reduced compensation costs, advertising and promotion costs and inventories, the availability of necessary working capital is subject to many factors beyond our control. Such factors include, among others, our ability to increase revenues and to reduce our losses from operations, economic conditions, market acceptance of our products, the intensity of competition in our markets and the level of demand for our products.

Our working capital decreased $34,222,000 to $104,725,000 at December 31, 2012 from $138,947,000 at December 31, 2011. Working capital decreased during 2012 mainly due to decreases in restricted cash and cash equivalents and restricted investments available for sale, inventories, accounts receivables, investments available for sale and prepaid expenses and other current assets and increases in the current portion of CPP and trade accounts payable, offset by increases in cash and cash equivalents and decreases in bank lines of credit and accrued liabilities.

We have historically maintained higher levels of inventories relative to sales compared to our competitors because (1) we do not ship directly to our major domestic customers from our foreign contract manufacturers to the same extent as our larger competitors, which would reduce inventory levels and increase inventory turns, and (2) unlike many of our competitors, we designate certain shoes as core products whereby we commit to our retail customers that we will carry core products from season to season and, therefore, we attempt to maintain open-stock positions on our core products in our distribution facilities to meet at-once orders.

Contractual Obligations

At December 31, 2012, our significant contractual obligations were as follows (in thousands):

	Payments due by period
	Total		Less than one year		One to three years		Three to five years		More than five years
Operating lease obligations	$	21,566	$	6,803	$	8,872	$	3,211	$	2,680
Endorsement obligations		3,116		2,948		168		0		0
Royalty obligations		590		560		30		0		0
Lines of credit, term loans and capital leases		1,443		1,253		154		36		0
Contingent purchase payments		2,644		2,644		0		0		0
Product purchase obligations (1)		30,891		30,891		0		0		0
Total	$	60,250	$	45,099	$	9,224	$	3,247	$	2,680

(1)

We generally order product four to five months in advance of sales based primarily on advance futures orders received from customers. The amounts listed for product purchase obligations represent open purchase orders to purchase products in the ordinary course of business that are enforceable and legally binding.

Off-Balance Sheet Arrangements

We did not enter into any off-balance sheet arrangements during 2012 or 2011, nor did we have any off-balance sheet arrangements outstanding at December 31, 2012 or 2011.

Inflation

We believe that distributors of footwear in the higher priced end of the footwear market, including ours, are able to adjust their prices in response to an increase in direct and general and administrative expenses in order to partially or completely offset rising prices, without experiencing a significant loss in sales.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Market Risk

Market risk is the potential change in an instrument’s value caused by, for example, fluctuations in interest and currency exchange rates. Our primary market risk exposure is the risk of unfavorable movements in exchange rates between the U.S. dollar and the Euro and between the Euro and the Pound Sterling. Monitoring and managing these risks is a continual process carried out by senior management, which reviews and approves our risk management policies. Market risk is managed based on an ongoing assessment of trends in foreign exchange rates and economic developments, giving consideration to possible effects on both total return and reported earnings.

Foreign Exchange Rate Risk

Sales denominated in currencies other than the U.S. dollar, which are primarily sales to customers in Europe, expose us to market risk from material movements in foreign exchange rates between the U.S. dollar and the foreign currency. Our primary risk exposures are from changes in the rates between the U.S. dollar and the Euro and between the Euro and the Pound Sterling. In 2012 and 2011, we entered into forward foreign exchange contracts to exchange Euros for U.S. dollars and Pound Sterling for Euros. The extent to which forward foreign exchange contracts are used is modified periodically in response to management’s estimate of market conditions and the terms and length of specific sales contracts.

We enter into forward foreign exchange contracts in order to reduce the impact of foreign currency fluctuations and not to engage in currency speculation. The use of derivative financial instruments allows us to reduce our exposure to the risk that the eventual net cash inflow resulting from the sale of products to foreign customers will be materially affected by changes in exchange rates. We do not hold or issue financial instruments for trading purposes. The forward foreign exchange contracts are designated for firmly committed or forecasted sales. These contracts settle in less than one year.

The forward foreign exchange contracts generally require us to exchange Euros for U.S. dollars or Pound Sterling for Euros at maturity, at rates agreed upon at the inception of the contracts. Our counterparties to derivative transactions are major financial institutions with an investment grade or better credit rating; however, we are exposed to credit risk with these institutions. The credit risk is limited to the unrealized gains in such contracts should these counterparties fail to perform as contracted.

At December 31, 2012, forward foreign exchange contracts with a notional value of $26,501,000 were outstanding to exchange various currencies with maturities ranging from January 2013 to September 2013, to sell the equivalent of approximately $4,401,000 in foreign currencies at contracted rates and to buy approximately $22,100,000 in foreign currencies at contracted rates. These contracts have been designated as cash flow hedges. Realized gains of $84,000 for 2012 and realized losses of $545,000 and $326,000 for 2011 and 2010, respectively, from cash flow hedges were recorded in cost of goods sold. Realized losses of $44,000 and $20,000 for 2012 and 2011, respectively, and realized gains of $81,000 for 2010, from cash flow hedges were recorded in selling, general and administrative expenses due to hedge ineffectiveness. At December 31, 2012, we did not have any forward foreign exchange contracts that do not qualify as hedges.

We do not anticipate any material adverse effect on our operations or financial position relating to these forward foreign exchange contracts. Based on our overall currency rate exposure at December 31, 2012, a 1% change in currency rates would not have a material effect on the financial position, results of operations or cash flows of the Company.

Interest Rate Risk

We are exposed to changes in interest rates primarily as a result of our short-term borrowings on our working capital lines of credit. A 1% change in interest rates would not have a material effect on the financial position, results of operations or cash flows of the Company.

Item 8. Financial Statements and Supplementary Data

The Consolidated Financial Statements required in response to this item are submitted as part of Item 15(a) of this Report.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Board of Directors and Shareholders

K•Swiss Inc.

We have audited the internal control over financial reporting of K•Swiss Inc. (a Delaware corporation) (the “Company”) as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of the Company as of and for the year ended December 31, 2012, and our report dated February 26, 2013 expressed an unqualified opinion on those financial statements.

/s/ GRANT THORNTON LLP

Los Angeles, California

February 26, 2013

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of K•Swiss Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of internal control over financial reporting. As defined by the Securities and Exchange Commission, internal control over financial reporting is a process designed by, or supervised by, the Company’s principal executive and principal financial officers, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles.

The Company’s internal control over financial reporting is supported by written policies and procedures, that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company’s assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of the Company’s management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In connection with the preparation of the Company’s annual financial statements, management of the Company has undertaken an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012 based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of the design of the Company’s internal control over financial reporting and testing of the operational effectiveness of the Company’s internal control over financial reporting.

Based on this assessment, management did not identify any material weakness in the Company’s internal control, and management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2012.

Grant Thornton LLP, the independent registered public accounting firm that audited the Company’s financial statements, has issued a report on internal control over financial reporting, a copy of which is included in this annual report on Form 10-K.

February 26, 2013

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders

K•Swiss Inc.

We have audited the accompanying consolidated balance sheets of K•Swiss Inc. (a Delaware corporation) (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of earnings/loss and comprehensive earnings/loss, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012. Our audits of the basic consolidated financial statements included Schedule II – Valuation and Qualifying Accounts. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of K•Swiss Inc. as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 26, 2013 expressed an unqualified opinion thereon.

/s/ GRANT THORNTON LLP

Los Angeles, California

February 26, 2013

K•SWISS INC.

CONSOLIDATED BALANCE SHEETS

December 31,

(Dollar amounts in thousands)

	2012		2011
ASSETS
CURRENT ASSETS
Cash and cash equivalents (Note A4)	$	42,711	$	28,701
Restricted cash and cash equivalents and restricted investments available for sale (Note B)		200		22,602
Investments available for sale (Note C)		0		2,057
Accounts receivable, less allowance for doubtful accounts of $1,714 and $1,678 at December 31, 2012 and 2011, respectively (Notes A13 and M)		25,740		31,449
Inventories, net (Note A5)		69,343		90,380
Prepaid expenses and other current assets (Notes A12 and F)		2,934		4,927
Income taxes receivable (Notes A9 and I)		0		770
Total current assets		140,928		180,886
PROPERTY, PLANT AND EQUIPMENT, net (Notes A6, A7, D and N)		17,402		19,593
OTHER ASSETS
Intangible assets (Notes A8 and E)		11,562		11,482
Deferred income taxes (Notes A9 and I)		2,308		2,914
Other		4,523		4,736
Total other assets		18,393		19,132
Total assets	$	176,723	$	219,611

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Bank lines of credit (Note G)	$	998		$	9,716
Current portion of long-term debt (Note G)		152			250
Current portion of long-term capital leases (Note G)		103			0
Trade accounts payable		20,420			18,101
Accrued income taxes payable (Note A9)		246			372
Current portion of contingent purchase price (Note O)		2,644			0
Accrued liabilities (Notes A12, F and H)		11,640			13,500
Total current liabilities		36,203			41,939
OTHER LIABILITIES
Long-term debt (Note G)		0			148
Long-term capital leases (Note G)		190			0
Contingent purchase price (Note O)		0			3,739
Other liabilities (Notes A9 and I)		8,716			7,816
Total other liabilities		8,906			11,703
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY
Preferred Stock - authorized 2,000,000 shares of $0.01 par value; none issued and outstanding		0			0
Common Stock:
Class A - authorized 90,000,000 shares of $0.01 par value; 29,989,588 shares issued, 27,567,971 shares outstanding and 2,421,617 shares held in treasury at December 31, 2012 and 29,982,254 shares issued, 27,560,637 shares outstanding and 2,421,617 shares held in treasury at December 31, 2011		300			300
Class B, convertible - authorized 18,000,000 shares of $0.01 par value; 8,039,524 shares issued and outstanding at December 31, 2012 and 2011		80			80
Additional paid-in capital		72,011			70,975
Treasury Stock		(58,190	)		(58,190	)
Retained earnings		114,924			149,703
Accumulated other comprehensive earnings/(loss):
Foreign currency translation (Note A10)		2,944			2,288
Net unrealized (loss)/gain on hedge derivatives (Notes A12 and F)		(455	)		811
Net unrealized gain on investments available for sale and restricted investments available for sale (Notes B and C)		0			2
Total stockholders’ equity		131,614			165,969
Total liabilities and stockholders’ equity	$	176,723		$	219,611

The accompanying notes are an integral part of these statements.

K•SWISS INC.

CONSOLIDATED STATEMENTS OF EARNINGS/LOSS

AND COMPREHENSIVE EARNINGS/LOSS

Year Ended December 31,

(Dollar amounts and shares in thousands, except per share amounts)

	2012			2011			2010
Revenues (Notes A13, M and N)	$	222,851		$	268,357		$	216,766
Cost of goods sold (Notes A14, A18, F and L)		145,726			175,735			131,774
Gross profit		77,125			92,622			84,992
Selling, general and administrative expenses (Notes A10, A13, A14, A15, A16, A18, F, K and L)		107,895			153,626			141,039
Impairment of goodwill (Notes A8 and E)		0			2,986			0
Operating loss (Note N)		(30,770	)		(63,990	)		(56,047	)
Other income/(expense) (Note A19)		0			3,000			(3,320	)
Interest (expense)/income, net (Notes G, N and O)		(812	)		219			435
Loss before income taxes and discontinued operations		(31,582	)		(60,771	)		(58,932	)
Income tax expense (Notes A9, I and N)		3,197			3,751			7,932
Loss from continuing operations		(34,779	)		(64,522	)		(66,864	)
Loss from discontinued operations, less applicable income taxes of $0, $0 and $0 for 2012, 2011 and 2010, respectively (Notes A1 and P)		0			(5,949	)		(1,348	)
Net Loss	$	(34,779	)	$	(70,471	)	$	(68,212	)

Loss per common share (Notes A17 and L)
Basic:
Loss from continuing operations	$	(0.98	)	$	(1.81	)	$	(1.90	)
Loss from discontinued operations		(0.00	)		(0.17	)		(0.04	)
Net Loss	$	(0.98	)	$	(1.98	)	$	(1.94	)
Diluted:
Loss from continuing operations	$	(0.98	)	$	(1.81	)	$	(1.90	)
Loss from discontinued operations		(0.00	)		(0.17	)		(0.04	)
Net Loss	$	(0.98	)	$	(1.98	)	$	(1.94	)

Weighted average number of shares outstanding (Note A17)
Basic		35,603			35,510			35,218
Diluted		35,603			35,510			35,218

Dividends declared per common share	$	0.00		$	0.00		$	0.00

Net Loss	$	(34,779	)	$	(70,471	)	$	(68,212	)
Other Comprehensive (Loss)/Earnings, net of tax:
Foreign currency translation adjustments, net of income taxes of $0, $0 and $0 for 2012, 2011 and 2010, respectively (Note A10)		656			(1,255	)		(2,129	)
Change in deferred (loss)/gain on hedge derivatives, net of income taxes of $0, $0 and $0 for 2012, 2011 and 2010, respectively (Notes A12 and F)		(1,266	)		961			416
Change in deferred (loss)/gain on investments available for sale and restricted investments available for sale, net of income tax (benefit)/expense of $(1), $(48) and $36 for 2012, 2011 and 2010, respectively (Notes B and C)		(2	)		(92	)		70
Comprehensive Loss	$	(35,391	)	$	(70,857	)	$	(69,855	)

The accompanying notes are an integral part of these statements.

K•SWISS INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Three years ended December 31, 2012

(Dollar amounts in thousands)

	Common Stock										Treasury Stock
	Class A				Class B						Class A
	Shares		Amount		Shares		Amount		Additional paid-in capital		Shares		Amount			Retained earnings			Accum-ulated other compre-hensive earnings			Total
Balance at January 1, 2010		29,519,757	$	295		8,039,524	$	80	$	66,082		2,421,617	$	(58,190	)	$	288,386		$	5,130		$	301,783
Exercise of options Note L)		241,999		3		0		0		1,244		0		0			0			0			1,247
Stock-based compensation (Notes A18 and L)		—		0		—		0		1,738		—		0			0			0			1,738
Net loss for the year		—		0		—		0		0		—		0			(68,212	)		0			(68,212	)
Foreign currency translation (Note A10)		—		0		—		0		0		—		0			0			(2,129	)		(2,129	)
Net unrealized gain on hedge derivatives (Notes A12 and F)		—		0		—		0		0		—		0			0			416			416
Net unrealized gain on investments available for sale and restricted investments available for sale (Notes B and C)		—		0		—		0		0		—		0			0			70			70
Balance at December 31, 2010		29,761,756		298		8,039,524		80		69,064		2,421,617		(58,190	)		220,174			3,487			234,913
Exercise of options Note L)		220,498		2		0		0		1,060		0		0			0			0			1,062
Stock-based compensation (Notes A18 and L)		—		0		—		0		851		—		0			0			0			851
Net loss for the year		—		0		—		0		0		—		0			(70,471	)		0			(70,471	)
Foreign currency translation (Note A10)		—		0		—		0		0		—		0			0			(1,255	)		(1,255	)
Net unrealized gain on hedge derivatives (Notes A12 and F)		—		0		—		0		0		—		0			0			961			961
Net unrealized loss on investments available for sale and restricted investments available for sale (Notes B and C)		—		0		—		0		0		—		0			0			(92	)		(92	)
Balance at December 31, 2011		29,982,254		300		8,039,524		80		70,975		2,421,617		(58,190	)		149,703			3,101			165,969
Exercise of options (Note L)		7,334		0		0		0		5		0		0			0			0			5
Stock-based compensation (Notes A18 and L)		—		0		—		0		1,031		—		0			0			0			1,031
Net loss for the year		—		0		—		0		0		—		0			(34,779	)		0			(34,779	)
Foreign currency translation (Note A10)		—		0		—		0		0		—		0			0			656			656
Net unrealized loss on hedge derivatives (Notes A12 and F)		—		0		—		0		0		—		0			0			(1,266	)		(1,266	)
Net unrealized loss on investments available for sale and restricted investments available for sale (Notes B and C)		—		0		—		0		0		—		0			0			(2	)		(2	)
Balance at December 31, 2012		29,989,588	$	300		8,039,524	$	80	$	72,011		2,421,617	$	(58,190	)	$	114,924		$	2,489		$	131,614

The accompanying notes are an integral part of these statements.

K•SWISS INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Year ended December 31,

(Dollar amounts in thousands)

	2012			2011			2010
Cash flows from operating activities:
Net loss from continuing operations	$	(34,779	)	$	(64,522	)	$	(66,864	)
Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:
Depreciation/amortization (Note N)		3,670			3,611			3,657
Impairment of goodwill (Note E)		0			2,986			0
Change in contingent purchase price (Note O)		(1,095	)		50			3,689
Net loss on disposal of property, plant and equipment		66			33			7
Deferred income taxes		650			1,000			8,469
Stock-based compensation		1,031			851			1,738
Decrease/(Increase) in accounts receivable		5,713			(7,417	)		3,555
Decrease/(Increase) in inventories		21,673			(24,083	)		(17,661	)
Decrease in income taxes receivable		770			0			13,052
Decrease/(Increase) in prepaid expenses and other assets		1,258			7,981			(2,442	)
Increase/(Decrease) in accounts payable and accrued liabilities		471			(6,307	)		7,783
Net cash used in operating activities from continuing operations		(572	)		(85,817	)		(45,017	)
Net cash used in discontinued operations		0			(3,848	)		(1,718	)
Net cash used in operating activities		(572	)		(89,665	)		(46,735	)
Cash flows from investing activities:
Change in restricted cash and cash equivalents		13,249			(5,614	)		14,435
Purchase of investments available for sale and restricted investments available for sale		0			(6,310	)		(87,961	)
Proceeds from the maturity or sale of investments available for sale and restricted investments available for sale		11,028			74,706			37,073
Purchase of intangible assets (Note E)		(35	)		0			0
Purchase of Form Athletics (Note P)		0			0			(1,600	)
Purchase of property, plant and equipment (Note N)		(1,528	)		(2,704	)		(2,377	)
Proceeds from disposal of property, plant and equipment		13			41			29
Net cash provided by/(used in) investing activities		22,727			60,119			(40,401	)
Cash flows from financing activities:
Borrowings under bank lines of credit and capital leases		19,763			31,507			42,875
Repayments on bank lines of credit, long-term debt and capital leases		(28,422	)		(22,452	)		(46,111	)
Proceeds from stock options exercised		5			1,062			1,247
Net cash (used in)/provided by financing activities		(8,654	)		10,117			(1,989	)
Effect of exchange rate changes on cash		509			(1,034	)		(1,374	)
Net increase/(decrease) in cash and cash equivalents		14,010			(20,463	)		(90,499	)
Cash and cash equivalents at beginning of period		28,701			49,164			139,663
Cash and cash equivalents at end of period	$	42,711		$	28,701		$	49,164
Supplemental disclosure of cash flow information:
Non-cash investing activities:
On July 23, 2010, the Company purchased the capital stock of Form Athletics. In connection with the acquisition, the assets acquired and liabilities assumed were as follows (Note P):
Fair value of assets acquired							$	39
Fair value of liabilities assumed								(18	)
Form Athletics contingent purchase price								(2,110	)
Excess fair value over purchase price								3,689
Cash paid on acquisition							$	1,600
Cash paid during the period for:
Interest	$	147		$	269		$	131
Income taxes	$	1,020		$	656		$	1,093

The accompanying notes are an integral part of these statements.

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE A – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1. Nature of Operations

K•Swiss Inc. (the “Company”) designs, develops and markets footwear, apparel and accessories for athletic, high performance sports and fitness activities and casual wear under the K•Swiss brand. Since July 2008, the Company also designs, develops and markets footwear for adventurers for all terrains under the Palladium brand. The Company operates in an industry dominated by a small number of very large competitors. The size of these competitors enables them to lead the product direction of the industry, and therefore, potentially diminish the value of the Company’s products. In addition to generally greater resources, these competitors spend substantially more money on advertising and promotion than the Company and therefore dominate market share. Lastly, due to the recent global economic crisis, the retail environment has been particularly challenging during the last several years, which could negatively impact the Company’s operations.

The Company purchases significantly all of its products from a small number of contract manufacturers in Asia. The concentration of suppliers in this location subjects the Company to the risk of interruptions of product flow for various reasons which could lead to possible loss of sales, which would adversely affect operating results. In addition, there are other risks associated with doing business in Asia, especially China, where the Company’s intellectual property rights may not be protected.

In July 2010, the Company entered into a Membership Interest Purchase Agreement with Form Athletics, LLC (“Form Athletics”) and its Members to purchase Form Athletics. The purchase of Form Athletics was part of an overall strategy to enter the action sports market, however, during 2011, the Company decided to no longer pursue operating in this line of business and operations of Form Athletics have been accounted for and presented as a discontinued operation in the accompanying consolidated financial statements. See further discussion in Note P.

2. Estimates in Financial Statements

In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period. Actual results could differ from those estimates.

3. Basis of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Certain reclassifications have been made in the 2011 and 2010 presentation to conform with the 2012 presentation. These reclassifications had no impact on previously reported results of operations or stockholders’ equity and do not affect previously reported cash flows from operations, investing and financing activities or net change in cash and cash equivalents.

4. Cash Equivalents

For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Balances maintained in foreign bank accounts that are included in cash and cash equivalents at December 31 were as follows (in thousands):

		2012				2011
Cash and cash equivalents – foreign bank accounts		$	22,470			$	17,232

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE A – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)

5. Inventories

Inventories, consisting of merchandise held for resale as finished goods, are stated at the lower of cost or market. Cost is determined using a moving average cost method. Management continually evaluates its inventory position and implements promotional or other plans to reduce inventories to appropriate levels relative to its sales estimates for particular product styles or lines. Estimated losses are recorded when such plans are implemented. It is possible that management’s plans to reduce inventory levels will be less than fully successful, and that such an outcome would result in a change in the inventory reserve in the near-term.

6. Property, Plant and Equipment

Property, plant and equipment are carried at cost. For financial reporting and tax purposes, depreciation and amortization are calculated using straight-line and accelerated methods, respectively, over the estimated service lives of the depreciable assets. The service lives of the Company’s building and related improvements are 30 and 5 years, respectively. Information systems and equipment is depreciated from 3 to 10 years and leasehold improvements are amortized over the lives of the respective leases.

7. Impairment of Long-Lived Assets

When events or circumstances indicate the carrying value of a long-lived asset may be impaired, the Company estimates the future undiscounted cash flows to be derived from the asset to assess whether or not a potential impairment exists. If the carrying value exceeds the Company’s estimate of future undiscounted cash flows, the Company then calculates the impairment as the excess of the carrying value of the asset over the Company’s estimate of its fair market value.

8. Intangible Assets

The Company reviews intangible assets related to trademarks for impairment by determining fair value using a “relief from royalty payments” methodology. This approach involves two steps: (i) estimating reasonable royalty rates for each trademark and (ii) applying these royalty rates to a net sales stream and discounting the resulting cash flows to determine fair value. If the fair value is less than the carrying value, then impairment is recognized.

Determining the fair value of intangible assets is highly subjective and requires the use of estimates and assumptions. The Company uses estimates including estimated future revenues, royalty rates and discount rates, among other factors. The Company also considers the following factors:

the asset’s ability to continue to generate income from operations and positive cash flow in future periods;

changes in consumer demand or acceptance of the Company’s brands and products; and

other considerations that could affect fair value or otherwise indicate potential impairment.

In addition, facts and circumstances could change, including further deterioration of general economic conditions, customers reducing orders in response to such conditions and increased competition. These and/or other factors could result in changes to the calculation of the fair value which could result in future impairment of the Company’s remaining intangible assets. Changes in any one or more of these estimates and assumptions could produce different financial results.

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE A – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)

9. Income Taxes

The Company accounts for income taxes under an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns.

The Company has not recorded United States income tax expense on earnings of selected foreign subsidiary companies as these are intended to be permanently invested, thus reducing the Company’s overall income tax expense. The amount of earnings designated as permanently invested is based upon the Company’s expectations of the future cash needs of its subsidiaries. Income tax considerations are also a factor in determining the amount of earnings to be permanently invested. Because the declaration involves the Company’s future plans and expectations of future events, the possibility exists that amounts declared as permanently invested may ultimately be repatriated. This would result in additional income tax expense in the year the Company determines that amounts were no longer permanently invested.

On a quarterly basis, the Company estimates what its effective tax rate will be for the full calendar year by estimating pre-tax income, excluding significant or infrequently occurring items, and tax expense for the remaining quarterly periods of the year. The estimated annual effective tax rate is then applied to year-to-date pre-tax income to determine the estimated year-to-date and quarterly tax expense. The income tax effects of infrequent or unusual items are recognized in the quarterly period in which they occur. As the year progresses, the Company continually refines its estimate based upon actual events and earnings. This continual estimation process periodically results in a change to the Company’s expected annual effective tax rate. When this occurs, the Company adjusts the income tax provision during the quarter in which the change in estimate occurs so that the year-to-date income tax provision equals the estimated annual rate.

The Company evaluates the future realization of its deferred tax assets quarterly. The Company reviews each material tax jurisdiction for which a deferred tax asset has been recorded. The Company’s analysis includes a review of past results, future income, the tax life of net operating loss carryforwards and tax credits. The Company assesses whether a valuation allowance should be established based on the consideration of all available evidence using a “more-likely-than-not” standard. In making such judgments, significant weight is given to evidence that can be objectively verified. All evidence is evaluated in forming a conclusion whether a valuation allowance, if any, needs to be recorded. A cumulative loss in recent years is significant negative evidence in considering whether deferred tax assets are realizable.

The accounting for the uncertainty in income tax positions prescribes a minimum recognition threshold a tax position must meet before recognition in the financial statements. The evaluation of a tax position is a two-step process. The first step is a recognition process to determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, it is presumed that the position will be examined by the appropriate taxing authority that has full knowledge of all relevant information. The second step is a measurement process whereby a tax position that meets the more-likely-than-not recognition threshold is calculated to determine the amount of benefit/expense to recognize in the financial statements. The tax position is measured at the largest amount of benefit/expense that is greater than 50% likely of being realized upon ultimate settlement.

Any tax position recognized would be an adjustment to the effective tax rate. The Company recognizes interest expense and penalties on income tax liabilities in income tax expense on its Consolidated Statement of Earnings/Loss. The Company recognizes its uncertain tax positions in either accrued income taxes, if determined to be short-term, or other liabilities if determined to be long-term, on its Consolidated Balance Sheet. For federal tax purposes, the Company’s 2009 through 2011 tax years remain open for examination by the tax authorities under the normal three year statute of limitations, however, the 2006 through 2008 tax years remain open for examination for limited issues. Generally, for state tax purposes, the Company’s 2008 through 2011 tax years remain open for examination by the tax authorities under a four year statute of limitations.

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE A – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)

10. Foreign Currency Translation

Assets and liabilities of certain foreign operations are translated into U.S. dollars at current exchange rates. Income and expenses are translated into U.S. dollars at average rates of exchange prevailing during the period. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are taken directly to a separate component of stockholders’ equity. Foreign currency transaction gains and losses are generated by the effect of foreign exchange on recorded assets and liabilities denominated in a currency different from the functional currency of the applicable foreign operations and are included in selling, general and administrative expenses.

11. Fair Value of Financial Instruments

On January 1, 2012, the Company adopted Accounting Standards Update (“ASU”) 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs,” which ensures U.S. generally accepted accounting principles are aligned with international accounting standards. ASU 2011-04 does not modify the requirements for when fair value measurements apply, but rather clarifies how to measure and disclose fair value. The adoption of ASU 2011-04 did not have a material impact on the Company’s financial position and results of operations. For certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, outstanding borrowings under the bank lines of credit, current portion of long-term debt, current portion of long-term capital leases, accounts payable and accrued liabilities, the carrying amounts approximate fair value due to their short maturities.

Accounting Standards Codification (“ASC”) No. 820, “Fair Value Measurements and Disclosures” establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

The following table provides the assets and liabilities carried at fair value measured on a recurring basis at December 31, 2012 (in thousands):

			Fair Value Measurements Using
	Total Carrying Value		Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Forward exchange contracts – assets	$	171	$	0	$	171	$	0
Forward exchange contracts – liabilities		1,057		0		1,057		0
Contingent purchase price (“CPP”) (1)		2,644		0		0		2,644

(1) See Note O for further discussion of valuation.

The Company’s counterparty (“Counterparty”) to a majority of its forward exchange contracts is a major financial institution. These forward exchange contracts are measured at fair value by the Counterparty based on a variety of pricing factors, which include the market price of the derivative instrument available in the dealer-market.

During the year ended December 31, 2012, there were no transfers of financial assets or liabilities between Level 1, Level 2 and Level 3 measurements. In addition, there were no changes in the valuation technique of assets and liabilities measured on a recurring basis during the year ended December 31, 2012.

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE A – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)

12. Financial Risk Management and Derivatives

Sales denominated in currencies other than the U.S. dollar, which are primarily sales to customers in Europe, expose the Company to market risk from material movements in foreign exchange rates between the U.S. dollar and the foreign currency. The Company’s primary risk exposures are from changes in the rates between the U.S. dollar and the Euro and between the Euro and the Pound Sterling. In 2012 and 2011, the Company entered into forward foreign exchange contracts to exchange Euros for U.S. dollars and Pound Sterling for Euros. The extent to which forward foreign exchange contracts are used is modified periodically in response to management’s estimate of market conditions and the terms and length of specific sales contracts.

The Company enters into forward foreign exchange contracts in order to reduce the impact of foreign currency fluctuations and not to engage in currency speculation. The use of derivative financial instruments allows the Company to reduce its exposure to the risk that the eventual net cash inflow resulting from the sale of products to foreign customers will be materially affected by changes in exchange rates. The Company does not hold or issue financial instruments for trading purposes. The forward foreign exchange contracts are designated for firmly committed or forecasted sales. These contracts settle in less than one year.

The forward foreign exchange contracts generally require the Company to exchange Euros for U.S. dollars or Pound Sterling for Euros at maturity, at rates agreed upon at the inception of the contracts. The Company’s counterparties to derivative transactions are major financial institutions with an investment grade or better credit rating; however, the Company is exposed to credit risk with these institutions. The credit risk is limited to the unrealized gains in such contracts should these counterparties fail to perform as contracted.

Cash flows from these forward foreign exchange contracts are classified in the same category as the cash flows from the items being hedged on the Consolidated Statements of Cash Flows.

13. Recognition of Revenues and Accounts Receivable

Sales are recognized when title passes and the risks and rewards of ownership have passed to the customer, based on the terms of sale. Title passes generally upon shipment. In some instances, product is shipped directly from the Company’s supplier to the customer. In these cases, the Company recognizes revenue when the product is delivered to the customer according to the terms of the order. Revenues may fluctuate in cases when customers delay accepting shipment of product for periods up to several weeks. Provisions for estimated sales returns and allowances are made at the time of sale based on historical rates of returns and allowances and specific identification of outstanding returns not yet received from customers. However, actual returns and allowances in any future period are inherently uncertain and thus may differ from these estimates. If actual or expected future returns and allowances were significantly greater or lower than established reserves, a reduction or increase to net revenues would be recorded in the period this determination was made.

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The Company estimates potential losses based on its knowledge of the financial condition of certain customers and historical level of credit losses, as well as an assessment of the overall retail conditions. Historically, losses have been within the Company’s expectations. If the financial condition of the Company’s customers were to change, adjustments may be required to these estimates. Furthermore, estimated losses are provided resulting from differences that arise from the gross carrying value of the Company’s receivables and the amounts which customers estimate are owed to the Company. The settlement or resolution of these differences could result in future changes to these estimates.

For the years ended December 31 licensing and other fees earned on sales by foreign licensees and distributors, which are included in revenues and recognized under the accrual basis of accounting, were as follows (in thousands):

		2012				2011				2010
Licensing and other fees		$	7,304			$	10,229			$	8,092

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE A – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)

13. Recognition of Revenues and Accounts Receivable – (Continued)

Shipping and handling costs billed to customers are included in revenues and the related costs are included in selling, general and administrative expenses in the Consolidated Statements of Earnings/Loss. For the years ended December 31 shipping and handling costs were as follows (in thousands):

		2012				2011				2010
Shipping and handling costs		$	3,506			$	4,311			$	3,260

14. Cost of Goods Sold

Cost of goods sold includes the landed cost of inventory (which includes procurement costs of the Company’s Asian purchasing office and factory inspections, inbound freight charges, broker and consolidation charges and duties), production mold expenses and inventory and royalty reserves. Cost of goods sold may not be comparable to those of other entities as a result of recognizing warehousing costs within selling, general and administrative expenses. For the years ended December 31 warehousing costs were as follows (in thousands):

		2012				2011				2010
Warehousing costs		$	13,871			$	16,511			$	13,610

15. Selling, General and Administrative Expenses

Selling, general and administrative expenses include salaries and benefits, advertising, commissions, travel expenses, bad debt expense, shipping and handling costs, data processing expenses, legal fees, professional fees, rent and other office expenses, product development activity expenses, depreciation and amortization, bank fees, utilities, repairs and maintenance expenses, gains/losses on foreign currency transactions/revaluations, gains/losses on ineffective hedges and other warehousing costs.

16. Advertising Costs

Advertising costs are generally expensed as incurred and are included in selling, general and administrative expenses. Advertising costs also include athlete endorsement fees, which are amortized over the contractual terms of the agreements. For the years ended December 31 advertising costs were as follows (in thousands):

		2012				2011				2010
Advertising costs		$	21,437			$	47,244			$	43,547

The Company engages in cooperative advertising programs with its customers. The Company recognizes this expense, based on the expected usage of the programs, in advertising expense.

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE A – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)

17. Loss per Share

Basic loss per share excludes dilution and is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted loss per share reflects the potential dilution that could occur if options to issue common stock were exercised.

The following is a reconciliation of the number of shares (denominator) used in the basic and diluted loss per share (“EPS”) computations (shares in thousands):

	2012					2011					2010
	Shares		Per Share Amount			Shares		Per Share Amount			Shares		Per Share Amount
Basic EPS		35,603	$	(0.98	)		35,510	$	(1.98	)		35,218	$	(1.94	)
Effect of Dilutive Stock Options		0		0.00			0		0.00			0		0.00
Diluted EPS		35,603	$	(0.98	)		35,510	$	(1.98	)		35,218	$	(1.94	)

Because the Company had a net loss for the years ended December 31, 2012, 2011 and 2010, the number of diluted shares is equal to the number of basic shares at December 31, 2012, 2011 and 2010, respectively. Outstanding stock options would have had an anti-dilutive effect on diluted EPS for the years ended December 31, 2012, 2011 and 2010. Outstanding stock options with either exercise prices or unrecognized compensation cost per share greater than the average market price of a share of the Company’s common stock also have an anti-dilutive effect on diluted EPS and were as follows (shares in thousands):

	2012		2011		2010
Options to purchase shares of common stock		3,668		1,359		1,154
Exercise prices range
Low		$2.76		$8.15		$11.64
High		$34.75		$34.75		$34.75
Expiration dates
Earliest	January 2013		May 2012		December 2012
Latest	November 2022		August 2021		December 2020

18. Stock-Based Compensation

The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award – the requisite service period. Compensation cost is not recognized for equity instruments for which employees do not render the requisite service. The Company determines the grant-date fair value of employee stock options using the Black-Scholes option-pricing model adjusted for the unique characteristics of these options.

19. Other Income/(Expense)

During 2011, the Company and one of its international distributors entered into a mutual settlement and termination agreement in which the Company agreed to an early termination of this distributor’s contracts for $3,000,000. The contracts with this distributor were terminated as a result of this distributor not performing in accordance with their contracts, and there was no litigation. The loss of this distributor did not have a significant impact on the Company’s revenues or gross margin.

Other expense for the year ended December 31, 2010 consists of the recognition of $3,320,000, which represents the net present value of the estimated Palladium CPP, see Note O for further discussion.

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE A – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – (Continued)

20. Recent Accounting Pronouncements

Comprehensive Income

On January 1, 2012, the Company adopted ASU 2011-05, “Presentation of Comprehensive Income,” which allows the Company the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, the Company is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income and the total amount for comprehensive income. The adoption of ASU 2011-05 did not have a material impact on the Company’s financial position and results of operations.

ASU 2013-02, “Comprehensive Income: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income,” improves the transparency of reporting reclassifications. ASU 2013-02 requires the Company to present the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (“GAAP”) to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, the Company is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. ASU 2013-02 is effective for reporting periods beginning after December 15, 2012. The Company does not expect ASU 2013-02 will have a material impact on its financial position and results of operations, however, it may change certain disclosures.

Intangible Asset Impairment Qualitative Assessment

ASU 2012-02, “Testing Indefinite-Lived Intangible Assets for Impairment,” intends to simplify indefinite-lived intangible asset impairment testing. ASU 2012-02 permits an entity to first assess qualitative factors to determine whether it is more-likely-than-not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. If this qualitative assessment determines that it is more-likely-than-not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, then the entity must review its indefinite-lived intangible asset by quantitative factors. ASU 2012-02 is effective for interim and annual periods beginning after September 15, 2012. The Company is currently assessing the impact of ASU 2012-02 on its financial position and results of operations.

NOTE B –

RESTRICTED CASH AND CASH EQUIVALENTS AND RESTRICTED INVESTMENTS AVAILABLE FOR SALE

At December 31, 2012, the Company collateralized certain operational bank accounts at Bank of America and at December 31, 2011, the Company collateralized its Bank of America line of credit with restricted cash and cash equivalents. The Company’s restricted cash and cash equivalents and restricted investments available for sale at December 31 were as follows (in thousands):

	2012		2011
Restricted cash and cash equivalents	$	200	$	13,449
Restricted investments available for sale:
U.S. Treasury Notes		0		5,007
Corporate Notes and Bonds		0		4,062
Accrued interest income		0		84
Total restricted investments available for sale		0		9,153
Total restricted cash and cash equivalents and restricted investments available for sale	$	200	$	22,602

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE B – RESTRICTED CASH AND CASH EQUIVALENTS AND RESTRICTED INVESTMENTS AVAILABLE FOR SALE – (Continued)

The restricted investments are classified as available for sale and are stated at fair value. The Company capitalized any premiums paid or discounts received and amortized the premiums or accreted the discounts on a straight-line basis over the remaining term of the security. At December 31 gross unrealized holding gains and losses were as follows (in thousands):

	2011
Gross unrealized holding gains	$	8
Gross unrealized holding losses		3

For the years ended December 31 the change in comprehensive income was as follows (in thousands):

		2012				2011				2010
(Decrease)/Increase in comprehensive income		$	(3	)		$	(30	)		$	34

The Company received proceeds from the sale of restricted investments available for sale and realized gain on sale for the year ended December 31 as follows (in thousands):

	2012
Proceeds from sale of restricted investments	$	2,015
Realized gain on sale of restricted investments		3

There were no sales of restricted investments available for sale during the years ended December 31, 2011 and 2010. Realized gains are recognized using the actual cost of the investment.

NOTE C – INVESTMENTS AVAILABLE FOR SALE

The Company’s investments are classified as available for sale and are stated at fair value. The Company’s investments available for sale at December 31 were as follows (in thousands):

	2011
Corporate Notes and Bonds	$	2,024
Accrued interest income		33
Total investments available for sale	$	2,057

The Company capitalized any premiums paid or discounts received and amortized the premiums or accreted the discounts on a straight-line basis over the remaining term of the security. At December 31 gross unrealized losses were as follows (in thousands):

		2011
Gross unrealized holding losses		$	3

For the years ended December 31 the change in comprehensive income was as follows (in thousands):

		2012				2011				2010
Increase/(Decrease) in comprehensive income		$	1			$	(62	)		$	36

The Company received proceeds from the sale of investments available for sale and realized gain on sale for the years ended December 31 as follows (in thousands):

	2012		2011		2010
Proceeds from sale of investments available for sale	$	1,013	$	25,852	$	6,002
Realized gain on sale of investments available for sale		0		13		0

Realized gains are recognized using the actual cost of the investment.

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE D - PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment at December 31 were as follows (in thousands):

	2012			2011
Building and improvements	$	12,541		$	12,541
Information systems		22,667			23,191
Furniture, machinery and equipment		9,054			8,523
Total plant and equipment, gross		44,262			44,255
Less accumulated depreciation and amortization		(27,555	)		(25,357	)
Total plant and equipment, net		16,707			18,898
Land		695			695
Total property, plant and equipment, net	$	17,402		$	19,593

NOTE E - INTANGIBLE ASSETS

Intangible assets at December 31 were as follows (in thousands):

	2012			2011
Trademarks	$	12,649		$	12,569
Less accumulated amortization		(1,087	)		(1,087	)
Total intangible assets	$	11,562		$	11,482

The change in the carrying amount of intangible assets during year ended December 31 was as follows (in thousands):

	2012		2011
Beginning Balance	$	11,482	$	18,212
Trademarks acquired		35		0
Impairment losses – trademarks (Note P)		0		(3,150	)
Impairment losses – goodwill (Note P)		0		(539	)
Impairment losses – K•Swiss goodwill		0		(2,986	)
Foreign currency translation effects		45		(55	)
Ending Balance	$	11,562	$	11,482

During 2012, the Company purchased a foreign country trademark right which it did not own for the Palladium brand.

During the second quarter of 2011, after a review of sales, backlog, cash flows and marketing strategy, the Company determined that its investment in the Form Athletics goodwill and trademarks was impaired. As a result, the Company evaluated the future discounted net cash flows and recognized a full impairment loss of $3,689,000 on the Form Athletics goodwill and trademarks for the year ended December 31, 2011. During the third quarter of 2011, the Company decided to no longer pursue operating the Form Athletics line of business, see discussion in Note P.

Goodwill impairment of $2,986,000 was recognized on the K•Swiss brand for the year ended December 31, 2011. During the latter part of 2011 the Company experienced a significant decline in its market capitalization due to a decline in the stock price. As such, the implied fair value of goodwill was less than the carrying amount of goodwill and it was determined that goodwill was fully impaired.

The Company has performed the annual reassessment and impairment test as of October 1, 2012 of its Palladium intangible assets related to trademarks and determined there was no impairment of its intangible assets.

The Company’s trademark registrations are renewable every 10 years for minimal cost. The Company continually renews its trademark registrations and evidence supports it has the ability to continue to do so. The Company believes that its trademarks have an indefinite useful life because it intends to renew its trademarks indefinitely.

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE F - FINANCIAL RISK MANAGEMENT AND DERIVATIVES

At December 31, 2012 forward foreign exchange contracts with a notional value of $26,501,000 were outstanding to exchange various currencies with maturities ranging from January 2013 to September 2013, to sell the equivalent of approximately $4,401,000 in foreign currencies at contracted rates and to buy approximately $22,100,000 in foreign currencies at contracted rates. These contracts have been designated as cash flow hedges. At December 31, 2012, 2011 and 2010, the Company did not have any forward foreign exchange contracts that do not qualify as hedges.

The fair value of the Company’s derivatives at December 31 was as follows (in thousands):

	Asset Derivatives					Liability Derivatives
	Balance Sheet Location	2012		2011		Balance Sheet Location	2012		2011
	Balance Sheet Location	Fair Value		Fair Value		Balance Sheet Location	Fair Value		Fair Value
Derivatives Designated as Hedging Instruments
Foreign exchange contracts	Prepaid expenses and other current assets	$	171	$	1,321	Accrued liabilities	$	1,057	$	306

The effect of the Company’s derivatives on its Consolidated Statements of Earnings/Loss for years ended December 31 were as follows (in thousands):

Derivatives in Cash Flow	Amount of Gain/(Loss) Recognized in Other Comprehensive Earnings (“OCE”) on Derivative (Effective Portion)							Location of Gain/(Loss) Reclassified from OCE into Income	Amount of Gain/(Loss) Reclassified from OCE into Income (Effective Portion)								Location of Gain/(Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from	Amount of Gain/(Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)
Hedging Relationships	2012			2011		2010		(Effective Portion)	2012		2011			2010			Effectiveness Testing)	2012			2011			2010
Foreign exchange contracts	$	(1,266	)	$	961	$	416	Cost of goods sold	$	84	$	(545	)	$	(326	)	Selling, general and administrative expenses	$	(44	)	$	(20	)	$	81

NOTE G – BANK LINES OF CREDIT AND OTHER DEBT

The Company’s bank lines of credit, long-term debt, long-term capital leases and outstanding letters of credit at December 31 were as follows (in thousands):

	2012		2011
Bank lines of credit	$	998	$	9,716
Long-term debt		152		398
Long-term capital leases		293		0
Total bank lines of credit, long-term debt and long-term capital leases	$	1,443	$	10,114
Outstanding letters of credit, not included above	$	378	$	280

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE G – BANK LINES OF CREDIT AND OTHER DEBT – (Continued)

Bank Lines of Credit

Outstanding bank lines of credit at December 31 were as follows (dollars and Euros in thousands):

	2012		2011
Secured Variable Rate Lines of Credit with Financial Institutions:
Credit Facility of $35,000 at an interest rate of 4.50% at December 31, 2012, due April 23, 2016 (1)	$	0	$	0
Bank line of credit of $21,000 at an interest rate of 2.69% at December 31, 2011, due July 1, 2013 (2)		0		9,716
Facility of €4,000, or approximately $5,288, at December 31, 2012, at an interest rate of 0.84%, due December 31, 2012 and approximately $5,182, at December 31, 2011, at an interest rate of 2.13%, due December 31, 2012 (3) (4)		998		0
Facilities of €1,200, or approximately $1,587, at December 31, 2012, at interest rates ranging from 1.39% to 2.57%, due December 31, 2012 and facilities of €1,000, or approximately $1,296, at December 31, 2011, at interest rates ranging from 2.56% to 3.12%, due December 31, 2011 (3) (5)		0		0
Total bank lines of credit	$	998	$	9,716
Outstanding letters of credit, not included above	$	378	$	280

(1)	Secured by all assets of K•Swiss Inc., K•Swiss Sales Corp. and K•Swiss Direct Inc. The amount available to borrow on this line of credit at December 31, 2012 was $16,234. See further discussion below.

(2)	Fully secured by cash (or the Company’s restricted cash and cash equivalents and restricted investments available for sale, see Note B). This facility was fully paid off on April 25, 2012. See further discussion below.

(3)	These lines of credit are secured by Palladium’s assets including accounts receivable and/or intellectual property rights (i.e. trademarks), as well as Palladium common stock.

(4)	A new facility of €9,000 was entered into as of January 2, 2013. This facility continues indefinitely with three months notice. This is secured by Palladium accounts receivables.

(5)

Loans made under the Credit Facility bear interest at:

(1)

the greatest of (i) the Federal Funds Rate plus 0.5%, (ii) the LIBOR Rate plus 1%, and (iii) Wells Fargo’s prime rate (the “Base Rate”); or

(2)

(3)

for loans made in Euros or Pound Sterling, the LIBOR Rate

plus, in each case, the “Applicable Margin.”

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE G – BANK LINES OF CREDIT AND OTHER DEBT – (Continued)

The financial covenants contained in the Credit Facility are as follows (in each case, with respect to the Company and its subsidiaries on a consolidated basis):

· The Company must achieve Minimum EBITDA specified in the Credit Facility for each month through November 30, 2013.

· The Company must maintain a Fixed Charge Coverage Ratio for each twelve month fiscal period, commencing for the fiscal period ending on December 31, 2013, of not less than 1.0:1.0.

· The Company must limit Capital Expenditures for each fiscal year to $2,400,000, except with the Lender’s consent.

The obligations of the Borrowers under the Credit Facility are guaranteed by four of the Company’s other domestic subsidiaries (the “Guarantors”) pursuant to a Guaranty and Security Agreement, dated April 25, 2012 (the “Guaranty and Security Agreement”). Pursuant to the Guaranty and Security Agreement, the Borrowers and the Guarantors pledged substantially all of their respective assets as collateral security for the loans to be made pursuant to the Credit Facility. The foreign subsidiaries of the Borrowers did not guaranty the Credit Facility or pledge any of their directly-owned assets. The Company has also granted a security interest in its real property to the Lenders, consisting of a deed of trust securing its corporate headquarters building.

At December 31, 2012, the Company was in compliance with its covenants under the Credit Facility.

On April 25, 2012, the Company drew down approximately $9,924,000 under the Credit Facility to repay in full all indebtedness outstanding under its previous line of credit with Bank of America and to pay fees and expenses related to the Credit Facility. The Company intends to utilize the Credit Facility for working capital, to issue letters of credit in connection with purchases of inventory and other general corporate purposes.

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE G – BANK LINES OF CREDIT AND OTHER DEBT – (Continued)

Long-term Debt

Long-term debt outstanding at December 31 was as follows (dollars and Euros in thousands):

	2012		2011
Secured Fixed Rate Term Loans with Financial Institutions of €800, or approximately $1,058, at December 31, 2012, at an interest rate of 5.42%, due February 2013 and €1,320, or approximately $1,710, at December 31, 2011, with interest rates ranging from 5.42% to 5.84%, due between February 2012 and February 2013 (1)	$	151	$	394
Accrued interest		1		4
Total long-term debt	$	152	$	398
Current portion of long-term debt	$	152	$	250
Long-term debt	$	0	$	148

(1) These are secured by Palladium’s assets including accounts receivable and/or intellectual property rights (i.e. trademarks), as well as Palladium common stock.

Long-term Capital Leases

Long-term capital leases outstanding at December 31 were as follows (dollars in thousands):

	2012
Capital leases for information systems, with interest rates ranging from 2.01% to 11.58%, due between June 2014 and December 2016	$	293
Current portion of long-term capital leases	$	103
Long-term capital leases	$	190

The leased property securing these long-term capital leases at December 31 were as follows (dollars in thousands):

	2012
Leased property – Information systems, gross	$	381
Less accumulated depreciation		(48	)
Total leased property – Information systems, net	$	333

Interest expense

Interest expense incurred on the Company’s bank loans, lines of credit and capital leases and amortization of loan origination costs on the Wells Fargo Credit Facility for the years ended December 31 were as follows (in thousands):

		2012				2011				2010
Interest expense		$	243			$	266			$	118

Amounts due under the Company’s lines of credit, term loans and capital leases as of December 31, 2012 were as follows (in thousands):

Year ending December 31,
2013	$	1,253
2014		103
2015		51
2016		36
2017		0
Thereafter		0
	$	1,443

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE H - ACCRUED LIABILITIES

Accrued liabilities at December 31 were as follows (in thousands):

	2012		2011
Compensation	$	3,625	$	4,118
Advertising		1,586		1,893
Other		6,429		7,489
Total accrued liabilities	$	11,640	$	13,500

NOTE I - INCOME TAXES

The provision for income tax expense for the years ended December 31 included the following (in thousands):

	2012		2011		2010
Current:
United States
Federal	$	1,681	$	2,278	$	(699	)
State		83		144		74
Foreign		826		642		565
Deferred:
United States
Federal		0		12		6,156
State		0		0		1,967
Foreign		607		675		(131	)
Total income tax expense	$	3,197	$	3,751	$	7,932

A reconciliation from the U.S. federal statutory income tax rate to the effective tax rate for the years ended December 31 were as follows:

	2012			2011			2010
U.S. Federal statutory rate		35.0	%		35.0	%		35.0	%
State income taxes		5.1			3.9			3.9
Net results of foreign subsidiaries		(8.7	)		(9.5	)		(6.0	)
Valuation allowance		(38.5	)		(26.4	)		(45.2	)
Goodwill impairment		0.0			(1.9	)		0.0
Non-deductible executive compensation		0.0			(4.2	)		0.0
Other		(3.0	)		(3.1	)		(1.2	)
Total effective tax rate		(10.1	)%		(6.2	)%		(13.5	)%

The federal income tax returns for 2006 through 2009 are currently under various stages of audit by the Internal Revenue Service (“IRS”). The Company received a Notice of Proposed Adjustment from the IRS for tax years 2006 and 2007 of $7,114,000 (which includes $1,186,000 in penalties). Interest will be assessed, and at this time it is estimated at approximately $1,879,000. This issue, which relates to intercompany transfer pricing, has been sent to the IRS Appeal’s office for further consideration. The Company does not believe that an additional tax accrual is required at this time.

In January 2012, the Company received a Notice of Proposed Adjustment for the 2008 tax year, also regarding intercompany transfer pricing. The 2008 proposed adjustment is $251,000. Interest will be assessed, and at this time it is estimated at approximately $40,000. This issue has been sent to the IRS Appeal’s office for further consideration. This will not create any additional financial statement impact due to the available U.S. tax losses that may be carried back from the 2010 tax year to the 2008 tax year.

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE I - INCOME TAXES – (Continued)

Also in January 2012, the Company received a Notice of Proposed Adjustment for the 2009 tax year of $496,000 related to the gain on sale of certain Royal Elastics assets. Interest will not be assessed as the adjustment will reduce the Company’s net operating loss for 2009. The Company has agreed to this adjustment. The IRS did not propose an adjustment to the Company’s 2009 intercompany transfer pricing even though the Company’s intercompany transfer pricing methodology has been the same during the 2006 to 2009 period.

The Company does not agree with the 2006 through 2008 adjustments and plans to vigorously defend its position. The amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year. The Company’s material tax jurisdiction is the United States.

Deferred income taxes are determined based on the estimated future tax effects of differences between the financial statement and the tax basis of assets and liabilities given the provisions of the enacted tax laws. The net non-current deferred income taxes recognized at December 31 were as follows (in thousands):

		2012				2011
Net non-current deferred income tax assets		$	2,308			$	2,914

Significant components of the Company’s deferred tax assets and liabilities at December 31 were as follows (in thousands):

	2012			2011
Assets:
State taxes	$	9,620		$	5,242
Bad debt reserves		391			454
Inventory reserve and capitalized costs		2,951			2,959
Sales return reserve		546			686
Stock-based compensation		4,374			3,969
Foreign research and development credit		33			28
Alternative minimum tax credit and U.S. foreign tax credit		4,254			3,660
Palladium Contingent Purchase Price		61			77
Federal net operating losses		41,601			30,998
Foreign net operating losses		1,914			2,341
Other		2,538			2,257
Gross deferred tax assets		68,283			52,671
Liabilities:
Depreciation		(3,887	)		(3,808	)
Other		(451	)		(430	)
Gross deferred tax liabilities		(4,338	)		(4,238	)
Valuation allowance:
United States		(61,062	)		(45,147	)
Foreign		(575	)		(372	)
Valuation allowance		(61,637	)		(45,519	)
Net deferred tax asset	$	2,308		$	2,914

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE I - INCOME TAXES – (Continued)

During 2012, the Company remained in a three year pre-tax cumulative loss position and can no longer support future profitability sufficient enough to realize all of its deferred tax assets in the near future. The valuation allowance was $61,637,000 and $45,519,000 at December 31, 2012 and 2011, respectively. At December 31, 2012, the Company’s net deferred tax asset after valuation allowance was $2,308,000 which consisted of U.S. foreign tax credits of $35,000 for the eventual carryback of foreign tax credits to the 2006 tax year as the Company believes it is more-likely-than-not that it will be utilized and foreign net operating losses of $2,273,000 which is related to the pre-acquisition losses of Palladium, a French company, which has an unlimited carryforward period and therefore the Company believes it is more-likely-than-not that the loss carryforward will be utilized. The ultimate realization of this loss carryforward is dependent upon the generation of future taxable income in France during the periods in which those temporary differences become deductible. This assessment could change in future periods if the Company does not achieve taxable income in France or projections of future taxable income decline. Changes in existing tax laws could also affect actual tax results and the valuation of deferred tax assets over time. The accounting for deferred taxes is based upon an estimate of future operating results. Differences between the anticipated and actual outcomes of these future tax consequences could have a material impact on the Company’s consolidated results of operations or financial position. If an increase in the valuation allowance in future periods is required, this would result in an increase in the Company’s income tax expense and could materially impact the effective income tax rate in the period recorded.

The Company’s uncertain tax positions were recognized in Other Liabilities on its Consolidated Balance Sheets and at December 31 was as follows (in thousands):

	2012			2011
Uncertain tax positions	$	7,827		$	7,112
Interest on uncertain tax positions		1,484			1,272
Total uncertain tax positions, gross		9,311			8,384
Less federal income tax benefit		(595	)		(568	)
Total uncertain tax positions, net	$	8,716		$	7,816

Income tax expense related to uncertain tax positions for the years ended December 31 was as follows (in thousands):

	2012		2011		2010
Income tax expense related to uncertain tax positions	$	715	$	810	$	137
Interest expense related to uncertain tax positions		212		228		141
Total income tax expense related to uncertain tax positions	$	927	$	1,038	$	278

The Company did not recognize any related penalties for uncertain tax positions for the years ended December 31, 2012, 2011 and 2010. The Company does not expect its uncertain tax positions to change significantly over the next twelve months. A reconciliation of the beginning and ending amount of the Company’s uncertain tax positions, gross, at December 31 was as follows (in thousands):

	2012		2011
Beginning balance	$	8,384	$	7,346
Additions for uncertain tax positions:
Related to uncertain tax positions taken in the current year		715		810
Related to uncertain tax positions taken in prior years		212		228
Ending balance	$	9,311	$	8,384

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE J - COMMITMENTS AND CONTINGENCIES

The Company leases its principal warehouse facility through January 2015. In addition, certain property and equipment is leased primarily on a month-to-month basis. Rent expense for operating leases for the years ended December 31 was as follows (in thousands).

		2012				2011				2010
Rent expense		$	7,967			$	7,661			$	6,550

The Company has entered into endorsement agreements with athletes that are sponsored by the Company through April 2014. The Company has entered into licensing agreements which require the Company to pay minimum royalties through June 2014.

Future minimum rental payments under leases, future minimum endorsement fees under endorsement agreements, future minimum royalties under licensing agreements and product purchase obligations at December 31, 2012 were as follows (in thousands):

	Year ending December 31,
	2013		2014		2015		2016		2017		Thereafter		Total
Rental payments	$	6,803	$	5,825	$	3,047	$	1,739	$	1,472	$	2,680	$	21,566
Endorsement fees		2,948		168		0		0		0		0		3,116
Royalty fees		560		30		0		0		0		0		590
Product purchase obligations (1)		30,891		0		0		0		0		0		30,891
Total	$	41,202	$	6,023	$	3,047	$	1,739	$	1,472	$	2,680	$	56,163

(1) The Company generally orders product four to five months in advance of sales based primarily on advance futures orders received from customers. Product purchase obligations represent open purchase orders to purchase products in the ordinary course of business that are enforceable and legally binding.

The Company has outstanding letters of credit totaling approximately $378,000 at December 31, 2012. These letters of credit collateralize the Company’s obligations to third parties for the purchase of inventory. The letters of credit outstanding at December 31, 2012 have original terms from two to fifteen months. The fair value of these letters of credit approximates the fees currently charged for similar agreements and is not significant at December 31, 2012 and 2011.

The Company is, from time to time, a party to litigation which arises in the normal course of its business operations. The Company does not believe that it is presently a party to any such litigation which will have a material adverse effect on its business or operations.

NOTE K - EMPLOYEE BENEFIT PLAN

In 1988, the Company adopted a domestic discretionary contribution profit sharing plan covering all employees meeting certain eligibility requirements. In 1993, the plan was amended to include a 401(k) plan. The Company’s contribution into this plan for the years ended December 31 was as follows (in thousands):

		2012				2011				2010
401(k) contributions		$	22			$	24			$	30

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE L - STOCKHOLDERS’ EQUITY

Each share of Class B Common Stock is freely convertible into one share of Class A Common Stock at the option of the Class B stockholder. Holders of Class A Common Stock are entitled to one vote per share and holders of Class B Common Stock are entitled to ten votes per share for all matters submitted to a vote of the stockholders of the Company, other than the election of directors. Holders of Class A Common Stock are initially entitled to elect two directors and holders of Class B Common Stock are entitled to elect all directors other than directors that the holders of Class A Common Stock are entitled to elect. If the number of members of the Company’s Board of Directors is increased to not less than eleven and not greater than fifteen (excluding directors representing holders of Preferred Stock, if any), holders of Class A Common Stock will be entitled to elect three directors. If the number of members of the Company’s Board of Directors is increased to a number greater than fifteen (excluding directors representing holders of Preferred Stock, if any), holders of Class A Common Stock will be entitled to elect four directors.

The 1999 Stock Incentive Plan, as amended, authorized the Company to award up to 4,600,000 shares or options to employees and directors of the Company. The awards have a term of ten years and generally become fully vested between the grant date and the ninth year following the grant date. At December 31, 2012, there were no awards available for future grants under the 1999 Stock Incentive Plan.

The 2009 Stock Incentive Plan authorized the Company to award up to 3,000,000 shares or options of the Company’s Class A Common Stock to employees and directors of the Company. The awards have a term of ten years and generally become fully vested between the third and fifth years following the grant date. At December 31, 2012, approximately 872,000 awards remain available for grant under the 2009 Stock Incentive Plan.

The following table summarizes compensation costs related to the Company’s stock-based compensation plans (in thousands) for the year ended December 31:

	2012			2011			2010
Cost of goods sold	$	26		$	(124	)	$	146
Selling, general and administrative expenses		1,005			975			1,592
Pre-tax stock-based compensation expenses		1,031			851			1,738
Income tax (benefit)/expense		(3	)		67			(114	)
Total stock-based compensation expenses	$	1,028		$	918		$	1,624

There were no capitalized stock-based compensation costs during the years ended December 31, 2012, 2011 and 2010. The Company recognizes stock-based compensation expense using the graded-vesting attribution method. The remaining unrecognized compensation expense related to unvested awards at December 31, 2012 was $3,969,000 and the weighted-average period of time over which this expense will be recognized is approximately 2.6 years. This amount does not include the cost of any additional options that may be granted in future periods nor any changes in the Company’s forfeiture rate. In connection with the exercise of options, the Company did not realize any income tax benefit during the years ended December 31, 2012, 2011 and 2010. There were no modifications to stock option awards during the years ended December 31, 2012, 2011 and 2010.

The fair value of stock options at date of grant was estimated using the Black-Scholes model. The expected life of employee stock options is determined using historical data of employee exercises and represents the period of time that stock options are expected to be outstanding. The risk-free interest rate is based on the U.S. Treasury constant maturity for the expected life of the stock option. Expected volatility is based on the historical volatilities of the Company’s Class A Common Stock. The Black-Scholes model was used with the following assumptions:

	2012			2011			2010
Expected life (years)		6			6			6
Risk-free interest rate		1.1	%		1.4	%		2.4	%
Expected volatility		53.9	%		51.6	%		46.0	%
Expected dividend yield		0.0	%		0.0	%		0.0	%

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE L - STOCKHOLDERS’ EQUITY – (Continued)

The following table summarizes stock option transactions for 2012, 2011 and 2010 (dollar amounts in thousands, except weighted average exercise price):

	Shares			Weighted average exercise price		Weighted average remaining contractual life (in years)		Aggregate intrinsic value
Options outstanding January 1, 2010		2,772,065		$	8.98
Granted		318,300			11.21
Exercised		(241,999	)		5.15
Canceled		(89,471	)		9.95
Options outstanding December 31, 2010		2,758,895			9.54
Granted		1,178,600			4.41
Exercised		(220,498	)		4.82
Canceled		(488,068	)		9.79
Options outstanding December 31, 2011		3,228,929			7.95
Granted		949,500			3.34
Exercised		(7,334	)		0.73
Canceled		(490,759	)		8.10
Options outstanding December 31, 2012		3,680,336		$	6.76		6.92	$	457

Options exercisable December 31, 2010		1,297,454
Options exercisable December 31, 2011		1,176,050
Options exercisable December 31, 2012		1,191,774		$	10.50		3.91	$	24

The weighted-average grant-date fair value of stock options granted for the years ended December 31 was as follows:

		2012				2011				2010
Weighted-average grant date fair value		$	1.73			$	2.18			$	5.35

The Company reflects income tax benefits resulting from tax deductions in excess of expense as a financing activity in its Consolidated Statement of Cash Flows. Cash proceeds and intrinsic value of related stock options exercised for the years ended December 31 were as follows (in thousands):

	2012		2011		2010
Proceeds from stock options exercised	$	5	$	1,062	$	1,247
Intrinsic value of stock options exercised	$	19	$	991	$	1,681

The Company issues new shares of Class A Common Stock to satisfy stock option exercises. Shares that are repurchased under the Company’s current stock repurchase programs will reduce the dilutive impact of the Company’s share-based compensation plans. Treasury Stock is shown on the Company’s Consolidated Balance Sheet as a reduction to stockholders’ equity at the full purchase price of purchased shares until retired. Under its stock repurchase program, the Company did not purchase shares of Class A Common Stock during the years ended December 31, 2012 and 2011.

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE M - CONCENTRATIONS OF CREDIT RISK

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents, trade accounts receivable and financial instruments used in hedging activities. The Company maintains cash and cash equivalents at financial institutions in excess of the amount insured by the Federal Deposit Insurance Corporation. For forward exchange contracts, the credit risk the Company is exposed to is limited to the unrealized gains in these contracts should the counterparties fail to perform. As part of its cash and risk management processes, the Company performs periodic evaluations of the relative credit standing of these financial institutions.

During the years ended December 31, 2012, 2011 and 2010, there were no customers that accounted for more than 10% of total revenues. At December 31, 2012 and 2011, approximately 14% and 10%, respectively, of accounts receivable was from one customer, which is fully secured by standby letters of credit. Credit risk with respect to trade accounts receivable is generally diversified due to the large number of entities comprising the Company’s customer base and their dispersion across many geographies. The Company controls credit risk through credit approvals, credit limits and monitoring procedures, and for international receivables from distributors, the use of letters of credit and letters of guarantee.

NOTE N – SEGMENT INFORMATION

The Company’s predominant business is the design, development and distribution of athletic footwear. The Company has identified its footwear products business to be its only segment as substantially all of the Company’s revenues are from the sales of footwear products. The Company is organized into three geographic regions: the United States, Europe, Middle East and Africa (“EMEA”) and Other International operations. The Company’s Other International geographic region includes the Company’s operations in Asia. The following tables summarize information by geographic region of the Company’s footwear segment (in thousands):

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE N – SEGMENT INFORMATION – (Continued)

	2012			2011			2010
Revenues from unrelated entities (1):
United States	$	75,872		$	116,781		$	92,178
EMEA		86,883			88,092			71,720
Other International		60,096			63,484			52,868
Total revenues from unrelated entities	$	222,851		$	268,357		$	216,766

Inter-geographic revenues:
United States	$	5,846		$	5,680		$	4,281
EMEA		47			1,470			6
Other International		177			212			132
Total inter-geographic revenues	$	6,070		$	7,362		$	4,419

Total revenues:
United States	$	81,718		$	122,461		$	96,459
EMEA		86,930			89,562			71,726
Other International		60,273			63,696			53,000
Less inter-geographic revenues		(6,070	)		(7,362	)		(4,419	)
Total revenues	$	222,851		$	268,357		$	216,766

Operating (loss)/profit:
United States	$	(20,581	)	$	(41,206	)	$	(36,900	)
EMEA		(2,986	)		(16,075	)		(10,939	)
Other International		4,737			9,570			5,323
Less corporate expenses (2)		(12,132	)		(16,842	)		(15,261	)
Eliminations		192			563			1,730
Total operating loss	$	(30,770	)	$	(63,990	)	$	(56,047	)

Interest income:
United States	$	66		$	437		$	859
EMEA		21			33			16
Other International		52			66			56
Total interest income		139			536			931
Interest expense:
United States	$	805		$	50		$	369
EMEA		145			267			127
Other International		1			0			0
Total interest expense		951			317			496
Interest (expense)/income, net	$	(812	)	$	219		$	435

Income tax expense:
United States	$	1,764		$	2,433		$	7,497
EMEA		1,121			704			182
Other International		312			614			253
Total income tax expense	$	3,197		$	3,751		$	7,932

Provision for depreciation and amortization:
United States	$	2,606		$	2,563		$	2,545
EMEA		489			498			553
Other International		575			550			559
Total provision for depreciation and amortization	$	3,670		$	3,611		$	3,657

Capital expenditures:
United States	$	532		$	1,184		$	853
EMEA		401			1,056			503
Other International		595			464			1,021
Total capital expenditures	$	1,528		$	2,704		$	2,377

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE N – SEGMENT INFORMATION - (Continued)

	2012		2011
Long-lived assets (3):
United States	$	14,570	$	16,719
EMEA		1,470		1,519
Other International		1,362		1,355
Total long-lived assets	$	17,402	$	19,593

(1) Revenue is attributable to geographic regions based on the location of the Company subsidiary.

(2) Corporate expenses include expenses such as salaries and related expenses for executive management and support departments such as accounting and treasury, information technology and legal which benefit the entire corporation and are not segment/region specific. The decrease in corporate expenses for the year ended December 31, 2012 compared to the year ended December 31, 2011 was due to decreases in compensation and data processing expenses during the year ended December 31, 2012 and to a K•Swiss goodwill impairment charge recognized during the year ended December 31, 2011. The increase in corporate expenses for the year ended December 31, 2011 compared to the year ended December 31, 2010 was due to a K•Swiss goodwill impairment charge recognized during the year ended December 31, 2011, offset by decreases in legal and data processing expenses. The decrease in compensation expenses for the year ended December 31, 2012, which include bonus/incentive related expenses and employee recruiting and relocation expenses, resulted primarily from a reduction of salary related expenses and interest expense related to the Company’s deferred compensation plan which was terminated in 2011, offset by an increase in stock option compensation expense. The decrease in legal expenses was a result of decreases in expenses incurred to defend the Company’s trademarks. The decrease in data processing expenses was a result of decreases in on-going maintenance expense for the Company’s SAP computer software system.

(3) Long-lived assets consist of property, plant and equipment, net.

NOTE O – PALLADIUM CONTINGENT PURCHASE PRICE

On May 16, 2008, the Company entered into a Share Purchase and Shareholders’ Rights Agreement (the “Agreement”) by and among an individual, Palladium and the Company providing for the purchase of a 57% equity interest in Palladium from its shareholders for a total purchase price of €5,350,000, or $8,448,000 (including a loan of €3,650,000, or $5,764,000). On June 2, 2009, the Company entered into Amendment No. 1 to the Agreement providing for the Company to purchase the remaining 43% equity interest in Palladium for €5,000,000 plus a variable future price. On May 1, 2010, the Company entered into Amendment No. 2 to the Agreement revising the terms of the remaining future purchase price for Palladium to be equal to €3,000,000 plus up to €500,000 based on an amount calculated in accordance with a formula driven by Palladium’s EBITDA for the twelve months ended December 2012. In July 2012, the Company entered into Amendment No. 3 to the Agreement, in which the Company made a payment of €1,443,000, or $1,776,000, and revised the terms of the remaining future purchase price to be equal to the net present value of €1,500,000 plus up to €500,000 based on an amount calculated in accordance with a formula driven by Palladium’s EBITDA for the twelve months ended December 31, 2012. At December 31, 2012, the CPP calculated in accordance with this formula was €2,000,000, or $2,644,000, and is payable in 2013.

The CPP was determined each quarter based on the current quarter’s projection of Palladium’s EBITDA for the twelve months ended December 31 of the current year. Excluding the initial recognition of the CPP, any change in CPP was based on the change in net present value of the remaining minimum guaranteed payment and the current quarter’s EBITDA projection, and was recognized as interest income or interest expense during the applicable quarter. During the second quarter of 2010, the Company recognized the initial fair value of the CPP of $3,320,000, which was recorded in Other Income/(Expense), net on its Consolidated Statement of Earnings/Loss.

The change in the CPP for the years ended December 31 was as follows (in thousands):

	2012			2011		2010
Beginning balance	$	3,739		$	3,689	$	0
Initial recognition of the net present value of the CPP		0			0		3,320
Payment		(1,776	)		0		0
Change in net present value of the CPP		681			50		369
Ending balance	$	2,644		$	3,739	$	3,689

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE P – FORM ATHLETICS

On July 23, 2010, the Company entered into a Membership Interest Purchase Agreement (“Purchase Agreement”) with Form Athletics, LLC and its Members to purchase Form Athletics for $1,600,000 in cash. Form Athletics was established in January 2010 to design, develop and distribute apparel for mixed martial arts under the Form Athletics brand worldwide. The purchase of Form Athletics was part of an overall strategy to enter the action sports market, however, during the third quarter of 2011, the Company decided to no longer pursue operating in this line of business, as discussed below. Operations of Form Athletics have been accounted for and presented as a discontinued operation in the accompanying Consolidated Financial Statements.

Pursuant to the Purchase Agreement, the Company was obligated to pay additional cash consideration to certain Members of Form Athletics in an amount equal to Form Athletics’ EBITDA for the twelve months ended December 31, 2012 (“Form CPP”), which was capitalized upon purchase. The fair value of the Form CPP was determined each quarter based on the net present value of the current quarter’s projection of Form Athletics’ EBITDA for the twelve months ended December 31, 2012. Any subsequent changes to the Form CPP was recognized as interest income or interest expense during the applicable quarter.

The acquisition of Form Athletics was recorded as a 100% purchase and the Form CPP liability was recognized and accordingly, the results of operations of the acquired business were included in the Company’s Consolidated Financial Statements from the date of acquisition. A trademark asset totaling $3,150,000 and goodwill of $539,000 were recognized for the amount of the excess purchase price paid over fair market value of the net assets acquired. The amount of goodwill that was deductible for tax purposes was $507,000 and will be amortized over 15 years. At July 23, 2010, the acquired assets and liabilities assumed in the purchase of Form Athletics was as follows (in thousands):

	Balance at July 23, 2010
Inventories	$	39
Intangible assets		3,689
Total assets	$	3,728

Current liabilities	$	18
Form CPP		2,110
Total liabilities		2,128
Contribution by K•Swiss Inc.		1,600
Total stockholders’ equity		1,600
Total liabilities and stockholders’ equity	$	3,728

Since Form Athletics began operating in early 2010, operating results prior to the Company’s purchase of Form Athletics were not significant and pro forma information was not materially different than what was reported on the Company’s Consolidated Financial Statements.

The intangible assets were accounted for at the lower of carrying value or fair value. These indefinite-lived assets were evaluated for impairment at least annually, and more often when events indicate that impairment exists. During the second quarter of 2011, after a review of sales, backlog, cash flows and marketing strategy, the Company determined that its investment in the Form Athletics goodwill and trademark was impaired and recognized impairment losses of $3,689,000 (see Note E) and reversed the Form CPP liability of $2,110,000, which is included in the loss from discontinued operations as interest income.

The change in the Form CPP for the years ended December 31 was as follows (in thousands):

	2011			2010
Beginning balance	$	2,110		$	0
Initial recognition of the net present value of the CPP		0			2,110
Change in net present value of the CPP		(2,110	)		0
Ending balance	$	0		$	2,110

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE P – FORM ATHLETICS – (Continued)

The operations for Form Athletics for the years ended December 31 were as follows (in thousands):

	2011			2010
Revenues	$	683		$	221
Cost of goods sold		1,223			134
Gross (loss)/profit		(540	)		87
Selling, general and administrative expenses		3,830			1,435
Impairment on intangibles and goodwill		3,689			0
Operating loss		(8,059	)		(1,348	)
Interest income, net		2,110			0
Net loss from discontinued operations	$	(5,949	)	$	(1,348	)

NOTE Q – QUARTERLY FINANCIAL DATA (Unaudited)

Summarized quarterly financial data for 2012 and 2011 follows (in thousands except for per share amounts):

	First quarter			Second quarter			Third quarter			Fourth quarter			Year
2012
Revenues	$	69,318		$	44,752		$	67,551		$	41,230		$	222,851
Gross profit		26,257			13,545			24,042			13,281			77,125
Net loss		(6,706	)		(11,631	)		(1,926	)		(14,516	)		(34,779	)
Loss per share, basic and diluted
Net loss	$	(0.19	)	$	(0.33	)	$	(0.05	)	$	(0.41	)	$	(0.98	)

2011
Revenues	$	72,441		$	65,297		$	80,456		$	50,163		$	268,357
Gross profit		28,522			22,434			28,825			12,841			92,622
Loss from continuing operations		(8,616	)		(17,400	)		(13,632	)		(24,874	)		(64,522	)
Loss from discontinued operations		(1,226	)		(2,626	)		(1,786	)		(311	)		(5,949	)
Net loss		(9,842	)		(20,026	)		(15,418	)		(25,185	)		(70,471	)
Loss per share, basic and diluted
Loss from continuing operations	$	(0.25	)	$	(0.49	)	$	(0.38	)	$	(0.70	)	$	(1.81	)
Loss from discontinued operations		(0.03	)		(0.07	)		(0.05	)		(0.01	)		(0.17	)
Net loss		(0.28	)		(0.56	)		(0.43	)		(0.71	)		(1.98	)

NOTE R – SUBSEQUENT EVENT

On January 16, 2013, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with E-Land World Limited, a corporation organized under the laws of the Republic of Korea (“Parent”), Ian Acquisition Sub, Inc., a Delaware corporation and an indirect wholly-owned subsidiary of Parent (“Merger Sub”), pursuant to which Merger Sub will be merged with and into the Company, with the Company surviving as an indirect wholly-owned subsidiary of Parent (the “Merger”). Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each outstanding share of the Company’s Class A Common Stock and Class B Common Stock will be converted into the right to receive $4.75 in cash, without interest (the “Merger Consideration”). Consummation of the Merger is subject to approval of the Merger by 80% of the Company’s voting power, and other customary closing conditions, including expiration or termination of the Hart-Scott-Rodino regulatory waiting period, expiration or termination of the relevant waiting period under the Korean Monopoly Regulation and Fair Trade Act (or approval of the business combination report filed thereunder by the Korean Fair Trade Commission), and the absence of any court order or other legal restraint prohibiting the Merger. The Merger is expected to close in the second quarter of 2013.

Each option to acquire shares of the Company’s common stock, whether vested or unvested, that is outstanding at the effective time of the Merger will be cancelled in exchange for an amount in cash (without interest) equal to the product of (i) the excess, if any, of the Merger Consideration over the per share exercise price of such option and (ii) the number of shares subject to such option.

K•SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE R – SUBSEQUENT EVENT – (Continued)

In connection with the entry into the Merger Agreement, on January 16, 2013, the Board adopted the K•Swiss Inc. Retention Bonus Plan (the “Plan”). The Plan provides for the payment of retention bonuses in an aggregate amount not to exceed $1,500,000 to designated employees of the Company (i) who remain employed with the Company or a subsidiary through the close of business on the first anniversary of the closing of the Merger, or (ii) who are terminated by the Company without cause, or by the designated employee with good reason, or due to death or disability, on or after the closing of the Merger and prior to the first anniversary of the closing of the Merger. Neither the Company’s Chief Executive Officer or his designee are eligible to participate in the Plan. Administration of the Plan has been delegated to the Company’s Chief Executive Officer (or, if his employment terminates prior to the date all amounts are paid under the Plan, the most senior executive of the Company by position who was an employee of the Company immediately prior to the closing date of the Merger) (the “CEO”). The CEO, as defined, has discretion to determine the employees who participate in the Plan and the bonus available to each participant, subject to approval of E-Land (which approval may not be unreasonably withheld or delayed). As of the date hereof, the CEO and E-Land have not determined the participants, but it is expected that some or all of the Company’s named executive officers (other than the Company’s Chief Executive Officer) will participate in the Plan.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures

Disclosure Controls and Procedures

The Company’s management carried out an evaluation, under the supervision and with the participation of the Company’s President and Chief Executive Officer and Vice President of Finance and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as amended (“Exchange Act”)) as of December 31, 2012, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Company’s President and Chief Executive Officer along with the Company’s Vice President of Finance and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of December 31, 2012 are effective in ensuring that (i) information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the S.E.C.’s rules and forms and (ii) information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Internal Control Over Financial Reporting

No changes in the Company’s internal control over financial reporting were identified in connection with the evaluation required by Exchange Act Rule 13a-15(d) or 15d-15(d) during the three months ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. See “Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting” and “Management’s Report on Internal Control Over Financial Reporting” on pages 41 and 42, respectively.

Item 9B. Other Information

None.

PART III

Item 10. Directors, Executive Officers and Corporate Governance

Directors and Executive Officers

The directors and executive officers of K•Swiss Inc. (“K•Swiss” or the “Company”) are as follows:

Directors:

Name	Age at December 31, 2012		Director Since
Steven Nichols		70		1987
Lawrence Feldman		70		1987
Stephen Fine		64		2000	(1)
Mark Louie		56		2003
George Powlick		68		1990

(1) Mr. Fine previously served as a director of the Company from 1987 to August 1998.

Executive Officers:

Name	Age at December 31, 2012	Position
Steven Nichols	70	Chairman of the Board, Chief Executive Officer and President
Edward Flora	61	Chief Operating Officer
Lee Green	59	Corporate Counsel
David Nichols (1)	43	Executive Vice President
George Powlick	68	Vice President of Finance, Chief Administrative Officer, Chief Financial Officer, Secretary and Director
Kimberly Scully	45	Corporate Controller
Brian Sullivan	59	Vice President of National Accounts

(1) Mr. David Nichols is the son of Mr. Steven Nichols.

Steven Nichols has been President, Chief Executive Officer and Chairman of the Board of the Company since 1987. From 1980 to 1986, Mr. Nichols was a director and Vice President—Merchandise of Stride Rite Corp., a footwear manufacturer and holding company. In addition, Mr. Nichols was President of Stride-Rite Footwear from 1982 to 1986. From 1979 to 1982, Mr. Nichols served as an officer and President of Stride Rite Retail Corp., the largest retailer of branded children’s shoes in the United States. From 1962 through 1979, Mr. Nichols was an officer of Nichols Foot Form Corp., which operated a chain of retail footwear stores in New York. Mr. Nichols’ qualifications to serve on the Board of Directors include his 50 years of experience in the footwear industry, including 26 years as the Company’s Chairman, President and Chief Executive Officer. This experience, comprehensive knowledge of the footwear industry and intimate knowledge of the Company’s challenges, opportunities and operations provide essential insight and guidance to the Board of Directors regarding the Company’s operations and the footwear industry in which it operates.

Edward Flora, Chief Operating Officer since January 2009, joined K•Swiss as a consultant in June 1990 and served as Director—Administration from October 1990 to February 1994 and Vice President—Operations from March 1994 to January 2009. Prior to joining the Company, Mr. Flora was Vice President—Distribution for Bugle Boy Industries, a manufacturer and distributor of men’s, women’s, and children’s apparel, from 1987 through May 1990.

Lee Green, Corporate Counsel since December 1992, joined K•Swiss in December 1992. Mr. Green was formerly a partner in the international law firm of Baker & McKenzie. He worked in the firm’s Taipei office from 1985 to 1988 and its Palo Alto office from 1988 to 1992.

David Nichols, Executive Vice President since May 2004, has held various positions with K•Swiss since joining the Company in November 1995, including President of K•Swiss Brand, Executive Vice President of K•Swiss Sales Corp., President of K•Swiss Europe BV and President of K•Swiss Direct Inc.

George Powlick has been Vice President of Finance, Chief Financial Officer and Secretary of the Company since January 1988, Director of the Company since 1990, Chief Operating Officer of the Company from September 2004 until January 2009, and Chief Administrative Officer since January 2009. Mr. Powlick is a certified public accountant and was an audit partner in the independent registered public accounting firm of Grant Thornton LLP from 1975 to 1987. Mr. Powlick’s qualifications to serve on the Board of Directors include his 25 years of experience at the Company, including a like number of years as the Company’s Chief Financial Officer and Secretary, as well as his 13 years as an audit partner at Grant Thornton LLP. Mr. Powlick’s experience with and extensive knowledge of accounting principles, financial reporting rules and regulations provides critical financial accounting and reporting knowledge to the Board of Directors. Additionally, Mr. Powlick’s 25 years at the Company provides the Board of Directors with extensive knowledge of the Company’s operations as well as insight on the Company’s challenges and opportunities.

Kimberly Scully, Corporate Controller since April 2003, joined K•Swiss in April 2003. Ms. Scully is a certified public accountant. From 2000 through April 2003, Ms. Scully was the Corporate Controller of SMTEK International, Inc., an electronics manufacturing services provider. From 1995 through 1999, Ms. Scully was a Corporate Accounting Manager of Home Savings of America, FSB, a $50 billion savings institution, which was acquired in 1998. From 1989 through 1995, Ms. Scully was an auditor in the independent public accounting firm of KPMG LLP and became an audit manager in 1994.

Brian Sullivan, Vice President of National Accounts since December 1989, joined K•Swiss in December 1989. From 1986 to 1989, he was Vice President and General Manager of Tretorn, Inc., a manufacturer and distributor of tennis shoes. From 1984 through 1985, Mr. Sullivan was Vice President of Sales of Bancroft/Tretorn, a tennis shoe manufacturer and distributor and predecessor to Tretorn, Inc. From 1978 to 1984, Mr. Sullivan held various positions at Bancroft/Tretorn, including Field Salesperson, Marketing and Sales Planning Manager and National Sales Manager.

Lawrence Feldman, a Director of the Company since 1987, has been President of the Rug Warehouse, Inc., a New York City oriental rug retailer and wholesaler, since 1977 and President of Loom & Weave, LLC, a wholesaler of collectible antique textiles and rugs, since 2000. From 1973 to 1977, Mr. Feldman was Vice President for Design and Product Development at Hart Schaffner & Marx, a clothing manufacturer and retailer. Mr. Feldman’s qualifications to serve on the Board of Directors include his 40 years in the retail industry, from which he brings to the Board of Directors a broad perspective for understanding the Company’s industry. Mr. Feldman also has extensive leadership and management experience, including experience derived from his involvement as a director of various not-for-profit organizations.

Stephen Fine, a Director of the Company since 2000, has been a Director, President and Chief Operating Officer of The Biltrite Corporation, a supplier of plastics products used in flooring and industrial applications, since 1985. From 1982 to 1985, Mr. Fine served as Executive Vice President of Biltrite. From 1970 to 1982, Mr. Fine held various executive positions with American Biltrite Inc. Mr. Fine was a Director of Maxwell Shoe Company Inc., a manufacturer of women’s casual and dress footwear from April 1994 to July 2004. Mr. Fine’s qualifications to serve on the Board of Directors include his 43 years of experience in the footwear business and his extensive leadership and management expertise, including membership on a number of finance and audit committees of non-public companies, as a director for various not-for-profit organizations and as a former director of Maxwell Shoe Company Inc. for over 10 years.

Mark Louie, a Director of the Company since 2003, is a director of Mingxin China Growth Management Company Ltd., a general partner of the Mingly China Growth Fund, LP, a general partner of the Mingxin China Growth Fund II, LP and a director of the Govtor Mingly Growth Venture Capital Company Ltd.; these funds invest primarily in private companies in the Greater China Area. In connection with his role with Mingly China Growth Fund LP, Mr. Louie has been a director of Baifendian Holdings Inc. Cayman Islands since 2012. Mingxin China Growth Management Company Ltd. is the manager of Minxin China Growth Fund II, LP, and beginning in March 2012, has been registered with the Securities and Exchange Commission as an Exempt Reporting Advisor. From April 2006 to February 2012, Mr. Louie was a Managing Director of C. M. Capital Corporation, an Advisor to a Hong Kong based family with investments in the U.S. and throughout the world. Mr. Louie has been a Managing Member and Chief Financial Officer of TechFund Europe Management, LLC and affiliated entities (“TechFund”), an early stage venture capital investor, since February 2000. Beginning in February 2004, Mr. Louie provided financial consulting services to various businesses and companies, affiliated with or independent of C. M. Capital Corporation or TechFund. Mr. Louie is also a member of the Advisory Board of Legato Capital Management, an investment management firm, and a director of Winery Exchange, Inc., a privately held company. From 1983 to 2000, Mr. Louie was a Vice President in the Investment Banking Division of Goldman Sachs Group, Inc. Mr. Louie’s qualifications to serve on the Board of Directors include his extensive experience with global companies, his financial expertise and his years of experience providing strategic advisory services to organizations.

Board Leadership

Mr. Steven Nichols currently serves as both Chairman of the Board and Chief Executive Officer. Combining these roles provides Mr. Nichols with primary responsibility for managing the Company’s business under the oversight and review of the Board of Directors. The Board of Directors believes this approach is the most appropriate for the Company because it provides the Chief Executive Officer with primary responsibility for implementing the Company’s strategy, directing the work of other officers and leading the implementation of the Company’s Board approved strategic plans. This structure also results in a single leader being directly accountable to the Company’s Board, and through the Board to its stockholders, and enables the Chief Executive Officer to act as the key link between the Board and other members of management. The Board also believes this structure is appropriate for the Company as the Chief Executive Officer is the person most knowledgeable about the Company and its business and is therefore in the best possible position to provide guidance for productive Board meetings. Because the Board also believes that strong, independent Board leadership is a critical aspect of effective corporate governance, in May 2010 the Board appointed Mr. Feldman as Lead Independent Director. The Lead Independent Director presides at all meetings of the Board at which the Chairman is not present, and at all executive sessions of the independent directors.

Executive Sessions of Independent Directors

During fiscal year 2012, the Company’s independent directors met regularly in executive sessions outside the presence of management and intend to do so in fiscal year 2013 as well. Such executive sessions are generally held in conjunction with each regularly scheduled meeting of the Board of Directors. As described above, in May 2010, the Board of Directors appointed Mr. Feldman to preside as Lead Independent Director of these executive sessions. The independent directors have discussed the issue of executive management succession planning. Communications to the independent directors may be sent to independent directors c/o Secretary, K•Swiss Inc., 31248 Oak Crest Drive, Westlake Village, California 91361.

The Board’s Role in Risk Oversight

The full Board of Directors oversees the Company’s risk management process. The Board oversees a Company-wide approach to risk management, designed to enhance stockholder value, support the achievement of strategic objectives and improve long-term organizational performance. The full Board determines the appropriate level of risk for the Company generally, assesses the specific risks faced by the Company and reviews the steps taken by management to manage those risks. The full Board’s involvement in setting the Company’s business strategy facilitates these assessments and reviews, culminating in the development of a strategic plan that reflects both the Board’s and management’s consensus as to appropriate levels of risk and the appropriate measures to manage those risks. During this time, risk is assessed throughout the enterprise, focusing on risks arising out of various aspects of the Company’s strategic plan and the implementation of that plan, including financial, legal/compliance, operational/strategic and compensation risks. In addition to discussing risk with the full Board at least once a year, the independent directors discuss risk management during executive sessions without management present.

While the full Board maintains the ultimate oversight responsibility for the risk management process, its committees oversee risk in certain specified areas. In particular, the Audit Committee focuses on financial risk, including internal controls, and discusses the Company’s risk profile with the Company’s independent registered public accounting firm. The Audit Committee also reviews potential violations of the Company’s Code of Ethics and related corporate policies. The Compensation and Stock Option Committee (“Compensation Committee”) periodically reviews compensation practices and policies to determine whether they encourage excessive risk taking. Finally, the Corporate Governance and Nominating Committee (“Governance Committee”) manages risks associated with the independence of directors and Board nominees. Pursuant to the Board’s instruction, management regularly reports on applicable risks to the relevant committee or the full Board, as appropriate, with additional review or reporting on risks being conducted as needed or as requested by the Board and its committees.

The Company believes that its leadership structure, as discussed above, supports the risk oversight function of the Board as the use of a combined Chairman and Chief Executive Officer provides open communication between management and the Board and allows all directors to be actively involved in the risk oversight function of the Board.

Independence of the Board of Directors

The Board of Directors has determined that a majority of the Board of Directors, as currently constituted are “independent” in accordance with the Marketplace Rules of The NASDAQ Stock Market as well as the independence standards adopted by the Board of Directors.

The Board of Directors has adopted the following independence standards which comply with the standards of independence set forth in the Marketplace Rules of The NASDAQ Stock Market. Under these standards of independence, an independent director is a person other than an executive officer or employee of the Company or its subsidiaries or any other individual having a relationship which, in the opinion of the Board of Directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director; provided that a director will not be considered independent if he or she:

is, or at any time during the past three years was, employed by the Company or any of its subsidiaries;

has accepted, or has an immediate family member that has accepted, compensation from the Company or any of its subsidiaries in excess of $120,000 during any period of twelve consecutive months within the past three years preceding the determination of independence, other than the following:

(i)

compensation for service on the Board of Directors or any committee of the Board of Directors;

(ii)

compensation paid to a member of the director’s immediate family who is an employee (other than an executive officer) of the Company or any of its subsidiaries; or

(iii)

benefits under a tax-qualified retirement plan, or non-discretionary compensation.

is an immediate family member of an individual who is, or at any time during the past three years was, an executive officer of the Company or any of its subsidiaries;

is, or has an immediate family member who is, a partner in, or a controlling stockholder or an executive officer of, any organization to which the Company made, or from which the Company received, payments for property or services in the current year or in any of the past three years that exceed 5% of the recipient’s consolidated gross revenues for that year, or $200,000, whichever is more, other than payments arising solely from investment in the Company’s securities or payments under non-discretionary charitable contribution matching programs;

is, or whose immediate family member is, an executive officer of another entity where at any time during the last three years any of the Company’s executive officers served on the compensation committee of such entity; or

is, or whose immediate family member is, a current partner of the Company’s outside auditor, or was a partner or employee of the Company’s outside auditor who worked on the Company’s audit at any time during the past three years.

The Board does not consider donations that do not exceed an aggregate of $100,000 in any twelve consecutive months, made by the Company or the 324 Foundation to a charitable organization in which a director (or an immediate family member thereof) is an employee or member of the board of directors, to interfere with the exercise of that director’s independent judgment.

For purposes of the standards set forth above, “immediate family member” means a person’s spouse, parents, children and siblings, whether by blood, marriage or adoption, or anyone residing in such person’s home.

Additionally, members of the Audit Committee must not accept, directly or indirectly, any compensation from the Company other than directors’ fees and must not be affiliated persons of the Company (other than by virtue of their directorship).

The Company or the 324 Foundation may from time to time make charitable donations of the type described in the independence standards set forth above.

The Board of Directors has determined that Messrs. Lawrence Feldman, Stephen Fine and Mark Louie are “independent” under these standards.

Stock Ownership and Corporate Governance Guidelines

Pursuant to a recommendation of the Governance Committee in 2005, the full Board of Directors adopted a non-binding stock ownership guideline for directors, recommending that each non-employee director own, no later than December 31, 2010 (or five years after a director first joins the Board of Directors, whichever is later), an amount of Class A Common Stock of the Company equal to four times the cash retainer the Company pays each director for that fiscal year. The Board of Directors encouraged each director to meet this guideline within the noted timeframe. At December 31, 2012, none of the non-employee directors met this recommended guideline as a result of a significant decline in the Company’s Class A Common Stock price during recent years.

Prior to accepting any other assignment on the board of directors of a for-profit entity, members of the Board of Directors must seek and receive approval from the Governance Committee. Additionally, the Governance Committee continues to review and evaluate potential enhancements to the Company’s corporate governance philosophy and structure, including the adoption of corporate governance guidelines.

Meetings of the Board of Directors and Committees

The Board of Directors held eight formal meetings during fiscal year 2012 and took action on three matters by unanimous written consent. Each Director attended at least 75% of the meetings of the Board of Directors and the Board Committees of which he was a member. Directors are expected to attend the annual meetings of stockholders. Last year all directors attended the annual meeting of stockholders.

The Board of Directors has the following separately-designated standing committees: the Compensation Committee, the Audit Committee and the Governance Committee.

Compensation and Stock Option Committee

The Compensation Committee is currently composed of Messrs. Feldman, Fine (Chairman) and Louie. The Board of Directors has determined that Messrs. Feldman, Fine and Louie are “independent” under the Marketplace Rules of The NASDAQ Stock Market as well as the independence standards adopted by the Board of Directors. This Committee met five times during fiscal year 2012.

The Compensation Committee’s purpose is to discharge the responsibilities of the Board of Directors relating to the compensation of the Company’s executive officers and produce the annual report on executive compensation for inclusion in the Company’s Form 10-K. The duties and responsibilities of the Compensation Committee, which are set forth in detail in its charter, include, among other duties, the responsibility to:

administer and make recommendations to the Board of Directors with respect to the Company’s incentive-based compensation and equity-based compensation plans, including the directors’ compensation plans;

review and approve corporate goals and objectives relevant to the compensation of the Chief Executive Officer, evaluate the Chief Executive Officer’s performance in light of those goals and objectives, and set the Chief Executive Officer’s compensation level based on this evaluation;

oversee the Company’s overall compensation structure, policies and programs with respect to the executive officers (other than the Chief Executive Officer) disclosed in the Summary Compensation Table and assess whether that compensation structure establishes appropriate incentives for such executive officers; and

perform such other duties and responsibilities as are consistent with the purpose of the Compensation Committee and as the Board of Directors or the Compensation Committee deems appropriate.

In overseeing these plans, the Compensation Committee may delegate any of the foregoing duties and responsibilities to a subcommittee of the Compensation Committee consisting of not less than two members of the committee. The Chief Executive Officer and Chief Financial Officer are active in setting compensation packages. See discussion in “Item 11. Executive Compensation – Compensation Discussion and Analysis.”

The Compensation Committee has the authority to retain, at the expense of the Company, such outside counsel, experts, and other advisors as it determines appropriate to assist it in the full performance of its functions, including sole authority to retain and terminate any compensation consultant used to assist the Compensation Committee in the evaluation of director, Chief Executive Officer or senior executive compensation, and to approve the consultant’s fees and other retention terms. In fiscal year 2012, the Compensation Committee did not retain any such compensation consultants.

During fiscal year 2012, the Compensation Committee assessed the risks, if any, arising from the Company’s compensation policies and practices for its employees. In performing its risk assessment, the Compensation Committee considered the following:

the fixed (or salary) portion of compensation is designed to provide steady income regardless of Company performance so that executives do not feel pressured to focus exclusively on Company performance to the detriment of other performance indicators or long-term goals;

the variable (Economic Value Added (“EVA”) awards) portion of compensation is designed to reward both short-term and long-term corporate performance. For short-term performance, the EVA awards are based on increases in economic profit (as discussed in “Item 11. Executive Compensation – Compensation Discussion and Analysis – EVA Incentive Program”) and capped where the remainder is set aside for potential future payout. For long-term performance, EVA awards may be paid out in a down year, thus extending the time horizon forward when making business decisions; and

the variable (equity) portion of compensation is designed to reward long-term corporate performance. Stock option awards generally vest over a three to five year period and are valuable if the Company’s stock price increases with time.

The Compensation Committee charter is available on K•Swiss’ website at www.kswiss.com.

Audit Committee

The Audit Committee is currently composed of Messrs. Feldman (Chairman), Fine and Louie. The Board of Directors has determined that Messrs. Feldman, Fine and Louie are “independent” under the Marketplace Rules of The NASDAQ Stock Market as well as the independence standards adopted by the Board of Directors and also meet the requirements set forth in Rule 10A-3(b)(1) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Board of Directors has determined that Mr. Louie qualifies as an “audit committee financial expert” as that term is defined in Item 407(d)(5) of Regulation S-K. The Audit Committee charter is available on K•Swiss’ website at www.kswiss.com. This committee met seven times during fiscal year 2012.

Corporate Governance and Nominating Committee

The Governance Committee is currently composed of Messrs. Feldman (Chairman), Fine and Louie. The Board of Directors has determined that Messrs. Feldman, Fine and Louie are “independent” under the Marketplace Rules of The NASDAQ Stock Market as well as the independence standards adopted by the Board of Directors. The Governance Committee charter is available on K•Swiss’ website at www.kswiss.com. This committee met once during fiscal year 2012.

Annual Evaluations and Director Education

Pursuant to the terms of their charters, each of the Compensation, Audit and Governance Committees evaluate their respective performance and assess the adequacy of their respective charters annually. Additionally, the Company’s policy is to provide an orientation process for new directors, including a review of background material on the Company, meetings with senior management and a briefing on key issues facing the Company.

Code of Ethics

The Company has adopted a “Code of Ethics,” which is applicable to the Company’s directors, the Chief Executive Officer and senior financial officers, including the Chief Financial Officer and Principal Accounting Officer. The Company has also adopted a “Code of Ethics” which is applicable to directors, officers and employees. Both “Codes of Ethics” are available on K•Swiss’ website at www.kswiss.com. The Company intends to post amendments to or waivers under the Codes of Ethics at this location on its website. Upon written request, the Company will provide a copy of the “Codes of Ethics” free of charge. Requests should be directed to K•Swiss Inc., 31248 Oak Crest Drive, Westlake Village, California 91361, Attention: George Powlick, Secretary.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Exchange Act requires that the Company’s directors, executive officers and persons who beneficially own more than 10 percent of the outstanding Class A Common Stock, and any person subject to Section 16 of the Exchange Act because of the requirements of Section 30 of the Investment Company Act, to file with the Securities and Exchange Commission and the Company reports of ownership and changes in beneficial ownership of their equity securities of the Company on Form 3, Form 4 and Form 5, as appropriate. Based solely upon the Company’s review of the information received, the Company believes that, during the year ended December 31, 2012, all persons complied with such filing requirements on a timely basis and there are no unreported filing failures from prior years.

Communications with the Board of Directors

Any stockholder interested in communicating with members of the Board of Directors, any of its committees, the independent directors as a group or the Board of Directors as a whole, may send written communications to the Board of Directors or any of the directors to K•Swiss Inc., 31248 Oak Crest Drive, Westlake Village, California 91361, Attention: George Powlick, Secretary. Communications received in writing are forwarded to the Board of Directors or to any individual director or directors to whom the communication is directed, unless the communication is unduly hostile, threatening, illegal, does not reasonably relate to the Company or its business, or is similarly inappropriate. The Secretary has the authority to discard or disregard any inappropriate communications or to take other appropriate actions with respect to any such inappropriate communications.

Item 11. Executive Compensation

COMPENSATION DISCUSSION AND ANALYSIS

Overview and Compensation Philosophy

The Company operates in an industry that is highly competitive. There are several footwear marketers, including companies that are larger and have substantially greater resources (financial and otherwise) than the Company, with whom the Company competes for executive talent. The personnel the Company strives to attract, retain and motivate are often in high demand among these footwear companies and other branded consumer goods companies, and have competing employment opportunities. As a result, the Company must offer attractive compensation packages to new employees as well as offer incentives to motivate and retain existing employees.

The Company’s philosophy is to maintain compensation programs which attract, retain and motivate executive management with economic incentives which are directly linked to financial performance and increased stockholder value. The key elements of the Company’s executive compensation program consists of a base salary, an annual bonus program directly linked to individual and overall Company performance and stock incentive awards intended to encourage the achievement of superior results over time and to further align executive officer and stockholder economic interests. Other elements of executive compensation include participation in broad-based welfare benefit programs and certain limited perquisites. The Company has no agreements with its named executive officers that require payments to be made upon a change-in-control of the Company, and, with the exception of the Company’s employment agreement with the Chief Executive Officer, the Company has no agreements or other arrangements with its named executive officers that require payments to be made upon a termination of a named executive officer’s employment with the Company for any reason.

The Compensation Committee is responsible for discharging the responsibilities of the Board of Directors relating to the compensation of the Company’s named executive officers listed in the Summary Compensation Table below. The Compensation Committee administers the Company’s incentive-based compensation and equity-based compensation plans, reviews and approves corporate goals and objectives relevant to the Company’s compensation of the Chief Executive Officer and the other named executive officers, evaluates their performance in light of these goals and objectives, and sets their compensation levels and the size and vesting period of stock-based awards based on this evaluation.

The Compensation Committee is also responsible for approving stock option and other stock incentive awards, reviewing and approving the design of other benefit plans and reviewing and recommending employment and severance agreements, including change-in-control provisions, plans or agreements for all executive officers.

Since early 2009, the Company curtailed its annual salary adjustment to all employees, with certain exceptions due to reasons such as, but not limited to, increased job responsibilities, and since 2009, substantially reduced bonuses for all employees in an effort to limit expenses. In addition, the named executive officers have not earned any bonuses under the Company’s EVA Incentive Program over the past three years as performance targets were not met in fiscal years 2012, 2011 and 2010.

Base Salary

The salaries of the Company’s named executive officers were established at the outset of each named executive officers’ employment with the Company by considering the salaries of similar executives of comparably-sized companies both within and outside the industry in which the Company operated at that time. This market information regarding salaries generally has been provided to the Company on a case-by-case basis by executive search firms that the Company retains when hiring new executive officers; the last such review took place in 2003. The Compensation Committee does not benchmark salaries on an annual basis.

The base salary of the Chief Financial Officer is reviewed annually by the Chief Executive Officer, while base salaries of the other named executive officers are reviewed annually by the Chief Executive Officer and Chief Financial Officer. While increases to base salaries may be approved on the basis of, among other attributes, the individual’s past performance and future potential, in general, increases made to base salaries are a cost of living increase. The reason for limiting increases in base salaries to cost of living adjustments is to emphasize incentive-based compensation over base salaries and thereby continually motivating the Company’s named executive officers. None of the named executive officers received a salary increase in fiscal year 2012 as a result of the corporate mandate to freeze salaries in the Company’s efforts to limit expenses with the exception of Ms. Scully. In addition, effective October 1, 2011, Messrs. S. Nichols, D. Nichols and Powlick voluntarily decreased their base salaries by 10% in order to further enhance the Company’s additional efforts to limit expenses. In addition, effective March 1, 2012, Mr. S. Nichols further reduced his salary by $50,000 per year.

In December 2010, the Board of Directors approved a five year employment agreement with Mr. S. Nichols commencing January 1, 2011 and ending December 31, 2015 (the “Employment Agreement”). Under the Employment Agreement, Mr. S. Nichols is entitled to receive annual cost of living increases each year commencing in 2012. As noted above, Mr. S. Nichols did not receive a salary increase in 2012 or 2011 and voluntarily reduced his fiscal year 2011 salary by 10% as of October 1, 2011 and further reduced his salary by $50,000 per year as of March 1, 2012.

EVA Incentive Program

The Company maintains the EVA Incentive Program, which rewards participants for increases in Economic Profit generated from one year to the next. Economic Profit is the Company’s net operating profit after taxes minus a charge for operating capital. Participants in the EVA Incentive Program are individuals who most influence the Company’s strategic direction, long-term growth and profitability. With the exception of Ms. Scully, whose position makes her ineligible to participate in the EVA Incentive Program, all named executive officers participate in the EVA Incentive Program. The objectives of the EVA Incentive Program are:

To link the creation of stockholder value with individual and group goals;

To recognize and reward individual performance based on absolute and relative contributions; and

To provide an award opportunity as part of a competitive total compensation program to enable the Company to attract, retain and motivate its named executive officers.

The Compensation Committee believes that Economic Profit represents a key financial indicator of stockholder value and is an appropriate measure of the Company’s financial performance as it recognizes and motivates individual performance and promotes long-term strategic planning for the Company’s future. The EVA Incentive Program is a formula driven incentive plan that is based on two factors which have been approved by the Compensation Committee:

(1)

A Target Bonus, which is a percentage of the named executive officer’s base salary (the percentages for the named executive officers are as follows: Steven Nichols – 60%, David Nichols – 40%, George Powlick – 50% and Brian Sullivan – 30%. The Target Bonus percentage for each named executive officer was determined by the Compensation Committee based upon a number of factors, including each named executive officer’s position, job responsibilities and ability to impact the Company’s performance. The Target Bonus amounts for fiscal year 2012 are set forth in the Grants of Plan Based Awards table below); and

(2)

A Financial Performance Factor, that corresponds to increases or decreases in Economic Profit; this Financial Performance Factor can be positive or negative and determines whether and to what extent each named executive officer will receive their Target Bonus. The Financial Performance Factor is based on the following two criteria:

EVA Improvement – is the measure used to determine a return on investment. It is the difference between the prior year’s Economic Profit and the current year’s Economic Profit minus the EVA Improvement Target for the year (for fiscal year 2012, the EVA Improvement Target for Messrs. S. Nichols, D. Nichols and Powlick was $2,500,000 and for Mr. Sullivan was $1,500,000) (see discussion below as to the determination of the EVA Improvement Target); and

EVA Interval – establishes the extent to which the participant will be rewarded or penalized if actual performance is better or worse (for fiscal year 2012, the EVA Interval for Messrs. S. Nichols, D. Nichols, Powlick and Sullivan was $4,000,000) (see discussion below as to the determination of the EVA Interval).

The EVA Interval is divided into the Excess (Deficit) EVA Improvement, which is the Performance Multiple. The Performance Multiple plus one (1) is the Financial Performance Factor.

The Target Bonus multiplied by the Financial Performance Factor determines the Bonus Declaration. Each year, the Bonus Declaration, which may be positive or negative, is placed in a notional account called the EVA Bank from which the EVA Award is made to the named executive officers. The EVA Bank:

Links cumulative pay to cumulative performance by reserving a portion of negative or exceptionally positive Bonus Declarations;

Consistently extends the named executive officer’s time horizon forward when making business decisions; and

Counterbalances the ups and downs of the business cycle.

The annual EVA Award payment to each participant is equal to the participant’s EVA Bank balance, if the EVA Bank balance is less than or equal to the participant’s Target Bonus. If the EVA Bank balance is greater than the Target Bonus, the bonus payment will equal the Target Bonus plus one third of any excess EVA Bank balance after the payment of the Target Bonus, limited to an additional amount equal to one times the Target Bonus. Therefore, the maximum bonus payment in any given year to any participant is limited to two times their Target Bonus. In addition, a participant may not be paid more than $2,000,000 under the EVA Incentive Program in any given year. Any remaining EVA Bank balances are carried forward to the next year and are subject to forfeiture if the named executive officer leaves the Company or reduction if there are decreases in subsequent years’ Economic Profit. The EVA Incentive Program is designed with the intention that amounts paid under it will qualify as “performance-based” compensation within the meaning of Section 162(m) of the Internal Revenue Code. Adjustments to the EVA Improvement Target and EVA Interval may be made from time to time as determined appropriate by the Compensation Committee. To date, the EVA Improvement Target and EVA Interval have not been adjusted from the levels set in 2005, despite the economic downturn and other macroeconomic issues affecting operating performance.

For fiscal years 2010, 2011 and 2012, each participating named executive officer’s Bonus Declaration was either negative or zero as Economic Profit was negative for these respective years, and the EVA Bank balances for each named executive officer was zero at December 31, 2010, 2011 and 2012, therefore each participating named executive officer did not receive a 2010, 2011 or 2012 EVA Award.

Bonuses

From time to time, special discretionary cash bonuses may be made to named executive officers based on a number of different factors, however, as discussed above, the Company generally relies on incentive-based compensation to motivate its named executive officers. Mr. Sullivan’s monthly compensation has historically included an advance of his potential EVA bonus. When his EVA Bank was exhausted, the advance of his potential bonus continued based on Mr. Sullivan’s position and responsibilities. This benefit has been provided to normalize Mr. Sullivan’s cash flow for compensation in recognition of his position, past performance and relationships with major customers. The advance will be recouped if EVA Awards are earned and paid out in the future. For fiscal years 2010, 2011 and 2012, the Chief Executive Officer and Chief Financial Officer also considered the overall contributions of Ms. Scully to the Company, based on a number of subjective factors including dedication evidenced through additional effort beyond normal requirements and approved a discretionary bonus for her in an amount that the Chief Executive Officer and Chief Financial Officer determined was appropriate given her position. Since Ms. Scully is not eligible to participate in the EVA Incentive Program, the discretionary cash bonus was the only annual bonus awarded to Ms. Scully. For fiscal year 2012, no other bonuses were awarded to named executive officers. These bonuses are shown in the Summary Compensation Table below.

Stock Incentive Plan

The Compensation Committee approves grants of all stock options to named executive officers based to a lesser extent upon a subjective evaluation of their past individual contribution to the Company in relation to their job responsibilities and to a greater extent upon a subjective evaluation of their future ability to influence the Company’s long-term growth and profitability. Stock option grants are not automatically granted every year. They are granted when the Compensation Committee believes they have greater potential to positively impact employee retention. When making grant decisions, the number of stock options already held by a named executive officer is considered. The primary purpose of this component of compensation is alignment of recipient interests to stockholder interests and retention of key employees. The Compensation Committee makes the determination of the appropriate grant size with respect to the Chief Executive Officer and Chief Financial Officer. To assist the Compensation Committee in its determination, the Chief Executive Officer and the Chief Financial Officer make recommendations as to the appropriate grant size for the other named executive officers. The grant size is determined, in each case, by reference to the named executive officer’s position, job responsibilities and ability to impact the Company’s performance. Options are granted at current market values (NASDAQ’s closing price of the Company’s Class A Common Stock on the date of grant) and generally vest over a three to five year period or longer after the date of option grant. The Compensation Committee may make exceptions to its general practice with respect to the vesting of stock option grants in special cases, for example, as a means to incentivize new hires to join the Company.

In fiscal year 2012, a review of total compensation for the named executive officers was performed and the Compensation Committee determined, based on the factors discussed above, to issue new stock options to certain named executive officers. The amount of the option grants and vesting periods were determined primarily based on responsibilities and perceived relative future contributions to the Company. In addition these stock option grants were primarily used for retention purposes because the relatively low stock price at the time rendered all stock options granted prior to November 2011 valueless.

401(k) and Profit Sharing Plan

The 401(k) and Profit Sharing Plan (the “Plan”) is a tax-qualified defined contribution plan in which all U.S.-based personnel meeting certain age and length of employment criteria are eligible to participate. Under the 401(k) portion of the Plan, the Company makes non-discretionary matching contributions in an amount equal to 33.33% of the employee contribution, subject to a maximum of $250 of eligible compensation contributed to the Plan. Under the Profit Sharing portion of the Plan, the Company may make annual discretionary profit sharing contributions in an amount determined by the Board of Directors. The named executive officers participate in the Plan and receive matching 401(k) and profit sharing contributions thereunder to the same extent as other U.S.-based personnel of the Company.

Non-Qualified Deferred Compensation Plan

In 1997, the Company established a Deferred Compensation Plan that accepted deferrals of salaries and/or bonuses for certain named executive officers for fiscal years 1998 through 2000. Irrevocable elections relating to the deferral amounts and distribution dates were made by each participant before the beginning of each plan year. No deferrals have been accepted since the 2000 plan year. During the third quarter of 2011, the Company terminated its Deferred Compensation Plan with an effective date of September 30, 2011. Amounts were paid to participants in October 2011.

Perquisites and Other Personal Benefits

The Company provides certain named executive officers with perquisites and other personal benefits that the Compensation Committee determines are reasonable and consistent with its overall compensation program to better enable the Company to attract and retain superior employees for key positions. The Compensation Committee periodically reviews the levels of other personal benefits provided to named executive officers.

Certain named executive officers are provided either use of a Company automobile or a car allowance. Certain named executive officers have certain insurance premiums fully paid by the Company and participate in a Medical Expense Reimbursement plan. The perquisites provided to the named executive officers during fiscal years 2010, 2011 and 2012 are shown in the Summary Compensation Table below.

Termination Arrangements

The Company has no agreements with its named executive officers that require payments to be made upon a change-in-control of the Company, and, with the exception of the Employment Agreement, the Company has no agreements or other arrangements with its named executive officers that require payments to be made upon a termination of the named executive officer for any reason. The termination payments available to Mr. S. Nichols upon certain termination events are disclosed in the Termination Payments discussed below.

2011 “Say-on-Pay” Advisory Vote on Executive Compensation

The Company provided stockholders a “say-on-pay” advisory vote on its executive compensation in June 2011 under recently adopted rules. At the Company’s 2011 Annual Meeting of Stockholders, stockholders expressed substantial support for the compensation of the Company’s named executive officers, with over 99% of the votes cast for approval of the “say-on-pay” advisory vote. The Compensation Committee carefully evaluated the results of the 2011 annual advisory “say-on-pay.” The Compensation Committee also considers numerous other factors in evaluating the Company’s executive compensation program as discussed in this Compensation Discussion and Analysis. While each of these factors formed the Committee’s decisions regarding the named executive officers’ compensation, the Compensation Committee did not implement changes to the Company’s executive compensation program as a result of the stockholder advisory vote.

Tax Implications

The Compensation Committee intends to design the Company’s compensation programs to conform with Section 162(m) of the Internal Revenue Code and related regulations so that total compensation paid to its named executive officers will not exceed $1,000,000 in any one year, except for compensation payments that qualify as “performance-based.” However, the Company may pay compensation which is not deductible in limited circumstances when the Compensation Committee or the Board of Directors determines it is in the best interests of the Company to do so.

Fiscal Years 2010, 2011 and 2012 Summary Compensation Table

The following table sets forth information with respect to total compensation paid by the Company during the years ended December 31, 2010, 2011 and 2012 to the individuals set forth below, who are referred to as the “named executive officers.”

Name and Principal Position	Year		Salary ($)		Bonus ($) (1)		Option Awards ($) (2)		Non-Equity Incentive Plan Compen-sation ($) (3)		Change in Pension Value and Nonqualified Deferred Compen-sation Earnings ($) (4)		All Other Compen- sation ($) (5)		Total ($)
Steven Nichols		2012	$	823,499	$	—	$	153,353	$	—	$	—	$	42,858	$	1,019,710
President and Chief Executive		2011		937,267		—		196,136		—		87,977		42,274		1,263,654
Officer		2010		961,299		—		7,303		—		115,583		41,557		1,125,742
David Nichols		2012		265,496		—		115,015		—		—		9,054		389,565
Executive Vice President		2011		287,621		—		67,412		—		—		8,971		364,004
		2010		294,996		—		7,303		—		—		8,059		310,358
George Powlick		2012		282,113		—		115,015		—		—		20,384		417,512
Vice President of Finance, Chief		2011		305,623		—		67,412		—		62,005		15,507		450,547
Financial Officer, Chief Administrative Officer and Secretary		2010		313,459		—		7,303		—		79,700		14,641		415,103
Kimberly Scully		2012		187,482		22,637		38,338		—		—		713		249,170
Corporate Controller		2011		179,489		17,500		47,686		—		—		760		245,435
		2010		180,612		10,000		51,790		—		—		471		242,873
Brian Sullivan		2012		207,571		25,946		—		—		—		19,767		253,284
Vice President – National		2011		207,571		25,946		7,130		—		6,721		18,154		265,522
Accounts		2010		207,571		25,946		10,954		—		8,830		17,457		270,758

(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2012
	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 0-18490 K•SWISS INC.
	(Exact name of registrant as specified in its charter)
Delaware			95-4265988
(State or other jurisdiction of incorporation or organization)			(I.R.S. Employer Identification Number)

31248 Oak Crest Drive, Westlake Village, California			91361
(Address of principal executive offices)			(Zip Code)
Registrant’s telephone number, including area code		(818) 706-5100

	Securities registered pursuant to Section 12(b) of the Act:
Title of each Class			Name of each exchange on which registered
Class A Common Stock, par value $0.01 per share			NASDAQ

	Securities registered pursuant to Section 12(g) of the Act:
	None
	(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
			[X] Yes [ ] No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
			[ ] Yes [X] No

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.
			[X] Yes [ ] No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
			[X] Yes [ ] No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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.
			[X]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Smaller reporting company [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).			[ ] Yes [X] No

	Caption	Page

PART I
Item 1.	Business	3
Item 1A.	Risk Factors	12
Item 1B.	Unresolved Staff Comments	20
Item 2.	Properties	20
Item 3.	Legal Proceedings	21
Item 4.	Mine Safety Disclosures	21

PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	22
Item 6.	Selected Financial Data	24
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	40
Item 8.	Financial Statements and Supplementary Data	40
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	74
Item 9A.	Controls and Procedures	74
Item 9B.	Other Information	74

PART III
Item 10.	Directors, Executive Officers and Corporate Governance	74
Item 11.	Executive Compensation	81
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	90
Item 13.	Certain Relationships and Related Transactions, and Director Independence	92
Item 14.	Principal Accounting Fees and Services	94

PART IV
Item 15.	Exhibits and Financial Statement Schedules	96

SIGNATURES		100

Option Grant Date	Expected Life (years)		Expected Volatility		Risk Free Rate		Expected Dividend Yield
March 2, 2010		6		44.9		2.7		—
May 18, 2010		6		46.9		2.5		—
February 17, 2011		6		47.0		2.7		—
September 14, 2011		6		50.3		1.5		—
November 15, 2011		6		52.9		1.2		—
February 28, 2012		6		53.7		1.1		—

Name	Year		Profit Sharing Contribution ($)		401(k) Matching Contri- bution ($)		Medical Insurance Premiums ($)		Medical Expense Reim- burse- ment ($)		Term Life and Disability Insurance Premiums ($)		Company- Provided Automobile or Automobile Allowance ($)		Total All Other Compen- sation ($)
Steven Nichols		2012	$	681	$	250	$	16,431	$	5,500	$	17,513	$	2,483	$	42,858
		2011		775		250		16,248		5,500		17,513		1,988		42,274
		2010		308		250		15,989		5,500		17,513		1,997		41,557
David Nichols		2012		681		250		8,123		—		—		—		9,054
		2011		775		250		7,946		—		—		—		8,971
		2010		308		250		7,501		—		—		—		8,059
George Powlick		2012		681		—		1,679		5,500		12,524		—		20,384
		2011		775		—		1,649		5,500		7,583		—		15,507
		2010		308		250		1,792		5,500		6,791		—		14,641
Kimberly Scully		2012		463		250		—		—		—		—		713
		2011		510		250		—		—		—		—		760
		2010		221		250		—		—		—		—		471
Brian Sullivan		2012		663		250		4,954		4,000		—		9,900		19,767
		2011		729		250		4,775		4,000		—		8,400		18,154
		2010		286		250		4,521		4,000		—		8,400		17,457

		Estimated Future Payouts Under Non-Equity Incentive Plan Awards (1)				All Other Option Awards Number of		Exercise or Base Price of Option		Grant Date Fair Value of
Name	Grant Date	Target ($) (2)		Maximum ($) (3)		Securities Underlying Options (#)		Awards ($/Share)		Option Awards ($) (4)
Steven Nichols (5)	2/28/2012	$	494,099	$	988,198		—	$	—	$	—
			—		—		200,000		3.39		153,353
David Nichols (5)	2/28/2012		106,198		212,396		—		—		—
			—		—		150,000		3.39		115,015
George Powlick (5)	2/28/2012		141,057		282,114		—		—		—
			—		—		150,000		3.39		115,015
Kimberly Scully (6)	2/28/2012		—		—		50,000		3.39		38,338
Brian Sullivan (7)			62,271		124,542		—		—		—

	Option Awards
Name	Grant Date	Number of Securities Underlying Unexercised Options (#) Exercisable		Number of Securities Underlying Unexercised Options (#) Unexercisable		Option Exercise Price ($) (1)		Option Expiration Date (2)
Steven Nichols	8/02/2004		50,000		—	$	16.18	8/02/2014
	3/04/2008		26,667		13,333		12.19	3/04/2018	(3)
	3/09/2009		50,000		—		7.17	3/09/2019
	3/02/2010		—		2,000		9.90	3/02/2020	(3)
	2/17/2011		—		50,000		9.98	2/17/2021	(4)
	11/15/2011		—		50,000		2.87	11/15/2021	(3)
	2/28/2012		—		200,000		3.39	2/28/2022	(3)
David Nichols	7/25/2003		40,000		—		15.62	7/25/2013
	3/04/2008		20,000		10,000		12.19	3/04/2018	(3)
	3/09/2009		250,000		—		7.17	3/09/2019
	3/02/2010		—		2,000		9.90	3/02/2020	(3)
	11/15/2011		—		100,000		2.87	11/15/2021	(3)
	2/28/2012		—		150,000		3.39	2/28/2022	(3)
George Powlick	7/25/2003		40,000		—		15.62	7/25/2013
	5/06/2004		5,000		—		17.26	5/06/2014
	9/27/2004		40,000		—		17.01	9/27/2014
	3/04/2008		—		30,000		12.19	3/04/2018	(5)
	3/09/2009		100,000		—		7.17	3/09/2019
	3/02/2010		—		2,000		9.90	3/02/2020	(3)
	11/15/2011		—		100,000		2.87	11/15/2021	(3)
	2/28/2012		—		150,000		3.39	2/28/2022	(3)
Kimberly Scully	3/20/2003		14,000		—		10.50	3/20/2013
	7/25/2003		4,000		—		12.19	7/25/2013
	10/22/2003		4,000		—		12.19	10/22/2013
	5/06/2004		10,000		—		12.19	5/06/2014
	10/26/2004		—		5,000		12.19	10/26/2014	(6)
	3/04/2008		3,334		6,666		12.19	3/04/2018	(7)
	3/09/2009		3,334		6,666		6.52	3/09/2019	(3)
	3/02/2010		—		3,000		9.90	3/02/2020	(3)
	5/18/2010		—		10,000		12.53	5/18/2020	(8)
	2/17/2011		—		2,000		9.98	2/17/2021	(3)
	9/14/2011		—		7,500		5.12	9/14/2021	(3)
	11/15/2011		—		44,500		2.87	11/15/2021	(3)
	2/28/2012		—		50,000		3.39	2/28/2022	(3)
Brian Sullivan	1/09/2003		4,000		—		9.17	1/09/2013
	8/12/2003		6,000		—		12.19	8/12/2013
	3/04/2008		2,000		4,000		12.19	3/04/2018	(7)
	3/09/2009		3,334		6,666		6.52	3/09/2019	(3)
	3/02/2010		—		3,000		9.90	3/02/2020	(3)
	9/14/2011		—		2,500		5.12	9/14/2021	(3)
	11/15/2011		—		5,000		2.87	11/15/2021	(3)

	Annual Retainer		Regular Quarterly Meeting
Board of Directors	$	15,000	$	1,600
Lead director		—		800
Audit Committee		3,200		800
Audit Committee Chairman		8,000		—
Compensation Committee		1,600		—
Governance Committee		2,400		—

Name (1)	Fees Earned or Paid in Cash ($)			Option Awards ($) (2)		Total ($)
Lawrence Feldman	$	43,000	(3)	$	57,507	$	100,507
Stephen Fine		31,800	(4)		57,507		89,307
Mark Louie		31,800	(5)		57,507		89,307

	Compensation and Stock Option Committee

	Stephen Fine, Chairman
	Lawrence Feldman
	Mark Louie

	(A)		(B)		(C)
Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (A))
Equity compensation plans approved by stockholders (1)		3,680,336	$	6.76		872,300
Equity compensation plans not approved by stockholders		—		—		—
Total		3,680,336	$	6.76		872,300

	Class A						Class B
Name and Address of Beneficial Owner(1)	Number of Shares Beneficially Owned(2)			Percent of Class A(3)			Number of Shares Beneficially Owned			Percent of Class B(3)
Directors, nominees and named executive officers:
Steven Nichols (4)		232,294	(5)		0.8	%		7,452,162	(6)		92.7	%
George Powlick (4)		392,803	(7)		1.4			—			—
Lawrence Feldman (4)		27,560	(8)		0.1			391,132	(9)		4.9
Stephen Fine (4)		41,000	(10)		0.1			—			—
Mark Louie (4)		30,500	(11)		0.1			—			—
David Nichols (4)		320,667	(12)		1.1			63,240	(13)		0.8
Kimberly Scully (4)		46,334	(14)		0.2			—			—
Brian Sullivan (4)		39,067	(15)		0.1			—			—
All Directors and Officers as a Group (10 persons)		1,161,226	(16)		4.1			7,906,534			98.3
Other Principal Stockholders:
Nichols Family Trust (4)		90,200	(17)		0.3			7,388,930	(17)		91.9
FMR LLC		3,320,200	(18)		12.0			—			—
82 Devonshire Street Boston, MA 02109
BlackRock, Inc.		2,317,780	(19)		8.4			—			—
40 East 52nd Street New York, NY 10022
Wallace Capital Management, Inc.		1,664,098	(20)		6.0			—			—
100 Crescent Court, Suite 1190 Dallas, TX 75201

	Corporate Governance and Nominating Committee

	Lawrence Feldman, Chairman
	Stephen Fine
	Mark Louie

	2012		2011
Audit fees (1)	$	606,200	$	594,200
Audit-related fees (2)		22,800		31,900
Tax fees (3)		7,000		7,600
All other fees (4)		—		—
Total	$	636,000	$	633,700

	Page Reference Form 10-K
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting	41
Management’s Report on Internal Control Over Financial Reporting	42
Report of Independent Registered Public Accounting Firm	43
Consolidated Balance Sheets as of December 31, 2012 and 2011	44
Consolidated Statements of Earnings/Loss and Comprehensive Earnings/Loss for the three years ended December 31, 2012	45
Consolidated Statement of Stockholders’ Equity for the three years ended December 31, 2012	46
Consolidated Statements of Cash Flows for the three years ended December 31, 2012	47
Notes to Consolidated Financial Statements	48 – 73

	Page

Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts	101

	K•Swiss Inc.


	By	/s/George Powlick
		George Powlick
		Vice President of Finance, Chief Administrative
		Officer and Chief Financial Officer

	February 26, 2013

Signature	Title	Date

/s/ Steven Nichols	Chairman of the Board, President	February 26, 2013
Steven Nichols	and Chief Executive Officer


/s/ George Powlick	Vice President of Finance, Chief	February 26, 2013
George Powlick	Administrative Officer, Chief Financial Officer, Principal Accounting Officer, Secretary and Director

/s/ Lawrence Feldman	Director	February 26, 2013
Lawrence Feldman


/s/ Stephen Fine	Director	February 26, 2013
Stephen Fine


/s/ Mark Louie	Director	February 26, 2013
Mark Louie

Column A		Column B		Column C				Column D			Column E
				Additions
Description		(1) Balance at beginning of period		(1) Charged to expenses		(1) Charged to other accounts		(1) Write-offs and deductions, net			(1) Balance at end of period
Allowance for bad debts	(2012)	$	1,678	$	481	$	0	$	(445	)	$	1,714
	(2011)		1,780		619		0		(721	)		1,678
	(2010)		2,162		691		0		(1,073	)		1,780

Allowance for inventories	(2012)	$	7,227	$	8,285	$	0	$	(7,354	)	$	8,158
	(2011)		4,747		9,356		0		(6,876	)		7,227
	(2010)		4,859		3,028		0		(3,140	)		4,747

Allowance for sales returns	(2012)	$	2,414	$	7,434	$	0	$	(7,650	)	$	2,198
	(2011)		1,388		7,424		0		(6,398	)		2,414
	(2010)		1,198		6,760		0		(6,570	)		1,388