Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

or

For the transition period from                      to                     

Commission file Number     0-18490

K•SWISS INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code    (818) 706-5100

Securities registered pursuant to Section 12(b) of the Act:

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 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

The aggregate market value of the Class A Common Stock of the Registrant held by non-affiliates of the Registrant as of June 30, 2008, the last business day of the Registrant’s most recently completed second fiscal quarter, based on the closing price of the Class A Common Stock on the Nasdaq Global Select Market on such date was $392,831,819.

The number of shares of the Registrant’s Class A Common Stock outstanding at March 4, 2009 was 26,800,908 shares. The number of shares of the Registrant’s Class B Common Stock outstanding at March 4, 2009 was 8,059,524 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement for the Registrant’s 2009 Annual Stockholders Meeting are incorporated by reference into Part III.

Table of Contents

K·SWISS INC.

INDEX TO ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2008

Table of Contents

PART I

Company History and General Strategy

K•Swiss Inc. designs, develops and markets an array of athletic footwear for high performance sports use, fitness activities and casual wear under the K•Swiss brand. We also design and manufacture footwear under the Royal Elastics and the Palladium brands. Royal Elastics, a wholly owned subsidiary, is a leading innovator of slip-on, laceless footwear. Palladium SAS (“Palladium”), a 57% owned subsidiary, is a designer, developer and marketer of footwear for adventurers for all terrains. Sales of the Royal Elastics and Palladium brands were not significant during 2008.

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 the People’s Republic of China (“China”). In June 1991 and September 1992, we established operations in Taiwan and Europe, respectively, to broaden our distribution on a global scale.

In November 2001, we acquired the worldwide rights and business of Royal Elastics, an Australian-based designer and manufacturer of elasticated footwear. The purchase excluded distribution rights in Australia, which were retained by Royal Management Pty, Ltd. In the third quarter of 2005, Royal Elastics launched a new collection that is part of a long-term licensing partnership with L.A.M.B.

In July 2008, we purchased a 57% equity interest in Palladium for a total purchase price of €5.3 million, or approximately $8.5 million (including a loan of €3.65 million, or approximately $5.8 million). We also agreed to acquire the remaining 43% equity interest in Palladium, subject to certain conditions set forth in the purchase agreement, which will occur in the first half of 2013, except in certain circumstances. If the purchase occurs in the first half of 2013, then the purchase price is equal to an amount calculated in accordance with a formula driven by Palladium’s EBITDA for the twelve months ended December 31, 2012 plus €1.7 million. Otherwise the purchase price is equal to €1.7 million plus an amount calculated in accordance with a formula driven by Palladium’s EBITDA for the twelve months ended (i) December 31 of the year preceding the purchase (or September 30, 2008 if the purchase occurs prior to December 31, 2009) or (ii) December 31, 2012, at the option of the seller. At December 31, 2008, the fair value of this liability is approximately $3.8 million, which is subject to final determination at the time of purchase in accordance with the purchase agreement. As discussed in Note M of our Consolidated Financial Statements, the acquisition of Palladium was recorded as a 100% purchase acquisition and accordingly, the results of operations of the acquired business are included in the Consolidated Financial Statements from the date of acquisition. Palladium designs, develops and markets footwear under the Palladium brand worldwide except for Canada and the U.S., where K•Swiss holds the exclusive rights to market footwear under the Palladium brand.

The discussion during the remainder of this Item 1, other than the discussion relating to backlog, trademarks and patents, and employees, relates solely to the K•Swiss brand.

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K•Swiss 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 consolidated subsidiaries.

Products

Footwear

Our primary product is footwear. Starting in 2008, we reclassified our footwear products into two product categories: lifestyle and performance. Historically our product categories were: Classic, tennis/court, training and children’s footwear. Each product category has 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.

Because of our reclassification of our product categories in 2008, we present below in two separate tables the revenue attributable to our K•Swiss brand footwear by product category. Each table sets forth the approximate contribution to revenues (in dollars and as a percentage of revenues) attributable to each footwear category utilized by us during the periods indicated preceded by a discussion of the applicable product categories.

As noted above, beginning in 2008 we reclassified our footwear products into two product categories: lifestyle and performance. This reclassification was a product of our brand position being directed more towards a performance orientation. Our lifestyle category will continue to emphasize the Classic and its derivatives. The performance category will now emphasize performance running, as well as tennis and training. In 2008, we entered the performance running segment with an emphasis on performance innovation. In February 2009, K•Swiss won the coveted Best New Shoe award from the Running Network for the innovative Run 1 that featured miSOUL technology.

Revenues, by product category, for the year ended December 31, 2008, are as follows (dollar amounts in thousands). Most styles within the lifestyle and performance categories are offered in men’s (approximately 61% of 2008 revenues), women’s (approximately 23% of 2008 revenues) and children’s (approximately 16% of 2008 revenues). There were no customers that accounted for more than 10% of total revenues during 2008. See Note K to our Consolidated Financial Statements.

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Historically, our product categories were the Classic, tennis/court, training and children’s footwear. The Classic 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 which is currently sold in the market today. In 2009 we plan to re-master and re-launch the original Classic.

The Classic category consisted of several collections, including the Classic collection and the Limited Edition collection, of contemporary sportstyle or casual products that gave the K•Swiss brand the ability to stay relevant and on trend. The Classic collection is comprised of products that we intend to carry in our product assortment for several years. They generally have K•Swiss shoe characteristics such as d-rings and five stripes, and, because they are long-term products, we maintain significant inventory positions of this collection. Significant inventory positions allow for effective electronic data interchange programs with retailers that fit into our strategy of attempting to become the retailers’ most profitable vendor. The Limited Edition collection is an example of contemporary or modern sportstyle footwear from the late 1990’s onward and is generally meant as a one-season offering as they are generally fashionable type shoes that are purchased from factories based only on futures orders received from retailers.

Our tennis and training categories through 2007 offered several types of specialty footwear, emphasizing footwear for tennis and training, respectively. K•Swiss has had a steady performance tennis business for many years that includes the 7.0 collection, which is specifically targeted to the elite tennis player and the specialty tennis market. In 2000, we successfully entered the training market with moderately priced products.

The Children’s category consisted primarily of takedowns of adult shoes from the Classic, tennis/court and training categories.

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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 upscale suburban consumers.

In 1999, we introduced a new 7.0 collection of high tech tennis apparel to complement our performance 7.0 collection of footwear. The collection continues to offer world-class apparel (skirts, shorts, tops, polos, dresses and warm-ups) for both men and women. Since our introduction of the 7.0 collection of tennis apparel, we have added full collections of fitness, training and running apparel to round out the performance offering. In addition, we also offer a collection for the casual athletic consumer 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, as well as sporting goods chains and sporting goods dealers 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 in the United States 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. See “Risk Factors: Our financial success is limited to the success of our customers and The loss of a significant customer, or a significant reduction in our sales to such customer, could adversely affect our sales and results of operations.” We also sell our products through our website which is increasingly becoming an important sales channel to us particularly in light of our limited distribution. We also sell our products to a number of foreign distributors. We now have sales offices or distributors throughout the world. In 1991 and 1992, we established sales offices, sales teams and distributors in Asia and Europe, respectively.

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 seasons. 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.

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

Marketing

Advertising and Promotion

We believe our strategy of designing products with longer life cycles and introducing fewer new models relative to our competition enhances the effectiveness of our advertising and promotions. Our current marketing strategy emphasizes distribution to retailers whose marketing strategies are consistent with our reputation for high quality and service. We have an integrated advertising plan with print, online initiatives, outdoor and television. Traditional media such as print and television is still an important part of our media plan but online and outdoor mediums 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

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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 “Backlog” and “Risk Factors—Our current backlog of open orders may not be indicative of our level 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 network and cable television and several sports, music and general interest/fashion magazines, as well as non-traditional media, including the internet, public relations, sports marketing, in-store merchandising and sponsorship.

Our footwear products are sold domestically through 30 independent regional sales representatives and 16 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 2,300, 2,200 and 2,600 separate accounts as of December 31, 2008, 2007 and 2006, respectively.

We maintain a customer service department consisting of 9 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.

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 primary source of advertising is television advertisements which are distributed through each region’s major network channels. Television advertising is supported by print media in fashion magazines and through other sources, such as in-store merchandising and local publicity events and sponsorships.

Internationally, at the end of 2008, K•Swiss had the exclusive right to market our products in 97 countries through 9 international subsidiaries and 23 distributors.

Distribution

We purchase footwear from independent manufacturers located predominantly in China. 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.

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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 the public distribution facilities for the Netherlands and United Kingdom offices. 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 “Marketing—Advertising and Promotion.”

Product Design and Development

We maintain offices in California, Taiwan and the Netherlands that include a staff of individuals responsible for the design and development of new styles for all global regions. This staff receives guidance from our management team in California, who meet regularly to review sales, consumer and market trends.

Manufacturing

In 2008, approximately 83% of our footwear products were manufactured in China, approximately 15% in Thailand and approximately 2% in Taiwan. 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. See “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 if we are unable to obtain some components used in our products from limited supply sources or supply chain disruptions and 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 2008, our apparel and accessory products were manufactured in China, Taiwan, Korea, Singapore, Macau, Hong Kong, Malaysia, Portugal and the United States by certain manufacturers selected by us.

Our operations are subject to compliance with relevant laws and regulations enforced by the United States Customs Service and other international customs service departments from which we import product and to the customary risks of doing business abroad, including fluctuations in the value of currencies, increases in customs duties and related fees resulting from position changes by the United States Customs Service or other international customs service departments, import controls

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and trade barriers (including the unilateral imposition of import quotas), restrictions on the transfer of funds, work stoppages and, in certain parts of the world, political instability causing disruption of trade. These factors have not had a material adverse impact upon our operations to date. Imports are also affected by the cost of transportation, the imposition of import duties, and increased competition from greater production demands abroad. The United States or the countries in which our products are manufactured may, from time to time, impose new quotas, duties, tariffs or other restrictions, or adjust presently prevailing quotas, duty or tariff levels, which could affect our operations and ability to import products at current or increased levels. We cannot predict the likelihood or frequency of any such events occurring. A change in any such duties, quotas or restrictions could result in increases in the costs of such products generally and might adversely affect the sales or profitability of K•Swiss and the athletic footwear industry as a whole.

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 which range from 7.0% to 8.0% of landed cost on technical footwear made principally of leather, a duty rate of 16.9% for synthetic footwear and a duty rate ranging from 23.5% to 24.5% for leather footwear that is considered non-technical or has a landed cost of under €7.00. 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 technical footwear made principally of leather and a duty rate of 11.9% for synthetic footwear. Currently, approximately 95% of our footwear volume is derived from sales of leather footwear and approximately 5% of our footwear volume is derived from sales of synthetic and textile footwear.

Backlog

“Backlog,” as of any date, represents orders scheduled to be shipped within the next six months. Backlog does not include orders scheduled to be shipped on or prior to the date of determination of backlog. At December 31, 2008 and 2007, total futures orders with start ship dates from January through June 2009 and 2008 were approximately $93,610,000 and $147,805,000, respectively, representing a decrease of 36.7% at December 31, 2008. The 36.7% decrease in total futures orders is comprised of a 28.5% decrease in the first quarter 2009 futures orders and a 51.6% decrease in the second quarter 2009 futures orders. At December 31, 2008 and 2007, domestic futures orders with start ship dates from January through June 2009 and 2008 were approximately $31,881,000 and $50,758,000, respectively, representing a decrease of 37.2% at December 31, 2008. At December 31, 2008 and 2007, international futures orders with start ship dates from January through June 2009 and 2008 were approximately $61,729,000 and $97,047,000, respectively, representing a decrease of 36.4% at December 31, 2008.

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.

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.

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We have increased our emphasis on product lines beyond our Classic model. In the past, 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 “Products.” There can be no assurance that we will penetrate these or other new markets or increase 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.

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. K•Swiss^® is a registered trademark in the United States and certain other countries. Our name is not registered as a trademark in certain countries because of restrictions on registering names having geographic connotations. However, since K•Swiss is not a geographic name, we have often secured registrations despite such objections. Our shield emblem and the five-stripe design are also registered in the United States and certain foreign countries. The five-stripe design is not presently registered in some countries because it has been deemed ornamental by regulatory authorities. We selectively seek to register the names of our shoes, logos and the names given to certain of our technical and performance innovations, including Aosta^® rubber and Shock Spring^® cushioning. We have obtained patents in the United States regarding the Bio Feedback^® ankle support system, the Shock Spring^® cushioning system incorporated into K•Swiss’ 7.0 System^® performance tennis shoes and training line, the stability design incorporated into the Si-18^® tennis shoe, and other features. The ROYAL ELASTICS and Fleur de Lis trademarks used on Royal Elastics products are registered in many countries. Both marks are registered in the United States. The PALLADIUM trademark is registered in many jurisdictions, including the United States, Canada, China and key European markets. Applications to register the mark are pending in many other countries. The Company is taking steps to strengthen protection for the PALLADIUM trademark and other marks related to the Palladium business. 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 counterfeiting problems regarding our products.

Employees

At December 31, 2008, we employed 219 persons in the United States, 220 persons in Korea, Singapore, Thailand, Taiwan and China, 131 persons in the United Kingdom, Germany, France, Italy and the Netherlands and 14 persons elsewhere.

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 the S.E.C. may be read and copied at the S.E.C.’s Public Reference Room at Station Place, 100 F. Street, N.E., Room 1580, 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

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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.

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.

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

The athletic footwear industry is intensely competitive. Certain of our competitors have substantially greater financial, distribution and marketing resources as well as greater brand awareness than us. The principal methods of competition in our industry include product design, product performance, quality, brand image, price, marketing and promotion, customer support and service, ability to meet delivery commitments to retailers, obtaining access to retail outlets and sufficient floor space. A major marketing or promotional success or technological innovation by one of our competitors could adversely impact our competitive position. Additionally, in countries where the athletic footwear market is mature, our ability to maintain and increase our market share can principally come at the expense of our competitors, 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.

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 may not continue to be popular 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 price adjustment or return to assist them in marking down the selling price to make the products more attractive to retail consumers.

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.

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The consumer environment has been particularly challenging over the last several quarters. The recent 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 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. If we fail to forecast consumer demand accurately, we may under-produce or over-produce a product and encounter difficulty in handling customer orders or in liquidating excess inventory. Additionally, if we over-produce a product based on an aggressive forecast of consumer demand, 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 backlog of open orders may not be indicative of our level of future sales.

Our “futures” program allows our customers to order our products five months or more prior to delivery of product. Our current backlog 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 (oil, 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 2008, we do have significant customers. The loss of any of these customers, or a significant reduction in our sales to any of such customers, could adversely affect our sales and results of operations. In addition, if any of such customers became insolvent or otherwise failed to pay its debts, it could have an adverse affect on our results of operations.

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

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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 its 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 may earn lower gross margins and our revenues and profitability may be adversely affected.

The prices that 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 may 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.

Significant volatility and disruption in the global capital and credit markets in 2008 and early 2009 have resulted in a tightening of business credit and liquidity, a contraction of consumer credit, business failures, increased unemployment and declines in consumer confidence and spending. If global economic and financial market conditions continue to deteriorate or remain 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:

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Our international sales and manufacturing operations are subject to the risks of doing business abroad, which could affect our ability to sell or manufacture our products in international markets, obtain products from foreign suppliers or control the cost of our products.

We operate offices and sell products in numerous countries outside the United States. In recent years, our percentage of revenue earned from international markets has increased. Additionally, all of our footwear products are manufactured abroad and we have suppliers located in China, Thailand and Taiwan. Our athletic footwear sales and manufacturing operations are subject to the risks of doing business abroad. These risks include:

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.

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 if we are unable to obtain some components used in our products from limited supply sources or 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

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heavily on manufacturing facilities located in China. In 2008, approximately 83% of our footwear manufacturing occurred in China. 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 are cancelable by customers if agreed-upon delivery windows are not met or products are not of agreed-upon quality. A failure by one or more of our manufacturers to meet established criteria for pricing, product quality or timely delivery 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, as noted above. The United States government has expressed serious concern over the level of intellectual property rights protection and enforcement available in China and has initiated annual bilateral discussions with China through the Joint Commission on Commerce and Trade to address outstanding issues in these areas. The United States Trade Representative (“USTR”) has elevated China onto its Priority Watch List based on China’s alleged lack of compliance with commitments made as part of its accession to the World Trade Organization (“WTO”) relating to enforcement of intellectual property rights. The USTR has also initiated WTO dispute settlement proceedings against China challenging deficiencies in China’s legal regime for protecting and enforcing trademarks and copyrights. If the United States government takes action against China, 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.

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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 and Heywood, the United Kingdom. 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.

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. 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.

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, and certain other key executives. Although we have entered into an employment agreement with Mr. Nichols that expires in December 2010, 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. Our

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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, 2008, the Company’s President and Chairman of the Board, Steven Nichols, held approximately 93% of the voting power of our Class B Common Stock taken as a whole and approximately 70% 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. Any interruption of this service from power loss, telecommunications failure, failure of our computer system or other interruption caused by weather, natural disasters or any similar event 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, which could have a material adverse effect on our business and operations.

We rely on our management information systems to operate our business and to track our operating results. Our management information systems will require modification and refinement as we grow and our business needs change. If we experience a significant system failure or if we are unable to 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.

During 2008 and early 2009, we have completed our implementation of the SAP information management software in a majority of our worldwide operations. During the next several years, we will continue to rollout various modules of SAP that were not implemented during our initial worldwide implementation. We may encounter computer and operational complications in connection with maintaining and implementing the SAP information system that could have a material adverse effect on our business, financial condition or results of operations.

None.

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 $91,000. In July 2008, we exercised an option under the lease to extend the term of the lease until January 2015.

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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.

None.

Executive Officers of the Registrant

The executive officers of K•Swiss are as follows:

Officers are appointed by and serve at the discretion of the Board of Directors.

Steven Nichols has been President, Chief Executive Officer and Chairman of the Board of K•Swiss 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, he was an officer of Nichols Foot Form Corp., which operated a chain of New York retail footwear stores.

Edward Flora, Vice President-Operations since March 1994, joined K•Swiss as a consultant in June 1990 and served as Director-Administration from October 1990 to February 1994. 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 Executive Vice President of K•Swiss Sales Corp., President of K•Swiss Europe BV and President of K•Swiss Direct Inc.

George Powlick, Vice President-Finance, Chief Financial Officer and Secretary since January 1988, Director since 1990 and Chief Operating Officer since September 2004, joined K•Swiss in January 1988. Mr. Powlick is a certified public accountant and was an audit partner in the independent public accounting firm of Grant Thornton, LLP from 1975 to 1987.

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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 accounting firm of KPMG LLP and became an audit manager in 1994.

Brian Sullivan, Vice President-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. From 1978 to 1984, Mr. Sullivan held various positions at Bancroft/Tretorn, including Field Salesperson, Marketing and Sales Planning Manager and National Sales Manager.

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PART II

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 2008 and 2007 as reported by Nasdaq were as follows:

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 December 31, 2008 was 129. However, based on available information, we believe that the total number of Class A Common stockholders, including beneficial stockholders, is approximately 5,000.

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 December 31, 2008 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 Market Index and the Hemscott Industry Group 321 Index—Textile—Apparel Footwear and Accessories. The graph assumes $100 was invested on December 31, 2003 and dividends are reinvested for all years ending December 31.

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Dividend Policy

The Board of Directors declared a quarterly dividend of 5 cents ($0.05) per share in each quarter of 2007 and 2008 to all stockholders of record as of the close of business on the last day of the applicable quarter. In addition, in November 2008, the Board of Directors declared a special dividend of $2.00 per share to all stockholders of record as of the close of business on December 10, 2008. On March 3, 2009, the Board of Directors has suspended the payment of dividends for the foreseeable future to preserve liquidity and enhance the strength of the Company’s balance sheet. We are currently limited in the extent to which we are able to pay dividends under our revolving credit agreement. See Note D to our Consolidated Financial Statements. The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon, among other things, our revolving credit agreement, future earnings, operations, capital requirements, our general financial condition and general business conditions.

Purchases of Equity Securities by the Issuer

In October 2004, the Board of Directors approved a 5 million share repurchase program which expires in December 2009. During the fourth quarter of 2008, the Company did not repurchase any shares of K•Swiss Class A Common Stock. Approximately 3,911,289 shares of K•Swiss Class A Common Stock remain available for repurchase under the program.

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The selected consolidated financial data presented below for each of the five years in the period ended December 31, 2008 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. Certain reclassifications have been made in the 2007, 2006, 2005 and 2004 presentations to conform to the 2008 presentation.

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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 other reports or 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; 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 and apparel for consumers and endorsers; market acceptance of all our product offerings; demographic changes; 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, consumer demand for our product, and various market factors described above; 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; 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 implementing SAP information management software; interruptions in data and communication systems; concentration of production in China; 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; customer service; adverse publicity; the loss of significant customers or suppliers; dependence on distributors; dependence on major customers; concentration of credit risk; 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; 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

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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 athletic footwear for high performance sports use, fitness activities and casual wear under the K•Swiss brand, and also designs and manufactures footwear under the Royal Elastics and the Palladium brands. Royal Elastics is our wholly owned subsidiary. We own a 57% equity interest in Palladium. The categories of footwear we sell are explained in more detail in Part I, Item 1, under the subheading, “Products.” We market our products in the United States (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 and department stores. We also sell our products through our website and internationally through Company employed sales managers, independent sales representatives and a number of foreign distributors.

The retail environment was particularly challenging during the last few quarters of 2008 and is forecasted for the near term to remain depressed, given the recent deterioration in the overall economy and financial markets, which could put additional pressure on the Company’s ability to maintain margins.

In 2008, approximately 83% of our footwear products were manufactured in China. We have no long-term manufacturing agreements, but we believe that our 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.

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 17.1% in 2008 from 2007, due to a decrease in the volume of footwear sold and a decrease in the average underlying wholesale price per pair. Our overall gross profit margins, as a percentage of revenues, were 39.8% and 46.3% in 2008 and 2007, respectively. The decrease in our gross profit margin is mainly due to product mix, recognition of inventory reserves and recognition of an underpayment of certain business taxes in a foreign jurisdiction. Our overall selling, general and administrative expenses increased to 43.5% of revenues in 2008 from 38.4% of revenues in 2007. However, our selling, general and administrative expenses decreased 6.1% in 2008 from 2007 due a decrease in advertising expenses offset by increases in compensation expenses and data processing expenses incurred as a result of our SAP implementation in certain operational regions.

In 2008, our largest single marketing expenditure was television. Our marketing campaign was run mainly on network and cable television, and was supported by sports, music and general interest/fashion magazines. Our domestic independent sales representatives sold to approximately 2,300

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separate accounts as of December 31, 2008 (up from 2,200 as of December 31, 2007). Internationally, at the end of 2008, we had the exclusive right to market our products in 97 countries through 9 international subsidiaries and 23 distributors.

Other income for 2008 consisted of a settlement payment of $30,000,000 in connection with a lawsuit protecting our trademarks, which is included in other income.

At December 31, 2008, our total futures orders with start ship dates from January through June 2009 were $93,610,000, a decrease of 36.7% from the comparable period of the prior year. Of this amount, domestic futures orders were $31,881,000, a decrease of 37.2%, and international futures orders were $61,729,000, a decrease of 36.4%. Notwithstanding the foregoing, we recognize that the athletic footwear industry is highly competitive. Several makers of footwear with whom we compete have substantially greater financial, distribution and marketing resources as well as greater brand awareness than us.

Net earnings and net earnings per diluted share for 2008 decreased 46.5% and 46.4%, respectively, to $20,885,000, or $0.59 per diluted share, compared with $39,073,000, or $1.10 per diluted share, in 2007. Net earnings and net earnings per diluted share for 2008 includes the $30,000,000 settlement payment described above.

In 2008, we had a net cash inflow of approximately $16,288,000 from operating activities, a net cash outflow of $13,749,000 from investing activities due to the net purchase of property, plant and equipment, the purchase of intangible assets and the purchase of Palladium SAS (“Palladium”) and a net cash outflow of $76,299,000 from financing activities mainly as a result of a distribution on December 24, 2008 of a special cash dividend of $2.00 per share to stockholders of record on December 10, 2008. We anticipate future cash needs for principal repayments required pursuant to borrowings under our lines of credit and, depending on future operating results, additional funds may be required for operating activities.

On July 1, 2008, we purchased a 57% equity interest in Palladium for €5.3 million, or approximately $8.5 million, (including a loan of €3.65 million, or approximately $5.8 million).

At December 31, 2008, we had debt outstanding of $5,376,000 (attributable to Palladium) and there was no debt outstanding at December 31, 2007, excluding outstanding letters of credit of $1,399,000 and $1,831,000 at December 31, 2008 and 2007, respectively. Our working capital decreased $74,019,000 to approximately $281,307,000 at December 31, 2008 from $355,326,000 at December 31, 2007, mainly as a result of the special cash dividend discussed above.

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, 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

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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. See “Results of Operations—2008 Compared to 2007—Other Income, Interest and Taxes,” for discussion regarding the estimate and settlement of an underpayment of payroll withholdings in a foreign jurisdiction from January 1, 1993 through December 31, 2005.

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 the customer. In these cases, we recognize revenue when the product is delivered to the 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.

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

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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 determined that 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.

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.

Palladium Purchase

On May 16, 2008, the Company entered into a Share Purchase and Shareholders’ Rights Agreement (the “Agreement”) by and among Christophe Mortemousque, Palladium and the Company providing for the purchase of 57% equity interest in Palladium from its shareholders for a total purchase price of €5.3 million, or approximately $8.5 million (including a loan of €3.65 million, or approximately $5.8 million). Pursuant to the terms of the Agreement, the Company also agreed to acquire the remaining 43% equity interest in Palladium, subject to certain conditions set forth in the Agreement, which will occur in the first half of 2013, except in certain circumstances. If the purchase occurs in the first half of 2013, then the purchase price is equal to an amount calculated in accordance

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with a formula driven by Palladium’s EBITDA for the twelve months ended December 31, 2012 plus €1.7 million. Otherwise the purchase price is equal to €1.7 million plus an amount calculated in accordance with a formula driven by Palladium’s EBITDA for the twelve months ended (i) December 31 of the year preceding the purchase (or September 30, 2008 if the purchase occurs prior to December 31, 2009) or (ii) December 31, 2012, at the option of the seller. At December 31, 2008, the fair value of this liability is approximately $3.8 million, which is subject to final determination at the time of purchase in accordance with the Agreement. Closing of the 57% equity purchase occurred on July 1, 2008. As discussed in more detail below, the acquisition of Palladium was recorded as a 100% purchase acquisition and accordingly, the results of operations of the acquired business are included in the Consolidated Financial Statements from the date of acquisition.

Palladium designs, develops and markets footwear under the Palladium brand worldwide except for Canada and the U.S., where the Company holds the exclusive rights to market footwear under the Palladium brand. The purchase of Palladium was part of an overall strategy to own the worldwide rights of the Palladium trademark. Prior to July 1, 2008, the Company owned only the United States and Canada trademarks as discussed below.

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” the Company has determined that the mandatory redemption provisions of the Agreement require the Company to purchase the remaining 43% equity interest as a single unit and that there are no substantive conditions to the future purchase of this remaining 43% equity interest that would reasonably change the redemption conditions from mandatory to contingent. As such, at July 1, 2008, the Company has recorded a liability, Mandatorily Redeemable Minority Interest (“MRMI”) on its balance sheet at fair value, or $4.2 million. Subsequent changes to the fair value of the MRMI will be recorded as interest income or interest expense. This amounted to $490,000 in interest income for the year ended December 31, 2008.

The fair value of the MRMI will be determined each quarter based on the current quarter’s projection of EBITDA for the twelve months ended December 31 of the current year, but not less than the amount determined at the previous twelve month measurement date per the Agreement. The change in MRMI is based on the current quarter’s EBITDA projection and will be recognized as interest income or interest expense during the current quarter. The fair value of the MRMI at December 31, 2008 was $3.8 million.

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In accordance with the provisions of SFAS No. 141, “Business Combinations” and SFAS No. 150, the acquisition of Palladium was recorded as a 100% purchase acquisition without reflecting any minority interest but recognizing the MRMI liability and accordingly, the results of operations of the acquired business are included in our Consolidated Financial Statements from the date of acquisition. A trademark asset totaling $8,688,000 and goodwill of $5,285,000, have been recognized for the amount of the excess of the purchase price paid over the fair market value of the net assets acquired. The amount of goodwill that is deductible for tax purposes is $3,626,000 and will be amortized over 15 years. At July 1, 2008, the assets acquired and liabilities assumed in the purchase of Palladium is as follows (in thousands):

The lines of credit of approximately $4.9 million include amounts outstanding under Palladium’s bank lines of credit and the short-term portion of loans with financial institutions. The loans are paid either on a monthly or quarterly basis and have maturity dates ranging from February 2012 to February 2013. See Note D to our Consolidated Financial Statements for further discussion. On a pro forma basis, as if Palladium had been acquired at the beginning of 2008, 2007 and 2006, consolidated revenue, net earnings and earnings per diluted common share would have been as follows for the years ended December 31, 2008, 2007 and 2006 (dollar amounts in thousands):

In addition, in a separate transaction on March 28, 2008, the Company entered into an Assignment and Assumption Agreement (the “Assignment Agreement”) with Palladium. The Assignment Agreement provided for the Company’s assumption of Palladium’s rights and obligations under a certain intellectual property purchase and sale agreement by and between Palladium and Consolidated Shoe Company pursuant to which Palladium agreed to acquire certain intellectual property from Consolidated Shoe Company for a purchase price of $6.0 million.

These trademarks are accounted for in accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets.” These indefinite-lived assets will be evaluated for impairment at least annually, and more often when events indicate that an impairment exists.

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Results of Operations

The following table sets forth, for the periods indicated, the percentage of certain items in the consolidated statements of earnings relative to revenues.

2008 Compared to 2007

Revenue and Gross Margin

Total revenues decreased 17.1% to $340,160,000 in 2008 from $410,432,000 in 2007. This decrease was attributable to a decrease in the volume of footwear sold and a decrease in the average underlying wholesale price per pair. The volume of footwear sold decreased 17.0% to 11,786,000 pair in 2008 from 14,195,000 pair in 2007. The average wholesale price per pair was $27.65 in 2008 and $28.05 in 2007, a decrease of 1.4%.

Domestic revenues decreased 29.9% to $141,801,000 in 2008 from $202,375,000 in 2007. International product revenues decreased 5.9% in 2008 to $190,665,000 from $202,532,000 in 2007. Fees earned by the Company on sales by foreign licensees and distributors were $7,694,000 for 2008 and $5,525,000 for 2007, an increase of 39.3%. International revenues, as a percentage of total revenues, increased to 58.3% in 2008 from 50.7% in 2007.

Customer acceptance of our domestic and international product has been weak and is likely to continue for the near term. In an effort to increase customer acceptance of our products, during late 2006/early 2007, we hired several individuals in product design and management, however, it will take additional time for the full impact of the contribution of these individuals to affect our business. In addition, the current downturn of the worldwide economy has had and will continue to have an adverse affect on our business.

K•Swiss brand revenues decreased 19.9% to $315,915,000 in 2008 from $394,540,000 in 2007. This decrease was the result of a decrease in the volume of footwear sold and a decrease in the average underlying wholesale price per pair. The volume of footwear sold decreased 18.6% to 11,187,000 pair in 2008 from 13,750,000 pair in 2007. The average wholesale price per pair was $27.02 in 2008 and $27.84 in 2007, a decrease of 2.9%, which resulted from product mix changes offset by international sales becoming a larger portion of revenues.

Royal Elastics brand revenues decreased 19.7% to $12,755,000 in 2008 (27% of which were derived from domestic sales) from $15,892,000 in 2007 (36% of which were derived from domestic sales). Palladium brand revenues were $11,492,000 in 2008 (all of this revenue was derived from sales outside the U.S.), representing six months of revenue.

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

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holiday seasons. 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, 2008, domestic and international futures orders with start ship dates from January through June 2009 were approximately $31,881,000 and $61,729,000, respectively, 37.2% lower and 36.4% lower, respectively, than such orders were at December 31, 2007 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.

Overall gross profit margins, as a percentage of revenues, were 39.8% in 2008 and 46.3% in 2007. Gross profit margin was affected by product mix changes, geographic mix of international sales and increases in inventory reserves. International sales generally yield a higher gross profit margin, however, the gross margin was lower in 2008 than in 2007. In addition, included in gross margin is an additional accrual for the underpayment of certain business taxes in a foreign jurisdiction. Prior to the third quarter of 2008, we had accrued approximately $638,000 related to this issue. A detailed analysis performed by our tax advisors and accountants during the third quarter of 2008 determined that the total amount of business taxes underpaid and related interest was approximately $2,447,000. We will finalize the amount owed with the appropriate taxing authority within the next three to six months. Penalties are discretionary, ranging from zero to 300% of taxes owed and, at this time, we cannot determine the likelihood of such assessment and have not recognized penalties related to this. However, there can be no guarantee that penalties will not be imposed. Our gross margins may not be comparable to some of our competitors as we recognize warehousing costs within selling, general and administrative expenses.

Selling, General and Administrative Expenses

Overall selling, general and administrative expenses decreased 6.1% to $147,869,000 (43.5% of revenues) in 2008 from $157,498,000 (38.4% of revenues) in 2007. The decrease in selling, general and administrative expenses during the year ended December 31, 2008 was the result of a decrease in advertising expenses, gains on ineffective hedges and a decrease in salesman sample expenses, offset by increases in compensation expenses and data processing expenses. Advertising expenses decreased 30.8% for the year ended December 31, 2008 primarily due to decreases in both domestic and international markets as part of an effort to reduce costs as our business declines. Gains on ineffective hedges contributed to a $1,604,000 decrease in selling, general and administrative expenses. Salesman sample expenses decreased 25.9% as a result of cost reductions and also as a result of our declining revenues. Data processing expenses increased 43.8% for the year ended December 31, 2008 as a result of on-going maintenance expenses incurred in connection with the Company’s fourth quarter of 2007 SAP implementation to our domestic and certain international operational regions and expenses related to the Company’s continuing SAP computer software implementation to other international operational regions in 2008. The increase in compensation expenses of 13.2% for the year ended December 31, 2008 was due to stock option expenses (recognized as a result of the repricing of stock options, see Note J to our Consolidated Financial Statements), an increase in headcount, a decrease in the reversal of bonus/incentive related expenses that were calculated in accordance with the bonus formula under our Economic Value Added (“EVA”) incentive program and severance payments made, offset by decreases in other bonus/incentive related expenses. Corporate expenses of $26,797,000 and $22,592,000 for the years ended December 31, 2008 and 2007, respectively, are included in selling, general and administrative expenses. The increase in corporate expenses for the year ended December 31, 2008 was due to an increase in data processing and compensation expenses for the reasons described above.

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Other Income, Interest and Taxes

Other income for the year ended December 31, 2008 consists of a $30 million settlement payment received on June 30, 2008. On June 24, 2008, the Company entered into a settlement agreement with Payless ShoeSource, Inc., a Missouri corporation and Payless ShoeSource Inc., a Delaware corporation (collectively, “Payless”) in connection with our 2004 action filed against Payless in the United States District Court for the Central District of California (Western District), in which we alleged trademark and trade dress infringement, trademark dilution, unfair competition and breach of contract. The settlement agreement provided, among other things, that Payless would pay to us $30 million in cash on or before July 1, 2008 in payment of compensatory damages claimed by us from Payless’ advertising, promotion and sale of certain footwear.

Other income for the year ended December 31, 2007 consists of a reversal of an estimate for our underpayment of payroll withholdings in a foreign jurisdiction from January 1, 1993 through December 31, 2005 of $5,232,000. As discussed in our Form 10-K for 2006, in the fourth quarter of 2006, we determined that there was an underpayment of payroll withholdings in a foreign jurisdiction from January 1, 1993 through December 31, 2006. In 2006, with the assistance of our tax advisors, we estimated an underpayment of withholdings and related interest totaling $11,105,000, of which $7,866,000 was recorded as a prior period adjustment, under Staff Accounting Bulletin No. 108. Penalties were discretionary, ranging from zero to 300% of the taxes owed, and at that time we could not determine the likelihood of such assessment and did not recognize penalties related to this issue. The September 2007 settlement reached with this foreign jurisdiction resulted in us paying 100% of the payroll withholding liability plus a 50% penalty for periods starting from May 2001 through August 2007, however interest was not assessed. Therefore, the amount settled was lower than the amounts previously estimated.

Overall net interest income was $6,965,000 (2.0% of revenues) in 2008 compared to $9,594,000 (2.3% of revenues) in 2007, a decrease of $2,629,000 or 27.4%. This decrease in net interest income was the result of lower average interest rates along with interest expense incurred by Palladium under its lines of credit and other debt offset by higher average cash balances, which resulted primarily from the $30,000,000 settlement received from Payless on June 30, 2008. Also included for the year ended December 31, 2008 is interest income from the change in fair value on the MRMI.

Our effective tax rate was 14.6% and 17.2% in 2008 and 2007, respectively. The $823,000 and $1,063,000 income tax benefit of options exercised during 2008 and 2007, respectively, were credited to additional paid-in capital and therefore did not impact the effective tax rate. The decrease in the effective tax rate was mainly due to our geographic mix of sales and earnings: international sales have become a larger portion of revenues, although domestic operations were more profitable, due to the settlement payment previously mentioned. In addition, starting January 1, 2005, the Company has not made any provision for United States income taxes on earnings of selected international subsidiary companies as these are intended to be permanently invested.

Net earnings decreased 46.5% to $20,885,000 or $0.59 per share (diluted earnings per share) in 2008 from $39,073,000 or $1.10 per share (diluted earnings per share) in 2007. Net earnings and net earnings per diluted share for 2008 includes the $30,000,000 settlement payment described above.

2007 Compared to 2006

Revenue and Gross Margin

Total revenues decreased 18.1% to $410,432,000 in 2007 from $501,148,000 in 2006. 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 23.1% to 14,195,000 pair in 2007 from 18,461,000 pair in 2006. The average wholesale price per pair was $28.05 in 2007 and $26.53 in 2006, an increase of 5.7%.

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Domestic revenues decreased 36.5% to $202,375,000 in 2007 from $318,687,000 in 2006. International product revenues increased 13.6% in 2007 to $202,532,000 from $178,307,000 in 2006. Fees earned by the Company on sales by foreign licensees and distributors were $5,525,000 for 2007 and $4,154,000 for 2006, an increase of 33.0%. International revenues, as a percentage of total revenues, increased to 50.7% in 2007 from 36.4% in 2006.

K•Swiss brand revenues decreased 19.4% to $394,540,000 in 2007 from $489,271,000 in 2006. This decrease was the result of a decrease in the volume of footwear sold, offset by higher average wholesale prices per pair. The volume of footwear sold decreased 24.1% to 13,750,000 pair in 2007 from 18,126,000 pair in 2006. The average wholesale price per pair was $27.84 in 2007 and $26.40 in 2006, an increase of 5.5%, which resulted from product mix changes and international sales becoming a larger portion of revenues. The decrease in volume of footwear sold for the year ended December 31, 2007 was due to decreased sales of training, children’s, Classic and tennis categories of 28.1%, 25.6%, 24.4% and 4.7%, respectively.

Royal Elastics brand revenues increased 33.8% to $15,892,000 in 2007 (36% of which were derived from domestic sales) from $11,877,000 in 2006 (26% of which were derived from domestic sales) as a result of increased sales of L.A.M.B. product and increased international sales.

Overall gross profit margins, as a percentage of revenues, were 46.3% in 2007 and 47.3% in 2006. Gross profit margin for 2007 was affected by product mix changes and increases in inventory reserves and reserves for prepaid royalties, offset by international sales, which generally yield a higher gross profit margin, becoming a larger portion of revenues.

Selling, General and Administrative Expenses

Overall selling, general and administrative expenses increased 14.5% to $157,498,000 (38.4% of revenues) in 2007 from $137,527,000 (27.4% of revenues) in 2006. The increase in selling, general and administrative expenses during the year ended December 31, 2007 was the result of the SAP implementation and on-going development related expenses incurred and increases in advertising expenses, compensation expenses, travel related expenses and sample development expenses, offset by a decrease in legal expenses. The increase in selling, general and administrative expenses for the year ended December 31, 2007 includes $6,447,000 in data conversion, training, training material and development expenses incurred as a result of our domestic and a portion of our international SAP computer software implementation. Advertising expenses increased 10.4% for the year ended December 31, 2007 primarily due to an increase in international advertising expenses as part of a strategic effort to drive higher international revenues and was slightly offset by a decrease in domestic advertising expenses to cut costs as result of declining domestic revenues. Compensation expenses, which includes commissions, bonus/incentive related expenses and employee recruiting and relocation expenses, increased 7.1% for the year ended December 31, 2007, primarily due to an increase in headcount and was offset by a decrease in bonus/incentive related expenses that were calculated in accordance with the bonus formula under our EVA incentive program. Travel related expenses increased 31.6% for the year ended December 31, 2007 as a result of increased travel due to our growing international operations and product development efforts. Sample development expenses increased 32.1% for the year ended December 31, 2007 as a result of our increasing international operations and our efforts to develop our apparel business. Legal expenses decreased 11.2% for the year ended December 31, 2007 primarily as a result of the court-mandated postponements of certain cases, which occurred in the first quarter of 2007. Corporate expenses of $22,592,000 and $17,803,000 for the years ended December 31, 2007 and 2006, respectively, are included in selling, general and administrative expenses. The increase in corporate expenses for the year ended December 31, 2007 was due to the SAP implementation and on-going development related expenses incurred, offset by a decrease in legal expenses for the reasons described above.

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Other Income, Interest and Taxes

Other income for the year ended December 31, 2007 consists of a reversal of an estimate for our underpayment of payroll withholdings in a foreign jurisdiction from January 1, 1993 through December 31, 2005 of $5,232,000, as discussed above.

Overall net interest income was $9,594,000 (2.3% of revenues) in 2007 compared to $7,005,000 (1.4% of revenues) in 2006, an increase of $2,589,000 or 37.0%. This increase in net interest income was the result of higher average cash balances and higher average interest rates.

Our effective tax rate was 17.2% and 28.0% in 2007 and 2006, respectively. The $1,063,000 and $3,506,000 income tax benefit of options exercised during 2007 and 2006, respectively, were credited to additional paid-in capital and therefore did not impact the effective tax rate. The decrease in our effective tax rate in 2007 was mainly due to our geographic mix of sales, as international sales have become a larger portion of revenues, with these subsidiaries being profitable and to an increase in our tax-exempt interest income.

Net earnings decreased 49.2% to $39,073,000 or $1.10 per share (diluted earnings per share) in 2007 from $76,864,000 or $2.17 per share (diluted earnings per share) in 2006.

Adoption of FIN No. 48

On January 1, 2007, we adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48 (“FIN No. 48”), “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109.” FIN No. 48 creates a single model to address the accounting for the uncertainty in income tax positions and prescribes a minimum recognition threshold a tax position must meet before recognition in the financial statements.

The evaluation of a tax position in accordance with FIN No. 48 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. FIN No. 48 allows the Company to prospectively change its accounting policy as to where interest expense and penalties on income tax liabilities are classified. Effective January 1, 2007, we changed our accounting policy and began to classify interest expense and penalties on income tax liabilities in income tax expense on our Consolidated Statement of Earnings. Prior to January 1, 2007, interest expense and penalties were recognized as a reduction to net interest income and an increase to selling, general and administrative expenses, respectively, on our Consolidated Statement of Earnings. 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.

Upon the adoption of FIN No. 48, we recognized a cumulative effect to beginning retained earnings of $2,575,000 and at December 31, 2007, we recognized uncertain tax positions, net of federal benefit, of $4,947,000, which includes interest, net of federal benefit, of $439,000, which was recognized in other liabilities.

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Liquidity and Capital Resources

We experienced a net cash inflow of $16,288,000, $42,515,000 and $71,998,000 from our operating activities during 2008, 2007 and 2006, respectively. Cash provided by operations in 2008 decreased from 2007 due primarily to the decrease in net earnings and to the difference in the amounts in changes in accounts receivable and accounts payable and accrued liabilities, offset by changes in prepaid expenses and other assets and by stock-based compensation and depreciation and amortization. Cash provided by operations in 2007 decreased from 2006 due primarily to the decrease in net earnings and to the difference in the amounts in changes in inventories, offset by changes in accounts receivable, accounts payable and accrued liabilities and by the excess income tax benefit of stock-based compensation.

We had a net outflow of cash of $13,749,000, $10,485,000 and $9,425,000 from our investing activities during 2008, 2007 and 2006, respectively. The increase in investing activities in 2008 is due to the purchase of intangible assets and the purchase of Palladium offset by lower purchases of property, plant and equipment during 2008. The increase in investing activities in 2007 is due to the purchase of property, plant and equipment. The purchases in property, plant and equipment in 2008 and 2007 is primarily due to the implementation of SAP information management software.

In 2008, 2007 and 2006, the net outflow of cash of $76,299,000, $5,091,000 and $2,197,000, respectively, from our financing activities was used for the purchase of our outstanding stock under our current stock repurchase program and to pay cash dividends (including our special cash dividend of $2.00 per share on December 24, 2008), partially offset by proceeds from stock options exercised and by the excess income tax benefit of stock-based compensation.

We anticipate future cash needs for principal repayments required pursuant to borrowings under our lines of credit facilities. In addition, depending on our future operating results, additional funds may be required by operating activities. No other material capital commitments exist at December 31, 2008. With continued use of our revolving credit facilities (as discussed below), we believe our present and currently anticipated sources of capital are sufficient to sustain our anticipated capital needs for the remainder of 2009.

On October 26, 2004, the Board of Directors authorized a stock repurchase program to supplement prior stock repurchase programs, which allows us to repurchase through December 2009, up to 5,000,000 shares of our Class A Common Stock from time to time on the open market, as market conditions warrant. As of December 31, 2008, a maximum of 3,911,289 shares may be repurchased pursuant to the stock repurchase program. We adopted this program because we believe that depending upon the then-array of alternatives, repurchasing our shares can be a good use of excess cash. Currently, we have made purchases under all stock repurchase programs from August 1996 through March 4, 2009 (the day prior to the filing of this Form 10-K) of 25.5 million shares at an aggregate cost totaling approximately $166,759,000, at an average price of $6.55 per share. See “Part II—Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”

Our domestic office has an agreement with a bank whereby we may borrow, in the form of an unsecured revolving credit facility, up to $15,000,000. The unused portion of this credit facility, which includes letters of credit and bankers acceptances, was $13,601,000 at December 31, 2008. This facility currently expires in July 2010. The credit facility provides for interest to be paid at the prime rate less 3/4% or, at our discretion and with certain restrictions, other market based rates. We pay a commitment fee of 1/8% of the unused line for availability of the credit facility. We must meet certain restrictive financial covenants as agreed upon in the facility. At December 31, 2008, we were in compliance with all relevant covenants under our $15,000,000 credit facility.

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Our Asian offices have agreements with a bank whereby they can borrow up to $5,500,000 in the form of unsecured revolving credit facilities. There were no borrowings on these credit facilities at December 31, 2008. Interest is to be paid on one facility at LIBOR plus 1.25% and on the other facility at the Australian Bank Bill Buying Rate plus 1.25%. These facilities currently expire in July 2010.

Our European offices (excluding Palladium, see discussion below) have agreements with a bank whereby they can borrow up to $7,000,000 in the form of unsecured revolving credit facilities. There were no borrowings on these credit facilities at December 31, 2008. Interest is to be paid on one facility at a rate of LIBOR plus 1.25% and on the other facility at IBOR plus 1.25%. One facility currently expires in July 2010 and the other facility is mutually cancellable at any time.

Our Canadian office has an agreement with a bank whereby it can borrow up to $2,000,000 in the form of an unsecured revolving credit facility. There were no borrowings on this credit facility at December 31, 2008. Interest is to be paid on the facility at the Canadian Prime Rate. This facility currently expires in July 2010.

At December 31, 2008, Palladium has agreements with various banks whereby it can borrow up to €6,300,000 (or approximately $8,801,000) in the form of secured lines of credit at variable interest rates ranging from 3.75% to 4.95%. At December 31, 2008, $4,032,000 was outstanding on these lines of credit. These lines of credit have maturity dates ranging from June 30, 2009 through December 31, 2009. In addition, Palladium has secured and unsecured term loans with various banks that carry a fixed rate of interest ranging from 5.42% to 5.84%, mature between February 2012 through February 2013 and carry outstanding balances totaling $1,314,000 at December 31, 2008. Accrued interest on all these facilities was $30,000 at December 31, 2008. At December 31, 2008, we were in compliance with all relevant covenants under these credit facilities. See Note D to our Consolidated Financial Statements for further discussion.

At December 31, 2008, the Company had debt outstanding of $5,376,000 (attributable to Palladium) and at December 31, 2007 there was no funded debt (excluding outstanding letters of credit of $1,399,000 and $1,831,000 at December 31, 2008 and 2007, respectively). Approximately $213,000 in interest expense was incurred for the year ended December 31, 2008 related to these bank loans and lines of credit. Interest expense was not incurred on the Company’s lines of credit for the year ended December 31, 2007.

Our working capital decreased $74,019,000 to $281,307,000 at December 31, 2008 from $355,326,000 at December 31, 2007. Working capital decreased during 2008 mainly due to a payment of a special cash dividend of $2.00 per share and increases in bank lines of credit and accounts payable, offset by an increase in inventory and a decrease in accrued liabilities at December 31, 2008 compared to December 31, 2007.

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.

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Contractual Obligations

At December 31, 2008, our significant contractual obligations were as follows (in thousands):

Off-Balance Sheet Arrangements

We did not enter into any off-balance sheet arrangements during 2008 or 2007, nor did we have any off-balance sheet arrangements outstanding at December 31, 2008 or 2007.

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. Accordingly, to date, inflation and changing prices have not had a material adverse effect on our revenues or earnings.

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, U.S. dollar and the Pound Sterling 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

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between the U.S. dollar and the Euro, U.S. dollar and the Pound Sterling and between the Euro and the Pound Sterling. In 2008 and 2007, we entered into forward foreign exchange contracts to exchange Euros for U.S. dollars, Pound Sterling 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 are generally expected to settle in less than one year.

The forward foreign exchange contracts generally require us to exchange Euros for U.S. dollars, Pound Sterling 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, 2008, forward foreign exchange contracts with a notional value of $21,755,000 were outstanding to exchange various currencies with maturities ranging from January 2009 to September 2009, to sell the equivalent of approximately $1,865,000 in foreign currencies at contracted rates and to buy approximately $19,890,000 in foreign currencies at contracted rates. These contracts have been designated as cash flow hedges. As of December 31, 2008, the fair value of forward exchange contracts of $2,703,000 and $438,000 have been recorded to prepaid expenses and other current assets and accrued liabilities, respectively, on our Consolidated Balance Sheet. Realized losses of $1,708,000, $2,258,000 and $129,000 from cash flow hedges were recorded in cost of goods sold during the years ended December 31, 2008, 2007 and 2006, respectively. Realized gains of $1,604,000, realized losses of $99,000 and realized gains of $38,000 from cash flow hedges were recorded in selling, general and administrative expenses due to hedge ineffectiveness during the years ended December 31, 2008, 2007 and 2006, respectively. Cash flows from these forward foreign exchange contracts are classified in the same category as the cash flows from the items being hedged on our Consolidated Statements of Cash Flows.

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, 2008, 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.

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

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Board of Directors and Stockholders

K•Swiss Inc.

We have audited K•Swiss Inc.’s (a Delaware Corporation) internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). K•Swiss Inc.’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 K•Swiss Inc.’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, K•Swiss Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, 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 balance sheets of K•Swiss Inc. as of December 31, 2008 and 2007, and the related consolidated statements of earnings and comprehensive earnings, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008 and our report dated March 4, 2009 expressed an unqualified opinion on those financial statements.

/s/ GRANT THORNTON LLP

Los Angeles, California

March 4, 2009

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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, 2008 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, 2008.

Grant Thornton LLP, the 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.

March 4, 2009

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

K•Swiss Inc.

We have audited the accompanying consolidated balance sheets of K•Swiss Inc. (a Delaware corporation) and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of earnings and comprehensive earnings, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. Our audits of the basic 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. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 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 financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

As discussed in Note A9 to the consolidated financial statements, as of January 1, 2007, K•Swiss Inc. adopted FASB Interpretation No. 48 (“FIN No. 48”), Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), K•Swiss Inc.’s internal control over financial reporting as of December 31, 2008, 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 March 4, 2009 expressed an unqualified opinion thereon.

/s/ GRANT THORNTON LLP

Los Angeles, California

March 4, 2009

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K•SWISS INC.

CONSOLIDATED BALANCE SHEETS

December 31,

(Dollar amounts in thousands)

The accompanying notes are an integral part of these statements.

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K•SWISS INC.

CONSOLIDATED STATEMENTS OF EARNINGS

AND COMPREHENSIVE EARNINGS

Year Ended December 31,

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

The accompanying notes are an integral part of these statements.

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K•SWISS INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Three years ended December 31, 2008

(Dollar amounts in thousands)