Form 10-K

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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange 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, 2006, 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 $693,999,083.

The number of shares of the Registrant’s Class A Common Stock outstanding at February 21, 2007 was 26,507,033 shares. The number of shares of the Registrant’s Class B Common Stock outstanding at February 21, 2007 was 8,100,128 shares.

Portions of the proxy statement for the Registrant’s 2007 Annual Stockholders Meeting are incorporated by reference into Part III.

K•Swiss Inc. (“K•Swiss,” “we,” “us” and “our”) 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 brand. Royal Elastics, a wholly owned subsidiary, is a leading innovator of slip-on, laceless footwear. Sales of Royal Elastics brand were not significant during 2006.

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. We have emphasized in our marketing the 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 President. 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 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 (“Royal”), 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.

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

K•Swiss is a corporation and 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.

Our product strategy is two pronged. The first combines classic styling with high quality components and technical features designed to meet performance requirements of specific sports. We endeavor to use classic styling to reduce the impact of changes in consumer preferences as we believe that this strategy leads to longer product life cycles than are typical of the products of certain of our competitors. We believe that long product life cycles reduce total markdowns over the life of the products, thereby enhancing their attractiveness to retailers. This strategy also enables us to maintain inventory with less risk of obsolescence than is typical of more fashion-oriented products. The second product strategy uses fashion-oriented footwear sold principally on a futures only basis usually with little or no planned inventory position taken on these products. This strategy allows us to take advantage of trends in the marketplace that we identify while attempting to minimize the risk generally associated with this type of product.

Presently, we compete in the Classic category (casual), training, basketball, tennis 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.

The following table summarizes our K•Swiss brand footwear into categories and sets forth the approximate contribution to revenues (in dollars and as a percentage of revenues) attributable to each footwear category for the periods indicated. All footwear categories come in both men’s (approximately 51% of 2006 revenues) and women’s (approximately 29% of 2006 revenues). Most styles within each footwear category are offered in men’s, women’s and children’s.

During 2006, the Foot Locker group of stores and affiliates accounted for approximately 16% of K•Swiss revenues. See Note K to our Consolidated Financial Statements. No other customer accounted for more than 10% of total revenues during this period.

Our product line through 1987 was primarily the Classic. The Classic 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. In 2000, we launched Classic Luxury Edition, which sells for slightly more than the original version.

The Classic, fueled by new products, has evolved into a category of shoes referred to as the Classic category. The Classic category is comprised of the Classic original, as described above, and its derivatives, and other casual athletic styles.

The Classic originals segment contains shoes that we intend to carry in our product assortment for several years. They generally have shoe characteristics such as d-rings and five stripes, and, because they are multiple season shoes, we maintain significant inventory positions of this segment. 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 other casual athletic styles category includes the K•S Collection which comprises shoes offered for several seasons and they generally do not contain d-rings and have diffused or no stripes. Sometimes inventory is maintained on these products. Other casual athletic styles also includes the Limited Edition segment which is generally meant as a one-season offering. They are generally fashionable type shoes that are purchased from factories based only on futures orders received from retailers.

In 2000, we entered the training performance category to compete with moderately priced running shoes and moderately priced cross training shoes. In 2004, we entered the basketball category, which is included in the training category in the above table.

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 new markets from an urban distribution to an upscale suburban consumer.

In 1999, we introduced a new 7.0 line of high tech tennis apparel to complement our performance 7.0 footwear. The product line consists of world-class apparel (skirts, shorts, tops, polos, dresses and warm-ups) for both men and women. We also offer a collection for the casual athletic consumer consisting of tee shirts, caps, socks and bags.

The apparel line is distributed through large chain sporting goods stores as well as independent shoe and sporting goods dealers nationwide. The tennis apparel line is sold primarily through tennis specialty and tennis pro shops. It also offers us visible promotional opportunities.

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. We also sell through our website which is becoming increasingly important 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, a sales team and distributors in Asia and Europe, respectively.

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

We believe that 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 quality and service. Television is our largest single marketing expenditure and is supported by magazine print advertising and our website.

The K•Swiss website (www.kswiss.com) was created in 1999 to provide consumers an opportunity to purchase our footwear, apparel and accessories at prices competitive with our retailers and have it shipped directly to them. Our website is visually integrated into the current United States television and print 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. 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 terms on initial orders of new styles.

Domestically, we use 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 43 independent regional sales representatives and 18 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 2,600, 2,700 and 2,900 separate accounts as of December 31, 2006, 2005 and 2004, respectively.

We maintain a customer service department consisting of 18 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.”

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 through television and 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.

By the end of 2006, K•Swiss was working through 7 international subsidiaries and 15 distributors to market K•Swiss products in potentially 86 countries.

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.

We maintain 371,000 square feet of warehouse space at two leased facilities 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 size of order, customer location and availability of inventory. Distribution to European customers and certain other European distributors is based out of the Netherlands office public distribution facility. 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.”

We maintain offices in Westlake Village, California, Taipei, Taiwan and Taichung, Taiwan 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.

In 2006, approximately 98% of our footwear products were manufactured in China and 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.

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 2006, our apparel and accessory products were manufactured in China, Taiwan, Korea, Vietnam 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 where 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 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 footwear ranging from 6.0% to 20.0% plus, for certain styles, $0.90 per pair, and duties on moderately priced textile footwear ranging from 20.0% to 37.5%. Our footwear products 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 of 16.5% for footwear that is considered non-technical or has a landed cost of under €7.00. Currently, approximately 99% of our footwear volume is derived from sales of leather footwear and approximately 1% of our footwear volume is derived from sales of synthetic and textile footwear.

A large portion of our imported products are manufactured in the People’s Republic of China (“China”). 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 indicated that the United States government will consider filing a case against China in the WTO if China does not more readily fulfill its obligations. 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.

At December 31, 2006 and 2005, total futures orders with start ship dates from January through June 2007 and 2006 were approximately $168,872,000 and $217,895,000, respectively, a decrease of 22.5%. The 22.5% decrease in total futures orders is comprised of a 13.6% decrease in the first quarter 2007 futures orders and a 35.5% decrease in the second quarter 2007 futures orders. At December 31, 2006 and 2005, domestic futures orders with start ship dates from January through June 2007 and 2006 were approximately $83,954,000 and $148,698,000, respectively, a decrease of 43.5%. At December 31, 2006 and 2005, international futures orders with start ship dates from January through June 2007 and 2006 were approximately $84,918,000 and $69,197,000, respectively, an increase of 22.7%. “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.

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 generally may be canceled by customers without financial penalty. We believe our rate of customer cancellations of domestic orders approximates industry averages for similar companies. Customers may also reject nonconforming goods. To date, we believe we have not experienced returns of our products or bad debts of customers materially in excess of industry averages for similar companies.

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.

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. 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.

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. 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. 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 D.R. Cinch System^®, the stability design incorporated into the Si-18^® tennis shoe, and other features. 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.

At December 31, 2006, we employed 236 persons in the United States, 201 persons in Korea, Taiwan and China, 73 persons in the United Kingdom, Germany, France and the Netherlands and 12 persons elsewhere.

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 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 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, our 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 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 may 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.

Furthermore, consumer preferences and purchasing patterns may be 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 and factors such as employment, business conditions, consumer confidence, interest rates and taxation.

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 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 generally may be cancelled by customers without financial penalty. We believe our current rate of customer cancellations of domestic orders approximates industry averages for similar companies; however, there is no assurance this current rate of customer cancellations will not change in a material adverse manner in the future. Customers may also reject nonconforming goods. To date, we believe we have not experienced returns of our products or bad debts of customers materially in excess of industry averages for similar companies; however, there is no assurance our past experience in this area will continue in the future. 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.

Our largest customer accounted for approximately 15% of our total revenues in 2006. While no other customer accounted for more than 10% of our total revenues in 2006, we do have other 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 directly related to the success of our customers and the willingness and financial resources of our customers to continue to buy our products. We do not have long-term contracts with any of our customers. Sales to our customers are generally on an order-by-order basis and are subject to rights of cancellation and rescheduling by our customers. If we cannot fill our customers’ orders in a timely manner, our relationships with our customers may suffer, and this could have a material adverse effect on us. Furthermore, if any of our major customers experiences a significant downturn in its business, or fails to remain committed to our products or brands, then these

customers may reduce or discontinue purchases from us, which could have a material adverse effect on our business, results of operations and financial conditions.

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 will be adversely affected.

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, general weakness in retail markets and changes in consumer purchasing power and preferences. Adverse changes in such economic factors could have a negative effect on our business.

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, we have experienced revenue growth in international markets. Additionally, all of our footwear products are manufactured abroad and we have suppliers located in China 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 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 heavily on manufacturing facilities located in China. In 2006, 98% of our footwear manufacturing occurred in China. We also rely upon the availability of sufficient production capacity at our manufacturers. Delivery of product depends on many 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.

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 and Rotterdam, the Netherlands. 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 either 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 a resulting loss of sales.

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 effect our business and ability to generate revenue.

Our brands and designs are constantly at risk for counterfeiting and infringement of our intellectual property rights, 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 not only cause us to lose significant sales, but also can

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. We may need to resort to litigation in the future to enforce our intellectual property rights. This litigation could result in substantial costs and may require the devotion of substantial resources.

We 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. 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 for earnings on certain subsidiary companies that we have declared 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 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, 2006, Steven Nichols held approximately 92% of the voting power of our Class B Common Stock taken as a whole and approximately 70% of total voting power. This voting power

would permit this stockholder 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 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.

Our business may be adversely affected if we encounter complications in connection with our implementation of SAP information management software.

In 2007 and over the next few years we will continue our implementation of SAP information management software in our domestic and international operations. The implementation of such software could be delayed and we may encounter computer and operational complications in connection with such implementation that could have a material adverse effect on our business, financial condition or results of operations.

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 $82,000. We lease another 62,000 square feet in a separate facility in Mira Loma, California for additional storage and distribution. The effective monthly commitment for this facility is approximately $23,000 per month. In July 2006, we exercised an option under both leases to extend the term of the leases for three years until January 2010.

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.

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

Steven Nichols has been President 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 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.

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.

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 2006 and 2005 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, 2006 was 108. However, based on available information, we believe that the total number of Class A Common stockholders, including beneficial stockholders, is approximately 12,800.

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, 2006 was 11.

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 29, 2000 and dividends are reinvested for all years ending December 31.

The Board of Directors declared a quarterly dividend of 2.5 cents per share to all stockholders of record as of the close of business on the last day of the first quarter of 2005. The Board declared a quarterly dividend of 5 cents per share to all stockholders of record as of the close of business on the last day of the second, third, and fourth quarters of 2005 and all quarters of 2006. The payment of any future dividends will be at the discretion of our Board of Directors and will depend upon, among other things, future earnings, operations, capital requirements, our general financial condition and general business conditions. 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 following table provides information with respect to purchases made by K•Swiss of K•Swiss Class A Common Stock during the fourth quarter of 2006:

The selected consolidated financial data presented below for each of the five years in the period ended December 31, 2006 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 2005, 2004, 2003 and 2002 presentations to conform to the 2006 presentation.

“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: our training shoe line, our new Limited Edition product, our basketball shoe line, our classic and non-performance product, Royal Elastics footwear (including the L.A.M.B. product) and our apparel product; 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; 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 commercialization; the ability to secure and protect trademarks, patents, and other intellectual property; inadvertent and nonwillfill 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 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 (the “Company,” “we,” “us,” and “our”) operates in a very competitive and rapidly changing environment. New risk factors can arise and it is not possible for management to predict all

such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

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

The Company designs, develops and markets 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 brand. Royal Elastics is our wholly owned subsidiary. The categories of footwear we sell are explained in more detail in Item 1, under the subheading, “Products.” We market 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. We also sell our products through our website and internationally through Company sales managers, independent sales representatives and a number of foreign distributors.

In 2006, approximately 98% 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 will 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 the customer, our revenues may fluctuate in cases when our customers delay accepting shipment of products. Our total revenues decreased 1.5% in 2006 from 2005, due to a decrease in the volume of footwear sold offset by an increase in the average underlying wholesale price, and our overall gross profit margins, as a percentage of revenues, were 47.3% and 46.7% in 2006 and 2005, respectively. Our overall selling, general and administrative expenses also increased to 27.4% of revenues in 2006 from 25.6% of revenues in 2005.

At December 31, 2006, our total futures orders with start ship dates from January through June 2007 were $168,872,000, a decrease of 22.5% from the comparable period of the prior year. Of this amount, domestic futures orders were $83,954,000, a decrease of 43.5%, and international futures orders were $84,918,000, an increase of 22.7%. Notwithstanding the foregoing, we recognize that the athletic footwear industry is highly competitive. Several makers of footwear have substantially greater financial, distribution and marketing resources as well as greater brand awareness than us.

In 2006, 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 independent sales representatives sold to approximately 2,600 separate accounts as of December 31, 2006 (down from 2,700 as of December 31, 2005). Internationally, by the end of 2006, we were working through 7 international subsidiaries and 15 distributors to market our products in potentially 86 countries. Also, during 2006, the Foot Locker group of stores and its affiliates accounted for approximately 15% of total revenues.

In 2006, we had a net cash inflow of approximately $71,998,000 from operating activities and a net cash outflow of $9,425,000 from investing activities due to the net purchase of property, plant and equipment. We anticipate future cash needs for principal repayments required pursuant to any borrowings under our lines of credit and, depending on future growth, additional funds may be required by operating activities.

There was no debt outstanding at December 31, 2006 and 2005 and our working capital increased $58,555,000 to approximately $324,378,000 at December 31, 2006 from $265,823,000 at December 31, 2005.

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 basis for making judgments about the carrying values of assets and liabilities. In the past, actual results have not been materially different from our estimates. However, results may differ from these estimates under different assumptions or conditions.

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

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.

We make ongoing estimates relating to the collectibility of our accounts receivables 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 conditions at retail. 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.

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.

We account for income taxes under an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. 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 for earnings on certain subsidiary companies that we have declared 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. The estimated annual effective tax rate is then applied to estimated pre-tax income excluding significant or infrequently occurring items, 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.

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.

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

Total revenues decreased 1.5% to $501,148,000 in 2006 from $508,574,000 in 2005. 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 5.5% to 18,431,000 pair in 2006 from 19,495,000 pair in 2005. The average wholesale price per pair was $26.48 in 2006 and $25.48 in 2005, an increase of 3.9%.

Domestic revenues decreased 16.2% to $318,687,000 in 2006 from $380,478,000 in 2005. International product revenues increased 42.3% in 2006 to $178,307,000 from $125,282,000 in 2005. Fees earned by the Company on sales by foreign licensees and distributors were $4,154,000 for 2006 and $2,814,000 for 2005. International revenues, as a percentage of total revenues, increased to 36.4% in 2006 from 25.2% in 2005.

K•Swiss brand revenues decreased 1.9% to $489,271,000 in 2006 from $498,929,000 in 2005. 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 5.8% to 18,126,000 pair in 2006 from 19,236,000 pair in 2005. The average wholesale price per pair was $26.40 in 2006 and $25.44 in 2005, an increase of 3.8%, which resulted from an increase in the price of the Classic during the third quarter of 2005 and change in the mix of sales. The decrease in volume of footwear sold for the year ended December 31, 2006 was due to decreased sales of Classic and children’s categories of 8.8% and 2.6%, respectively, offset by increased sales of tennis and training (includes basketball) categories of 6.1% and 6.0%, respectively.

Royal Elastics brand revenues increased 23.1% to $11,877,000 in 2006 (26% domestic) from $9,645,000 in 2005 (41% domestic).

Customer acceptance of our domestic product has been weak and is likely to continue for the near term. We have recently 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.

We believe the athletic and casual footwear industry experiences seasonal fluctuations, due to increased domestic sales during certain selling seasons, including Easter, back-to-school and the year-end holiday season. We present full-line offerings for the Easter and back-to-school seasons, for delivery during the first and third quarters, respectively, but not for the year-end holiday season.

At December 31, 2006, domestic and international futures orders with start ship dates from January through June 2007 were approximately $83,954,000 and $84,918,000, respectively, 43.5% lower and 22.7% higher, respectively, than such orders were at December 31, 2005 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 47.3% in 2006 and 46.7% in 2005. Gross profit margin for 2006 was affected by product mix changes, international sales becoming a larger portion of revenues and changes in our at-once business. Our gross margins may not be comparable to some of our competitors as we recognize warehousing costs within selling, general and administrative expenses.

Overall selling, general and administrative expenses increased 5.7% to $137,527,000 (27.4% of revenues) in 2006 from $130,144,000 (25.6% of revenues) in 2005. The increase in selling, general and administrative expenses during the year ended December 31, 2006 was the result of increases in legal, compensation and warehousing expenses offset by a decrease in advertising expenses. Legal expenses increased 71.9% in connection with pursuing a lawsuit to protect our trademarks. Compensation expenses, which includes commissions, bonus/incentive related expenses and employee recruiting and relocation expenses, increased 3.2% primarily due to recognizing compensation expenses related to stock options as required by Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004) and an increase in headcount offset by a decrease in bonus/incentive related expenses that were calculated in accordance with our bonus formula under our Economic Value Added (“EVA”) incentive program. Warehousing expenses, other than compensation and compensation related expenses, increased 9.6% primarily as a result of higher freight and supply costs. Advertising expenses decreased 2.9%, primarily due to a decrease in domestic advertising expenses from an effort to reduce costs as a result of declining domestic revenues offset by an increase in our international advertising expenses as part of a strategic effort to drive higher revenues. Corporate expenses of $17,857,000 and $14,784,000 for the years ended December 31, 2006 and 2005, respectively, are included in selling, general and administrative expenses. The increase in corporate expenses during the year ended December 31, 2006 was due to an increase in legal expenses, as explained above.

On January 1, 2006, we adopted SFAS No. 123 (Revised 2004), “Share Based Payment,” using the modified prospective method. In accordance with SFAS No. 123 (Revised 2004), we measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award—the requisite service period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. We

determine the grant-date fair value of employee stock options using the Black-Scholes option-pricing model adjusted for the unique characteristics of these options. For the year ended December 31, 2006, we recognized $2,397,000, in compensation costs. In accordance with the modified prospective method, our Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123 (Revised 2004).

Prior to January 1, 2006, we accounted for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. In accordance with APB Opinion No. 25, compensation cost for stock options was measured as the excess, if any, of the quoted market price of our stock at the date of grant over the amount an employee must pay to acquire the stock. For the years ended December 31, 2005 and 2004, we recognized $249,000 and $345,000, respectively, in compensation costs. However, proforma net earnings and proforma earnings per share disclosures were provided as if the fair value of all stock options as of the grant date were recognized as expense over the vesting period in accordance with SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an Amendment of SFAS No. 123.”

Overall net interest income was $7,005,000 (1.4% of revenues) in 2006 compared to $3,333,000 (0.6% of revenues) in 2005, an increase of $3,672,000 or 110.2%. This increase in net interest income was the result of higher average cash balances and higher average interest rates.

Our effective tax rate was 28.0% and 31.9% in 2006 and 2005, respectively. The $3,506,000 and $3,994,000 income tax benefit of options exercised during 2006 and 2005, respectively, were credited to additional paid-in capital and therefore did not impact the effective tax rate. Starting January 1, 2005, provision has not been made for United States income taxes on earnings of selected international subsidiary companies as these are intended to be permanently invested. The decrease in the effective tax rate 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 increased 2.1% to $76,864,000 or $2.17 per share (diluted earnings per share) in 2006 from $75,248,000 or $2.11 per share (diluted earnings per share) in 2005.

In September 2006, the S.E.C. released Staff Accounting Bulletin No. 108 (“SAB No. 108”), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB No. 108 addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current year financial statements. SAB No. 108 requires an entity to quantify misstatements using a balance sheet and income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. We adopted SAB No. 108 in the fourth quarter of 2006.

The transition provisions of SAB No. 108 permit us to adjust for the cumulative effect on retained earnings of immaterial errors relating to prior years. SAB No. 108 also requires the adjustment of any prior quarterly financial statements within the fiscal year of adoption for the effects of such errors on the quarters when the information is next presented. Such adjustments do not require previously filed reports with the S.E.C. to be amended.

In 2006, we determined that there was an underpayment of payroll withholdings in a foreign jurisdiction from January 1, 1993 through December 31, 2006. With the assistance of our tax advisors,

we estimated underpayment of withholdings of approximately $5,131,000 and related interest of approximately $5,974,000, totaling $11,105,000. We will finalize the amount owed with the government agency in early 2007. Amounts relating to January 1 through December 31, 2006 were $846,000, net of taxes, and recognized by us in the fourth quarter of 2006. Amounts relating to January 1, 1993 through December 31, 2005 were $10,136,000. For the same period, it was determined that EVA bonuses be reduced by approximately $1,400,000, which also resulted in a decrease of the related deferred tax asset of approximately $416,000. The Federal income tax benefit related to these adjustments for prior years is approximately $870,000. In accordance with SAB No. 108, we have adjusted beginning retained earnings for the year ended December 31, 2006 by $7,866,000. Penalties are discretionary, ranging from zero to 300% of the taxes owed, and at this time we cannot determine the likelihood of such assessment and have not recognized penalties related to this issue. However, there can be no guarantee that penalties will not be imposed.

We believe that the net effect of these adjustments were not material, either quantitatively or qualitatively, in any of the years affected. In reaching that determination, the following measures were considered (dollar amounts in thousands):

Total revenues increased 5.1% to $508,574,000 in 2005 from $484,079,000 in 2004. This increase was attributable to an increase in the volume of footwear sold and an increase in the average underlying wholesale price per pair. The volume of footwear sold increased 2.5% to 19,495,000 pair in 2005 from 19,014,000 pair in 2004. The average wholesale price per pair was $25.48 in 2005 and $24.94 in 2004.

Domestic revenues decreased 4.3% to $380,478,000 in 2005 from $397,390,000 in 2004. International product revenues increased 48.1% in 2005 to $125,282,000 from $84,603,000 in 2004. Fees earned by the Company on sales by foreign licensees and distributors were $2,814,000 for 2005 and $2,086,000 for 2004. International revenues, as a percentage of total revenues, increased to 25.2% in 2005 from 17.9% in 2004.

K•Swiss brand revenues increased 4.6% to $498,929,000 in 2005 from $477,209,000 in 2004. This increase was the result of an increase in the volume of footwear sold at slightly higher average wholesale prices per pair. The volume of footwear sold increased 3.0% to 19,236,000 pair in 2005 from 18,683,000 pair in 2004. The average wholesale price per pair was $25.44 in 2005 and $25.03 in 2004, an increase of 1.6%, which resulted from an increase in the price of the Classic during the third quarter of 2005 and changes in the mix of sales. The increase in volume of footwear sold for the year ended December 31, 2005 was due to increased sales of Classic and children’s categories of 5.8% and 4.3%, respectively, offset by decreased sales of tennis and training (includes basketball) categories of 21.4% and 7.4%, respectively.

Royal Elastics brand revenues increased 40.4% to $9,645,000 in 2005 (41% domestic) from $6,870,000 in 2004 (33% domestic).

Overall gross profit margins, as a percentage of revenues, were 46.7% in 2005 and 45.7% in 2004. Gross profit margin for 2005 was affected by product mix changes, international sales becoming a larger portion of revenues and changes in our at-once business.

Overall selling, general and administrative expenses increased 6.4% to $130,144,000 (25.6% of revenues) in 2005 from $122,262,000 (25.3% of revenues) in 2004. The increase in selling, general and administrative expenses during the year ended December 31, 2005 was the result of increases in advertising, legal and warehousing expenses. In addition, impairment expenses of $2,776,000 were recognized during the year ended December 31, 2004 on the trademark and goodwill of the Royal Elastics brand based on many factors including the brand not growing as rapidly as we expected and bad debt expenses decreased 89.1% as a result of the write-off of The Athlete’s Foot account in 2004 due to the bankruptcy of that company. Advertising expenses increased 12.8% for the year ended December 31, 2005 as part of a strategic effort to drive higher revenues. Legal expenses increased 158.5% for the year ended December 31, 2005 in connection with pursuing a lawsuit to protect our trademarks. Warehousing expenses, excluding compensation and compensation related expenses, increased 22.4% as a result of the increase in revenues and increased costs of transportation. Corporate expenses of $14,784,000 and $12,713,000 for the year ended December 31, 2005 and 2004, respectively, are included in selling, general and administrative expenses. The increase in corporate expenses during the year ended December 31, 2005 was due to an increase in legal expenses as explained above.

Overall net interest income was $3,333,000 (0.6% of revenues) in 2005 compared to $1,038,000 (0.2% of revenues) in 2004, an increase of $2,295,000 or 221.1%. This increase in net interest income was the result of higher average cash balances and higher average interest rates, offset slightly by interest expense on our lines of credit.

Our effective tax rate was 31.9% and 28.7% in 2005 and 2004, respectively. The $3,994,000 and $3,899,000 income tax benefit of options exercised during 2005 and 2004, respectively, were credited to additional paid-in capital and therefore did not impact the effective tax rate. The lower effective tax rate for the year ended December 31, 2004 is principally attributed to the repatriating dividends of $22,700,000 related to foreign subsidiaries earnings, which were not considered indefinitely invested, with an 85% dividends received deduction, for eligible dividends, under the American Jobs Creation Act of 2004.

Net earnings increased 5.6% to $75,248,000 or $2.11 per share (diluted earnings per share) in 2005 from $71,251,000 or $1.96 per share (diluted earnings per share) in 2004.

We experienced a net cash inflow of approximately $71,998,000, $94,200,000 and $85,481,000 from our operating activities during 2006, 2005 and 2004, respectively. Cash provided by operations in 2006 decreased from 2005 due primarily to differences in the amounts in changes in accounts payable and accrued liabilities, accounts receivables, prepaid expenses and other assets, inventories and by the difference in the changes in the income tax benefit of stock options exercised and by the excess income tax benefit of stock-based compensation, offset by stock based compensation. Cash provided

by operations in 2005 increased from 2004 due primarily to differences in the amounts in changes in deferred income taxes and accounts receivable, offset by differences in the amounts in changes in inventories and accounts payable and accrued liabilities.

We had a net outflow of cash from our investing activities during 2006, 2005 and 2004 due to the net purchase of property, plant and equipment. The increase in investment in 2006 is due to the implementation of SAP information management software. In 2007 and over the next few years we will continue our implementation of SAP information management software in our domestic and international operations.

In 2006, 2005 and 2004, the net outflow of cash from our financing activities was used for the purchase of our outstanding stock under our current stock repurchase program and to pay cash dividends, partially offset by proceeds from stock options exercised. For 2006, cash outflows from our financing activities were also offset by the excess income tax benefit of stock-based compensation. For 2005, cash outflows from financing activities were also due to net repayments on borrowings on our bank lines of credit.

We anticipate future cash needs for principal repayments required pursuant to any borrowings under our lines of credit facilities. In addition, depending on our future growth rate, additional funds may be required by operating activities. No other material capital commitments exist at December 31, 2006. With continued use of our revolving credit facility (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 2007.

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. We adopted this program because we believe repurchasing our shares can be a good use of excess cash depending on our array of alternatives. Currently, we have made purchases under all stock repurchase programs from August 1996 through February 21, 2007 (the day prior to the filing of the Form 10-K) of 25.3 million shares at an aggregate cost totaling approximately $164,229,000, at an average price of $6.49 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 $14,915,000 at December 31, 2006. This facility currently expires in July 2007. 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.

Our Asian offices have agreements with a bank whereby they can borrow up to $7,500,000 in the form of unsecured revolving credit facilities. There were no borrowings on these credit facilities at December 31, 2006. 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 2007.

Our European offices have agreements with a bank whereby they can borrow up to $4,500,000 in the form of unsecured revolving credit facilities. The unused portion of these credit facilities, which includes letters of credit and bankers acceptances, was $4,389,000 at December 31, 2006. 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 2007 and the other facility is mutually cancellable at anytime.

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, 2006. Interest is to be paid on the facility at the Canadian Prime Rate. This facility currently expires in July 2007.

At December 31, 2006 and 2005 there was no funded debt (excluding outstanding letters of credit of $196,000 and $675,000 at December 31, 2006 and 2005, respectively). Approximately $197,000 and $5,000 in interest expense was incurred for the years ended December 31, 2005 and 2004, respectively, related to these lines of credit.

At December 31, 2006, we were in compliance with all relevant covenants under each of the credit facilities described above.

Our working capital increased $58,555,000 to $324,378,000 at December 31, 2006 from $265,823,000 at December 31, 2005. Working capital increased during 2006 mainly due to an increase in cash and a decrease of accounts payable balances, offset by an increase in accrued liabilities and decreases in inventories and accounts receivable balances at December 31, 2006 compared to December 31, 2005.

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 Mira Loma, California distribution center to meet at-once orders.

At December 31, 2006, our significant contractual obligations were as follows (in thousands):

We did not enter into any off-balance sheet arrangements during 2006 or 2005, nor did we have any off-balance sheet arrangements outstanding at December 31, 2006 or 2005.

Market risk is the potential change in an instrument’s value caused by, for example, fluctuations in interest and currency exchange rates. Our primary market risk exposure is the risk of unfavorable movements in exchange rates between the U.S. dollar and the Euro and between the Euro and 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.

Sales denominated in currencies other than the U.S. dollar, which are primarily sales to customers in Europe, expose us to market risk from material movements in foreign exchange rates between the U.S. dollar and the foreign currency. Our primary risk exposures are from changes in the rates between the U.S. dollar and the Euro and between the Euro and Pound Sterling. In 2006 and 2005, we entered into forward foreign exchange contracts to exchange Euros for U.S. dollars and Pounds 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 occur in less than one year.

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

At December 31, 2006, forward foreign exchange contracts with a notional value of $50,680,000 were outstanding to exchange various currencies with maturities ranging from January 2007 to August 2007, to sell the equivalent of approximately $21,780,000 in foreign currencies at contracted rates and to buy $28,900,000 at contracted rates. These contracts have been designated as cash flow hedges. As of December 31, 2006, assets of $20,000 and liabilities of $1,161,000 have been recorded for the fair value of the forward foreign exchange contracts. Realized losses of $129,000 and $634,000 and realized gains of $46,000 from cash flow hedges were recorded in cost of goods sold during the years ended December 31, 2006, 2005 and 2004, respectively. Realized gains of $38,000, $116,000 and $14,000 from cash flow hedges were recorded in selling, general and administrative expenses due to hedge ineffectiveness during the years ended December 31, 2006, 2005 and 2004, respectively.

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, 2006, a 1% change in currency rates would not have had a material effect on the financial position, results of operations and cash flows of the Company.

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 had a material effect on the financial position, results of operations and cash flows of the Company.

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, without a significant loss in sales. Accordingly, to date, inflation and changing prices have not had a material adverse effect on our revenues or earnings.

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

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that K•Swiss Inc. maintained effective internal control over financial reporting as of December 31, 2006, 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. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and the operating effectiveness of internal control, 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, management’s assessment that K•Swiss Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, K•Swiss Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

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, 2006 and 2005, 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, 2006 and our report dated February 14, 2007 expressed an unqualified opinion on those financial statements.

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, 2006 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, 2006.

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

We have audited the accompanying consolidated balance sheets of K•Swiss Inc. (the “Company”) as of December 31, 2006 and 2005, 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, 2006. These financial statements are the responsibility of management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of K•Swiss Inc. as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.

Our audits were conducted for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule II—Valuation and Qualifying Accounts is presented for the purposes of complying with the Securities and Exchange Commission’s rules and is not part of the basic financial statements. For each of the years ended December 31, 2006, 2005 and 2004, this schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole.

As discussed in Note A18 to the consolidated financial statements, K•Swiss Inc. adopted SFAS No. 123 (Revised 2004), “Share Based Payment,” using the modified prospective method. As discussed in Note A19 to the consolidated financial statements, the Company recorded a cumulative effect adjustment as of January 1, 2006, in connection with the adoption of the Securities and Exchange Commission Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.”

We have also audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the effectiveness of K•Swiss Inc.’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 14, 2007, expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

The Company designs, develops and markets footwear for high performance use, fitness and casual activities. The Company operates in an industry dominated by a small number of very large competitors. The size of these competitors enables them to lead the product direction of the industry, and therefore, potentially diminish the value of the Company’s products. In addition to generally greater resources, these competitors spend substantially more money on advertising and promotion than the Company and therefore dominate market share. The Company’s market share is estimated between two and three percent. Lastly, the retail environment forecasted for the near term is difficult, which could put additional pressure on the Company’s ability to maintain margins.

The Company purchases significantly all of its products from a small number of contract manufacturers in China. This concentration of suppliers in this location subjects the Company to the risk of interruptions of product flow for various reasons which could lead to possible loss of sales, which would adversely affect operating results.

The United States Trade Representative has expressed concern about the protection of intellectual property rights within China. The failure of the Chinese government to make substantial progress with respect to these concerns could result in the imposition of retaliatory duties on imports from China, including footwear, which could affect the cost of products purchased and sold by the Company.

In November 2001, the Company acquired the worldwide rights and business of Royal Elastics, an Australian-based designer and manufacturer of elasticated footwear. 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 preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities; the disclosure of contingent assets and liabilities at the date of the financial statements; and revenues and expenses during the reporting period. Actual results could differ from those estimates.

The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated. Certain reclassifications have been made in the 2005 and 2004 presentation to conform to the 2006 presentation.

For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Included in cash and cash equivalents as of December 31, 2006 and 2005 is $33,662,000 and $15,789,000, respectively, of balances maintained in foreign bank accounts.

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

Property, plant and equipment are carried at cost. Development costs related to the implementation of SAP information management software have been capitalized in accordance with Statement of Position 98-1, “Accounting for Software Developed or Obtained for Internal Use.” For financial reporting and tax purposes, depreciation and amortization are calculated using straight-line and accelerated methods over the estimated service lives of the depreciable assets. The service lives of the Company’s building and related improvements are 30 and 5 years, respectively. Equipment is depreciated from 3 to 10 years and leasehold improvements are amortized over the lives of the respective leases.

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

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

The Company accounts for income taxes under Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.” SFAS No. 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns.

Assets and liabilities of certain foreign operations are translated into U.S. dollars at current exchange rates. Income and expenses are translated into U.S. dollars at average rates of exchange

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

For certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, outstanding borrowings under the lines of credit, accounts payable and other accrued liabilities, the carrying amounts approximate fair value due to their short maturities.

Sales denominated in currencies other than the U.S. dollar, which are primarily sales to customers in Europe, expose the Company to market risk from material movements in foreign exchange rates between the U.S. dollar and the foreign currency. The Company’s primary risk exposures are from changes in the rates between the U.S. dollar and the Euro and between the Euro and Pound Sterling. In 2006 and 2005, the Company entered into forward foreign exchange contracts to exchange Euros for U.S. dollars and Pounds Sterling for Euros. The extent to which forward foreign exchange contracts are used is modified periodically in response to management’s estimate of market conditions and the terms and length of specific sales contracts.

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

The forward foreign exchange contracts generally require the Company to exchange Euros for U.S. dollars or Pounds Sterling for Euros at maturity, at rates agreed at the inception of the contracts. The counterparty to derivative transactions is a major financial institution with an investment grade or better credit rating; however, the Company is exposed to credit risk with this institution. The credit risk is limited to the unrealized gains in such contracts should this counterparty fail to perform as contracted.

ended December 31, 2006, 2005 and 2004, respectively. Realized gains of $38,000, $116,000 and $14,000 from cash flow hedges were recorded in selling, general and administrative expenses due to hedge ineffectiveness during the years ended December 31, 2006, 2005 and 2004, 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 the Consolidated Statements of Cash Flows.

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

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

In accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-10, “Accounting for Shipping and Handling Fees and Costs,” shipping and handling costs billed to customers are included in sales and the related costs are included in selling, general and administrative expenses in the Consolidated Statements of Earnings. Shipping and handling costs included in selling, general and administrative expenses totaled $4,175,000, $3,686,000 and $3,175,000 for the years ended December 31, 2006, 2005 and 2004, respectively.

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

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

Advertising costs are expensed as incurred and are included in selling, general and administrative expenses. Advertising expenses amounted to $47,726,000, $50,059,000 and $44,293,000 for 2006, 2005 and 2004, respectively. The Company engages in cooperative advertising programs with its customers. The Company recognizes this expense, based on the expected usage of the programs, in advertising expense. The Company accounts for its cooperative advertising programs in accordance with Issue 1 of EITF No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).”

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

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

The following options were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares:

On January 1, 2006, the Company adopted SFAS No. 123 (Revised 2004), “Share Based Payment,” using the modified prospective method. In accordance with SFAS No. 123 (Revised 2004), the Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award—the requisite service period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. The Company determines the grant-date fair value of employee stock options using the Black-Scholes option-pricing model adjusted for the unique characteristics of these options.

In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48 (“FIN No. 48”), “Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109,” to create a single model to address the accounting for the uncertainty in income tax positions. FIN No. 48 also prescribes a minimum recognition threshold a tax position must meet before recognition in the financial statements. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

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.

FIN No. 48 is effective for fiscal years beginning after December 15, 2006. The cumulative effect of applying FIN No. 48 should be reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that fiscal year. The Company will adopt FIN No. 48 on January 1, 2007 and is currently assessing the impact of implementing FIN No. 48 on its financial position, operating results and cash flows.

income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. The Company adopted SAB No. 108 in the fourth quarter of 2006.

The transition provisions of SAB No. 108 permit the Company to adjust for the cumulative effect on retained earnings of immaterial errors relating to prior years. SAB No. 108 also requires the adjustment of any prior quarterly financial statements within the fiscal year of adoption for the effects of such errors on the quarters when the information is next presented. Such adjustments do not require previously filed reports with the S.E.C. to be amended.

In 2006, the Company determined that there is an underpayment of payroll withholdings in a foreign jurisdiction from January 1, 1993 through December 31, 2006. With the assistance of its tax advisors, the Company estimated the underpayment of withholdings of approximately $5,131,000 and related interest owed of approximately $5,974,000, totaling $11,105,000. The Company will finalize the amount owed with the government agency in early 2007. Amounts relating to January 1 through December 31, 2006 were $846,000, net of taxes, and recognized by the Company in the fourth quarter of 2006. Amounts relating to January 1, 1993 through December 31, 2005 were $10,136,000. For the same period, it was determined that the Economic Value Added bonuses be reduced by approximately $1,400,000, which also resulted in a decrease of the related deferred tax asset of approximately $416,000. The Federal income tax benefit related to these items is approximately $870,000. In accordance with SAB No. 108, the Company has adjusted beginning retained earnings for the year ended December 31, 2006 by $7,866,000. Penalties are discretionary, ranging from zero to 300% of the taxes owed, and at this time the Company cannot determine the likelihood of such assessment and has not recognized penalties related to this issue. However, there can be no guarantee that penalties will not be imposed.

The Company believes that the net effect of these adjustments were not material, either quantitatively or qualitatively, in any of the years affected. In reaching that determination, the following measures were considered (dollar amounts in thousands):

Property, plant and equipment as of December 31 consists of the following (in thousands):

There were no changes in the carrying amount of goodwill and intangible assets during 2006 and 2005.

In applying SFAS No. 142, the Company has performed the annual reassessment and impairment test required as of January 1, 2006 and 2005 to determine whether goodwill and intangible assets were impaired and determined there was no impairment. In the first quarter of 2004, as a result of the annual reassessment and impairment test and after a review of sales, backlog, cash flows and marketing strategy, the Company determined that its investment in the Royal Elastics goodwill and trademark was partially impaired and recognized an impairment loss of $1,730,000. During the third quarter of 2004, after a subsequent review of sales, backlog, cash flows and marketing strategy, the Company determined that its remaining investment in the Royal Elastics goodwill and trademark was impaired and recognized an additional impairment loss of $1,046,000.

At December 31, 2006 and 2005 there was no funded debt (excluding outstanding letters of credit of $196,000 and $675,000 at December 31, 2006 and 2005, respectively).

The Company’s domestic office has an agreement with a bank whereby it 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 $14,915,000 at December 31, 2006.

This facility currently expires in July 2007. The credit facility provides for interest to be paid at the prime rate less 3/4% or, at the Company’s discretion and with certain restrictions, other market based rates. The Company pays a commitment fee of 1/8% of the unused line for availability of the credit facility. The Company must meet certain restrictive financial covenants as agreed upon in the facility.

The Company’s Asian offices have agreements with a bank whereby they can borrow up to $7,500,000 in the form of unsecured revolving credit facilities. There were no borrowings on these credit facilities at December 31, 2006. 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 2007.

The Company’s European offices have agreements with a bank whereby they can borrow up to $4,500,000 in the form of unsecured revolving credit facilities. The unused portion of these credit facilities, which includes letters of credit and bankers acceptances, was $4,389,000 at December 31, 2006. 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 2007 and the other facility is mutually cancellable at anytime.

The Company’s 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, 2006. Interest is to be paid on the facility at the Canadian Prime Rate. This facility currently expires in July 2007.

The Company’s $15,000,000 unsecured revolving credit facility contains a cross-default provision which indicates that if any defaults occur on any of the above mentioned facilities, then the Company would be in default on its $15,000,000 credit facility. Upon default, the bank may do one or more of the following: declare the Company in default, stop making additional credit available to the Company, and/or require the Company to repay its entire debt immediately and without notice. Upon the occurrence of default, the interest rate will reprice at a rate of 2% higher than prime rate less 3/4%.

Interest expense was not incurred on the Company’s lines of credit for the year ended December 31, 2006. Interest expense of $197,000 and $5,000 was incurred during the years ended December 31, 2005 and 2004, respectively, as a result of the borrowings on its lines of credit.

The domestic line of credit agreement contains certain covenants and financial ratio requirements, including restrictions on dividend payments and repurchases of its Class A Common Stock. At December 31, 2006, $84,043,000 was unrestricted as to the payment of dividends and repurchases of Class A Common Stock. Under another covenant, the Company must maintain stockholders’ equity, less intangible assets and exclusive of treasury stock, of at least $239,084,000 at December 31, 2006. At December 31, 2006, the Company was in compliance with all relevant covenants under each of the credit facilities described above.

Other liabilities consist of amounts due under employee benefit plans, including the long-term portion of the Company’s Economic Value Added (“EVA”) incentive program and deferred compensation. The EVA incentive program amounts are at risk of forfeiture to the plan participants depending on the Company maintaining presently achieved levels of EVA. The amounts as of December 31 are as follows (in thousands):

The provision for income taxes includes the following for the years ended December 31 (in thousands):

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

In December 2004, pursuant to the American Jobs Creation Act of 2004, the Company repatriated dividends of $22,700,000 related to foreign subsidiary earnings which were not considered indefinitely invested. The Company received an 85% dividends received deduction for eligible dividends, resulting in a lower effective tax rate. The Company used these funds on qualified expenditures in the United States in accordance with its approved Domestic Reinvestment Plan. Future provision will not be made for United States income taxes on earnings of selected subsidiary companies as these are intended to be permanently invested.

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

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

The Company did not record any valuation allowances against deferred tax assets at December 31, 2006 and 2005. Management has determined, based on the Company’s history of prior operating earnings and its expectations for the future, that operating income of the Company will more likely than not be sufficient to recognize fully these deferred tax assets.

The Company leases its principal warehouse facility through January 2010. In addition, certain property and equipment is leased primarily on a month-to-month basis. The Company recognizes its operating leases in accordance with SFAS No. 13, “Accounting for Leases.” Future minimum rental payments under these leases as of December 31, 2006 are as follows (in thousands):

Rent expense for these operating leases was approximately $3,389,000, $2,945,000 and $2,543,000 for the years ended December 31, 2006, 2005 and 2004, respectively.

The Company has outstanding letters of credit totaling approximately $196,000 and $675,000 at December 31, 2006 and 2005, respectively. These letters of credit collateralize the Company’s obligations to third parties for the purchase of inventory. The letters of credit outstanding at December 31, 2006 have original terms from two to three months. The fair value of these letters of credit is based on fees currently charged for similar agreements and is not significant at December 31, 2006 and 2005.

The Company has product purchase obligations of approximately $38,642,000 at December 31, 2006. The Company generally orders product four to five months in advance of sales based primarily on advanced future orders received from customers. Product purchase obligations represent open purchase orders to purchase products in the ordinary course of business that are enforceable and legally binding.

As discussed in Note A19 to the Consolidated Financial Statements, the Company has recognized the underpayment of payroll withholdings and related interest owed of $11,105,000 to a foreign jurisdiction. Penalties are discretionary, ranging from zero to 300% of the taxes owed, and at this time the Company cannot determine the likelihood of such assessment and has not recognized penalties related to this issue. However, there can be no guarantee that penalties will not be imposed.

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

In 1988, the Company adopted a discretionary domestic contribution profit sharing plan covering all employees meeting certain eligibility requirements. In 1993, the plan was amended to include a 401(k) plan. The expense for this plan was approximately $993,000, $760,000 and $960,000 for 2006, 2005 and 2004, respectively.

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

In 1990, the Company adopted the 1990 Stock Option Plan under which it was authorized to issue non-qualified stock options, incentive stock options, and warrants to key employees. As amended, the number of options or awards available for issuance under the 1990 Stock Option Plan was 6,600,000 shares of Class A Common Stock. Options granted under the 1990 Stock Option Plan have a term of ten years and generally become fully vested by the end of the fifth year.

In 1999, the Company adopted the 1999 Stock Incentive Plan under which it is authorized to award up to 2,400,000 shares or options to employees and directors of the Company. As amended, the number of options or awards available for issuance under the 1999 Stock Incentive Plan is for 4,600,000 shares of Class A Common Stock. The awards have a term of ten years and generally become fully vested between the third and ninth years.

In accordance with the modified prospective method, the Company’s Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123 (Revised 2004). The following table summarizes compensation costs related to the Company’s stock-based compensation plans (in thousands) for the year ended December 31:

There were no significant capitalized stock-based compensation costs at December 31, 2006. There have been no modifications to stock option awards during 2006. The Company recognizes stock-based compensation expense using the graded-vesting attribution method. The remaining unrecognized compensation expense related to unvested awards at December 31, 2006 is $6,161,000 and the weighted-average period of time over which this expense will be recognized is 2.2 years. This amount does not include the cost of any additional options that may be granted in future periods nor any changes in the Company’s forfeiture rate. In connection with the exercise of options, the Company realized income tax benefits in the year ended December 31, 2006 that have been credited to additional paid-in capital.

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

The following table summarizes the stock option transactions for 2006, 2005 and 2004:

Options exercisable at December 31, 2005 and 2004 were 851,074 and 728,377, respectively. The weighted-average grant-date fair value of stock options granted during 2006 was $15.09.

SFAS No. 123 (Revised 2004) requires the Company to reflect income tax benefits resulting from tax deductions in excess of expense as a financing cash flow in its consolidated statement of cash flows rather than as an operating cash flow as in prior periods. Cash proceeds, income tax benefit and intrinsic value of related stock options exercised during the year ended December 31, 2006 are as follows (in thousands):

The Company issues new shares of Class A Common Stock to satisfy stock option exercises. Shares that are repurchased under the Company’s current stock repurchase program will reduce the dilutive impact of the Company’s share-based compensation plans. Under its stock repurchase program, the Company purchased 35,000 shares of Class A Common Stock during the year ended December 31, 2006. The Company purchased these shares on the open market.

Prior to January 1, 2006, the Company accounted for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations.

During 2005 and 2004, 5,000 and 12,000 options, respectively, were granted at exercise prices below fair market value. This resulted in net compensation expense of $249,000 and $345,000 for 2005 and 2004, respectively. All other options were granted at an exercise price equal to the fair market value of the Company’s common stock at the date of grant. Accordingly, no compensation cost has been recognized for such options granted.

In connection with the exercise of options, the Company realized income tax benefits of $3,994,000 and $3,899,000 in 2005 and 2004, respectively that have been credited to additional paid-in capital.

Had compensation cost for the plan been determined based on the fair value of the options at the grant dates consistent with the method of SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an Amendment of SFAS No. 123,” the Company’s net earnings and earnings per share would have been:

Under SFAS No. 148, the fair value of options at date of grant was estimated using the Black-Scholes model with the following assumptions:

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents, trade accounts receivable and financial instruments used in hedging activities. The Company maintains cash and cash equivalents with high

quality institutions and limits the amount of credit exposure to any one institution. For forward exchange contracts, the credit risk the Company is exposed to is limited to the unrealized gains in these contracts should the counterparty fail to perform. As part of its cash and risk management processes, the Company performs periodic evaluations of the relative credit standing of the financial institutions.

During the years ended December 31, 2006, 2005 and 2004, approximately 15% (12% domestic), 18% (15% domestic) and 20% (17% domestic), respectively, of revenues were from one customer. At December 31, 2006, approximately 34% of accounts receivable were from four customers. At December 31, 2005 approximately 32% of accounts receivable were from two customers. Credit risk with respect to other trade accounts receivable is generally diversified due to the large number of entities comprising the Company’s customer base and their dispersion across many geographies. The Company controls credit risk through credit approvals, credit limits and monitoring procedures, and for international receivables from distributors, the use of letters of credit and letters of guarantee.

The Company’s predominant business is the design, development and distribution of athletic footwear. Substantially all of the Company’s revenues are from the sales of footwear products. The Company is organized into three geographic regions: the United States, Europe and Other International operations. Certain reclassifications have been made in the 2005 and 2004 presentations to conform to the 2006 presentation. The following tables summarize segment information (in thousands):

Summarized quarterly financial data for 2006 and 2005 follows (in thousands except for per share amounts):

The Company’s management carried out an evaluation, under the supervision and with the participation of the Company’s President and Chief Executive Officer and Vice President of Finance and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2006, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Company’s President and Chief Executive Officer along with the Company’s Vice President of Finance and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as of December 31, 2006 are effective in ensuring that (i) information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the S.E.C.’s rules and forms and (ii) information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

No changes in the Company’s internal control over financial reporting identified in connection with the evaluation required by Exchange Act Rule 13a-15(d) or 15d-15(d) have come to management’s attention that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. See “Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting” and “Management’s Report on Internal Control Over Financial Reporting” on pages 33 and 34, respectively.

Except for the information disclosed in Part I under the heading “Executive Officers of the Registrant,” the information required by this item will be contained in the Company’s Proxy Statement for its Annual Stockholders Meeting to be held May 22, 2007 to be filed with the S.E.C. within 120 days after December 31, 2006 and is incorporated herein by reference.

The information required by this item will be contained in the Company’s Proxy Statement for its Annual Stockholders Meeting to be held May 22, 2007 to be filed with the S.E.C. within 120 days after December 31, 2006 and is incorporated herein by reference.

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.


K•Swiss Inc.

By	/s/	GEORGE POWLICK
		George Powlick, Vice President, Chief Operating Officer and Chief Financial Officer

February 21, 2007

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.


	Caption	Page
PART I

Item 1.	Business	3

Item 1A.	Risk Factors	10

Item 1B.	Unresolved Staff Comments	15

Item 2.	Properties	15

Item 3.	Legal Proceedings	15

Item 4.	Submission of Matters to a Vote of Security Holders	15

PART II

Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	17

Item 6.	Selected Financial Data	19

Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20

Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	31

Item 8.	Financial Statements and Supplementary Data	32

Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	59

Item 9A.	Controls and Procedures	59

Item 9B.	Other Information	59

PART III

Item 10.	Directors, Executive Officers and Corporate Governance	60

Item 11.	Executive Compensation	60

Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	60

Item 13.	Certain Relationships and Related Transactions, and Director Independence	60

Item 14.	Principal Accounting Fees and Services	60

PART IV

Item 15.	Exhibits, Financial Statement Schedules	61


	Revenues (1)
	Year Ended December 31,
	2006				2005				2004
K•Swiss Footwear Category	$		%		$		%		$		%
	(Dollar amounts in thousands)
Classic	$	326,245	68	%	$	339,123	69	%	$	313,833	67	%
Tennis/Court		24,776	5			24,231	5			28,867	6
Training		38,257	8			33,911	7			38,487	8
Children’s		89,103	18			91,842	18			86,113	18
Other (2)		4,582	1			4,711	1			5,661	1

Total	$	482,963	100	%	$	493,818	100	%	$	472,961	100	%

Domestic (3)	$	313,411	65	%	$	374,181	76	%	$	392,889	83	%

Foreign (3)	$	169,552	35	%	$	119,637	24	%	$	80,072	17	%


	March 31,		June 30,		September 30,		December 31,
2006
Low	$	27.81	$	25.00	$	22.54	$	29.33
High		32.74		30.85		31.48		37.81
2005
Low	$	28.58	$	29.68	$	27.52	$	27.61
High		33.21		34.85		36.89		34.23


	Year ended December 31,
	2006		2005		2004		2003			2002
	(In thousands, except per share data)
Income Statement Data
Revenues	$	501,148	$	508,574	$	484,079	$	429,162		$	289,593
Cost of goods sold		263,935		271,212		262,859		235,603			159,026

Gross profit		237,213		237,362		221,220		193,559			130,567
Selling, general and administrative expenses		137,527		130,144		122,262		106,267			79,258

Operating profit		99,686		107,218		98,958		87,292			51,309
Interest income, net		7,005		3,333		1,038		699			1,058

Earnings from continuing operations before income taxes		106,691		110,551		99,996		87,991			52,367
Income tax expense		29,827		35,303		28,745		34,199			20,554

Earnings from continuing operations		76,864		75,248		71,251		53,792			31,813
Loss from discontinued operations, less applicable income taxes (1)		—		—		—		(3,736	)		(3,116	)

Net earnings	$	76,864	$	75,248	$	71,251	$	50,056		$	28,697


Earnings per share
Basic:
Earnings from continuing operations	$	2.23	$	2.20	$	2.04	$	1.52		$	0.87
Loss from discontinued operations		—		—		—		(0.11	)		(0.09	)

Net earnings	$	2.23	$	2.20	$	2.04	$	1.41		$	0.78

Diluted:
Earnings from continuing operations	$	2.17	$	2.11	$	1.96	$	1.42		$	0.81
Loss from discontinued operations		—		—		—		(0.10	)		(0.08	)

Net earnings	$	2.17	$	2.11	$	1.96	$	1.32		$	0.73

Dividends declared per common share	$	0.20	$	0.175	$	0.100	$	0.040		$	0.019


Weighted average number of shares outstanding
Basic		34,401		34,220		34,917		35,396			36,700
Diluted (2)		35,378		35,626		36,433		37,913			39,415

Balance Sheet Data (at period end)
Current assets	$	373,440	$	312,747	$	271,613	$	213,918		$	163,801
Current liabilities		49,062		46,924		53,044		36,532			30,883
Total assets		404,560		336,236		294,957		234,653			183,891
Total debt (3)		—		—		6,750		—			—
Stockholders’ equity		345,903		275,321		226,830		179,527			139,793


	Year ended December 31,
	2006		2005		2004
Revenues	100.0	%	100.0	%	100.0	%
Cost of goods sold	52.7		53.3		54.3
Gross profit	47.3		46.7		45.7
Selling, general and administrative expenses	27.4		25.6		25.3
Interest income, net	1.4		0.6		0.2
Earnings before income taxes	21.3		21.7		20.6
Income tax expense	6.0		6.9		5.9
Net earnings	15.3		14.8		14.7


Name	Age at December 31, 2006	Position
Steven Nichols	64	Chairman of the Board and President
Edward Flora	55	Vice President-Operations
Lee Green	53	Corporate Counsel
David Nichols	37	Executive Vice President
George Powlick	62	Vice President-Finance, Chief Operating Officer, Chief Financial Officer, Secretary and Director
Kimberly Scully	39	Corporate Controller
Brian Sullivan	53	Vice President-National Accounts


	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares Purchased as Part of a Publicly Announced Program (1)	Approximate Number of Shares that May Yet Be Purchased Under the Program (1)
October 1 through October 31,
2006	—	$	—	—	4,080,745 shares
November 1 through November 30,
2006	—		—	—	4,080,745 shares
December 1 through December 31,
2006	5,000		32.12	5,000	4,075,745 shares

Total	5,000	$	32.12	5,000	4,075,745 shares


Year	Net after-tax effect of adjustment		Reported Net Income		Percent of Reported Net Income
2005	$	1,157	$	75,248	1.54	%
2004		913		71,251	1.28
2003		1,079		50,056	2.16
2002		605		28,697	2.11
1993–2001		4,112		114,622	3.59

Total	$	7,866	$	339,874	2.31	%


	Payments due by period
	Total		Less than one year		One to three years		Three to five years		More than five years
Operating lease obligations	$	8,692	$	3,025	$	4,818	$	849	$	—
Product purchase obligations (1)		38,642		38,642		—		—		—

Total	$	47,334	$	41,667	$	4,818	$	849	$	—


	2006			2005
A S S E T S

CURRENT ASSETS
Cash and cash equivalents (Notes A4 and K)	$	260,229		$	197,464
Accounts receivable, less allowance for doubtful accounts of $2,133 and $1,924 for 2006 and 2005, respectively (Notes A13 and K)		40,988			42,411
Inventories (Note A5)		59,178			61,164
Prepaid expenses and other current assets		8,005			7,484
Deferred taxes (Notes A9 and G)		5,040			4,224

Total current assets		373,440			312,747
PROPERTY, PLANT AND EQUIPMENT, net (Notes A6, A7 and B)		15,831			8,016
OTHER ASSETS
Intangible assets (Notes A7, A8 and C)		4,700			4,700
Deferred taxes (Notes A9 and G)		2,970			4,810
Other		7,619			5,963

		15,289			15,473

	$	404,560		$	336,236

L I A B I L I T I E S A N D S T O C K H O L D E R S’ E Q U I T Y

CURRENT LIABILITIES
Bank lines of credit (Note D)	$	—		$	—
Trade accounts payable		12,262			19,654
Accrued liabilities (Note E)		36,800			27,270

Total current liabilities		49,062			46,924
OTHER LIABILITIES (Note F)		9,595			13,991

COMMITMENTS AND CONTINGENCIES (Note H)

STOCKHOLDERS’ EQUITY (Notes D and J)
Preferred Stock—authorized 2,000,000 shares of $0.01 par value; none issued and outstanding		—			—
Common Stock:
Class A-authorized 90,000,000 shares of $0.01 par value; 28,764,194 shares issued, 26,507,033 shares outstanding and 2,257,161 shares held in treasury at December 31, 2006 and 28,108,027 shares issued, 25,885,866 shares outstanding and 2,222,161 shares held in treasury at December 31, 2005		288			281
Class B-authorized 18,000,000 shares of $0.01 par value; issued and outstanding 8,100,128 shares at December 31, 2006 and 8,340,128 shares at December 31, 2005		81			83
Additional paid-in capital		51,370			42,677
Treasury Stock		(55,661	)		(54,705	)
Retained earnings (Note A19)		342,575			280,465
Accumulated other comprehensive earnings—
Foreign currency translation (Note A10)		8,965			5,371
Net (loss) gain on hedge derivatives (Note A12)		(1,715	)		1,149

		345,903			275,321

	$	404,560		$	336,236


	Common Stock								Additional paid-in capital		Treasury Stock				Retained earnings			Accumulated other comprehensive earnings			Total
	Class A			Class B							Class A
	Shares	Amount		Shares		Amount					Shares	Amount
Balance at January 1, 2004	26,755,362	$	268	8,682,734		$	87		$	31,059	—	$	—		$	143,427		$	4,686		$	179,527
Conversion of shares (Note J)	271,706		3	(271,706	)		(3	)		—	—		—			—			—			—
Exercise of options (Note J)	509,822		4	—			—			1,734	—		—			—			—			1,738
Income tax benefit of options exercised (Note J)	—		—	—			—			3,899	—		—			—			—			3,899
Purchase of treasury stock	—		—	—			—			—	1,343,396		(27,000	)		—			—			(27,000	)
Dividends paid (Note D)	—		—	—			—			—	—		—			(3,485	)		—			(3,485	)
Net earnings for the year	—		—	—			—			—	—		—			71,251			—			71,251
Foreign currency translation (Note A10)	—		—	—			—			—	—		—			—			2,185			2,185
Net loss on hedge derivatives (Note A12)	—		—	—			—			—	—		—			—			(1,285	)		(1,285	)

Balance at December 31, 2004	27,536,890		275	8,411,028			84			36,692	1,343,396		(27,000	)		211,193			5,586			226,830
Conversion of shares (Note J)	70,900		1	(70,900	)		(1	)		—	—		—			—			—			—
Exercise of options (Note J)	500,237		5	—			—			1,991	—		—			—			—			1,996
Income tax benefit of options exercised (Note J)	—		—	—			—			3,994	—		—			—			—			3,994
Purchase of treasury stock	—		—	—			—			—	878,765		(27,705	)		—			—			(27,705	)
Dividends paid (Note D)	—		—	—			—			—	—		—			(5,976	)		—			(5,976	)
Net earnings for the year	—		—	—			—			—	—		—			75,248			—			75,248
Foreign currency translation (Note A10)	—		—	—			—			—	—		—			—			(1,500	)		(1,500	)
Net gain on hedge derivatives (Note A12)	—		—	—			—			—	—		—			—			2,434			2,434

Balance at December 31, 2005	28,108,027		281	8,340,128			83			42,677	2,222,161		(54,705	)		280,465			6,520			275,321
Cumulative effect of adjustments resulting from the adoption of SAB No. 108, net of tax (Note A19)	—		—	—			—			—	—		—			(7,866	)		—			(7,866	)
Conversion of shares (Note J)	240,000		2	(240,000	)		(2	)		—	—		—			—			—			—
Exercise of options (Note J)	416,167		5	—			—			2,790	—		—			—			—			2,795
Excess income tax benefit of options exercised (Note J)	—		—	—			—			3,506	—		—			—			—			3,506
Stock-based compensation (Notes A18 and J)	—		—	—			—			2,397	—		—			—			—			2,397
Purchase of treasury stock	—		—	—			—			—	35,000		(956	)		—			—			(956	)
Dividends paid (Note D)	—		—	—			—			—	—		—			(6,888	)		—			(6,888	)
Net earnings for the year	—		—	—			—			—	—		—			76,864			—			76,864
Foreign currency translation (Note A10)	—		—	—			—			—	—		—			—			3,594			3,594
Net loss on hedge derivatives (Note A12)	—		—	—			—			—	—		—			—			(2,864	)		(2,864	)

Balance at December 31, 2006	28,764,194	$	288	8,100,128		$	81		$	51,370	2,257,161	$	(55,661	)	$	342,575		$	7,250		$	345,903


	2006			2005
Building and improvements	$	8,295		$	6,939
Information systems		11,609			5,822
Furniture, machinery and equipment		6,791			5,490

		26,695			18,251
Less accumulated depreciation and amortization		(11,559	)		(10,930	)

		15,136			7,321
Land		695			695

	$	15,831		$	8,016


	2006			2005
Goodwill	$	4,618		$	4,618
Trademarks		2,761			2,761
Other		8			8
Less accumulated amortization		(2,687	)		(2,687	)

	$	4,700		$	4,700


	2006		2005
Compensation	$	4,888	$	6,649
Advertising		2,545		7,582
Payroll withholding payable		11,105		—
Other		18,262		13,039

	$	36,800	$	27,270


	2006		2005
EVA incentive program	$	4,198	$	8,883
Deferred compensation		5,397		5,108

	$	9,595	$	13,991


	2006		2005
Net current assets	$	5,040	$	4,224
Net non-current assets		2,970		4,810

Net asset	$	8,010	$	9,034


	2006			2005
Assets
State taxes	$	1,311		$	1,487
Bad debts reserve		723			693
Inventory reserve and capitalized costs		1,719			1,194
Sales return reserve		836			577
Impairment reserve		358			411
Incentive program		995			3,394
Deferred compensation plan		2,049			1,972
Stock-based compensation		626			—
Other		451			449

Gross deferred tax assets		9,068			10,177
Liabilities
Contingent purchase payments		(154	)		(154	)
Other		(904	)		(989	)

Gross deferred tax liabilities		(1,058	)		(1,143	)

Net deferred tax asset	$	8,010		$	9,034


Year ending December 31,
2007	$	3,025
2008		2,585
2009		2,233
2010		767
2011		82
Thereafter		—

	$	8,692


	2006
Cost of sales	$	402
Selling, general and administrative		1,995

Pre-tax stock-based compensation expense		2,397
Income tax benefit		690

Total stock-based compensation expense	$	1,707


	2006
Expected life (years)	5
Risk-free interest rate	4.8	%
Expected volatility	39.3	%
Expected dividend yield	0.7	%


	Shares		Weighted average exercise price		Weighted average remaining contractual life (in years)	Aggregate intrinsic value
Options outstanding January 1, 2004	3,669,270		$	7.17
Granted	331,799			19.43
Exercised	(509,822	)		2.63
Canceled	(103,997	)		11.68

Options outstanding December 31, 2004	3,387,250			8.91
Granted	81,500			30.86
Exercised	(500,237	)		3.46
Canceled	(220,664	)		12.84

Options outstanding December 31, 2005	2,747,849			10.24
Granted	158,600			29.06
Exercised	(416,167	)		5.14
Canceled	(243,767	)		12.19

Options outstanding December 31, 2006	2,246,515		$	12.30	5.6	$	41,866,000


Options exercisable December 31, 2006	840,576		$	6.30	3.8	$	20,544,000


	2006
Proceeds from stock options exercised	$	2,141
Income tax benefit related to stock options exercised	$	3,517
Intrinsic value of stock options exercised	$	10,679


	2005			2004
Net earnings (in thousands)
As reported	$	75,248		$	71,251
Add stock-based employee compensation charges reported in net earnings		169			246
Less total stock-based employee compensation expense, determined under the fair value method		(1,916	)		(2,175	)

Pro forma	$	73,501		$	69,322

Basic earnings per share
As reported	$	2.20		$	2.04
Pro forma		2.15			1.99

Diluted earnings per share
As reported	$	2.11		$	1.96
Pro forma		2.06			1.90


	First Quarter		Second Quarter		Third Quarter		Fourth Quarter		Year
2006
Revenues	$	149,984	$	124,196	$	133,135	$	93,833	$	501,148
Gross profit		69,623		61,650		63,353		42,587		237,213
Net earnings		24,910		20,334		20,950		10,670		76,864
Earnings per share
Basic net earnings	$	0.73	$	0.59	$	0.61	$	0.31	$	2.23
Diluted net earnings		0.70		0.58		0.59		0.30		2.17
2005
Revenues	$	153,143	$	126,474	$	136,668	$	92,289	$	508,574
Gross profit		71,983		58,826		63,568		42,985		237,362
Net earnings		25,864		16,765		21,062		11,557		75,248
Earnings per share
Basic net earnings	$	0.75	$	0.49	$	0.62	$	0.34	$	2.20
Diluted net earnings		0.72		0.47		0.59		0.33		2.11


		Page Reference Form 10-K
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting		33
Management’s Report on Internal Control Over Financial Reporting		34
Report of Independent Registered Public Accounting Firm		35
Consolidated Balance Sheets as of December 31, 2006 and 2005		36
Consolidated Statements of Earnings and Comprehensive Earnings for the three years ended December 31, 2006		37
Consolidated Statement of Stockholders’ Equity for the three years ended December 31, 2006		38
Consolidated Statements of Cash Flows for the three years ended December 31, 2006		39
Notes to Consolidated Financial Statements		40-58


3.1		Amended and Restated Bylaws of K•Swiss Inc. (incorporated by reference to exhibit 3.1 to the Registrant’s Form 8-K filed with the S.E.C. on October 1, 2004)

3.2		Amended and Restated Certificate of Incorporation of K•Swiss Inc. (incorporated by reference to exhibit 3.2 to the Registrant’s Form 10-K for fiscal year ended December 31, 2004)

3.3		Amendment to the Bylaws of K•Swiss Inc. (incorporated by reference to exhibit 3.1 to the Registrant’s Form 8-K filed with the S.E.C. on April 18, 2006)

4.1		Certificate of Designations of Class A Common Stock of K•Swiss Inc. (incorporated by reference to exhibit 3.2 to the Registrant’s Form S-1 Registration Statement No. 33-34369)

4.2		Certificate of Designations of Class B Common Stock of K•Swiss Inc. (incorporated by reference to exhibit 3.3 to the Registrant’s Form S-1 Registration Statement No. 33-34369)

4.3		Specimen K•Swiss Inc. Class A Common Stock Certificate (incorporated by reference to exhibit 4.1 to the Registrant’s Form S-1 Registration Statement No. 33-34369)

4.4		Specimen K•Swiss Inc. Class B Common Stock Certificate (incorporated by reference to exhibit 4.2 to the Registrant’s Form S-1 Registration Statement No. 33-34369)

10.1		K•Swiss Inc. 1990 Stock Incentive Plan, as amended through October 28, 2002 (incorporated by reference to exhibit 10.1 to the Registrant’s Form 10-K for the year ended December 31, 2002)

10.2		Form of Amendment No. 1 to K•Swiss Inc. Employee Stock Option Agreement Pursuant to the 1990 Stock Incentive Plan (incorporated by reference to exhibit 10.2 to the Registrant’s Form 10-K for the year ended December 31, 2002)

10.3		K•Swiss Inc. 1999 Stock Incentive Plan, as amended through October 26, 2004 (incorporated by reference to exhibit 4.1 to the Registrant’s Form S-8 with the S.E.C. on February 23, 2005)



10.4		Form of Amendment No. 1 to K•Swiss Inc. Employee Stock Option Agreement Pursuant to the 1999 Stock Incentive Plan (incorporated by reference to exhibit 10.4 to the Registrant’s Form 10-K for the year ended December 31, 2002)

10.5		K•Swiss Inc. Profit Sharing Plan, as amended (incorporated by reference to exhibit 10.3 to the Registrant’s Form S-1 Registration Statement No. 33-34369)

10.6		Amendment to K•Swiss Inc. 401(k) and Profit Sharing Plan (incorporated by reference to exhibit 10.35 to the Registrant’s Form 10-K for the fiscal year ended December 31, 1993)

10.7		Amendment to K•Swiss Inc. 401(k) and Profit Sharing Plan dated May 26, 1994 (incorporated by reference to exhibit 10.32 to the Registrant’s Form 10-K for the fiscal year ended December 31, 1994)

10.8		Amendment to K•Swiss Inc. 401(k) and Profit Sharing Plan dated January 1, 2000 (incorporated by reference to exhibit 10.30 to the Registrant’s Form 10-K for the fiscal year ended December 31, 1999)

10.9		Amendment to K•Swiss Inc. 401(k) and Profit Sharing Plan (incorporated by reference to exhibit 10 to the Registrant’s Form 10-Q for the quarter ended March 31, 2002)

10.10		Amendment to K•Swiss Inc. 401(k) and Profit Sharing Plan dated January 10, 2003 (incorporated by reference to exhibit 10.23 to the Registrant’s Form 10-Q for the quarter ended June 30, 2003)

10.11		Amendment to K•Swiss Inc. 401(k) and Profit Sharing Plan dated October 9, 2003 (incorporated by reference to exhibit 10.11 to the Registrant’s Form 10-Q for the quarter ended June 30, 2004)

10.12		Amendment to K•Swiss Inc. 401(k) and Profit Sharing Plan dated May 23, 2005 (incorporated by reference to exhibit 10.12 to the Registrant’s Form 10-Q for the quarter ended June 30, 2005)

10.13		Amendment to K•Swiss Inc. 401(k) and Profit Sharing Plan dated June 1, 2005 (incorporated by reference to exhibit 10.13 to the Registrant’s Form 10-Q for the quarter ended June 30, 2005)

10.14		Form of Indemnity Agreement entered into by and between K•Swiss Inc. and directors (incorporated by reference to exhibit 10.4 to the Registrant’s Form S-1 Registration Statement No. 33-34369)

10.15		Employment Agreement between the Registrant and Steven B. Nichols dated as of August 2, 2004 (incorporated by reference to exhibit 10.14 to the Registrant’s Form 10-Q for the quarter ended September 30, 2004)

10.16		Lease Agreement dated March 11, 1997 by and between K•Swiss Inc. and Space Center Mira Loma, Inc. (incorporated by reference to exhibit 10 to the Registrant’s Form 10-Q for the quarter ended March 31, 1997)

10.17		Loan Agreement dated June 1, 2005, between the Company and Bank of America (incorporated by reference to exhibit 10.18 to the Registrant’s Form 10-Q for the quarter ended June 30, 2005)

10.18		Amendment No. 1 to Loan Agreement, dated June 28, 2005, between the Company and Bank of America (incorporated by reference to exhibit 10.19 to the Registrant’s Form 10-Q for the quarter ended June 30, 2005)

10.19		K•Swiss Inc. Deferred Compensation Plan, Master Plan Document (incorporated by reference to exhibit 10.1 to the Registrant’s Form 10-Q for the quarter ended March 31, 1998)



10.20		K•Swiss Inc. Deferred Compensation Plan, Master Trust Agreement (incorporated by reference to exhibit 10.2 to the Registrant’s Form 10-Q for the quarter ended March 31, 1998)

14.1		K•Swiss Inc. Code of Ethics for the Chief Executive Officer, Senior Financial Officers and Board of Directors (incorporated by reference to exhibit 14 to the Registrant’s Form 10-K for the year ended December 31, 2003)

14.2		K•Swiss Inc. Code of Ethics for Directors, Officers and Employees (incorporated by reference to exhibit 14.2 to the Registrant’s Form 10-Q for the quarter ended March 31, 2004)

21		Subsidiaries of K•Swiss Inc.

23		Consent of Grant Thornton LLP

31.1		Certification of President and Chief Executive Officer Pursuant to Exchange Act Rule 13a-14

31.2		Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14

32		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


		Page
Financial Statement Schedules:
Schedule II—Valuation and Qualifying Accounts		65

All supplemental schedules other than as set forth above are omitted as inapplicable or because the required information is included in the Consolidated Financial Statements or the Notes to Consolidated Financial Statements.


	Signature	Title	Date

/s/	STEVEN NICHOLS Steven Nichols	Chairman of the Board, President and Chief Executive Officer	February 21, 2007

/s/	GEORGE POWLICK George Powlick	Vice President Finance, Chief Operating Officer, Chief Financial Officer, Principal Accounting Officer, Secretary and Director	February 21, 2007

/s/	LAWRENCE FELDMAN Lawrence Feldman	Director	February 21, 2007

/s/	STEPHEN FINE Stephen Fine	Director	February 21, 2007

/s/	DAVID LEWIN David Lewin	Director	February 21, 2007

/s/	MARK LOUIE Mark Louie	Director	February 21, 2007


Column A	Column B				Column C				Column D			Column E
					Additions
Description	Balance at Beginning of Period				Charged to Costs and Expenses		Charged to Other Accounts		Write-offs and Deductions, Net			Balance at End of Period
Allowance for bad debts	(2006 (2005 (2004	) ) )	$	1,924 2,009 2,079	$	233 223 2,302	$	— — —	$	(24 (308 (2,372	) ) )	$	2,133 1,924 2,009

Allowance for inventories	(2006 (2005 (2004	) ) )	$	2,465 2,759 3,228	$	4,098 2,353 3,393	$	— — —	$	(2,360 (2,647 (3,862	) ) )	$	4,203 2,465 2,759

Allowance for sales returns	(2006 (2005 (2004	) ) )	$	1,951 2,376 541	$	15,420 14,259 7,463	$	— — —	$	(14,104 (14,684 (5,628	) ) )	$	3,267 1,951 2,376


Exhibit

21		Subsidiaries of K•Swiss Inc.

23		Consent of Grant Thornton LLP

31.1		Certification of President and Chief Executive Officer Pursuant to Exchange Act Rule 13a-14

31.2		Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14

32		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002