K-Swiss (KSWS)

2004 Compared to 2003

Total revenues increased 12.8% to $484,079,000 in 2004 from $429,162,000 in 2003. 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 12.3% to 19,014,000 pair in 2004 from 16,939,000 pair in 2003. The average wholesale price per pair was $24.94 in 2004 and $24.81 in 2003.

Domestic revenues increased 6.7% to $397,390,000 in 2004 from $372,443,000 in 2003. International product revenues increased 54.8% in 2004 to $84,603,000 from $54,640,000 in 2003. Fees earned by the Company on sales by foreign licensees and distributors were $2,086,000 for 2004 and $2,079,000 for 2003. International revenues, as a percentage of total revenues, increased to 17.9% in 2004 from 13.2% in 2003.

K•Swiss brand revenues increased 12.6% to $477,209,000 in 2004 from $423,696,000 in 2003. 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 11.8% to 18,683,000 pair in 2004 from 16,718,000 pair in 2003. The average wholesale price per pair was $25.03 in 2004 and $24.83 in 2003. The major changes in volume for footwear categories are as follows: Classics, training (includes basketball), tennis and children’s categories increased 12.1%, 8.6%, 20.9% and 10.1%, respectively.

Royal Elastics brand revenues increased 25.7% to $6,870,000 in 2004 (33% domestic) from $5,466,000 in 2003 (28% domestic).

Overall gross profit margins, as a percentage of revenues, were 45.7% in 2004 and 45.1% in 2003.

Selling, General and Administrative Expenses

Overall selling, general and administrative expenses increased 15.1% to $122,262,000 (25.3% of revenues) in 2004 from $106,267,000 (24.8% of revenues) in 2003. The increase in the amounts for the year ended December 31, 2004 compared to the year ended December 31, 2003 were due to an impairment recognition and increases in advertising, bad debt and warehousing expenses offset by decreases in compensation and compensation related expenses and legal expenses. During the year ended December 31, 2004, impairment of $2,776,000 was recognized on the trademark and goodwill of the Royal Elastics brand based on many factors including the brand not growing as rapidly as we had expected. Advertising expenses increased 35.0% for the year ended December 31, 2004, as part of a strategic effort to drive higher revenues. Bad debt expenses increased 133.4% for the year ended December 31, 2004 as a result of the write-off of The Athlete’s Foot account due to the bankruptcy of that company. Warehousing expenses, excluding compensation and compensation related expenses, increased 13.9% for the year ended December 31, 2004, as a result of additional expenses incurred resulting from an increase in sales during the year ended December 31, 2004 and moving our warehouse location in Europe during the second quarter of 2004. Compensation and compensation related expenses, including commissions and bonus/incentive related expenses, decreased 6.9% for the year ended December 31, 2004, due to a decrease in bonus/incentive related expenses that was calculated in accordance with our bonus formula for the year ended December 31, 2004 offset by an increase in headcount and commissions (as a result of the increase in volume). Legal expenses decreased 53.9% for the year ended December 31, 2004, as a result of the defense and settlement of two lawsuits during the year ended December 31, 2003. Corporate expenses of $12,686,000 and $18,835,000, for the years ended December 31, 2004 and 2003, respectively, are included in selling, general and administrative expenses. The decrease in corporate expenses during the year ended December 31, 2004 is due to decreases in bonus/incentive related expenses and legal expenses which have been explained above.

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Interest, Other and Taxes

Overall net interest income was $1,038,000 (0.2% of revenues) in 2004 compared to $699,000 (0.2% of revenues) in 2003, an increase of $339,000 or 48.5%. This increase in net interest income was the result of higher average balances and higher average interest rates, offset slightly by interest expense on our lines of credit.

Our effective tax rate was 28.7% and 38.9% in 2004 and 2003, respectively. The $3,899,000 and $3,965,000 income tax benefit of options exercised during 2004 and 2003, respectively, were credited to additional paid-in capital and therefore did not impact the effective tax rate. The decrease in the effective tax rate for the year ended December 31, 2004 is principally attributed to repatriating dividends of $22,700,000 related to foreign subsidiaries earnings and also due to our UK operation having become profitable in 2004 thereby realizing net operating loss carryforwards of approximately $3,190,000 for the year ended December 31, 2004, and adjustments to our provision for state income taxes.

The net loss from discontinued operations was $3,736,000 in 2003. Included in 2003 was a $2,000,000 settlement to terminate our agreement with National Geographic and a $746,000 impairment loss on the National Geographic license.

Net earnings increased 42.3% to $71,251,000 or $1.96 per share (diluted earnings per share) in 2004 from $50,056,000 or $1.32 per share (diluted earnings per share) in 2003.

2004 Compared to 2003

Revenue and Gross Margin

Total revenues increased 12.8% to $484,079,000 in 2004 from $429,162,000 in 2003. 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 12.3% to 19,014,000 pair in 2004 from 16,939,000 pair in 2003. The average wholesale price per pair was $24.94 in 2004 and $24.81 in 2003.

Domestic revenues increased 6.7% to $397,390,000 in 2004 from $372,443,000 in 2003. International product revenues increased 54.8% in 2004 to $84,603,000 from $54,640,000 in 2003. Fees earned by the Company on sales by foreign licensees and distributors were $2,086,000 for 2004 and $2,079,000 for 2003. International revenues, as a percentage of total revenues, increased to 17.9% in 2004 from 13.2% in 2003.

K•Swiss brand revenues increased 12.6% to $477,209,000 in 2004 from $423,696,000 in 2003. 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 11.8% to 18,683,000 pair in 2004 from 16,718,000 pair in 2003. The average wholesale price per pair was $25.03 in 2004 and $24.83 in 2003. The major changes in volume for footwear categories are as follows: Classics, training (includes basketball), tennis and children’s categories increased 12.1%, 8.6%, 20.9% and 10.1%, respectively.

Royal Elastics brand revenues increased 25.7% to $6,870,000 in 2004 (33% domestic) from $5,466,000 in 2003 (28% domestic).

We believe that 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 seasons. 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, 2004, domestic and international futures orders with start ship dates from January through June 2005 were approximately $170,291,000 and $53,942,000, respectively, 11.9% lower and 71.4% higher, respectively, than such orders were at December 31, 2003 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 45.7% in 2004 and 45.1% in 2003. Gross profit margin for 2004 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.

Selling, General and Administrative Expenses

Overall selling, general and administrative expenses increased 15.1% to $122,262,000 (25.3% of revenues) in 2004 from $106,267,000 (24.8% of revenues) in 2003. The increase in the amounts for the year ended December 31, 2004 compared to the year ended December 31, 2003 were due to an impairment recognition and increases in advertising, bad debt and warehousing expenses offset by decreases in compensation and compensation related expenses and legal expenses. During the year ended December 31, 2004, impairment of $2,776,000 was recognized on the trademark and goodwill

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Table of Contents

of the Royal Elastics brand based on many factors including the brand not growing as rapidly as we had expected. Advertising expenses increased 35.0% for the year December 31, 2004, as part of a strategic effort to drive higher revenues. Bad debt expenses increased 133.4% for the year ended December 31, 2004 as a result of the write-off of The Athlete’s Foot account as a result of the bankruptcy of that company. Warehousing expenses, excluding compensation and compensation related expenses, increased 13.9% for the year ended December 31, 2004, as a result of additional expenses incurred resulting from an increase in sales during the year ended December 31, 2004 and moving our warehouse location in Europe during the second quarter of 2004. Compensation and compensation related expenses, including commissions and bonus/incentive related expenses, decreased 6.9% for the year ended December 31, 2004, due to a decrease in bonus/incentive related expenses that was calculated in accordance with our bonus formula for the year ended December 31, 2004 offset by an increase in headcount and commissions (as a result of the increase in volume). Legal expenses decreased 53.9% for the year ended December 31, 2004, as a result of the defense and settlement of two lawsuits during the year ended December 31, 2003. Corporate expenses of $12,686,000 and $18,835,000, for the years ended December 31, 2004 and 2003, respectively, are included in selling, general and administrative expenses. The decrease in corporate expenses during the year ended December 31, 2004 is due to decreases in bonus/incentive related expenses and legal expenses which have been explained above.

Interest, Other and Taxes

Overall net interest income was $1,038,000 (0.2% of revenues) in 2004 compared to $699,000 (0.2% of revenues) in 2003, an increase of $339,000 or 48.5%. This increase in net interest income was the result of higher average balances and higher average interest rates, offset slightly by interest expense on our lines of credit.

Our effective tax rate was 28.7% and 38.9% in 2004 and 2003, respectively. The $3,899,000 and $3,965,000 income tax benefit of options exercised during 2004 and 2003, respectively, were credited to additional paid-in capital and therefore did not impact the effective tax rate. The decrease in the effective tax rate for the year ended December 31, 2004 is principally attributed to 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. We will use these funds on qualified expenditures in the United States in accordance with our approved Domestic Reinvestment Plan. The lower effective tax rate is also due to our UK operation having become profitable in 2004 thereby realizing net operating loss carryforwards of approximately $3,190,000 for the year ended December 31, 2004, and adjustments to our provision for state income taxes.

The net loss from discontinued operations was $3,736,000 in 2003. Included in 2003 was a $2,000,000 settlement to terminate our agreement with National Geographic and a $746,000 impairment loss on the National Geographic license.

Net earnings increased 42.3% to $71,251,000 or $1.96 per share (diluted earnings per share) in 2004 from $50,056,000 or $1.32 per share (diluted earnings per share) in 2003.