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K-Swiss 10-K 2010
Form 10-K
Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

(Mark One)

   x   

Annual Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2009

or

   ¨   

Transition Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the transition period from                      to                     

Commission file Number 0-18490

 

K•SWISS INC.

(Exact name of registrant as specified in its charter)

Delaware   95-4265988

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

31248 Oak Crest Drive,

Westlake Village, California

  91361
(Address of principal executive offices)   (Zip Code)

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

 

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

Title of each Class

 

Name of each exchange

on which registered

Class A Common Stock, par value $0.01 per share   NASDAQ

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

None

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    x  Yes    ¨  No

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No

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

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

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

Large accelerated filer  ¨        Accelerated filer  x        Non-accelerated filer  ¨        Smaller reporting company  ¨

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

The aggregate market value of the Class A Common Stock of the Registrant held by non-affiliates of the Registrant as of June 30, 2009, 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 $227,604,636.

The number of shares of the Registrant’s Class A Common Stock outstanding at February 17, 2010 was 27,098,140 shares. The number of shares of the Registrant’s Class B Common Stock outstanding at February 17, 2010 was 8,039,524 shares.

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement for the Registrant’s 2010 Annual Stockholders Meeting are incorporated by reference into Part III.

 

 

 


Table of Contents

K·SWISS INC.

 

INDEX TO ANNUAL REPORT ON FORM 10-K

 

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009

 

 

 

    

Caption

   Page

PART I

     

Item 1.

   Business    3

Item 1A.

   Risk Factors    11

Item 1B.

   Unresolved Staff Comments    18

Item 2.

   Properties    18

Item 3.

   Legal Proceedings    18

Item 4.

   Submission of Matters to a Vote of Security Holders    18

PART II

     

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    20

Item 6.

   Selected Financial Data    22

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    23

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk    37

Item 8.

   Financial Statements and Supplementary Data    38

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    77

Item 9A.

   Controls and Procedures    77

Item 9B.

   Other Information    77

PART III

     

Item 10.

   Directors, Executive Officers and Corporate Governance    78

Item 11.

   Executive Compensation    78

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    78

Item 13.

   Certain Relationships and Related Transactions, and Director Independence    78

Item 14.

   Principal Accountant Fees and Services    78

PART IV

     

Item 15.

   Exhibits and Financial Statement Schedules    79

SIGNATURES

   83


Table of Contents

PART I

 

Item 1.   Business

 

Company History and General Strategy

 

K•Swiss Inc. designs, develops and markets an array of athletic footwear for high performance sports use, fitness activities and casual wear under the K•Swiss brand. We also design and manufacture footwear under the Palladium brand. Palladium designs, develops and markets footwear for adventurers for all terrains. Sales of the Palladium brand were approximately 9.8% of total sales in 2009.

 

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

 

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

 

In November 2001, we acquired the worldwide rights and business of Royal Elastics, an Australian-based designer and manufacturer of elasticated footwear. The purchase excluded distribution rights in Australia, which were retained by Royal Management Pty, Ltd. In April 2009, we sold certain Royal Elastics assets, consisting of its inventory located in Taiwan and its intangible trademarks to Royal Elastics Holdings Ltd. (“REH”), a third party, in an arm’s length transaction. Operations of the Royal Elastics brand have been accounted for and presented as a discontinued operation in the accompanying financial information.

 

In July 2008, we purchased a 57% equity interest in Palladium for a total purchase price of 5.3 million, or approximately $8.5 million (including a loan of 3.65 million, or approximately $5.8 million). In June 2009, we purchased the remaining 43% equity interest in Palladium for 5,000,000 plus a variable future price. The future purchase price is equal to an amount calculated in accordance with a formula driven by Palladium’s EBITDA for the twelve months ended December 31, 2012 less 3,300,000, but not to exceed 6,700,000. The fair value of this new liability (the “Contingent Purchase Price” or “CPP”) will be determined each quarter based on the current quarter’s projection of Palladium’s EBITDA for the twelve months ended December 31 of the current year, less 3,300,000, but not less than zero. The change in CPP is based on the current quarter’s EBITDA projection and will be recognized as interest income or interest expense during the current quarter. The fair value of the CPP at December 31, 2009 was zero.

 

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

 

K•Swiss is a corporation that was organized under the laws of the State of Delaware on April 16, 1990. The Company is successor in interest to K•Swiss Inc., a Massachusetts corporation, which in

 

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turn was successor in interest to K•Swiss Inc., a California corporation. Unless the context otherwise indicates, the terms “we,” “us,” “K•Swiss” and the “Company” as used herein refers to K•Swiss Inc. and its consolidated subsidiaries.

 

Products

 

Footwear

 

Our primary product is footwear. Starting in 2008, we reclassified our footwear products into two product categories: lifestyle and performance. Historically our product categories were: Classic, tennis/court, training and children’s footwear. Each product category has certain styles designated as core products. Our core products offer style continuity and often include on-going improvement. We believe our core product program is a critical factor in attempting to achieve our goal of becoming the “retailers’ most profitable vendor.” The core program tends to minimize retailers’ markdowns and maximizes the effectiveness of marketing expenditures because of longer product life cycles.

 

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

 

The reclassification was a result of our brand position being directed more towards a performance orientation. Our lifestyle category will continue to emphasize the Classic and its derivatives. The performance category will now emphasize performance running, as well as tennis and training. In 2008, we entered the performance running segment with an emphasis on performance innovation. In 2009, we entered into a three year agreement to be the Official Run Course Sponsor (for footwear and apparel) of the Ford Ironman World Championship, the Foster Grant Ironman World Championship 70.3, Ford Ironman Louisville, Amica Ironman 70.3, Ironman 70.3 Boise, Ironman European Championship (Ironman 70.3 Germany), Ironman UK and Ironman 70.3 Hawaii. In 2009, we also entered into a three year agreement (through 2012) to be the Presenting Sponsor of the Los Angeles Marathon.

 

Revenues, by product category, for the years ended December 31, 2009 and 2008, are as follows (dollar amounts in thousands). Most styles within the lifestyle and performance categories are offered in men’s (approximately 59% of 2009 revenues), women’s (approximately 25% of 2009 revenues) and children’s (approximately 16% of 2009 revenues). There were no customers that accounted for more than 10% of total revenues during 2009. See Note M to our Consolidated Financial Statements.

 

     2009     2008  

K•Swiss Footwear Category

   $    %     $    %  

Lifestyle

   $ 152,905    73   $ 253,787    83

Performance

     47,811    23        48,451    16   

Other (1)

     8,961    4        4,851    1   
                          

Total (2)

   $ 209,677    100   $ 307,089    100
                          

Domestic (2, 3)

   $ 99,482    47   $ 137,141    45
                          

Foreign (2, 3)

   $ 110,195    53   $ 169,948    55
                          

 

(1)   Other consists of apparel, accessories, sport sandals and blemished shoes.

 

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

 

(3)   Included in “Total.”

 

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Historically, our product categories were the Classic, tennis/court, training and children’s footwear. The Classic category evolved from a shoe called the Classic, which was originally developed in 1966 as a high-performance tennis shoe. Since that time, the Classic has become a popular casual shoe. The upper of the Classic includes only three separate pieces of leather, which allows for a relatively simple manufacturing process and yields a product with few seams. This simple construction improves the shoe’s comfort, fit and durability. We have from time to time incorporated certain technical advances in materials and construction, but the Classic has remained relatively unchanged in style since 1966, and continues to be the Company’s single most important product. In 2000, we successfully launched the Classic Luxury Edition which is currently sold in the market today. In 2009, we re-mastered and re-launched the original Classic.

 

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

 

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

 

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

 

     2007  

K•Swiss Footwear Category

   $    %  

Classic

   $ 267,362    69

Tennis/Court

     25,854    7   

Training

     19,822    5   

Children’s

     69,732    18   

Other (1)

     4,650    1   
             

Total (2)

   $ 387,420    100
             

Domestic (2, 3)

   $ 194,949    50
             

Foreign (2, 3)

   $ 192,471    50
             

 

(1)   Other consists of apparel, accessories, sport sandals and blemished shoes.

 

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

 

(3)   Included in “Total.”

 

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Apparel and Accessories

 

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

 

K•Swiss introduced apparel in 1999, with a new 7.0 collection of high tech tennis apparel to complement our performance 7.0 collection of footwear. Our tennis and running collections continue to offer world-class performance apparel (skirts, shorts, tops, polos, dresses and warm-ups) for both men and women. Since our introduction of the 7.0 collection of tennis apparel, we have added full collections of fitness, training and running apparel to round out the performance offering. In addition, we also offer a collection for the casual athletic consumer consisting of jackets, sweaters, sweatshirts, track jackets, tee shirts, caps, socks and bags.

 

The apparel line is distributed through better specialty stores, resorts and fitness centers, as well as sporting goods chains and sporting goods dealers worldwide. The tennis apparel line is sold primarily through tennis specialty and tennis pro shops. We also outfit professional and celebrity figures which offers us global branding exposure. As discussed in “Products—Footwear,” K•Swiss has entered into three year agreements as the Official Run Course Sponsor of certain Ironman Events and the Presenting Sponsor of the Los Angeles Marathon. K•Swiss sells its apparel and footwear at these events and markets all products globally.

 

Sales

 

We sell our products in the United States through our sales executives and independent sales representatives primarily to a limited number of specialty athletic footwear stores, pro shops, sporting good stores and department stores. See “Risk Factors: Our financial success is limited to the success of our customers and The loss of a significant customer, or a significant reduction in our sales to such customer, could adversely affect our sales and results of operations.” We also sell our products through our website which is increasingly becoming an important sales channel to us particularly in light of our limited distribution. We also sell our products to a number of foreign distributors. We now have sales offices or distributors throughout the world. In 1991 and 1992, we established sales offices, sales teams and distributors in Asia and Europe, respectively.

 

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

 

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

 

Marketing

 

Advertising and Promotion

 

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

 

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important part of our media plan but online and outdoor mediums are becoming increasingly more important to our advertising strategy given the changing media landscape and consumer preferences.

 

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

 

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

 

Domestic Marketing

 

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

 

Our footwear products are sold domestically through 31 independent regional sales representatives and 15 Company-employed sales managers. The independent sales representatives are paid on a commission basis, and are prohibited by contract from representing other brands of athletic footwear and related products. These sales personnel sold to approximately 2,300, 2,300 and 2,200 separate accounts as of December 31, 2009, 2008 and 2007, respectively.

 

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

 

International Marketing

 

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

 

To expand the sales and marketing of our products into Europe, we opened our own office in the Netherlands in 1992. Our product is sold through Company-employed sales managers, independent sales representatives and distributors. Our European marketing uses a variety of media distribution including television advertisements, which are distributed through each region’s major network channels, print media in fashion magazines, in-store merchandising and local publicity events and sponsorships.

 

Internationally, at the end of 2009, K•Swiss had the exclusive right to market our products in 124 countries through 10 international subsidiaries and 29 distributors.

 

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Distribution

 

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

 

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

 

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

 

Product Design and Development

 

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

 

Manufacturing

 

In 2009, approximately 78% of our footwear products were manufactured in China, approximately 21% in Thailand and approximately 1% in Taiwan. Although we have no long-term manufacturing agreements and compete with other athletic shoe companies for production facilities (including companies that are much larger than us), we believe our relationships with our footwear producers are satisfactory and that we have the ability to develop, over time, alternative sources for our footwear. Our operations, however, could be materially and adversely affected if a substantial delay occurred in locating and obtaining alternative producers. See “Risk Factors: Because we rely on independent manufacturers to produce our products, our sales and profitability may be adversely affected if our independent manufacturers fail to meet pricing, product quality and timeliness requirements or if we are unable to obtain some components used in our products from limited supply sources or experience supply chain disruptions” and “Risk Factors: Because a large portion of our imported products are manufactured in China, our profitability may be adversely affected if the United States government takes action against China for its concern over the level of intellectual property rights protection and enforcements available in China.”

 

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

 

During 2009, our apparel and accessory products were manufactured in China, Hong Kong, Korea, Malaysia, Singapore, Taiwan, Thailand, Turkey and the United States by certain manufacturers selected by us.

 

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Our operations are subject to compliance with relevant laws and regulations enforced by the United States Customs Service and other international customs service departments from which we import product and to the customary risks of doing business abroad, including fluctuations in the value of currencies, increases in customs duties and related fees resulting from position changes by the United States Customs Service or other international customs service departments, import controls and trade barriers (including the unilateral imposition of import quotas), restrictions on the transfer of funds, work stoppages and, in certain parts of the world, political instability causing disruption of trade. These factors have not had a material adverse impact upon our operations to date. Imports are also affected by the cost of transportation, the imposition of import duties, and increased competition from greater production demands abroad. The United States or the countries in which our products are manufactured may, from time to time, impose new quotas, duties, tariffs or other restrictions, or adjust presently prevailing quotas, duty or tariff levels, which could affect our operations and ability to import products at current or increased levels. We cannot predict the likelihood or frequency of any such events occurring. A change in any such duties, quotas or restrictions could result in increases in the costs of such products generally and might adversely affect the sales or profitability of K•Swiss and the athletic footwear industry as a whole.

 

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

 

Our footwear products entering the United States are subject to customs duties which range from 8.5% to 10.0% of factory cost on footwear made principally of leather, to duties on synthetic and textile footwear ranging from 6.0% to 20.0% plus, for certain styles, $0.90 per pair. Our footwear products, manufactured in China, entering the European Union are subject to customs duties which range from 7.0% to 8.0% of landed cost on sports/technical footwear with uppers made principally of leather, a duty rate of 16.8% for synthetic upper footwear and a duty rate ranging from 23.5% to 24.5% for leather upper footwear that is considered non-sports/non-technical or has a landed cost of under 7.50. Our footwear products, manufactured in Thailand, entering the European Union are subject to customs duties which range from 3.5% to 4.5% of landed cost on footwear with uppers made principally of leather and a duty rate of 11.9% for synthetic upper footwear. Currently, approximately 91% of our footwear volume is derived from sales of leather footwear and approximately 9% of our footwear volume is derived from sales of synthetic and textile footwear.

 

Backlog

 

“Backlog,” as of any date, represents orders scheduled to be shipped within the next six months. Backlog does not include orders scheduled to be shipped on or prior to the date of determination of backlog. At December 31, 2009 and 2008, total futures orders with start ship dates from January through June 2010 and 2009 were approximately $80,924,000 and $92,566,000, respectively, representing a decrease of 12.6% at December 31, 2009. The 12.6% decrease in total futures orders is comprised of a 22.6% decrease in the first quarter 2010 futures orders offset by a 14.4% increase in the second quarter 2010 futures orders. At December 31, 2009 and 2008, domestic futures orders with start ship dates from January through June 2010 and 2009 were approximately $29,583,000 and $31,689,000, respectively, representing a decrease of 6.6% at December 31, 2009. At December 31, 2009 and 2008, international futures orders with start ship dates from January through June 2010 and 2009 were approximately $51,341,000 and $60,877,000, respectively, representing a decrease of 15.7% at December 31, 2009.

 

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

 

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Competition

 

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

 

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

 

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

 

Trademarks and Patents

 

We utilize trademarks on all our products and believe our products are more marketable on a long-term basis when identified with distinctive markings. K•Swiss® is a registered trademark in the United States and certain other countries. Our name is not registered as a trademark in certain countries because of restrictions on registering names having geographic connotations. However, since K•Swiss is not a geographic name, we have often secured registrations despite such objections. Our shield emblem and the five-stripe design are also registered in the United States and certain foreign countries. The five-stripe design is not presently registered in some countries because it has been deemed ornamental by regulatory authorities in those countries. We selectively seek to register the names of our shoes, logos and the names given to certain of our technical and performance innovations, including Aosta® rubber and Shock Spring® cushioning. We have obtained patents in the United States regarding the Bio Feedback® ankle support system, the Shock Spring® cushioning system incorporated into K•Swiss’ 7.0 System® performance tennis shoes and training line, the stability design incorporated into the Si-18® tennis shoe, and other features. The PALLADIUM trademark is registered in many jurisdictions, including the United States, Canada, China and key European markets. Applications to register the mark are pending in many other countries. The Company is taking steps to strengthen protection for the PALLADIUM trademark and other marks related to the Palladium business. We vigorously defend our trademarks and patent rights against infringement worldwide and employ independent security consultants to assist in such protection. To date, we are not aware of any significant counterfeiting problems regarding our products.

 

Employees

 

At December 31, 2009, we employed 207 persons in the United States, 194 persons in Singapore, Thailand, Taiwan, Hong Kong and China, 107 persons in the United Kingdom, Germany, France and the Netherlands and 11 persons elsewhere.

 

Available Information

 

K•Swiss’ internet address is www.kswiss.com. We make available free of charge on or through our internet website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the

 

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Securities and Exchange Act of 1934, as amended (the “Exchange Act”) as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (“S.E.C.”). Materials K•Swiss files with or furnishes to the S.E.C. may be read and copied at the S.E.C.’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. This information may also be obtained by calling the S.E.C. at 1-800-SEC-0330. The S.E.C. also maintains an internet website that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the S.E.C. at www.sec.gov. The Company will provide a copy of any of the foregoing documents to stockholders upon request.

 

Item 1A. Risk Factors

 

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

 

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

 

The athletic footwear industry is intensely competitive. Certain of our competitors have substantially greater financial, distribution and marketing resources as well as greater brand awareness than us. Their greater capabilities in these areas may enable them to better withstand periodic downturns in the footwear industry, compete more effectively on the basis of price and production and more quickly develop new products. Further, a major marketing or promotional success or technological innovation by one of our competitors could adversely impact our competitive position. In addition, the availability of overseas manufacturing opportunities and capacity more readily allows for the introduction of competitors with new products. In countries where the athletic footwear market is mature, 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.

 

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

 

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

 

The athletic footwear industry is subject to rapid changes in consumer preferences. Consumer demand for athletic footwear and apparel is heavily influenced by brand image. Our initiatives to strengthen our brand image, which include conducting market research, introducing new and innovative products and initiating focused advertising campaigns, may not be successful. Our current

 

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products may not continue to be popular and new products we introduce may not achieve adequate consumer acceptance for us to recover development, manufacturing, marketing and other costs. Our failure to anticipate, identify and react to shifts in consumer preferences and maintain a strong brand image could have an adverse effect on our sales and results of operations. Also, if our customers purchase our products and do not have success in selling our products at retail, they may request a return or price adjustment to assist them in marking down the selling price to make the products more attractive to retail consumers.

 

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

 

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

 

The consumer environment has been particularly challenging over the last several years. The recent disruptions in the overall economy and financial markets could further reduce consumer income, liquidity, credit and confidence in the economy and result in further reductions in consumer spending. Further deterioration of the consumer spending environment may result in reduced demand for our products, which would be harmful to our financial position and results of operations.

 

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

 

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

 

Our current backlog of open orders may not be indicative of our level of future sales.

 

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

 

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

 

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

 

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

 

While no customer accounted for more than 10% of our total revenues in 2009, we do have significant customers. The loss of any of these customers, or a significant reduction in our sales to any of such customers, could adversely affect our sales and results of operations. In addition, if any of such customers became insolvent or otherwise failed to pay its debts, it could have an adverse affect on our results of operations.

 

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

 

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

 

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

 

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

 

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

 

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

 

Significant volatility and disruption in the global capital and credit markets and an economic downturn in 2008 and 2009 have resulted in a tightening of business credit and liquidity, a contraction

 

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of consumer credit, business failures, increased unemployment and declines in consumer confidence and spending. If global economic and financial market conditions remain weak for an extended period of time, any of the following factors, among others, could have a material adverse effect on our financial condition and results of operations:

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

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

 

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

 

   

fluctuations in currency exchange rates;

 

   

political instability;

 

   

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

 

   

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

 

   

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

 

   

investment regulation and other restrictions by foreign governments.

 

If these risks limit or prevent us from selling or manufacturing products in any significant international market, prevent us from acquiring products from our foreign suppliers or significantly increase the cost of our products, our operations could be seriously disrupted until alternative suppliers

 

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are found or alternative markets are developed. Although we enter into certain forward currency exchange contracts to hedge the risk of exchange rate fluctuations, these steps may not fully protect us against this risk and we may incur losses.

 

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

 

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

 

Our 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 experience supply chain disruptions.

 

We depend upon independent manufacturers to manufacture our products in a timely and cost-efficient manner while maintaining specified quality standards. We also compete with other larger companies for production capacity of independent manufacturers that produce our products. We rely heavily on manufacturing facilities located in China. In 2009, approximately 78% of our footwear manufacturing occurred in China. We also rely upon the availability of sufficient production capacity at our manufacturers. Timely delivery of product may be impacted by factors such as weather conditions, disruption of the transportation systems or shipping lines used by our suppliers, or uncontrollable factors such as natural disasters, epidemic diseases, terrorism and war. It is essential that our manufacturers deliver our products in a timely manner and in accordance with our quality standards because our orders may be cancelled 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.

 

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

 

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

 

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

 

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

 

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

 

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

 

We rely on warehouses in Mira Loma, California 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 loss of sales.

 

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

 

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

 

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

 

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

 

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

 

Our success is largely dependent upon the efforts of Steven Nichols, our President, Chief Executive Officer and Chairman, 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, 2009, the Company’s President, Chief Executive Officer and Chairman of the Board, Steven Nichols, held approximately 92.7% of the voting power of our Class B Common Stock taken as a whole and approximately 69.3% of total voting power. This voting power permits Mr. Nichols to exert significant influence over the outcome of stockholder votes, including votes concerning the election of a certain class of directors, by-law amendments, possible mergers, corporate control contests and other significant corporate transactions.

 

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We depend on our computer and communications systems.

 

We extensively utilize computer and communications systems to operate our Internet business and manage our internal operations including without limitation, demand and supply planning, and inventory control. Any interruption of this service from power loss, telecommunications failure, failure of our computer system or other interruption caused by weather, natural disasters or any similar event could disrupt our operations and result in lost sales. In addition, hackers and computer viruses have disrupted operations at many major companies. We may be vulnerable to similar acts of sabotage, which could have a material adverse effect on our business and operations.

 

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

 

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

 

Item 1B. Unresolved Staff Comments

 

None.

 

Item 2. Properties

 

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

 

We lease a 309,000 square foot distribution facility in Mira Loma, California. We use this facility as our main distribution center. The effective monthly commitment for this facility is approximately $91,000. In July 2008, we exercised an option under the lease to extend the term of the lease until January 2015.

 

We also lease office space of approximately 14,000 square feet in Haarlem, the Netherlands, which is our primary European headquarters. The effective monthly commitment for this office space is approximately $34,000. The lease expires in March 2011 and can be renewed for an additional five years. In addition, we contract with a third party public distribution facility in Rotterdam, the Netherlands, to manage our inventory destined to European customers.

 

Item 3.    Legal   Proceedings

 

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

 

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

 

None.

 

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Executive Officers of the Registrant

 

The executive officers of K•Swiss are as follows:

 

Name

   Age at
December 31,
2009
  

Position

Steven Nichols

   67   

Chairman of the Board, Chief Executive Officer and President

Edward Flora

   58    Chief Operating Officer

Lee Green

   56    Corporate Counsel

David Nichols

   40    Executive Vice President

George Powlick

   65   

Vice President of Finance, Chief Administrative Officer, Chief Financial Officer, Secretary and Director

Kimberly Scully

   42    Corporate Controller

Brian Sullivan

   56    Vice President of National Accounts

 

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

 

Steven Nichols has been President, Chief Executive Officer and Chairman of the Board of K•Swiss since 1987. From 1980 to 1986, Mr. Nichols was a director and Vice President—Merchandise of Stride Rite Corp., a footwear manufacturer and holding company. In addition, Mr. Nichols was President of Stride-Rite Footwear from 1982 to 1986. From 1979 to 1982, Mr. Nichols served as an officer and President of Stride Rite Retail Corp., the largest retailer of branded children’s shoes in the United States. From 1962 through 1979, Mr. Nichols was an officer of Nichols Foot Form Corp., which operated a chain of New York retail footwear stores.

 

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

 

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

 

David Nichols, Executive Vice President since May 2004, has held various positions with K•Swiss since joining the Company in November 1995, including 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 of Finance, Chief Financial Officer and Secretary of the Company since January 1988, Director of the Company since 1990, Chief Operating Officer of the Company from September 2004 until January 2009, and Chief Administrative Officer since January 2009 joined the Company 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.

 

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

 

PART II

 

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

 

K•Swiss Inc.’s Class A Common Stock began trading June 4, 1990 on the National Market System maintained by the National Association of Securities Dealers (now the Nasdaq Global Select Market) upon completion of our initial public offering. Per share high and low sales prices (in dollars) for the quarterly periods during 2009 and 2008 as reported by Nasdaq were as follows:

 

     March 31,    June 30,    September 30,    December 31,

2009

           

Low

   $ 6.44    $ 7.43    $ 8.70    $ 7.68

High

     12.13      10.98      11.23      10.25

2008

           

Low

   $ 13.88    $ 14.00    $ 14.04    $ 9.87

High

     19.49      18.38      20.67      17.73

 

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, 2009 was 131. However, based on available information, we believe that the total number of Class A Common stockholders, including beneficial stockholders, is approximately 4,600.

 

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, 2009 was 9.

 

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Stock Price Performance Graph

 

The Stock Price Performance Graph below represents a comparison of the five year total return of K•Swiss Inc. Class A Common Stock, the NASDAQ Market Index and the Hemscott Industry Group 321 Index—Textile—Apparel Footwear and Accessories. The graph assumes $100 was invested on December 31, 2004 and dividends are reinvested for all years ending December 31.

 

LOGO

 

Dividend Policy

 

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

 

Purchases of Equity Securities by the Issuer

 

In October 2004, the Board of Directors approved a 5 million share repurchase program which expired in December 2009. In November 2009, the Board of Directors approved a new stock repurchase program to purchase through December 31, 2014 up to $70 million of the Company’s Class A Common Stock.

 

During the fourth quarter of 2009, the Company did not repurchase any shares of K•Swiss Class A Common Stock.

 

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Item 6.   Selected Financial Data

 

The selected consolidated financial data presented below for each of the five years in the period ended December 31, 2009 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 2008, 2007, 2006 and 2005 presentations to conform to the 2009 presentation. These reclassifications had no impact on previously reported results of operations or stockholders’ equity and do not affect previously reported cash flows from operations, investing and financing activities or net change in cash and cash equivalents.

 

    Year ended December 31,  
    2009     2008     2007     2006     2005  
    (In thousands, except per share data)  

Income Statement Data

         

Revenues

  $ 240,729      $ 327,405      $ 394,540      $ 489,271      $ 498,929   

Cost of goods sold

    154,558        195,385        210,910        255,865        265,031   
                                       

Gross profit

    86,171        132,020        183,630        233,406        233,898   

Selling, general and administrative expenses

    118,303        139,899        148,283        130,811        123,801   

Impairment on intangibles and goodwill

    4,830        —          —          —          —     
                                       

Operating (loss)/profit

    (36,962     (7,879     35,347        102,595        110,097   

Other (expense)/income, net

    (1,249     30,000        5,232        —          —     

Interest income, net

    1,050        8,216        11,184        8,275        4,131   
                                       

(Loss)/Earnings before income taxes and discontinued operations

    (37,161     30,337        51,763        110,870        114,228   

Income tax (benefit)/expense

    (9,663     5,882        9,868        31,759        36,766   
                                       

(Loss)/Earnings from continuing operations

    (27,498     24,455        41,895        79,111        77,462   

Loss from discontinued operations, less applicable income taxes (1)

    (464     (3,570     (2,822     (2,247     (2,214
                                       

Net (Loss)/Earnings

  $ (27,962   $ 20,885      $ 39,073      $ 76,864      $ 75,248   
                                       

(Loss)/Earnings per share

         

Basic:

         

(Loss)/Earnings from continuing operations

  $ (0.79   $ 0.70      $ 1.21      $ 2.30      $ 2.26   

Loss from discontinued operations

    (0.01     (0.10     (0.08     (0.07     (0.06
                                       

Net (Loss)/Earnings

  $ (0.80   $ 0.60      $ 1.13      $ 2.23      $ 2.20   
                                       

Diluted:

         

(Loss)/Earnings from continuing operations

  $ (0.79   $ 0.69      $ 1.18      $ 2.23      $ 2.17   

Loss from discontinued operations

    (0.01     (0.10     (0.08     (0.06     (0.06
                                       

Net (Loss)/Earnings

  $ (0.80   $ 0.59      $ 1.10      $ 2.17      $ 2.11   
                                       

Dividends declared per common share

  $ —        $ 2.20      $ 0.20      $ 0.20      $ 0.175   
                                       

Weighted average number of shares outstanding

         

Basic

    34,962        34,785        34,705        34,401        34,220   

Diluted (2)

    34,962        35,407        35,472        35,378        35,626   

Balance Sheet Data (at period end)

         

Current assets

  $ 287,986      $ 332,776      $ 405,617      $ 373,440      $ 312,747   

Current liabilities

    28,335        52,139        50,401        49,062        46,924   

Total assets

    344,150        394,290        446,353        404,560        336,236   

Total debt (3)

    4,207        5,376        —          —          —     

Stockholders’ equity

    301,783        324,762        384,233        345,903        275,321   

 

(1)   On April 30, 2009, the Company sold certain Royal Elastics assets. Operations of the Royal Elastics brand have been accounted for and presented as a discounted operation.

 

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

 

(3)   Includes all interest-bearing debt, but excludes outstanding letters of credit ($700,000, $1,399,000, $1,831,000, $196,000 and $675,000 as of December 31, 2009, 2008, 2007, 2006 and 2005, respectively).

 

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

 

Note Regarding Forward-Looking Statements and Analyst Reports

 

“Forward-looking statements,” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Act”), include certain written and oral statements made, or incorporated by reference, by us or our representatives in this report, other reports, filings with the Securities and Exchange Commission (the “S.E.C.”), press releases, conferences, or otherwise. Such forward-looking statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance, or achievements, and may contain the words “believe,” “anticipate,” “expect,” “estimate,” “intend,” “plan,” “project,” “will be,” “will continue,” “will likely result,” or any variations of such words with similar meaning. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed or forecasted in any such forward-looking statements. Investors should carefully review the risk factors set forth in other reports or documents we file with the S.E.C., including Forms 10-Q, 10-K and 8-K. Some of the other risks and uncertainties that should be considered include, but are not limited to, the following: international, national and local general economic and market conditions; the size and growth of the overall athletic footwear and apparel markets; the size of our competitors; intense competition among designers, marketers, distributors and sellers of athletic footwear and apparel for consumers and endorsers; market acceptance of all our product offerings; demographic changes; popularity of particular designs, categories of products, and sports; seasonal and geographic demand for our products; the size, timing and mix of purchases of our products; performance and reliability of products; difficulties in anticipating or forecasting changes in consumer preferences, consumer demand for our product, and various market factors described above; the availability of credit facilities for our customers and/or the stability of credit markets; fluctuations and difficulty in forecasting operating results, including, without limitation, the fact that advance “futures” orders may not be indicative of future revenues due to the changing mix of futures and at-once orders; potential cancellation of future orders; our ability to continue, manage or forecast our growth and inventories; new product development and timely commercialization; the ability to secure and protect trademarks, patents, and other intellectual property; inadvertent and nonwillful infringement on others’ trademarks, patents and other intellectual property; difficulties in implementing, operating, maintaining, and protecting our increasingly complex information systems and controls including, without limitation, the systems related to demand and supply planning, and inventory control; difficulties in implementing SAP information management software; interruptions in data and communication systems; concentration of production in China; changes in our effective tax rates as a result of changes in tax laws or changes in our geographic mix of sales and level of earnings; potential earthquake disruption due to the location of our warehouse and headquarters; potential disruption in supply chain due to various factors including but not limited to natural disasters, epidemic diseases or customer purchasing habits; customer service; adverse publicity; the loss of significant customers or suppliers; dependence on distributors; dependence on major customers; concentration of credit risk; business disruptions; increased costs of freight and transportation to meet delivery deadlines; increased material and/or labor costs; increased duties and tariffs and/or other trade restrictions; the effects of terrorist actions on business activities, customer orders and cancellations, and the United States and international governments’ responses to these terrorist actions; changes in business strategy or development plans; general risks associated with doing business outside the United States, including, without limitation, exchange rate fluctuations, import duties, tariffs, quotas and political and economic instability; changes in government regulations; liability and other claims asserted against us; the ability to attract and retain qualified personnel; and other factors referenced or incorporated by reference in this report and other reports.

 

K•Swiss Inc. (the “Company,” “K•Swiss,” “we,” “us,” and “our”) operates in a very competitive and rapidly changing environment. New risk factors can arise and it is not possible for management to

 

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

 

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

 

Overview

 

The Company designs, develops and markets an array of 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 Palladium brand. For the Palladium brand, footwear is designed, developed and marketed to adventurers for all terrains. The categories of footwear we sell are explained in more detail in Part I, Item 1, under the subheading, “Products.” We market our products in the United States (through Company employed sales managers and independent regional sales representatives) primarily to a limited number of specialty athletic footwear stores, pro shops, sporting good stores and department stores. We also sell our products through our website and internationally through Company employed sales managers, independent sales representatives and a number of foreign distributors.

 

The retail environment has been particularly challenging during the last few years and is forecasted for the near term to remain depressed, given the deterioration in the overall economy and financial markets. This could put additional pressure on the Company’s ability to maintain margins.

 

In 2009, approximately 78% of our K•Swiss brand footwear products were manufactured in China. We have no long-term manufacturing agreements, but we believe that our relationships with our producers are satisfactory and that we have the ability to develop alternative sources for our footwear. Our operations could, however, be materially and adversely affected if a substantial delay occurred in locating and obtaining alternative producers.

 

Because we record revenues when title passes and the risks and rewards of ownership have passed to our customer, our revenues may fluctuate in cases when our customers delay accepting shipment of products. Our total revenues decreased 26.5% in 2009 from 2008, due to a decrease in the volume of footwear sold and a decrease in the average underlying wholesale price per pair. Our overall gross profit margins, as a percentage of revenues, were 35.8% and 40.3% in 2009 and 2008, respectively. The decrease in our gross profit margin is mainly due to product mix changes, geographic mix of international sales and a general decline in sales prices (partially due to a higher percentage of sales of close out product which contributes to a lower gross profit margin). Our overall selling, general and administrative expenses decreased to $118,303,000 in 2009 from $139,899,000 in 2008 as a result of decreases in advertising expenses, data processing expenses, compensation expenses and legal expenses. In addition, an impairment charge of $4,830,000 on the goodwill and intangible assets related to the trademarks of the Palladium brand was recognized in 2009.

 

Other expense for 2009 includes a loss upon the purchase of the remaining 43% equity interest of Palladium of $2,616,000, offset by a gain on the sale of certain assets of the Royal Elastics brand of $1,367,000. Operations of the Royal Elastics brand have been accounted for and presented as a

 

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discontinued operation in the Consolidated Financial Statements. Other income for 2008 consisted of a settlement payment of $30,000,000 in connection with a lawsuit protecting our trademarks.

 

At December 31, 2009, our total futures orders with start ship dates from January through June 2010 were $80,924,000, a decrease of 12.6% from the comparable period of the prior year. Of this amount, domestic futures orders were $29,583,000, a decrease of 6.6%, and international futures orders were $51,341,000, a decrease of 15.7%.

 

The net loss for 2009 was $27,962,000, or $0.80 per share (diluted loss per share), compared to net earnings of $20,885,000, or $0.59 per share (diluted earnings per share), for 2008. Net loss and diluted loss per share for 2009 included the pre-tax impairment charge on the goodwill and intangible assets related to the trademarks of the Palladium brand of $4,830,000 and the pre-tax loss of $2,616,000 on the purchase of the remaining 43% of Palladium, offset by the net pre-tax gain on the sale of certain Royal Elastics assets of $1,367,000, described above. Net earnings and diluted earnings per share for 2008 included the pre-tax settlement of litigation of $30,000,000, described above.

 

In 2009, we had a net cash outflow of $22,476,000 from continuing operations, a net cash outflow of $54,829,000 from investing activities due the purchase of investments available for sale, reclassification of $22,270,000 to restricted cash and cash equivalents as collateral for our lines of credit and the purchase of property plant and equipment and a net cash inflow of $207,000 from financing activities mainly as a result of proceeds from stock options exercised and by the excess income tax benefit of stock-based compensation, offset by net repayments on bank lines of credit. We anticipate future cash needs for principal repayments required pursuant to borrowings under our lines of credit and, depending on future operating results, additional funds may be required for operating activities.

 

At December 31, 2009 and 2008, we had debt outstanding of $4,207,000 and $5,376,000 (attributable to outstanding borrowings by Palladium under its lines of credit facilities and term loans), excluding outstanding letters of credit of $700,000 and $1,399,000 at December 31, 2009 and 2008, respectively. Our working capital decreased $20,986,000 to $259,651,000 at December 31, 2009 from $280,637,000 at December 31, 2008, mainly due to decreases in cash and cash equivalents (including restricted cash), inventory, accounts receivable, prepaid expenses and other current assets and current deferred income taxes, offset by decreases in trade accounts payable, accrued liabilities and bank lines of credit and short-term debt and increases in investments available for sale and income taxes receivable.

 

Critical Accounting Policies

 

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

 

On an on-going basis, we evaluate our estimates, including those related to the carrying value of inventories, realizability of outstanding accounts receivable, intangible assets, sales returns and allowances, and the provision for income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. In the

 

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past, actual results have not been materially different from our estimates. However, results may differ from these estimates under different assumptions or conditions. See “Results of Operations—2008 Compared to 2007—Other Income, Interest and Taxes,” for discussion regarding the estimate and settlement of an underpayment of payroll withholdings in a foreign jurisdiction from January 1, 1993 through December 31, 2005.

 

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

 

Revenue Recognition

 

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

 

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

 

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

 

Accounts Receivable

 

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

 

Inventory Reserves

 

We also make ongoing estimates relating to the market value of inventories, based upon our assumptions about future demand and market conditions. If we estimate that the market value of our inventory is less than the cost of the inventory recorded on our books, we record a reserve equal to the difference between the cost of the inventory and the estimated market value. This reserve is recorded as a charge to cost of sales. If changes in market conditions result in reductions in the estimated market value of our inventory below our previous estimate, we would increase our reserve in the period in which we made such a determination and record the additional charge to cost of sales. The inventory reserve as a percentage of inventory has decreased in 2009 from 2008 as a result of significant reserves being established in 2008 and substantial liquidation of impaired inventory in 2009.

 

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Income Taxes

 

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

 

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

 

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

 

We evaluate the future realization of our deferred tax assets quarterly. We review each material tax jurisdiction for which a deferred tax asset has been recorded. Our analysis includes a review of past results, future income and the tax life of net operating loss carryforwards. All evidence is evaluated in forming a conclusion whether a valuation allowance, if any, needs to be recorded.

 

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

 

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Goodwill and Intangible Assets

 

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

 

We review goodwill for impairment in a two step process. The first step is to determine whether there is potential impairment by comparing the estimated fair value of a reporting unit to its carrying value (which includes goodwill). If the fair value exceeds the carrying value, then goodwill is not considered impaired, however, if the carrying amount exceeds the fair value, then step two is performed to measure the amount of impairment loss, if any. The second step compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined by allocating fair value to all assets and liabilities. The excess, if any, is the implied fair value of goodwill. If the implied fair value of goodwill is less than the carrying amount of goodwill, then impairment is recognized.

 

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

 

Other Contingencies

 

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

 

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Results of Operations

 

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

 

     Year ended December 31,  
     2009     2008     2007  

Revenues

   100.0   100.0   100.0

Cost of goods sold

   64.2      59.7      53.5   

Gross profit

   35.8      40.3      46.5   

Selling, general and administrative expenses

   49.1      42.7      37.5   

Impairment on intangibles and goodwill

   2.0      —        —     

Other (expense)/income

   (0.5   9.2      1.3   

Interest income, net

   0.4      2.5      2.8   

(Loss)/Earnings before income taxes and
discontinued operations

   (15.4   9.3      13.1   

Income tax (benefit)/expense

   (4.0   1.8      2.5   

Loss from discontinued operations, net of
income tax benefit

   (0.2   (1.1   (0.7

Net (loss)/earnings

   (11.6   6.4      9.9   

 

2009 Compared to 2008

 

Revenue and Gross Margin

 

Total revenues decreased 26.5% to $240,729,000 in 2009 from $327,405,000 in 2008. This decrease was attributable to a decrease in the volume of footwear sold and a decrease in the average underlying wholesale price per pair. The volume of footwear sold decreased 21.4% to 8,944,000 pair in 2009 from 11,384,000 pair in 2008. The average wholesale price per pair was $25.06 in 2009 and $27.56 in 2008, a decrease of 9.1%.

 

Domestic revenues decreased 26.9% to $101,181,000 in 2009 from $138,390,000 in 2008. International product revenues decreased 26.7% in 2009 to $133,041,000 from $181,380,000 in 2008. Fees earned by the Company on sales by foreign licensees and distributors were $6,507,000 for 2009 and $7,635,000 for 2008, a decrease of 14.8%. International revenues, as a percentage of total revenues, increased to 58.0% in 2009 from 57.7% in 2008.

 

Customer acceptance of our domestic and international product has been weak and is likely to remain weak for the near term. In addition, the current downturn of the worldwide economy has had and will continue to have an adverse affect on our business.

 

K•Swiss brand revenues decreased 31.3% to $217,181,000 in 2009 from $315,913,000 in 2008. This decrease was the result of a decrease in the volume of footwear sold and a decrease in the average underlying wholesale price per pair. The volume of footwear sold decreased 25.0% to 8,395,000 pair in 2009 from 11,187,000 pair in 2008. The average wholesale price per pair was $23.91 in 2009 and $27.02 in 2008, a decrease of 11.5%, which resulted from the product mix of sales, including a higher percentage of sales of closeout product, and from the geographic mix of sales, in which domestic sales generally sell at a lower price; and a general decline in worldwide selling prices.

 

Palladium brand revenues were $23,548,000 in 2009 (2.7% of which were derived from domestic sales) compared to $11,492,000 for the six month period ended December 31, 2008 (all of this revenue was derived from sales outside the U.S.). We purchased Palladium in July 2008. See Note O to our Consolidated Financial Statements for further discussion.

 

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

 

At December 31, 2009, domestic and international futures orders with start ship dates from January through June 2010 were approximately $29,583,000 and $51,341,000, respectively, 6.6% lower and 15.7% lower, respectively, than such orders were at December 31, 2008 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 margin, as a percentage of revenues, was 35.8% in 2009, a decrease from 40.3% in 2008. Gross profit margin was affected by product mix changes, including a higher percentage of closeout product sales, which carry a lower gross profit margin than our non-closeout product sales, geographic mix of sales and a general decline in sales prices. On August 5, 2009, the Company settled the underpayment of business taxes in a foreign jurisdiction for approximately $1,529,000 plus interest of approximately $1,185,000, see discussion “Results of Operations—2008 Compared to 2007—Revenue and Gross Margin.” Our gross margins may not be comparable to some of our competitors as we recognize warehousing costs within selling, general and administrative expenses.

 

Selling, General and Administrative Expenses

 

Overall selling, general and administrative expenses decreased 15.4% to $118,303,000 (49.1% of revenues) in 2009 from $139,899,000 (42.7% of revenues) in 2008. The decrease in selling, general and administrative expenses during 2009 was the result of a decreases in advertising expenses, data processing expenses, compensation expenses and legal expenses. Advertising expenses decreased 29.5% primarily due to decreases in both our domestic and international markets as part of an effort to reduce costs as our business declines. Data processing costs decreased 31.9% as a result of the decrease in on-going maintenance expense for our SAP computer software system which resulted from the completion of the SAP implementation in certain international regions in the fourth quarter of 2008. Compensation expenses, which includes commissions, bonus/incentive related expenses and employee recruiting and relocation expenses, decreased 6.7% as a result of decreases in headcount and other bonuses/incentive related expenses, offset by an increase in stock option compensation expenses. Legal expenses decreased 39.8% as a result of the decreased expenses incurred to defend our trademarks. Corporate expenses of $18,766,000 and $25,931,000 for the years ended December 31, 2009 and 2008, respectively, are included in selling, general and administrative expenses. The decrease in corporate expenses for 2009 was a result of decreases in data processing expenses, legal expenses and accounting expenses. The decrease in data processing expenses and legal expenses are due to the reasons discussed above. The decrease in accounting expense was a result of lower auditing fees for non-recurring 2008 events and a reduction of the outsourcing of certain accounting services.

 

Impairment on Intangibles and Goodwill

 

An impairment charge of $2,653,000 on the intangible assets related to the trademarks of the Palladium brand was recognized for 2009 as a result of the Company’s annual reassessment of impairment using the relief from royalty payment methodology, using current market discount rates and royalty rates.

 

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Goodwill impairment of $2,177,000 was also recognized on the Palladium brand for 2009. As part of its annual reassessment of impairment, the Company determined the fair value of a reporting unit using both an income approach (i.e., “discounted cash flow” methodology) and a market approach (i.e., “guideline public company” and “guideline transactions” methodologies). As a result of the assessment, primarily based on deteriorating economic market conditions in 2009, it was determined goodwill was impaired.

 

These impairment charges are included as corporate expenses for 2009.

 

Other Income, Interest and Taxes

 

Other expense for 2009 includes a loss upon the purchase of the remaining 43% equity interest of Palladium of $2,616,000, offset by a gain on the sale of certain assets of the Royal Elastics brand of $1,367,000.

 

On April 30, 2009, we sold certain Royal Elastics assets, consisting of its inventory located in Taiwan and its intangible trademarks, with an approximate net book value of $1.0 million, to Royal Elastics Holdings Ltd. (“REH”), a third party, in an arm’s length transaction for $4.0 million. Pursuant to the Asset Sale Agreement, REH agreed to pay us $2.9 million in cash by April 30, 2010 (of which the Company has received approximately $1.9 million as of December 31, 2009) and a $1.1 million promissory note from REH for the remaining balance. Interest on the promissory note is payable quarterly at an interest rate of Wall Street Journal Prime plus 1%. The principal balance is due on April 30, 2016. The pre-tax gain on sale is $1.4 million for 2009.

 

On June 16, 2009, we purchased the remaining 43% equity interest in Palladium for 5.0 million (or $7.0 million) and recognized a loss of $2.6 million on the purchase. The loss was calculated as the difference between the purchase price and the recorded Mandatorily Redeemable Minority Interest (“MRMI”). We acquired the initial 57% equity interest in Palladium on July 1, 2008 and the acquisition of Palladium was recorded as a 100% purchase acquisition without reflecting any minority interest but recognizing the MRMI liability.

 

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

 

Overall net interest income was $1,050,000 (0.4% of revenues) in 2009 compared to $8,216,000 (2.5% of revenues) in 2008, a decrease of $7,166,000 or 87.2%. The decrease in net interest income for the year ended December 31, 2009 was the result of lower average cash balances, lower interest rates, interest expense incurred by Palladium on lines of credit and term loans, and recognition of the change in the fair value of the MRMI.

 

Our effective tax benefit was 26.0% for 2009 compared to an effective tax rate of 19.4% for 2008. The $550,000 and $823,000 income tax benefit of options exercised during 2009 and 2008, respectively, were credited to additional paid-in capital and therefore did not impact the effective tax rate. The absolute value of the effective tax rate/benefit increased as a result of the geographic mix of losses, as domestic operations generated more losses at a higher effective tax benefit.

 

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At December 31, 2009, uncertain tax positions and the related interest were $6,165,000 and $903,000, respectively, all of which would affect the income tax rate if reversed. We recognized income tax expense related to uncertain tax positions of $121,000 and $209,000 for 2009 and 2008, respectively.

 

We did not record any valuation allowances against deferred tax assets at December 31, 2009 based on our history of prior operating earnings and our expectations for 2011 and beyond. If, however, during the later part of 2010 evidence does not materialize to support our expectations for 2011 and beyond, we will record a deferred tax valuation allowance of $8,160,000 plus deferred taxes established in 2010, if any.

 

The net loss for 2009 was $27,962,000, or $0.80 per share (diluted loss per share), compared to net earnings of $20,885,000, or $0.59 per share (diluted earnings per share), for 2008. Net loss and diluted loss per share for 2009 included the pre-tax impairment charge on the goodwill and intangible assets related to the trademarks of the Palladium brand of $4,830,000 and the pre-tax loss of $2,616,000 from the purchase of the remaining 43% equity interest of Palladium, offset by the net pre-tax gain on the sale of certain Royal Elastics assets of $1,367,000, described above, or $0.18 per diluted share (after tax). Net earnings and diluted earnings per share for 2008 included the pre-tax settlement of litigation of $30,000,000, described above, or $0.52 per diluted share (after tax).

 

2008 Compared to 2007

 

Revenue and Gross Margin

 

Total revenues decreased 17.0% to $327,405,000 in 2008 from $394,540,000 in 2007. This decrease was attributable to a decrease in the volume of footwear sold and a decrease in the average underlying wholesale price per pair. The volume of footwear sold decreased 17.2% to 11,384,000 pair in 2008 from 13,750,000 pair in 2007. The average wholesale price per pair was $27.56 in 2008 and $27.84 in 2007, a decrease of 1.0%.

 

Domestic revenues decreased 29.6% to $138,390,000 in 2008 from $196,607,000 in 2007. International product revenues decreased 5.8% in 2008 to $181,380,000 from $192,471,000 in 2007. Fees earned by the Company on sales by foreign licensees and distributors were $7,635,000 for 2008 and $5,462,000 for 2007, an increase of 39.8%. International revenues, as a percentage of total revenues, increased to 57.7% in 2008 from 50.2% in 2007.

 

K•Swiss brand revenues decreased 19.9% to $315,913,000 in 2008 from $394,540,000 in 2007. This decrease was the result of a decrease in the volume of footwear sold and a decrease in the average underlying wholesale price per pair. The volume of footwear sold decreased 18.6% to 11,187,000 pair in 2008 from 13,750,000 pair in 2007. The average wholesale price per pair was $27.02 in 2008 and $27.84 in 2007, a decrease of 2.9%, which resulted from product mix changes offset by international sales becoming a larger portion of revenues.

 

Palladium brand revenues were $11,492,000 in 2008 (all of this revenue was derived from sales outside the U.S.), representing six months of revenue.

 

Overall gross profit margin, as a percentage of revenues, was 40.3% in 2008 and 46.5% in 2007. Gross profit margin was affected by product mix changes, geographic mix of international sales and increases in inventory reserves. International sales generally yield a higher gross profit margin, however, the gross profit margin was lower in 2008 than in 2007. In addition, included in gross margin is an additional accrual for the underpayment of certain business taxes in a foreign jurisdiction. Prior to the third quarter of 2008, we had accrued approximately $638,000 related to this issue. A detailed

 

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analysis performed by our tax advisors and accountants during the third quarter of 2008 determined that the total amount of business taxes underpaid and related interest was approximately $2,447,000. Penalties were discretionary, ranging from zero to 300% of taxes owed and at that time, penalties were not accrued as the Company could not determine the likelihood of such assessment. As discussed above, on August 5, 2009, the Company settled the underpayment of such business taxes for approximately $1,529,000 plus interest of approximately $1,185,000, with no penalties assessed.

 

Selling, General and Administrative Expenses

 

Overall selling, general and administrative expenses decreased 5.7% to $139,899,000 (42.7% of revenues) in 2008 from $148,283,000 (37.5% of revenues) in 2007. The decrease in selling, general and administrative expenses during 2008 was the result of a decrease in advertising expenses, gains on ineffective hedges and a decrease in salesman sample expenses, offset by increases in compensation expenses and data processing expenses. Advertising expenses decreased 31.1% primarily due to decreases in both domestic and international markets as part of an effort to reduce costs as our business declines. Gains on ineffective hedges contributed to a $1,604,000 decrease in selling, general and administrative expenses. Salesman sample expenses decreased 19.7% as a result of cost reductions and also as a result of our declining revenues. Data processing expenses increased 43.9% as a result of on-going maintenance expenses incurred in connection with the Company’s fourth quarter of 2007 SAP implementation to our domestic and certain international operational regions and expenses related to the Company’s continuing SAP computer software implementation to other international operational regions in 2008. The increase in compensation expenses of 16.8% was due to stock option expenses (recognized as a result of the repricing of stock options, see Note L to our Consolidated Financial Statements), an increase in headcount, a decrease in the reversal of bonus/incentive related expenses that were calculated in accordance with the bonus formula under our Economic Value Added incentive program and severance payments made, offset by decreases in other bonus/incentive related expenses. Corporate expenses of $25,931,000 and $21,886,000 for the years ended December 31, 2008 and 2007, respectively, are included in selling, general and administrative expenses. The increase in corporate expenses for 2008 was due to an increase in data processing and compensation expenses for the reasons described above.

 

Other Income, Interest and Taxes

 

Other income for the year ended December 31, 2008 consists of a $30 million settlement payment received on June 30, 2008, as discussed above.

 

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

 

Overall net interest income was $8,216,000 (2.5% of revenues) in 2008 compared to $11,184,000 (2.8% of revenues) in 2007, a decrease of $2,968,000 or 26.5%. This decrease in net interest income

 

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was the result of lower average interest rates along with interest expense incurred by Palladium under its lines of credit and other debt offset by higher average cash balances, which resulted primarily from the $30,000,000 settlement received from Payless on June 30, 2008. Also included for the year ended December 31, 2008 was interest income from the change in fair value on the MRMI.

 

Our effective tax rate was 19.4% and 19.1% in 2008 and 2007, respectively. The $823,000 and $1,063,000 income tax benefit of options exercised during 2008 and 2007, respectively, were credited to additional paid-in capital and therefore did not impact the effective tax rate.

 

At December 31, 2008, uncertain tax positions and the related interest were $6,120,000 and $756,000, respectively, all of which would affect the income tax rate if reversed. We recognized income tax expense related to uncertain tax positions of $209,000 and $169,000 for 2008 and 2007, respectively.

 

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

 

Liquidity and Capital Resources

 

We experienced a net cash outflow of $22,476,000 from our continuing operations during 2009 compared to a net cash inflow of $17,510,000 and $47,043,000 from our continuing operations during 2008 and 2007, respectively. The decrease in operating cash inflows in 2009 from 2008 is due to the decrease in net earnings and to the differences in the amounts of changes in accounts payable and accrued liabilities, income taxes receivable and MRMI, offset by the differences in the amounts of changes in inventories and accounts receivable and the impairment of intangibles and goodwill. Cash from continuing operations in 2008 decreased from 2007 due primarily to the decrease in net earnings and to the difference in the amounts in changes in accounts receivable and accounts payable and accrued liabilities, offset by changes in prepaid expenses and other assets and by stock-based compensation and depreciation and amortization.

 

We had a net outflow of cash of $54,829,000, $13,749,000 and $10,485,000 from our investing activities during 2009, 2008 and 2007, respectively. The increase in investing activities in 2009 is due to the purchase of investments available for sale and the reclassification of $22,270,000 as collateral for our lines of credit to restricted cash and cash equivalents, partially offset by lower purchases of property plant and equipment. The increase in investing activities in 2008 is due to the purchase of intangible assets and the purchase of Palladium offset by lower purchases of property, plant and equipment.

 

We had a net inflow of cash from financing activities of $207,000 during 2009 and net outflow of cash from financing activities of $76,299,000 and $5,091,000 during 2008 and 2007, respectively. The increase in net cash inflow during 2009 is due to a decrease in payments of dividends, offset by an increase in net repayments on bank lines of credit and decreases in excess income tax benefit of stock-based compensation and proceeds from stock options exercised. The increase in net cash outflows during 2008 was primarily due to an increase in payment of cash dividends (including our special cash dividend of $2.00 per share on December 24, 2008), and an increase in the purchase of our outstanding stock under our then-current stock repurchase program.

 

We anticipate future cash needs for repayments required pursuant to borrowings under Palladium’s lines of credit facilities and term loans. In addition, depending on our future operating results, additional funds may be required by operating activities. No other material capital commitments

 

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exist at December 31, 2009. With continued use of our revolving credit facilities (as discussed below), we believe our present and currently anticipated sources of capital are sufficient to sustain our anticipated capital needs for the remainder of 2010.

 

On October 26, 2004, the Board of Directors authorized a stock repurchase program to supplement prior stock repurchase programs, which allowed 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. In November 2009, the Board of Directors approved a new stock repurchase program to purchase through December 31, 2014 up to $70,000,000 of the Company’s Class A Common Stock. As of December 31, 2009, $70,000,000 is remaining in this program. We adopted the $70,000,000 program because we believe that depending upon the array of alternatives, repurchasing our shares can be a good use of excess cash. Currently, we have made purchases under all stock repurchase programs from August 1996 through February 17, 2010 (the day prior to the filing of this Form 10-K) of 25.5 million shares at an aggregate cost totaling approximately $166,759,000, at an average price of $6.55 per share. See “Part II—Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”

 

Effective June 30, 2009, we amended certain of our bank agreements, reducing the amount we can borrow on our lines of credit facilities. Pursuant to the amendment, certain covenants were eliminated and we agreed to collateralize our lines of credit with $22,270,000 of cash held at the bank, which is reflected as Restricted Cash and Cash Equivalents in the Company’s Consolidated Balance Sheet. The covenants that have been eliminated are the Company’s obligation (1) to maintain at all times unencumbered liquid assets having an aggregate market value of not less than $100,000,000; (2) to maintain positive net income after taxes and extraordinary items on a rolling four consecutive fiscal quarter basis; and (3) not to declare or pay dividends or redeem stock in an aggregate amount greater than $150,000,000. We pay a commitment fee of 1/8% of the unused line for availability of the $10,000,000 credit facility. The terms of and current borrowings under our lines of credit (not including borrowings by Palladium) as of December 31, 2009 are as follows (dollars in thousands):

 

     Amount
Outstanding
   Outstanding
Letters of
Credit
   Unused
Lines of
Credit
   Total   

Interest Rate

  

Expiration Date

Domestic

   $ —      $ 700    $ 9,300    $ 10,000    Prime - 0.75%    July 1, 2010

Europe

   $ —      $ —      $ 4,500    $ 4,500   

LIBOR + 1.25%;

IBOR + 1.25%

  

July 1, 2010; mutually

cancelable at any time

Asia

   $ —      $ —      $ 3,000    $ 3,000    LIBOR + 1.25%; Australian Bank Bill Buying Rate + 1.25%    July 1, 2010

Canada

   $ —      $ —      $ 1,000    $ 1,000    Canadian Prime    July 1, 2010

 

The Company’s $10,000,000 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 $10,000,000 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 under the Company’s unsecured revolving credit facility will reprice at a rate of 2% higher than prime rate less 3/4%. At December 31, 2009, the Company was in compliance with all relevant covenants under its $10,000,000 credit facility.

 

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At December 31, 2009, we had debt outstanding of $4,207,000 (attributable to outstanding borrowings by Palladium under its lines of credit facilities and term loans) with no letters of credit outstanding under these facilities. The terms of and current borrowing under Palladium’s lines of credit facilities and term loans at December 31, 2009 is as follows (dollars in thousands):

 

    Amount
Outstanding
  Outstanding
Letters of
Credit
  Unused
Lines of
Credit
  Total  

Interest Rate at
December 31,

2009

 

Expiration Date

Secured lines of credit (1)

  $ 3,145   $ —     $ 295   $ 3,440  

Variable, 1.91% -

2.85%

  December 31, 2009 (1)

Secured line of credit

    —       —       5,735     5,735   Variable, 1.37%   December 31, 2010

Fixed rate loans

    1,048     —       —       1,048   5.42% - 5.84%   2012 - 2013

Accrued interest

    14     —       —       14    
                           
  $ 4,207   $ —     $ 6,030   $ 10,237    
                           

 

(1)   Under these lines of credit, the maximum facility amount available between July 1 through December 31, 2009 range from 1,700,000 to 2,400,000 (or approximately $2,437,000 to $3,441,000). These lines of credit were renewed until June 30, 2010 and the maximum facility amount available between January 1 through June 30, 2010 range from 1,600,000 to 2,400,000 (or approximately $2,294,000 to $3,441,000).

 

In accordance with these financing arrangements with the financial institutions, Palladium must meet minimum working capital requirements and is restricted as to the amount of dividends it can pay. At December 31, 2009, Palladium was in compliance with its debt covenants. See Note F to our Consolidated Financial Statements for further discussion.

 

Our working capital decreased $20,986,000 to $259,651,000 at December 31, 2009 from $280,637,000 at December 31, 2008. Working capital decreased during 2009 mainly due to decreases in cash and cash equivalents (including restricted cash), inventory, accounts receivable, prepaid expenses and other current assets and current deferred income taxes, offset by decreases in trade accounts payable, accrued liabilities and bank lines of credit and short-term debt and increases in investments available for sale and income taxes receivable.

 

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

 

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Contractual Obligations

 

At December 31, 2009, our significant contractual obligations were as follows (in thousands):

 

     Payments due by period
     Total    Less
than one
year
   One to
three
years
   Three
to five
years
   More
than five
years

Operating lease obligations

   $ 17,536    $ 4,947    $ 6,786    $ 4,226    $ 1,577

Endorsement obligations

     5,910      2,295      2,578      1,000      37

Royalty obligations

     2,200      750      1,450      —        —  

Bank debt

     4,207      3,463      580      164      —  

Product purchase obligations (1)

     35,193      35,193      —        —        —  
                                  

Total

   $ 65,046    $ 46,648    $ 11,394    $ 5,390    $ 1,614
                                  

 

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

 

Off-Balance Sheet Arrangements

 

We did not enter into any off-balance sheet arrangements during 2009 or 2008, nor did we have any off-balance sheet arrangements outstanding at December 31, 2009 or 2008.

 

Inflation

 

We believe that distributors of footwear in the higher priced end of the footwear market, including ours, are able to adjust their prices in response to an increase in direct and general and administrative expenses in order to partially or completely offset rising prices, without experiencing a significant loss in sales. Accordingly, to date, inflation and changing prices have not had a material adverse effect on our revenues or earnings.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

Market Risk

 

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

 

Foreign Exchange Rate Risk

 

Sales denominated in currencies other than the U.S. dollar, which are primarily sales to customers in Europe, expose 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, U.S. dollar and the Pound Sterling and between the Euro and the Pound Sterling. In 2009 and 2008, the Company entered into forward

 

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foreign exchange contracts to exchange Euros for U.S. dollars, Pound Sterling for U.S. dollars and Pound Sterling for Euros. The extent to which forward foreign exchange contracts are used is modified periodically in response to management’s estimate of market conditions and the terms and length of specific sales contracts.

 

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 settle in less than one year.

 

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

 

At December 31, 2009, forward foreign exchange contracts with a notional value of $17,100,000 were outstanding to exchange various currencies with maturities ranging from January 2010 to September 2010, to sell the equivalent of approximately $4,050,000 in foreign currencies at contracted rates and to buy approximately $13,050,000 in foreign currencies at contracted rates. These contracts have been designated as cash flow hedges. Realized gains of $1,810,000 for 2009 and realized losses of $1,708,000 and $2,258,000 for 2008 and 2007, respectively, from cash flow hedges were recorded in cost of goods sold. Realized gains of $258,000 and $1,036,000 for 2009 and 2008, respectively, and realized losses of $99,000 for 2007 from cash flow hedges were recorded in selling, general and administrative expenses due to hedge ineffectiveness. Realized losses of $6,000 for 2009 and realized gains of $568,000 for 2008 from forward contracts not designated as hedging instruments were recorded in selling, general and administrative expenses. At December 31, 2009, the Company did not have any forward foreign exchange contracts that do not qualify as hedges.

 

We do not anticipate any material adverse effect on our operations or financial position relating to these forward foreign exchange contracts. Based on our overall currency rate exposure at December 31, 2009, a 1% change in currency rates would not have a material effect on the financial position, results of operations or cash flows of the Company.

 

Interest Rate Risk

 

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

 

Item 8.   Financial Statements and Supplementary Data

 

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

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

Board of Directors and Stockholders

K•Swiss Inc.

 

We have audited K•Swiss Inc.’s (a Delaware Corporation) internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). K•Swiss Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report of Internal Control Over Financial Reporting. Our responsibility is to express an opinion on K•Swiss Inc.’s internal control over financial reporting based on our audit.

 

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

 

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

 

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

 

In our opinion, K•Swiss Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by COSO.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of K•Swiss Inc. as of December 31, 2009 and 2008, and the related consolidated statements of earnings/loss and comprehensive earnings/loss, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009 and our report dated February 18, 2010 expressed an unqualified opinion on those financial statements.

 

/s/ GRANT THORNTON LLP

 

Los Angeles, California

February 18, 2010

 

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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

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

 

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

 

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

 

In connection with the preparation of the Company’s annual financial statements, management of the Company has undertaken an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009 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, 2009.

 

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

 

February 18, 2010

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors and Stockholders

K•Swiss Inc.

 

We have audited the accompanying consolidated balance sheets of K•Swiss Inc. (a Delaware corporation) and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of earnings/loss and comprehensive earnings/loss, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. Our audits of the basic financial statements included Schedule II—Valuation and Qualifying Accounts. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

 

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

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of K•Swiss Inc. and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), K•Swiss Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 18, 2010 expressed an unqualified opinion thereon.

 

/s/ GRANT THORNTON LLP

 

Los Angeles, California

February 18, 2010

 

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K•SWISS INC.

 

CONSOLIDATED BALANCE SHEETS

 

December 31,

 

(Dollar amounts in thousands)

 

     2009     2008  
A S S E T S     

CURRENT ASSETS

    

Cash and cash equivalents (Note A4)

   $ 139,663      $ 207,423   

Restricted cash and cash equivalents (Note F)

     22,270        —     

Investments available for sale (Note B)

     31,209        —     

Accounts receivable, less allowance for doubtful accounts of $2,162 and $2,897 for 2009 and 2008, respectively (Notes A13 and M)

  

 

27,487

  

 

 

34,959

  

Inventories (Note A5)

     48,183        74,417   

Prepaid expenses and other current assets (Notes A12 and E)

     2,472        9,301   

Income taxes receivable (Notes A9 and I)

     13,821        —     

Deferred income taxes (Notes A9 and I)

     2,881        6,676   
                

Total current assets

     287,986        332,776   

PROPERTY, PLANT AND EQUIPMENT, net (Notes A6, A7 and C)

     22,053        25,686   

OTHER ASSETS

    

Intangible assets (Notes A8 and D)

     15,259        22,776   

Deferred income taxes (Notes A9 and I)

     9,538        4,474   

Other

     9,314        8,578   
                

Total other assets

     34,111        35,828   
                
   $ 344,150      $ 394,290   
                
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 and short-term debt (Note F)

   $ 3,463      $ 4,355   

Trade accounts payable

     11,639        25,059   

Income taxes payable (Note A9)

     335        339   

Accrued liabilities (Notes A12, E and G)

     12,898        22,386   
                

Total current liabilities

     28,335        52,139   

OTHER LIABILITIES

    

Long-term debt (Note F)

     744        1,021   

Mandatorily redeemable minority interest (Note O)

     —          3,759   

Other liabilities (Notes A9 and H)

     13,288        12,609   
                

Total other liabilities

     14,032        17,389   

COMMITMENTS AND CONTINGENCIES (Note J)

    

STOCKHOLDERS’ EQUITY (Note L)

    

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; 29,519,757 shares issued, 27,098,140 shares outstanding and 2,421,617 shares held in treasury at December 31, 2009 and 29,218,392 shares issued, 26,796,775 shares outstanding and 2,421,617 shares held in treasury at December 31, 2008

  

 

295

  

 

 

292

  

Class B, convertible—authorized 18,000,000 shares of $0.01 par value; 8,039,524 and 8,059,524 shares issued and outstanding at December 31, 2009 and 2008, respectively

  

 

80

  

 

 

81

  

Additional paid-in capital

     66,082        61,412   

Treasury Stock

     (58,190     (58,190

Retained earnings (Note A9)

     288,386        316,348   

Accumulated other comprehensive earnings—

    

Foreign currency translation (Note A10)

     5,672        1,398   

Net (loss)/gain on hedge derivatives (Notes A12 and E)

     (566     3,421   

Net gain on investments available for sale (Note B)

     24        —     
                
     301,783        324,762   
                
   $ 344,150      $ 394,290   
                

 

The accompanying notes are an integral part of these statements.

 

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K•SWISS INC.

 

CONSOLIDATED STATEMENTS OF EARNINGS/LOSS

 

AND COMPREHENSIVE EARNINGS/LOSS

 

Year Ended December 31,

 

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

 

    2009     2008     2007  

Revenues (Notes A13, M and N)

  $ 240,729      $ 327,405      $ 394,540   

Cost of goods sold (Note A14)

    154,558        195,385        210,910   
                       

Gross profit

    86,171        132,020        183,630   

Selling, general and administrative expenses (Notes A10, A13, A15, A16, A18,
E and K)

    118,303        139,899        148,283   

Impairment on intangibles and goodwill (Notes A8 and D)

    4,830        —          —     
                       

Operating (loss)/profit (Note N)

    (36,962     (7,879     35,347   

Other (expense)/income (Notes A19, O and P)

    (1,249     30,000        5,232   

Interest income, net (Notes N and O)

    1,050        8,216        11,184   
                       

(Loss)/Earnings before income taxes and discontinued operations

    (37,161     30,337        51,763   

Income tax (benefit)/expense (Notes A9, I and N)

    (9,663     5,882        9,868   
                       

(Loss)/Earnings from continuing operations

    (27,498     24,455        41,895   

Loss from discontinued operations, less applicable income tax benefit of $648, $2,312 and $1,754 for 2009, 2008 and 2007, respectively (Notes A1, A19 and P)

    (464     (3,570     (2,822
                       

NET (LOSS)/EARNINGS

  $ (27,962   $ 20,885      $ 39,073   
                       

(Loss)/Earnings per common share (Notes A17 and L)

     

Basic:

     

(Loss)/Earnings from continuing operations

  $ (0.79   $ 0.70      $ 1.21   

Loss from discontinued operations

    (0.01     (0.10     (0.08
                       

Net (Loss)/Earnings

  $ (0.80   $ 0.60      $ 1.13   
                       

Diluted:

     

(Loss)/Earnings from continuing operations

  $ (0.79   $ 0.69      $ 1.18   

Loss from discontinued operations

    (0.01     (0.10     (0.08
                       

Net (Loss)/Earnings

  $ (0.80   $ 0.59      $ 1.10   
                       

Weighted average number of shares outstanding (Note A17)

     

Basic

    34,962        34,785        34,705   
                       

Diluted

    34,962        35,407        35,472   
                       

Dividends declared per common share (Note L)

  $ —        $ 2.20      $ 0.20   
                       

Net (Loss)/Earnings

  $ (27,962   $ 20,885      $ 39,073   

Other comprehensive (loss)/earnings, net of tax—

     

Foreign currency translation adjustments, net of income taxes of $0, $0 and $0 for 2009, 2008 and 2007, respectively (Note A10)

    4,274        (11,968     4,401   

Change in deferred (loss)/gain on hedge derivatives, net of income taxes of $0, $0 and $0 for 2009, 2008 and 2007, respectively (Notes A12 and E)

    (3,987     4,640        496   

Change in deferred gain on investments available for sale, net of income taxes of $12, $0 and $0 for 2009, 2008 and 2007, respectively
(Note B)

    24        —          —     
                       

Comprehensive (Loss)/Earnings

  $ (27,651   $ 13,557      $ 43,970   
                       

 

The accompanying notes are an integral part of these statements.

 

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K•SWISS INC.

 

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

 

Three years ended December 31, 2009

 

(Dollar amounts in thousands)

 

    Common Stock     Addi-
tional
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, 2007

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

Cumulative effect of adjustments resulting from the adoption of Uncertain Tax Positions, ASC No. 740 (Notes A9 and I)

 

—  

 

 

—  

 

—  

  

 

 

—  

  

 

 

—  

 

—  

 

 

—  

  

 

 

(2,575

 

 

—  

  

 

 

(2,575

                   

Conversion of shares (Note L)

  40,604     —     (40,604     —          —     —       —          —          —          —     

Exercise of options (Note L)

  165,935     2   —          —          1,198   —       —          —          —          1,200   

Excess income tax benefit of options exercised (Note L)

  —       —     —          —          1,063   —       —          —          —          1,063   

Stock-based compensation (Notes A18 and L)

  —       —     —          —          2,026   —       —          —          —          2,026   

Purchase of treasury stock

  —       —     —          —          —     15,000     (409     —          —          (409

Dividends paid

  —       —     —          —          —     —       —          (6,945     —          (6,945

Net earnings for the year

  —       —     —          —          —     —       —          39,073        —          39,073   

Foreign currency translation (Note A10)

  —       —     —          —          —     —       —          —          4,401        4,401   

Net gain on hedge derivatives (Notes A12 and E)

  —       —     —          —          —     —       —          —          496        496   
                                                                 

BALANCE AT DECEMBER 31, 2007

  28,970,733     290   8,059,524        81        55,657   2,272,161     (56,070     372,128        12,147        384,233   

Exercise of options (Note L)

  247,659     2   —          —          1,619   —       —          —          —          1,621   

Excess income tax benefit of options exercised (Note L)

  —       —     —          —          823   —       —          —          —          823   

Stock-based compensation (Notes A18 and L)

  —       —     —          —          3,313   —       —          —          —          3,313   

Purchase of treasury stock

  —       —     —          —          —     149,456     (2,120     —          —          (2,120

Dividends paid (Note L)

  —       —     —          —          —     —       —          (76,665     —          (76,665

Net earnings for the year

  —       —     —          —          —     —       —          20,885        —          20,885   

Foreign currency translation (Note A10)

  —       —     —          —          —     —       —          —          (11,968     (11,968

Net gain on hedge derivatives (Notes A12 and E)

  —       —     —          —          —     —       —          —          4,640        4,640   
                                                                 

BALANCE AT DECEMBER 31, 2008

  29,218,392     292   8,059,524        81        61,412   2,421,617     (58,190     316,348        4,819        324,762   

Conversion of shares (Note L)

  20,000     1   (20,000     (1     —     —       —          —          —          —     

Exercise of options (Note L)

  281,365     2   —          —          929   —       —          —          —          931   

Excess income tax benefit of options exercised (Note L)

  —       —     —          —          550   —       —          —          —          550   

Stock-based compensation (Notes A18 and L)

  —       —     —          —          3,191   —       —          —          —          3,191   

Net loss for the year

  —       —     —          —          —     —       —          (27,962     —          (27,962

Foreign currency translation (Note A10)

  —       —     —          —          —     —       —          —          4,274        4,274   

Net loss on hedge derivatives (Notes A12 and E)

  —       —     —          —          —     —       —          —          (3,987     (3,987

Net gain on investments available for sale (Note B)

  —       —     —          —          —     —       —          —          24        24   
                                                                 

BALANCE AT DECEMBER 31, 2009

  29,519,757   $ 295   8,039,524      $ 80      $ 66,082   2,421,617   $ (58,190   $ 288,386      $ 5,130      $ 301,783   
                                                                 

 

The accompanying notes are an integral part of this statement.

 

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K•SWISS INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

Year ended December 31,

 

(Dollar amounts in thousands)

 

     2009     2008     2007  

Cash flows from operating activities:

      

Net (loss)/earnings from continuing operations

   $ (27,498   $ 24,455      $ 41,895   

Adjustments to reconcile net (loss)/earnings from continuing operations to net cash (used in)/provided by operating activities:

      

Depreciation and amortization (Note N)

     4,159        3,534        2,246   

Impairment on intangibles and goodwill (Note D)

     4,830        —          —     

Change in mandatorily redeemable minority interest (Note O)

     (3,759     (490     —     

Net loss on disposal of property, plant and equipment

     789        74        29   

Deferred income taxes

     (212     (1,823     (559

Stock-based compensation

     3,191        3,313        2,026   

Excess income tax benefit of stock-based compensation

     (550     (823     (1,063

Decrease/(increase) in accounts receivable

     6,523        (4,409     6,931   

Decrease/(increase) in inventories

     21,579        (5,560     (2,604

Increase in income taxes receivable

     (13,821     —          —     

Decrease/(increase) in prepaid expenses and other assets

     3,255        3,031        (2,492

(Decrease)/increase in accounts payable and accrued liabilities

     (20,962     (3,792     634   
                        

Net cash (used in)/provided by operating activities from continuing operations

     (22,476     17,510        47,043   

Net cash provided by/(used in) discontinued operations

     4,945        (1,222     (4,528
                        

Net cash (used in)/provided by operating activities

     (17,531     16,288        42,515   

Cash flows from investing activities:

      

Change in restricted cash and cash equivalents

     (22,270     —          —     

Purchase of investments available for sale

     (31,115     —          —     

Purchase of Palladium (Note O)

     —          (2,684     —     

Purchase of intangible assets

     —          (6,015     —     

Purchase of property, plant and equipment

     (1,444     (5,050     (10,489

Proceeds from disposal of property, plant and equipment

     —          —          4   
                        

Net cash used in investing activities

     (54,829     (13,749     (10,485

Cash flows from financing activities:

      

Borrowings under bank lines of credit

     49,674        27,287        —     

Repayments on bank lines of credit and term debt

     (50,948     (27,245     —     

Repurchase of stock

     —          (2,120     (409

Payment of dividends

     —          (76,665     (6,945

Excess income tax benefit of stock-based compensation

     550        823        1,063   

Proceeds from stock options exercised

     931        1,621        1,200   
                        

Net cash provided by/(used in) financing activities

     207        (76,299     (5,091

Effect of exchange rate changes on cash

     4,393        (10,052     4,067   
                        

Net (decrease)/increase in cash and cash equivalents

     (67,760     (83,812     31,006   

Cash and cash equivalents at beginning of year

     207,423        291,235        260,229   
                        

Cash and cash equivalents at end of year

   $ 139,663      $ 207,423      $ 291,235   
                        

Supplemental disclosure of cash flow information:

      

Non-cash investing activities:

      

On July 1, 2008, the Company purchased the capital stock of Palladium. In connection with the acquisition, the assets acquired and liabilities assumed were as follows (Note O):

      

Fair value of assets acquired

     $ 10,775     

Fair value of liabilities assumed

     $ (17,815  

Mandatorily redeemable minority interest

     $ (4,249  

Excess fair value over purchase price

     $ 13,973     

Cash paid during the year for:

      

Interest

   $ 261      $ 265      $ 57   

Income taxes

   $ 710      $ 2,128      $ 7,332   

 

The accompanying notes are an integral part of these statements.

 

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Table of Contents

K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

December 31, 2009, 2008 and 2007

 

NOTE A—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

1.   Nature of Operations

 

K•Swiss Inc. (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 at above one percent. Lastly, the retail environment forecasted for the near term is challenging, given the general deterioration in the overall economy and financial markets in the past several years, which could negatively impact the Company’s operations.

 

The Company purchases significantly all of its products from a small number of contract manufacturers in 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. In addition, there are other risks associated with doing business in China, including the protection of intellectual property rights within China.

 

In November 2001, the Company acquired the worldwide rights and business of Royal Elastics, an Australian-based designer and manufacturer of elasticated footwear. On April 30, 2009, the Company sold certain Royal Elastics assets, consisting of its inventory located in Taiwan and its intangible trademarks to Royal Elastics Holdings Ltd. (“REH”), a third party, in an arm’s length transaction. Operations of the Royal Elastics brand have been accounted for and presented as a discontinued operation in the accompanying financial information. See further discussion in Note P.

 

In July 2008, the Company purchased a 57% equity interest in Palladium SAS (“Palladium”) for a total purchase price of 5.3 million, or approximately $8.5 million (including a loan of 3.65 million, or approximately $5.8 million). On June 2, 2009, the Company purchased the remaining 43% equity interest in Palladium for 5.0 million plus a variable future price. The future purchase price is equal to an amount calculated in accordance with a formula driven by Palladium’s EBITDA for the twelve months ended December 31, 2012 less 3.3 million, but not to exceed 6.7 million. The fair value of this new liability (the “Contingent Purchase Price” or “CPP”) will be determined each quarter based on the current quarter’s projection of Palladium’s EBITDA for the twelve months ended December 31 of the current year, less 3.3 million, but not less than zero. The change in CPP is based on the current quarter’s EBITDA projection and will be recognized as interest income or interest expense during the current quarter. The fair value of the CPP at December 31, 2009 was zero. Under the Palladium brand, the Company designs, develops and markets footwear for adventurers for all terrains. See further discussion in Note O.

 

The Company evaluated subsequent events through February 18, 2010.

 

2.   Estimates in Financial Statements

 

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

 

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Table of Contents

K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

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

 

3.   Basis of Consolidation

 

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 2008 and 2007 presentation to conform to the 2009 presentation. These reclassifications had no impact on previously reported results of operations or stockholders’ equity and do not affect previously reported cash flows from operations, investing and financing activities or net change in cash and cash equivalents.

 

4.   Cash Equivalents

 

For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Included in cash and cash equivalents as of December 31, 2009 and 2008 is $36,369,000 and $33,082,000, respectively, of balances maintained in foreign bank accounts.

 

5.   Inventories

 

Inventories, consisting of merchandise held for resale as finished goods, are stated at the lower of cost or market. Cost is determined using a moving average cost method. Management continually evaluates its inventory position and implements promotional or other plans to reduce inventories to appropriate levels relative to its sales estimates for particular product styles or lines. Estimated losses are recorded when such plans are implemented. It is 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.

 

6.   Property, Plant and Equipment

 

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 Accounting Standards Codification (“ASC”) No. 350, “Intangibles – Goodwill and Others.” For financial reporting and tax purposes, depreciation and amortization are calculated using straight-line and accelerated methods, respectively, over the estimated service lives of the depreciable assets. The service lives of the Company’s building and related improvements are 30 and 5 years, respectively. Information systems and equipment is depreciated from 3 to 10 years and leasehold improvements are amortized over the lives of the respective leases.

 

7.   Impairment of Long-Lived Assets

 

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

 

47


Table of Contents

K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

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

 

8.   Goodwill and Intangible Assets

 

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

 

The Company reviews goodwill for impairment in a two step process. The first step is to determine whether there is potential impairment by comparing the estimated fair value of a reporting unit to its carrying value (which includes goodwill). If the fair value exceeds the carrying value, then goodwill is not considered impaired, however, if the carrying amount exceeds the fair value, then step two is performed to measure the amount of impairment loss, if any. The second step compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined by allocating fair value to all assets and liabilities. The excess, if any, is the implied fair value of goodwill. If the implied fair value of goodwill is less than the carrying amount of goodwill, then impairment is recognized.

 

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

 

9.   Income Taxes

 

The Company accounts for income taxes under ASC No. 740, “Income Taxes.” ASC No. 740 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.

 

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

 

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

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

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

 

9.   Income Taxes—(Continued)

 

Company’s expected annual effective tax rate. When this occurs, the Company adjusts the income tax provision during the quarter in which the change in estimate occurs so that the year-to-date income tax provision equals the estimated annual rate.

 

The Company evaluates the future realization of its deferred tax assets quarterly. The Company reviews each material tax jurisdiction for which a deferred tax asset has been recorded. The Company’s analysis includes a review of past results, future income and the tax life of net operating loss carryforwards. All evidence is evaluated in forming a conclusion whether a valuation allowance, if any, needs to be recorded.

 

ASC No. 740 creates a single model to address the accounting for the uncertainty in income tax positions and prescribes a minimum recognition threshold a tax position must meet before recognition in the financial statements. The evaluation of a tax position 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. On January 1, 2007, upon the adoption of the accounting for uncertain tax positions, the Company recognized a cumulative effect to beginning retained earnings of $2,575,000.

 

Any tax position recognized would be an adjustment to the effective tax rate. The Company recognizes interest expense and penalties on income tax liabilities in income tax expense on its Consolidated Statement of Earnings/Loss. The Company recognizes its uncertain tax positions in either accrued income taxes, if determined to be short-term, or other liabilities if determined to be long-term, on its Consolidated Balance Sheet. For federal tax purposes, the Company’s 2006 through 2008 tax years remain open for examination by the tax authorities under the normal three year statute of limitations. Generally, for state tax purposes, the Company’s 2005 through 2008 tax years remain open for examination by the tax authorities under a four year statute of limitations, however, certain states may keep their statute open for six to ten years.

 

10.   Foreign Currency Translation

 

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

 

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Table of Contents

K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

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

 

11.   Fair Value of Financial Instruments

 

For certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, outstanding borrowings under the lines of credit and short-term debt, accounts payable and other accrued liabilities, the carrying amounts approximate fair value due to their short maturities. In addition, the Company has long-term debt with financial institutions. The fair value of long-term debt is measured by obtaining the current interest rate from the financial institutions and then comparing that to the actual interest rate owed on the debt. At December 31, 2009, the fair value of the long-term debt is estimated at $726,000.

 

ASC No. 820, “Fair Value Measurements and Disclosures,” defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements which increase the consistency and the comparability of fair value measurements in financial statement disclosures. ASC No. 820 applies in situations where other accounting pronouncements require or permit fair value measurements.

 

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

 

The following table provides the assets and liabilities carried at fair value measured on a recurring basis at December 31, 2009 (in thousands):

 

          Fair Value Measurements Using
     Total
Carrying
Value
   Quoted
Prices in
Active
Markets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs

(Level 3)

Investments Available for Sale

   $ 31,209    $ 15,069    $ 16,140    $ —  

Forward Exchange Contracts—Assets

     184      —        184      —  

Forward Exchange Contracts—Liabilities

     351      —        351      —  

 

The Company purchases its investments available for sale through several major financial institutions. These financial institutions have hired a third party to measure fair value of these investments.

 

U.S. Treasury securities are measured at fair value by obtaining information from a number of live data sources including active market makers and inter-dealer brokers. These data sources are reviewed based on their historical accuracy for individual issues and maturity ranges.

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

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

 

11.   Fair Value of Financial Instruments—(Continued)

 

U.S. Government Corporate and Agency securities are measured at fair value by obtaining (a) a bullet (non-call) spread scale that is created for each issuer going out to forty years (these spreads represent credit risk and are obtained from the new issue market, secondary trading and dealer quotes), (b) an option adjusted spread model which is incorporated to adjust spreads of issues that have early redemption features and (c) final spreads are added to the U.S. Treasury curve and a special cash discounting yield/price routine calculates prices from final yields to accommodate odd coupon payment dates. Evaluators maintain quality by surveying the dealer community, obtaining benchmark quotes, incorporating relevant trade data and updating spreads daily.

 

The Company’s counterparty (“Counterparty”) to a majority of its forward exchange contracts is a major financial institution. These forward exchange contracts are measured at fair value using a “mid-market” valuation which represents either (1) the Counterparty’s good faith estimate of the mid-market value of the position, based on estimated or actual bids and offers for the positions, or (2) a “mid-market” price generated by the Counterparty’s proprietary valuation models utilized by the Counterparty.

 

The following table provides Palladium’s goodwill and intangible assets carried at fair value measured on a non-recurring basis at December 31, 2009 (in thousands):

 

          Fair Value Measurements Using       
     Total
Carrying
Value
   Quoted
Prices in
Active
Markets
(Level 1)
   Significant
Other
Observable
Inputs

(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Total
Losses
 

Palladium Goodwill (1)

   $ —      $ —      $ —      $ —      $ (2,177

Palladium Intangible Assets (1)

     11,235      —        —        11,235      (2,653

 

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

 

12.   Financial Risk Management and Derivatives

 

Sales denominated in currencies other than the U.S. dollar, which are primarily sales to customers in Europe, expose the Company to market risk from material movements in foreign exchange rates between the U.S. dollar and the foreign currency. The Company’s primary risk exposures are from changes in the rates between the U.S. dollar and the Euro, U.S. dollar and the Pound Sterling and between the Euro and the Pound Sterling. In 2009 and 2008, the Company entered into forward foreign exchange contracts to exchange Euros for U.S. dollars, Pound Sterling for U.S. dollars and Pound Sterling for Euros. The extent to which forward foreign exchange contracts are used is modified periodically in response to management’s estimate of market conditions and the terms and length of specific sales contracts.

 

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

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

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

 

12.   Financial Risk Management and Derivatives(Continued)

 

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 settle in less than one year.

 

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

 

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

 

13.   Recognition of Revenues and Accounts Receivable

 

Sales are recognized when title passes and the risks and rewards of ownership have passed to the customer, based on the terms of sale. Title passes generally upon shipment. In some instances, product is shipped directly from the Company’s supplier to the customer. In these cases, the Company recognizes revenue when the product is delivered to the customer according to the terms of the order. Revenues may fluctuate in cases when customers delay accepting shipment of product for periods up to several weeks. Provisions for estimated sales returns and allowances are made at the time of sale based on historical rates of returns and allowances and specific identification of outstanding returns not yet received from customers. However, actual returns and allowances in any future period are inherently uncertain and thus may differ from these estimates. If actual or expected future returns and allowances were significantly greater or lower than established reserves, a reduction or increase to net revenues would be recorded in the period this determination was made. The Company 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 retail conditions. Historically, losses have been within the Company’s expectations. If the financial condition of the Company’s customers were to change, adjustments may be required to these estimates. Furthermore, estimated losses are provided resulting from differences that arise from the gross carrying value of the Company’s receivables and the amounts which customers estimate are owed to the Company. The settlement or resolution of these differences could result in future changes to these estimates.

 

Fees earned on sales by licensees are included in revenues and recognized under the accrual basis of accounting. Licensing fees totaling $6,118,000, $7,078,000 and $5,304,000 were earned during the years ended December 31, 2009, 2008 and 2007, respectively.

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

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

 

13.   Recognition of Revenues and Accounts Receivable(Continued)

 

In accordance with ASC No. 605, “Revenue Recognition,” 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/Loss. Shipping and handling costs included in selling, general and administrative expenses totaled $3,093,000, $3,460,000 and $3,637,000 for the years ended December 31, 2009, 2008 and 2007, respectively.

 

14.   Cost of Goods Sold

 

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

 

Included in cost of goods sold for the year ended December 31, 2008 is an additional accrual for an underpayment of certain business taxes in a foreign jurisdiction. Prior to the third quarter of 2008, the Company had accrued approximately $638,000 related to this issue. A detailed analysis performed by the Company’s tax advisors and accountants during the third quarter of 2008 determined that the total amount of business taxes underpaid and related interest was approximately $2,447,000. Penalties were discretionary, ranging from zero to 300% of taxes owed and at that time, penalties were not accrued as the Company could not determine the likelihood of such assessment. On August 5, 2009, the Company settled the underpayment of such business taxes for approximately $1,529,000 plus interest of approximately $1,185,000, with no penalties assessed.

 

15.   Selling, General and Administrative Expenses

 

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

 

16.   Advertising Costs

 

Advertising costs are generally expensed as incurred and are included in selling, general and administrative expenses. Advertising costs also include athlete endorsement fees, which are amortized over the contractual terms of the agreements. Advertising expenses amounted to $19,254,000, $33,367,000 and $46,369,000 for the years ended December 31, 2009, 2008 and 2007, 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 ASC No. 605, “Revenue Recognition.”

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

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

 

17.   Loss/Earnings per Share

 

Basic earnings per share excludes dilution and is computed by dividing net earnings/loss 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 loss/earnings per share (“EPS”) computations (shares in thousands):

 

     2009     2008     2007  
     Shares    Per Share
Amount
    Shares    Per Share
Amount
    Shares    Per Share
Amount
 

Basic EPS

   34,962    $ (0.80   34,785    $ 0.60      34,705    $ 1.13   

Effect of dilutive stock options

   —        —        622      (0.01   767      (0.03
                                       

Diluted EPS

   34,962    $ (0.80   35,407    $ 0.59      35,472    $ 1.10   
                                       

 

Because the Company had a net loss for the year ended December 31, 2009, the number of diluted shares is equal to the number of basic shares at December 31, 2009. Outstanding stock options would have had an anti-dilutive effect on diluted EPS for the year ended December 31, 2009. Outstanding stock options with exercise prices greater than the average market price of a share of the Company’s common stock also have an anti-dilutive effect on diluted EPS. The following options were not included in the computation of diluted EPS because of their anti-dilutive effect:

 

     2009    2008    2007

Options to purchase shares of common stock (in thousands)

   1,127    222    181

Exercise prices

   $9.52—$34.75    $15.62—$34.75    $27.55—$35.89
   May 2012—    November 2014—    February 2015—

Expiration dates

   August 2019    December 2018    May 2017

 

18.   Stock-Based Compensation

 

The Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the award – the requisite service period. 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.

 

19.   Other Expense/Income

 

Other expense for the year ended December 31, 2009 includes a loss upon purchase of the remaining 43% of Palladium of $2,616,000, see Note O for further discussion, offset by a gain on sale of certain assets of the Royal Elastics brand of $1,367,000, see Note P for further discussion.

 

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Table of Contents

K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

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

 

19.   Other Expense/Income(Continued)

 

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

 

Other income for the year ended December 31, 2007, includes a reversal of an estimate for the Company’s underpayment of payroll withholdings in a foreign jurisdiction from January 1, 1993 through December 31, 2005 of $5,232,000. The September 2007 settlement reached with this foreign jurisdiction resulted in the Company paying 100% of the payroll withholding liability plus a 50% penalty for periods starting from May 2001 through August 2007, however, interest was not assessed. Thus, the amount settled was lower than amounts previously estimated.

 

NOTE B—INVESTMENTS AVAILABLE FOR SALE

 

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

 

     2009

U.S. Treasury

   $ 15,048

U.S. Government Corporations and Agencies

     16,088

Accrued interest income

     73
      
   $ 31,209
      

 

The Company did not have investments classified as available for sale at December 31, 2008. At December 31, 2009, gross unrealized holding gains were $48,000 and gross unrealized holding losses were $12,000. The change in net unrealized holding gains that are included in comprehensive income is $24,000 for the year ended December 31, 2009. The Company immediately recognizes any premiums paid or discounts received on purchases of investments available for sale in its Consolidated Statements of Earnings/Loss as amounts are not material.

 

Investments by contractual maturities as of December 31, 2009 are as follows (in thousands):

 

Within one year

   $

After one year through five years

     31,209

After five years through ten years

     —  

After ten years

     —  
      
   $ 31,209
      

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

NOTE C—PROPERTY, PLANT AND EQUIPMENT

 

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

 

     2009     2008  

Building and improvements

   $ 11,246      $ 12,242   

Information systems

     22,257        23,567   

Furniture, machinery and equipment

     8,133        7,891   
                
     41,636        43,700   

Less accumulated depreciation and amortization

     (20,278     (18,709
                
     21,358        24,991   

Land

     695        695   
                
   $ 22,053      $ 25,686   
                

 

NOTE D—INTANGIBLE ASSETS

 

Intangible assets as of December 31 consist of the following (in thousands):

 

     2009     2008  

Goodwill

   $ 4,608      $ 9,673   

Trademarks

     13,331        15,782   

Other

     —          8   

Less accumulated amortization

     (2,680     (2,687
                
   $ 15,259      $ 22,776   
                

 

The change in the carrying amount of goodwill and intangible assets during year ended December 31, 2009 is as follows (in thousands):

 

     2009     2008  

Beginning Balance

   $ 22,776      $ 4,700   

Trademarks acquired (Note O)

     —          14,703   

Goodwill acquired (Note O)

     —          5,285   

Purchase accounting adjustments to goodwill (Note O)

     (3,077     —     

Impairment losses—goodwill

     (2,177     (25

Impairment losses—trademarks

     (2,653     (694

Foreign currency translation effects

     390        (1,193
                

Ending Balance

   $ 15,259      $ 22,776   
                

 

The Company has performed the annual reassessment and impairment test as of October 1, 2009 of its Palladium goodwill and intangible assets related to trademarks.

 

As part of its assessment of goodwill, the Company determines the fair value of a reporting unit using both an income approach (i.e., “discounted cash flow” methodology) and a market approach (i.e., “guideline public company” and “guideline transactions” methodologies). As a result of the assessment,

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

NOTE D—INTANGIBLE ASSETS—(Continued)

 

primarily based on deteriorating economic market conditions in 2009, it was determined that all the goodwill related to Palladium was impaired by $2,177,000 for 2009.

 

As a result of the Company’s annual assessment, based on current market discount rates and royalty rates, it was determined that Palladium’s intangible assets related to trademarks were impaired by $2,653,000 for 2009.

 

Impairment losses are included in the Corporate Expenses category for segment reporting purposes. See further discussion in Note N.

 

During the year ended December 31, 2008, the Company acquired trademarks of $14,703,000 and goodwill of $5,285,000 mainly as a result of the acquisition of a 57% equity interest in Palladium, see discussion in Note O.

 

The Company has performed the annual reassessment and impairment test required as of January 1, 2008 of its Royal Elastics goodwill and intangible assets related to trademarks. During the fourth quarter of 2008, after a subsequent review of sales, backlog, cash flows and marketing strategy, the Company determined that its investment in the Royal Elastics goodwill and trademarks was impaired and recognized an impairment loss of $719,000 which is included in discontinued operations in the Company’s Consolidated Statements of Earnings/Loss.

 

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

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

NOTE E—FINANCIAL RISK MANAGEMENT AND DERIVATIVES

 

At December 31, 2009, forward foreign exchange contracts with a notional value of $17,100,000 were outstanding to exchange various currencies with maturities ranging from January 2010 to September 2010, to sell the equivalent of approximately $4,050,000 in foreign currencies at contracted rates and to buy approximately $13,050,000 in foreign currencies at contracted rates. These contracts have been designated as cash flow hedges. At December 31, 2009, the Company did not have any forward foreign exchange contracts that do not qualify as hedges.

 

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

 

   

Asset Derivatives

 

Liability Derivatives

 

Balance Sheet
Location

  2009   2008  

Balance Sheet
Location

  2009   2008
    Fair Value   Fair Value     Fair Value   Fair Value

Derivatives designated as hedging instruments

           

Foreign exchange contracts

  Prepaid expenses and other current assets   $ 184   $ 2,585   Accrued liabilities   $ 351   $ 333

Derivatives not designated as hedging instruments

           

Foreign exchange contracts

  Prepaid expenses and other current assets     —       118   Accrued liabilities     —       105
                           

Total derivatives

    $ 184   $ 2,703     $ 351   $ 438
                           

 

The effect of the Company’s derivatives on its Consolidated Statements of Earnings/Loss for years ended December 31, 2009, 2008 and 2007 are as follows (in thousands):

 

Derivatives in Cash
Flow Hedging
Relationships

  Amount of Gain/(Loss)
Recognized in Other
Comprehensive
Earnings (“OCE”) on
Derivative (Effective
Portion)
  Location of
Gain/(Loss)
Reclassified
from OCE
into Income
(Effective
Portion)
  Amount of Gain/(Loss)
Reclassified from OCE into
Income (Effective Portion)
    Location of
Gain/(Loss) in
Income on
Derivative
(Ineffective
Portion and
Amount
Excluded from
Effectiveness
Testing)
  Amount of
Gain/(Loss) in
Income on Derivative
(Ineffective Portion
and Amount
Excluded from
Effectiveness
Testing)
 
  2009     2008   2007     2009   2008     2007       2009   2008   2007  

Foreign exchange contracts

  $ (3,987   $ 4,640   $ 496   Cost
of
goods
  $ 1,810   $ (1,708   $ (2,258   General and
administrative
expenses
  $ 258   $ 1,036   $ (99
                                                                 

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

NOTE E—FINANCIAL RISK MANAGEMENT AND DERIVATIVES—(Continued)

 

Derivatives Not Designated as

Hedging Instruments

   Location of Gain/(Loss)
Recognized in Income on
Derivative
   Amount of Gain/(Loss) Recognized
in Income on Derivative
          2009             2008            2007    

Foreign exchange contracts

   General and administrative
expenses
   $ (6   $ 568    $ —  
                        

 

NOTE F—BANK LINES OF CREDIT AND OTHER DEBT

 

At December 31, 2009 and 2008, the Company had debt outstanding of $4,207,000 and $5,376,000 (attributable to outstanding borrowings by Palladium under its lines of credit facilities and term loans), respectively, (excluding outstanding letters of credit of $700,000 and $1,399,000 at December 31, 2009 and 2008, respectively).

 

Effective June 30, 2009, the Company amended certain of its bank agreements, reducing the amount it can borrow on its lines of credit facilities. Pursuant to the amendment, certain covenants were eliminated and the Company agreed to collateralize its lines of credit with $22,270,000 of cash held at the bank, which is reflected as Restricted Cash and Cash Equivalents in the Company’s Consolidated Balance Sheet at December 31, 2009. The covenants that have been eliminated are the Company’s obligation (1) to maintain at all times unencumbered liquid assets having an aggregate market value of not less than $100,000,000; (2) to maintain positive net income after taxes and extraordinary items on a rolling four consecutive fiscal quarter basis; and (3) not to declare or pay dividends or redeem stock in an aggregate amount greater than $150,000,000. The Company pays a commitment fee of 1/8% of the unused line for availability of the $10,000,000 credit facility. The terms of and current borrowings under the Company’s lines of credit as of December 31, 2009 are as follows (dollars in thousands):

 

     Amount
Outstanding
   Outstanding
Letters of
Credit
   Unused
Lines of
Credit
   Total    Interest Rate    Expiration Date

Domestic

   $ —      $ 700    $ 9,300    $ 10,000    Prime - 0.75%    July 1, 2010

Europe

   $ —      $ —      $ 4,500    $ 4,500    LIBOR + 1.25%;
IBOR + 1.25%
   July 1, 2010;
mutually
cancelable at any
time

Asia

   $ —      $ —      $ 3,000    $ 3,000    LIBOR + 1.25%;
Australian Bank Bill
Buying Rate + 1.25%
   July 1, 2010

Canada

   $ —      $ —      $ 1,000    $ 1,000    Canadian Prime    July 1, 2010

 

The Company’s $10,000,000 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 $10,000,000 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 under the Company’s unsecured revolving credit facility will reprice at a rate of 2% higher than prime rate less 3/4%. At December 31, 2009, the Company was in compliance with all relevant covenants under its $10,000,000 credit facility.

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

NOTE F—BANK LINES OF CREDIT AND OTHER DEBT—(Continued)

 

At December 31, 2009 and 2008, Palladium debt outstanding, under its lines of credit and term loans was $4,207,000 and $5,376,000, respectively. There were no letters of credit outstanding under these facilities at December 31, 2009 or 2008. The breakdown of the debt outstanding at December 31 is as follows (dollars and Euros in thousands):

 

     2009    2008

Secured Fixed Rate Term Loans with Financial Institutions (1):

     

300 (or approximately $430 and $419 at December 31, 2009 and 2008, respectively) at 5.60%, due July 2012

   $ 235    $ 310

165 (or approximately $237 and $231 at December 31, 2009 and 2008, respectively) at 5.82%, due February 2012

     118      154

55 (or approximately $79 and $77 at December 31, 2009 and 2008, respectively) at 5.84%, due February 2012

     40      51

800 (or approximately $1,147 and $1,117 at December 31, 2009 and 2008, respectively) at 5.42%, due February 2013

     655      799

Secured Variable Rate Lines of Credit with Financial Institutions (1):

     

Facility of 4,000 and 4,000 (or approximately $5,735 and $5,588) at December 31, 2009 and 2008, respectively, at Euribor 3 months for the previous month plus 0.65%, or approximately 1.37% and 3.91% at December 31, 2009 and 2008, respectively, due December 31, 2010 and 2009, respectively

     —        913

Facility of 600 and 600 (or approximately $860 and $838) at December 31, 2009 and 2008, respectively, at Euribor prior 3 months plus 1.30%, or approximately 2.02% and 4.56% at December 31, 2009 and 2008, respectively, due June 30, 2010 and 2009, respectively (2)

     1,443      838

Facility of 300 and 300 (or approximately $430 and $419) at December 31, 2009 and 2008, respectively, at T4M (Average Monthly Money Market) plus 2.50%, or approximately 2.85% and 4.95% at December 31, 2009 and 2008, respectively, due June 30, 2010 and 2009, respectively (2)

     363      419

Facility of 600 and 350 (or approximately $860 and $489) at December 31, 2009 and 2008, respectively, at Euribor 1 month + 2.00%, or 2.45%, at December 31, 2009, and at T4M plus 1.50%, or approximately 3.95%, at December 31, 2008, due June 30, 2010 and 2009, respectively (2)

     860      487

Facility of 300 (or approximately $419) at December 31, 2008, at T4M plus 1.30%, or approximately 3.75%, at December 31, 2008, due June 30, 2009 (2)

     —        348

Facility of 600 and 450 (or approximately $860 and $629) at December 31, 2009 and 2008, respectively, at EONIA (Euro Overnight Index Average) plus 1.50%, or approximately 1.91% at December 31, 2009, and at EONIA plus 1.10%, or approximately 3.59% at December 31, 2008, due June 30, 2010 and 2009, respectively (2)

     365      628

Facility of 300 and 300 (or approximately $430 and $419) at December 31, 2009 and 2008, respectively, at Euribor 3 months plus 1.50%, or approximately 2.20% and 4.76% at December 31, 2009 and 2008, respectively, due June 30, 2010 and 2009, respectively (2)

     114      399

Accrued interest

     14      30
             

Total

   $ 4,207    $ 5,376
             

Less short-term

   $ 3,463    $ 4,355
             

Long-term

   $ 744    $ 1,021
             

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

NOTE F—BANK LINES OF CREDIT AND OTHER DEBT—(Continued)

 

 

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

 

(2)   These lines of credit are renewable every six months. The amount available under these facilities range from 1,700 to 2,400 (or approximately $2,437 to $3,441) and from 2,100 to 2,350 (or approximately $2,934 to $3,283) during the six month period July 1 through December 31, 2009 and 2008, respectively, depending on Palladium’s cash needs. The lines of credit facility amounts in the table above are the maximum amounts that could be borrowed upon at December 31, 2009 and 2008. Subsequent to December 31, 2009 and 2008, these lines of credit were renewed until June 30, 2010 and 2009, respectively, and the maximum facility amount available between January 1 through June 30, 2010 and 2009 range from 1,600 to 2,400 (or approximately $2,294 to $3,441) and 700 to 2,700 (or approximately $978 to $3,772), respectively.

 

Amounts due under Palladium’s lines of credit and term loans as of December 31, 2009 are as follows (in thousands):

 

Year ending December 31,

    

2010

   $ 3,463

2011

     308

2012

     272

2013

     164

2014

     —  

Thereafter

     —  
      
   $ 4,207
      

 

In accordance with these financing arrangements with the financial institutions, Palladium must meet minimum working capital requirements and is restricted as to the amount of dividends it can pay. At December 31, 2009, Palladium was in compliance with its debt covenants.

 

Interest expense of $214,000 and $212,000 was incurred on the Company’s bank loans and lines of credit during the years ended December 31, 2009 and 2008, respectively.

 

NOTE G—ACCRUED LIABILITIES

 

Accrued liabilities as of December 31 consist of the following (in thousands):

 

     2009    2008

Compensation

   $ 3,548    $ 5,550

Production molds

     1,735      1,918

Advertising

     1,736      1,847

Other

     5,879      13,071
             
   $ 12,898    $ 22,386
             

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

NOTE H – OTHER LIABILITIES

 

Other liabilities as of December 31 consist of the following (in thousands):

 

     2009    2008

Deferred compensation

   $ 6,736    $ 6,242

Uncertain tax positions, net of federal benefit of $516 and $509, for 2009 and 2008, respectively (Note I)

     6,552      6,367
             
   $ 13,288    $ 12,609
             

 

NOTE I—INCOME TAXES

 

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

 

     2009     2008     2007  

Current:

      

United States

      

Federal

   $ (10,681   $ 6,786      $ 8,160   

State

     339        (146     1,083   

Foreign

     664        707        1,073   

Deferred:

      

United States

      

Federal

     2,178        (1,022     (572

State

     (1,062     (132     (62

Foreign

     (1,101     (311     186   
                        
   $ (9,663   $ 5,882      $ 9,868   
                        

 

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:

 

       2009     2008     2007  

U.S. Federal statutory rate

     (35.0 )%    34.0   35.0

State income taxes

     (2.0   4.4      3.8   

Net results of foreign subsidiaries

     4.0      (17.2   (17.1

Goodwill impairment

     4.3      —        —     

Other

     2.7      (1.8   (2.6
                    
     (26.0 )%    19.4   19.1
                    

 

At any point in time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with tax authorities may affect tax positions taken by the Company. Additionally, the Company’s effective tax rate in a given financial statement period may be materially impacted by changes in the geographic mix or level of earnings.

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

NOTE I—INCOME TAXES—(Continued)

 

The federal income tax returns for 2006 and 2007, certain state returns for 2007 and 2008 and certain foreign income tax returns for 2005 through 2007 are currently under various stages of audit by the applicable taxing authorities. The amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ materially from the amounts accrued for each year. The Company’s material tax jurisdiction is the United States.

 

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

 

     2009    2008

Net current assets

   $ 2,881    $ 6,676

Net non-current assets

     9,538      4,474
             

Net asset

   $ 12,419    $ 11,150
             

 

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

 

     2009     2008  

Assets

    

State taxes

   $ 671      $ 216   

Bad debts reserve

     396        798   

Inventory reserve and capitalized costs

     2,132        4,686   

Sales return reserve

     238        162   

Deferred compensation plan

     2,602        2,388   

Stock-based compensation

     3,012        2,190   

Foreign research and development credit

     180        310   

Alternative minimum tax credit and U.S. foreign tax credit

     1,548        676   

Foreign net operating losses

     4,079        670   

Other

     1,022        1,381   
                

Gross deferred tax assets

     15,880        13,477   

Liabilities

    

Contingent purchase payments

     (154     (154

Depreciation

     (3,295     (2,170

Other

     (12     (3
                

Gross deferred tax liabilities

     (3,461     (2,327
                

Net deferred tax asset

   $ 12,419      $ 11,150   
                

 

The Company did not record any valuation allowances against deferred tax assets at December 31, 2009 and 2008. 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. For 2009, the Company has a

 

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K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

NOTE I—INCOME TAXES—(Continued)

 

U.S. tax loss valued at $13,821,000, which is recorded as Income Taxes Receivable on the Consolidated Balance Sheet. The entire loss will be carried back to the 2004 tax year and fully realized. The Company has foreign net operating losses valued at $4,079,000, which are primarily related to the pre-acquisition losses of ARFI, a French company. The carryforward period in France is unlimited. The Company has a U.S. alternative minimum tax credit carryforward of approximately $655,000, which does not expire. The Company has a U.S. foreign tax credit carryforward of approximately $893,000 which will expire in 2019.

 

The Company’s recognized uncertain tax positions at December 31 are as follows (in thousands):

 

     2009     2008  

Uncertain tax positions

   $ 6,165      $ 6,120   

Interest on uncertain tax positions

     903        756   
                

Total uncertain tax positions, gross

     7,068        6,876   

Less federal income tax benefit

     (516     (509
                

Total uncertain tax positions, net

   $ 6,552      $ 6,367   
                

 

The Company recognized interest expense, net of federal income tax benefit, on uncertain tax positions of $121,000, $209,000 and $169,000 for the years ended December 31, 2009, 2008 and 2007, respectively. The Company did not recognize any related penalties for uncertain tax positions for the years ended December 31, 2009, 2008 and 2007.

 

The Company does not expect its uncertain tax positions to change significantly over the next twelve months. A reconciliation of the beginning and ending amount of the Company’s uncertain tax positions, gross, at December 31 is as follows (in thousands):

 

     2009     2008  

Beginning balance

   $ 6,876      $ 5,933   

Additions for uncertain tax positions

     1,107        2,576   

Reductions for uncertain tax positions

     (915     (452

Settlements for uncertain tax positions

     —          (1,181
                

Ending balance

   $ 7,068      $ 6,876   
                

 

NOTE J—COMMITMENTS AND CONTINGENCIES

 

The Company leases its principal warehouse facility through January 2015. In addition, certain property and equipment is leased primarily on a month-to-month basis. The Company recognizes its operating leases in accordance with ASC No. 840, “Leases.” Rent expense for these operating leases was approximately $5,885,000, $5,150,000 and $4,021,000 for the years ended December 31, 2009, 2008 and 2007, respectively.

 

The Company has entered into endorsement agreements with athletes that are sponsored by the Company through April 2014. The Company has entered into licensing agreements which require the Company to pay minimum royalties through December 2012.

 

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Table of Contents

K•SWISS INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

December 31, 2009, 2008 and 2007

 

NOTE J—COMMITMENTS AND CONTINGENCIES—(Continued)

 

Future minimum rental payments under leases, future minimum endorsement fees under endorsement agreements and future minimum royalties under licensing agreements at December 31, 2009 are as follows (in thousands):

 

     Year ending December 31,
     2010    2011    2012    2013    Thereafter    Total

Rental payments

   $ 4,947    $ 3,758    $ 3,028    $ 2,199    $ 3,604    $ 17,536

Endorsement fees

     2,295      1,443      1,135      850      187      5,910

Royalty fees

     750      820      630      —        —        2,200
                                         
   $ 7,992    $ 6,021    $ 4,793    $ 3,049    $ 3,791