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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2004

OR

For the transition period from              to             

Commission File number 0-18490

K-SWISS INC.

(Exact name of registrant as specified in its charter)

818-706-5100

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report.)

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.    Yes  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Shares of common stock outstanding at October 27, 2004:

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

K-SWISS INC.

CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands)

The accompanying notes are an integral part of these statements.

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K-SWISS INC.

CONSOLIDATED STATEMENTS OF EARNINGS

AND COMPREHENSIVE EARNINGS

(Amounts in thousands, except per share amounts)

(Unaudited)

The accompanying notes are an integral part of these statements.

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K-SWISS INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(Unaudited)

The accompanying notes are an integral part of these statements.

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K-SWISS INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “S.E.C.”). Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the consolidated financial position of K-Swiss Inc. (the “Company” or “K-Swiss”) as of September 30, 2004 and the results of its operations and its cash flows for the nine and three months ended September 30, 2004 and 2003 have been included for the periods presented. The results of operations and cash flows for the nine and three months ended September 30, 2004 are not necessarily indicative of the results to be expected for any other interim period or the full year. The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. These consolidated financial statements should be read in combination with the audited consolidated financial statements and notes thereto for the year ended December 31, 2003. Certain reclassifications have been made in the nine and three months ended September 30, 2003 presentation to conform to the nine and three months ended September 30, 2004 presentation.

2. National Geographic

In the fourth quarter of 2003, the Company reached an agreement with National Geographic to terminate its licensing agreement for $2.0 million. Operations of the National Geographic brand have been accounted for and shown as a discontinued operation in the accompanying financial information. The operations for National Geographic for the nine and three months ended September 30, 2003 are as follows (in thousands):

3. Earnings per Share

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

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

4. Accounting for Stock-Based Compensation

Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure – an amendment of SFAS 123,” encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company’s stock at the date of grant over the amount an employee must pay to acquire the stock.

During the nine months ended September 30, 2004 and 2003, 8,500 and 34,000 options, respectively, were granted at exercise prices below fair market value. During the three months ended September 30, 2004 there were no options that were granted at exercise process below fair market value and during the three months ended September 30, 2003, there were 2,000 options that were granted at exercise prices below fair market value. All other options were granted at an exercise price equal to the fair market value of the Company’s common stock at the date of grant. Accordingly, no compensation cost has been recognized for such options granted.

In connection with the exercise of options, the Company realized income tax benefits in the nine and three months ended September 30, 2004 and 2003 that have been credited to additional paid-in capital.

Had compensation cost for the plan been determined based on the fair value of the options at the grant dates consistent with the method of SFAS No. 148, the Company’s net earnings and earnings per share would have been:

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The fair value of options at date of grant was estimated using the Black-Scholes model with the following assumptions:

5. Goodwill and Intangible Assets

SFAS No. 142, “Goodwill and Other Intangible Assets,” eliminates the requirement to amortize goodwill and indefinite-lived intangible assets, requiring instead that those assets be measured for impairment at least annually, and more often when events indicate that an impairment exists. Intangible assets with finite lives will continue to be amortized over their useful lives. Goodwill and intangible assets are as follows (in thousands):

The changes in the carrying amount of goodwill and intangible assets is as follows (in thousands):

In applying SFAS No. 142, the Company has performed the annual reassessment and impairment test required as of January 1, 2004 to determine whether goodwill and intangible assets were impaired. In the first quarter of 2004, as a result of the annual reassessment and impairment test and after a review of sales, backlog, cash flows and marketing strategy, the Company determined that its investment in the Royal Elastics goodwill and trademark was impaired and recognized an impairment loss of $1,730,000. During the third quarter of 2004, after a subsequent review of sales, backlog, cash flows and marketing strategy, the Company determined that its remaining investment in the Royal Elastics goodwill and trademark was impaired and recognized an additional impairment loss of $1,046,000. In the first quarter of 2003, after a review of sales backlog, the Company determined based on estimated revenues, operating profits and cash flows that its investment in the National Geographic license was impaired and recognized an impairment loss of $746,000. See Note 2 for additional information on National Geographic.

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6. Segment Information

The Company’s predominant business is the design, development and distribution of athletic footwear. Substantially all of the Company’s revenues are from sales of footwear products. The Company is organized into three geographic regions: the United States, Europe and other international operations. Certain segment information that follows excludes the operations of the National Geographic brand, which was discontinued in 2003. Certain reclassifications have been made in the 2003 presentations. The following tables summarize segment information (in thousands):

During the nine months ended September 30, 2004 and 2003, approximately 20% and 28%, respectively, of revenues were attributable to one customer. During the three months ended September 30, 2004 and 2003, approximately 22% and 30%, respectively, of revenues were attributable to this same customer.

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7. Financial Risk Management and Derivatives

The Company enters into 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 and purchases from foreign suppliers will be materially affected by changes in exchange rates. The Company does not hold or issue financial instruments for trading purposes. The foreign exchange contracts are designated for firmly committed or forecasted purchases and sales. These transactions are expected to occur in less than one year.

The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking hedge transactions. This process includes linking all derivatives to either specific assets and liabilities on the balance sheet or specific firm commitments or forecasted transactions.

Substantially all derivatives entered into by the Company are designated as cash flow hedges. All derivatives are recognized on the balance sheet at their fair value. Unrealized gain positions are recorded as other current assets. Unrealized loss positions are recorded as accrued liabilities. Changes in fair values of outstanding cash flow hedge derivatives that are highly effective are recorded in other comprehensive income, until net income is affected by the variability of cash flows of the hedged transaction.

All derivatives are linked to specific firm commitments and forecasted transactions and are monitored to assess the past and prospective effectiveness. Fluctuations in the value of the hedging instruments are offset by fluctuations in the value of the underlying exposures being hedged. If it is determined that a hedge is not highly effective, the Company discontinues hedge accounting on the ineffective portion of the hedge and takes appropriate action to recognize the related amount residing in Other Comprehensive Earnings into current earnings.

The forward contracts generally require the Company to exchange Euros for U.S. dollars or Pounds Sterling for Euros at maturity, at rates agreed to at the inception of the contracts. The counterparties to derivative transactions are major financial institutions with investment grade or better credit ratings; 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.

Unrealized derivative gains and losses recorded in current assets and liabilities and amounts recorded in other comprehensive earnings are non-cash items and therefore are taken into account in the preparation of the consolidated statement of cash flows based on their respective balance sheet classifications.

At September 30, 2004, forward foreign exchange contacts with a notional value of $16,891,000 were outstanding to exchange various currencies (principally U.S. dollars and Euros) with maturities ranging from October 2004 to May 2005 to sell the equivalent of approximately $6,391,000 in foreign currencies at contracted rates and to buy $10,500,000 at contracted rates. These contracts have been designated as cash flow hedges. As of September 30, 2004, assets of $105,000 and liabilities of $310,000 have been recorded for the fair value of the foreign exchange contracts. Realized losses of $5,000 from cash flow hedges were recorded in cost of goods sold during the quarter and nine months ended September 30, 2004. There was no hedge ineffectiveness in the quarter and nine months ended September 30, 2004. The Company did not enter into any derivative financial instruments during 2003 and did not have any derivative financial instruments outstanding at September 30, 2003.

8. Stockholders’ Equity

Under its stock repurchase programs, the Company purchased 1,174,226 shares of Class A Common Stock during the nine months ended September 30, 2004 for a total expenditure of approximately $23,629,000.

9. Income Taxes

The Company’s effective tax rate was 32.4% and 36.7% for the quarter and nine months ended September 30, 2004, respectively, compared to 39.4% for the quarter and nine months ended September 30, 2003, respectively. The effective tax rate for the quarter and nine months ended September 30, 2004 is different than the statutory rate principally due to realizing net operating loss carry forwards of $475,000 and $568,000, respectively, as a result of the Company’s UK operation having become profitable in the third quarter of 2004 along with adjustments to the Company’s provision for state income taxes.

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10. Recent Accounting Pronouncements

In December 2003, the S.E.C. issued Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” which revises or rescinds portions of the interpretative guidance included in SAB No. 101, “Revenue Recognition in Financial Statements” in order to make guidance consistent with authoritative accounting and auditing guidance and with S.E.C. rules and regulations. The principal revisions relate to the rescission of material no longer necessary because of private sector developments in United States generally accepted accounting principles. The adoption of SAB No. 104 did not have a material impact on the Company’s financial position or results of operations.

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ITEM 2. 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 our training shoe line; market acceptance of new Limited Edition product; market acceptance of non-performance product in Europe; market acceptance of Royal Elastics footwear; demographic changes; changes in consumer preferences; 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; fluctuations and difficulty in forecasting operating results, including, without limitation, the fact that advance “futures” orders may not be indicative of future revenues due to the changing mix of futures and at-once orders; potential cancellation of future orders; our ability to continue, manage or forecast our growth and inventories; new product development and commercialization; the ability to secure and protect trademarks, patents, and other intellectual property; difficulties in implementing, operating and maintaining our increasingly complex information systems and controls; concentration of production in China; 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 epidemic diseases or customer purchasing habits; performance and reliability of products; 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; 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, import duties, tariffs, quotas and political and economic instability; changes in government regulations; liability and other claims asserted against us; the ability to attract and retain qualified personnel; and other factors referenced or incorporated by reference in this report and other reports.

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

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

Critical Accounting Policies

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 judgements that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.

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We believe that the estimates, assumptions and judgements involved in the accounting policies described in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our most recent Annual Report on Form 10-K have the greatest potential impact on our financial statements, so we consider these to be our critical accounting policies. Because of the uncertainty inherent in these matters, actual results could differ from the estimates we use in applying the critical accounting policies. Certain of these critical accounting policies affect working capital account balances, including the policies for revenue recognition, the reserve for uncollectible accounts receivable and inventory reserves. These policies require that we make estimates in the preparation of our financial statements as of a given date.

Within the context of these critical accounting policies, we are not currently aware of any reasonably likely events or circumstances that would result in materially different amounts being reported.

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.

Revenues

K-Swiss brand revenues increased to $133,911,000 for the quarter ended September 30, 2004 from $119,673,000 for the quarter ended September 30, 2003, an increase of $14,238,000 or 11.9%. K-Swiss brand revenues increased to $390,190,000 for the nine months ended September 30, 2004 from $343,960,000 for the nine months ended September 30, 2003, an increase of $46,230,000 or 13.4%. The increase for the quarter and nine months ended September 30, 2004 was the result of increases in the volume of footwear sold along with higher average wholesale prices per pair. The volume of footwear sold increased to 5,346,000 and to 15,207,000 pair for the quarter and nine months ended September 30, 2004, respectively, from 4,820,000 and 13,677,000 pair for the quarter and nine months ended September 30, 2003, respectively. The increase in the volume of footwear sold for the quarter ended September 30, 2004 was primarily the result of increased sales of the Classic, tennis and children’s shoes of 13.5%, 12.8% and 10.2%, respectively, offset by decreased sales of training shoes at 9.6%. This increase for the quarter ended September 30, 2004 was also the result of an increase in the average wholesale price per pair to $24.70 for the quarter ended September 30, 2004 from $24.51 for the quarter ended September 30, 2003, an increase of 0.8%, was due to the mix of sales. This increase for the nine months ended September 30, 2004 was also due to an increase in the average wholesale price per pair to $25.16 for the nine months ended September 30, 2004 from $24.71 for the nine months ended September 30, 2003, an increase of 1.8%, also due to the mix of sales.

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The breakdown of revenues (dollar amounts in thousands) is as follows:

Gross Margin

Overall gross profit margins, as a percentage of revenues, increased to 45.5% for the quarter ended September 30, 2004, from 43.7% for the quarter ended September 30, 2003. Overall gross profit margins, as a percentage of revenues, increased to 45.8% for the nine months ended September 30, 2004, from 45.5% for the nine months ended September 30, 2003. Gross profit margin for the quarter and nine months ended September 30, 2004 was affected by product mix changes, international sales becoming a larger portion of revenues and changes in our at-once business. Our gross margins may not be comparable to some of our competitors as we recognize warehousing costs within selling, general and administrative expenses.

Selling, General and Administrative Expenses

Overall selling, general and administrative expenses increased to $31,406,000 (23.1% of revenues) for the quarter ended September 30, 2004, from $27,545,000 (22.7% of revenues) for the quarter ended September 30, 2003, an increase of $3,861,000 or 14.0%. Overall selling, general and administrative expenses increased to $93,920,000 (23.7% of revenues) for the nine months ended September 30, 2004, from $82,725,000 (23.7% of revenues) for the nine months ended September 30, 2003, an increase of $11,195,000 or 13.5%. The increase in selling, general and administrative expenses during the quarter ended September 30, 2004 was primarily due to an impairment recognition and an increase in advertising expenses offset by a decrease in compensation and compensation related expenses. The increase in selling, general and administrative expenses during the nine months ended September 30, 2004 was due to impairment recognition and increases in advertising and warehousing expenses offset by decreases in compensation and compensation related expenses and legal expenses. In the quarter and nine months ended September 30, 2004, impairment of $1,046,000 and $2,776,000, respectively, was recognized on the trademark and goodwill of the Royal Elastics brand based on many factors including the brand not growing as rapidly as we had expected. Advertising expenses increased 32.1% and 24.4%, for the quarter and nine months ended September 30, 2004, respectively, as part of a strategic effort to drive higher revenues. Warehousing expenses, excluding compensation and compensation related expenses, increased 18.2% for the nine months ended September 30, 2004, as a result of additional expenses incurred resulting from an increase in sales during the nine months ended September 30, 2004 and moving our warehouse location in Europe during the second quarter of 2004. Compensation and compensation related expenses, including commissions and bonus/incentive related expenses, decreased 9.7% and 1.2% for the quarter and nine months ended September 30, 2004, respectively, due to a decrease in bonus/incentive related expenses that was calculated in accordance with our bonus formula in the quarter and nine months ended September 30, 2004 offset by an increase in headcount and commissions (as a result of the increase in volume). Legal expenses decreased 66.8% for the nine months ended September 30, 2004, as a result of the defense of two lawsuits during the nine months ended September 30, 2003 which were settled in the second quarter of 2003. Corporate expenses of $3,186,000 and $4,545,000, for the quarter ended September 30, 2004 and 2003, respectively, and $10,147,000 and $14,507,000, for the nine months ended September 30, 2004 and 2003, respectively, are included in selling, general and administrative expenses. The decrease in corporate expenses during the quarter and nine months ended September 30, 2004 is due to decreases in bonus/incentive related expenses and legal expenses which have been explained above.

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Interest, Other and Taxes

Overall net interest income was $252,000 (0.1% of revenues) and $552,000 (0.1% of revenues) for the quarter and nine months ended September 30, 2004, respectively, compared to $87,000 (0.1% of revenues) and $451,000 (0.1% of revenues) for the quarter and nine months ended September 30, 2003, respectively, representing an increase of $165,000 and $101,000 for the quarter and nine months ended September 30, 2004, respectively, compared to the same prior year periods, respectively. The increase in net interest income for the quarter ended September 30, 2004 is a result of higher average balances and higher average interest rates and the increase for the nine months ended September 30, 2004 is a result of higher average balances offset by lower average interest rates.

Our effective tax rate was 32.4% and 36.7% for the quarter and nine months ended September 30, 2004, respectively, compared to 39.4% for the quarter and nine months ended September 30, 2003, respectively. The decrease in the effective tax rates for the quarter and nine months ended September 30, 2004 is principally due to our UK operation having become profitable in the third quarter of 2004 thereby realizing net operating loss carry forwards of approximately $475,000 and $568,000 for the quarter and nine months ended September 30, 2004, respectively, along with adjustments to our provision for state income taxes.

The net loss from discontinued operations was $398,000 and $4,861,000 for the quarter and nine months ended September 30, 2003, respectively. Included in the nine months ended 2003 was a $4.1 million expense related to a guaranteed royalty payment commitment to National Geographic and a $746,000 impairment loss on the National Geographic license.

Net earnings increased 36.9% to $20,681,000, or $0.57 per share (diluted earnings per share), for the quarter ended September 30, 2004 from $15,106,000, or $0.40 per share (diluted earnings per share) for the quarter ended September 30, 2003. Net earnings increased 34.5% to $55,637,000, or $1.52 per share (diluted earnings per share), for the nine months ended September 30, 2004 from $41,369,000, or $1.09 per share (diluted earnings per share) for the nine months ended September 30, 2003.

Backlog

At September 30, 2004 and 2003 total futures orders with start ship dates from October 2004 and 2003 through March 2005 and 2004 were approximately $192,702,000 and $193,949,000, respectively, a decrease of 0.6%. The 0.6% decrease in total futures orders is comprised of a 0.6% increase in the fourth quarter 2004 future orders and a 1.4% decrease in the first quarter 2005 future orders. At September 30, 2004 and 2003, domestic futures orders with start ship dates from October 2004 and 2003 through March 2005 and 2004 were approximately $153,922,000 and $171,244,000, respectively, a decrease of 10.1%. At September 30, 2004 and 2003, international futures orders with start ship dates from October 2004 and 2003 through March 2005 and 2004 were approximately $38,780,000 and $22,705,000, respectively, an increase of 70.8%. “Backlog,” as of any date, represents orders scheduled to be shipped within the next six months. Backlog does not include orders scheduled to be shipped on or prior to the date of determination of backlog. The mix of “futures” and “at once” orders can vary significantly from quarter to quarter and year to year and therefore “futures” are not necessarily indicative of revenues for subsequent periods. Orders generally may be canceled by customers without financial penalty. We believe our rate of net customer cancellations of domestic orders approximates industry averages for similar companies. Customers may also reject nonconforming goods. To date, we believe we have not experienced returns of our products or bad debts of customers materially in excess of industry averages for similar companies.

Liquidity and Capital Resources

We experienced net cash inflows of approximately $74,731,000 from our operating activities during the nine months ended September 30, 2004 compared to net cash inflows of approximately $20,067,000 from our operating activities during the nine months ended September 30, 2003. The increase in operating cash inflows from the prior year is due primarily to an increase in net earnings, a greater increase in accounts receivable in 2003 relative to 2004 and a greater decrease in inventories in 2004 relative to 2003.

We had a net outflow of cash from our investing activities for the nine months ended September 30, 2004 and 2003 due to the purchase of property, plant and equipment.

We had a net outflow of cash from our financing activities for the nine months ended September 30, 2004 and 2003 primarily due to the purchase of treasury stock.

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During the first quarter of 2004, we completed our October 2002 $25 million stock repurchase program. However, prior to this, on October 22, 2003, the Board of Directors authorized a new stock repurchase program to repurchase through December 2008 up to an additional $25 million of our Class A Common Stock. On October 26, 2004, the Board of Directors authorized a new stock repurchase program to repurchase through December 2009 up to an additional 5,000,000 shares of our Class A Common Stock. We adopted these programs because we believe repurchasing our shares can be a good use of excess cash depending on our array of alternatives. Currently, we have made purchases under all stock repurchase programs from August 1996 through October 27, 2004 (the day prior to the filing of the Form 10-Q) of 12.9 million shares at an aggregate cost totaling approximately $135,267,000. See Part II – Other Information, Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

No other material capital commitments exist at September 30, 2004. Depending on our future growth rate, funds may be required by operating activities. With continued use of our revolving credit facility and internally generated funds, we believe our present and currently anticipated sources of capital are sufficient to sustain our anticipated capital needs for the remainder of 2004. At September 30, 2004, we do not have any funded debt on our lines of credit and are in compliance with all relevant covenants under our credit facilities. We did not enter into off-balance sheet arrangements during the quarter or nine months ended September 30, 2004 or 2003, nor did we have any off-balance sheet arrangements outstanding at September 30, 2004 or 2003.

Our working capital increased $32,580,000 to $209,966,000 at September 30, 2004 from $177,386,000 at December 31, 2003. Working capital increased during the nine months ended September 30, 2004 mainly due to higher revenues in the first nine months of 2004 compared to revenues in first nine months of 2003.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes from the information previously reported under Item 7A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, which Item 7A is hereby incorporated by reference, except as follows.

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 historical primary risk exposures have been from changes in the rates between the U.S. dollar and the Euro. This trend is expected to continue. In 2004, the Company entered into forward exchange contracts to exchange Euros for U.S. dollars and Pounds Sterling for Euros. The extent to which forward foreign exchange contracts are used is modified periodically in response to management’s estimate of market conditions and the terms and length of specific sales contracts.

The Company enters into 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 foreign exchange contracts are designated for firmly committed or forecasted sales. These contracts are generally expected to occur in less than one year.

The forward contracts generally require the Company to exchange Euros for U.S. dollars or Pounds Sterling for Euros at maturity, at rates agreed at the inception of the contracts. The counterparties to derivative transactions are major financial institutions with investment grade or better credit ratings; 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.

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At September 30, 2004, forward foreign exchange contacts with a notional value of $16,891,000 were outstanding to exchange various currencies (principally U.S. dollars and Euros) with maturities ranging from October 2004 to May 2005 to sell the equivalent of approximately $6,391,000 in foreign currencies at contracted rates and to buy $10,500,000 at contracted rates. These contracts have been designated as cash flow hedges. As of September 30, 2004, assets of $105,000 and liabilities of $310,000 have been recorded for the fair value of the foreign exchange contracts. Realized losses of $5,000 from cash flow hedges were recorded in cost of goods sold during the quarter and nine months ended September 30, 2004. There was no hedge ineffectiveness in the quarter and nine months ended September 30, 2004. The Company did not enter into any derivative financial instruments during 2003 and did not have any derivative financial instruments outstanding at September 30, 2003

The Company does not anticipate any material adverse effect on its operations or financial position relating to these foreign currency forward contracts. Based on the Company’s overall currency rate exposure at September 30, 2004, a 10% change in currency rates would not have had a material effect on the financial position, results of operations and cash flows of the Company.

ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES

The Company’s management carried out an evaluation under the supervision and with the participation of the Company’s President and Chief Executive Officer and Vice President of Finance and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation Date”). Disclosure controls and procedures include controls and other procedures designed to ensure that information required to be disclosed in the Company’s reports filed under the Exchange Act, such as this Form 10-Q, is properly recorded, processed, summarized and reported within the time periods required by the Commission’s rules and forms. Management necessarily applied its judgement in assessing the costs and benefits of such controls and procedures that, by their nature, can provide only reasonable assurance regarding management’s control objectives. Management does not expect that its disclosure controls and procedures will prevent all errors and fraud. A control system, irrespective of how well it is designed and operated, can only provide reasonable assurance, and cannot guarantee, that it will succeed in its stated objectives.

Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company’s disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic filings under the Exchange Act.

During the period covered by this Quarterly Report on Form 10-Q, there were no significant changes in the Company’s internal controls or in other factors that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. Legal Proceedings

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

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ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

(c) The following table provides information with respect to purchases made by K-Swiss of K-Swiss Class A Common Stock during the third quarter of 2004:

ISSUER PURCHASES OF EQUITY SECURITIES